UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) FOR THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _________ to _________
Commission File Number 0-24100
HMN FINANCIAL, INC.
(Exact name of Registrant as specified in its Charter)
Delaware 41-1777397
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
101 North Broadway, Spring Valley, Minnesota 55975-0231
(Address of principal executive offices) (ZIP Code)
Registrant's telephone number, including area code:
(507) 346-1100
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes (X) No ( )
Indicate the number of shares outstanding of each of the issuer's common stock
as of the latest practicable date.
Class Outstanding at May 5, 2000
Common stock, $0.01 par value 4,575,877
<PAGE>
HMN FINANCIAL, INC.
CONTENTS
PART I - FINANCIAL INFORMATION Page
Item 1: Financial Statements (unaudited)
Consolidated Balance Sheets at
March 31, 2000 and December 31, 1999 3
Consolidated Statements of Income for the
Three Months Ended March 31, 2000 and 1999 4
Consolidated Statement of Comprehensive Income for the
Three Months Ended March 31, 2000 and 1999 5
Consolidated Statement of Stockholders' Equity
for the Three Month Period Ended March 31, 2000 5
Consolidated Statements of Cash Flows for
the Three Months Ended March 31, 2000 and 1999 6
Notes to Consolidated Financial Statements 7-12
Item 2: Management's Discussion and Analysis of Financial
Condition and Results of Operations 13-20
Item 3: Quantitative and Qualitative Disclosures about Market Risk
Discussion included in Item 2 under Market Risk 16
PART II - OTHER INFORMATION
Item 1: Legal Proceedings 21
Item 2: Changes in Securities 21
Item 3: Defaults Upon Senior Securities 21
Item 4: Submission of Matters to a Vote of
Security Holders 21
Item 5: Other Information 21
Item 6: Exhibits and Reports on Form 8-K 21
Signatures 22
2
<PAGE>
PART I - FINANCIAL STATEMENTS
<PAGE>
HMN FINANCIAL, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(unaudited)
<TABLE>
<CAPTION>
March 31, December 31,
Assets 2000 1999
---------- -----------
<S> <C> <C>
Cash and cash equivalents $ 8,253,729 9,051,380
Securities available for sale:
Mortgage-backed and related
securities (amortized cost
$98,934,903 and $101,906,303) 97,189,509 100,777,266
Other marketable securities
(amortized cost $74,142,717
and $76,863,919) 69,479,395 72,699,513
----------- -----------
166,668,904 173,476,779
----------- -----------
Loans held for sale 3,398,312 4,083,061
Loans receivable, net 486,631,574 477,895,602
Accrued interest receivable 3,975,070 3,860,454
Federal Home Loan Bank stock, at cost 11,790,000 11,470,000
Mortgage servicing rights, net 1,119,425 1,123,674
Premises and equipment, net 8,678,450 8,530,434
Investment in limited partnerships 3,006,906 2,975,138
Goodwill 4,115,992 4,160,998
Core deposit intangible 968,693 1,026,803
Prepaid expenses and other assets 735,378 639,619
Due from brokers 5,042,979 0
Deferred tax assets 1,318,500 892,500
----------- -----------
Total assets $ 705,703,912 699,186,442
=========== ===========
Liabilities and Stockholders' Equity
Deposits $ 401,453,270 400,382,118
Federal Home Loan Bank advances 233,900,000 229,400,000
Accrued interest payable 2,126,550 1,433,111
Advance payments by borrowers
for taxes and insurance 1,057,916 814,092
Accrued expenses and other liabilities 3,613,742 2,596,253
----------- -----------
Total liabilities 642,151,478 634,625,574
----------- -----------
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 59,674,493 59,674,715
Retained earnings, subject
to certain restrictions 69,556,228 68,423,008
Accumulated other
comprehensive loss (3,877,016) (3,187,743)
Unearned employee stock
ownership plan shares (5,463,395) (5,511,851)
Unearned compensation
restricted stock awards (54,992) (96,508)
Treasury stock, at cost
4,508,185 and 4,370,285 shares (56,374,171) (54,832,040)
----------- -----------
Total stockholders' equity 63,552,434 64,560,868
----------- -----------
Total liabilities and
stockholders' equity $ 705,703,912 699,186,442
=========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
3
<PAGE>
HMN FINANCIAL, INC. AND SUBSIDIARIES
Consolidated Statements of Income
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
2000 1999
--------------------------
<S> <C> <C>
Interest Income:
Loans receivable $ 9,442,625 8,643,574
Securities available for sale:
Mortgage-backed and related 1,805,672 1,949,496
Other marketable 1,182,516 762,138
Cash equivalents 37,455 96,552
Other 192,762 151,611
----------- ----------
Total interest income 12,661,030 11,603,371
----------- ----------
Interest expense:
Deposits 4,336,621 4,622,019
Federal Home Loan Bank advances 3,368,660 2,541,321
Other borrowed money 0 7,207
----------- ----------
Total interest expense 7,705,281 7,170,547
----------- ----------
Net interest income 4,955,749 4,432,824
Provision for loan losses 45,000 75,000
----------- ----------
Net interest income after
provision for loan losses 4,910,749 4,357,824
----------- ----------
Non-interest income:
Fees and service charges 256,872 126,791
Mortgage servicing fees 79,243 88,636
Securities gains (losses), net (68,761) 139,438
Gain on sales of loans 182,729 694,992
Earnings in limited partnerships 36,989 17,067
Other 125,618 119,542
---------- ----------
Total non-interest income 612,690 1,186,466
---------- ----------
Non-interest expense:
Compensation and benefits 1,696,100 1,428,498
Occupancy 425,596 420,099
Federal deposit insurance premiums 21,451 72,608
Advertising 43,708 69,796
Data processing 185,421 184,712
Amortization of mortgage servicing
rights and net valuation adjustments 69,017 168,098
Other 589,632 590,079
---------- ----------
Total non-interest expense 3,030,925 2,933,890
---------- ----------
Income before income tax expense 2,492,514 2,610,400
Income tax expense 962,800 1,008,400
---------- ----------
Net income $ 1,529,714 1,602,000
========== ==========
Basic earnings per share $ 0.38 0.36
========== ==========
Diluted earnings per share $ 0.37 0.34
========== ==========
</TABLE>
See accompanying notes to consolidated financial statements.
4
<PAGE>
HMN FINANCIAL, INC. AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended March 31,
2000 1999
---------------------- ----------------------
<S> <C> <C>
Net income $ 1,529,714 1,602,000
Other comprehensive
income (losses),
net of tax:
Unrealized gains (losses) on
securities:
Unrealized holding gains
(losses) arising
during period (731,542) 108,709
Less: reclassification
adjustment for gains
included in net income (42,269) 85,814
---------- ---------
Other comprehensive income (loss) (689,273) 22,895
--------- ---------
Comprehensive income $ 840,441 1,624,895
========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
HMN FINANCIAL, INC. AND SUBSIDIARIES
Consolidated Statement of Stockholders' Equity
For the Three Months Ended March 31, 2000
(unaudited)
<TABLE>
<CAPTION>
Unearned
Employee
Accumulated Stock
Additional Other Ownership
Common Paid-in Retained Comprehensive Plan
Stock Capital Earnings Loss Shares
-------- ---------- ----------- --------------- ---------
<S> <C> <C> <C> <C> <C>
Balance,
December 31, 1999 $ 91,287 59,674,715 68,423,008 (3,187,743) (5,511,851)
Net income 1,529,714
Other comprehensive
loss (689,273)
Treasury stock
purchases
Employee stock
options exercised (15,513)
Tax benefits of
exercised
stock options 3,732
Amortization of
restricted
stock awards
Dividends paid (396,494)
Earned employee
stock ownership
plan shares 11,559 48,456
-------- ---------- ----------- ----------- -----------
Balance,
March 31, 2000 $ 91,287 59,674,493 69,556,228 (3,877,016) (5,463,395)
======== ========== =========== =========== ===========
<CAPTION>
Unearned
Compensation Total
Restricted Stockholders'
Stock Awards Treasury Stock Equity
-------------- -------------- --------------
<S> <C> <C> <C>
Balance,
December 31, 1999 $ (96,508) (54,832,040) 64,560,868
Net income 1,529,714
Other comprehensive
loss (689,273)
Treasury stock
purchases (1,603,694) (1,603,694)
Employee stock
options exercised 61,563 46,050
Tax benefits of
exercised
stock options 3,732
Amortization of
restricted
stock awards 41,516 41,516
Dividends paid (396,494)
Earned employee stock
ownership plan shares 60,015
--------------- -------------- --------------
Balance,
March 31, 2000 $ (54,992) (56,374,171) 63,552,434
=============== ============== ==============
</TABLE>
See accompanying notes to consolidated financial statements.
5
<PAGE>
HMN FINANCIAL, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
---------------------------
2000 1999
------------ -------------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 1,529,714 1,602,000
Adjustments to reconcile net income
to cash provided by operating activities:
Provision for loan losses 45,000 75,000
Depreciation 204,711 173,068
Amortization of (discounts) premiums, net 25,070 41,093
Amortization of deferred loan fees (96,990) (165,405)
Amortization of goodwill 45,006 45,009
Amortization of core deposit intangible 58,110 58,112
Amortization of other purchase accounting
adjustments (21,434) 11,384
Amortization of mortgage servicing rights
and net valuation adjustments 61,279 165,598
Capitalized mortgage servicing rights (57,030) (184,874)
Increase in deferred income taxes 103,500 81,000
Securities (gains) losses, net 68,761 (139,438)
Gain on sales of loans (182,729) (694,992)
Proceeds from sales of loans held for sale 19,473,383 52,911,809
Disbursements on loans held for sale (18,365,757) (47,100,100)
Principal collected on loans held for sale 8,671 1,099
Amortization of restricted stock awards 41,516 43,761
Amortization of unearned ESOP shares 48,456 48,317
Earned employee stock ownership shares
priced above original cost 11,559 16,465
Decrease (increase) in accrued interest
receivable (114,616) 148,003
Increase in accrued interest payable 693,439 344,743
Equity earnings of limited partnerships (36,989) (17,067)
Increase in other assets (149,606) (344,256)
Increase in other liabilities 1,021,221 1,214,279
Other, net 838 14,254
---------- ----------
Net cash provided by operating
activities 4,415,083 8,348,862
---------- ----------
Cash flows from investing activities:
Proceeds from sales of securities
available for sale 6,020,320 2,858,250
Principal collected on securities
available for sale 2,077,722 19,954,254
Proceeds collected on maturity of securities
available for sale 1,500,000 11,400,000
Purchases of securities available for sale (986,500) (34,591,894)
Proceeds from sales of loans receivable 105,464 119,835
Purchase of Federal Home Loan Bank stock (320,000) 0
Net increase in loans receivable (17,145,578) (6,050,512)
Purchases of premises and equipment (352,727) (243,209)
---------- ----------
Net cash used by investing activities (9,101,299) (6,553,276)
---------- ----------
Cash flows from financing activities:
Increase (decrease) in deposits 1,098,879 (12,631,056)
Purchase of treasury stock (1,603,694) (802,312)
Stock options exercised 46,050 0
Dividends to stockholders (396,494) (362,798)
Proceeds from Federal Home
Loan Bank advances 46,900,000 11,500,000
Repayment of Federal Home
Loan Bank advances (42,400,000) (11,500,000)
Decrease in other borrowed money 0 (2,500,000)
Increase in advance payments by borrowers
for taxes and insurance 243,824 227,791
---------- -----------
Net cash provided (used) by
financing activities 3,888,565 (16,068,375)
---------- -----------
Decrease in cash and cash equivalents (797,651) (14,272,789)
Cash and cash equivalents, beginning of period 9,051,380 20,960,957
---------- -----------
Cash and cash equivalents, end of period $ 8,253,729 6,688,168
========== ===========
Supplemental cash flow disclosures:
Cash paid for interest $ 7,011,842 6,825,804
Cash paid for income taxes 190,000 640,000
Supplemental noncash flow disclosures:
SBA certificates transferred from loans
to securities available for sale $ 0 2,528,442
Loans securitized and transferred to
securities available for sale 8,106,230 0
Loans transferred to loans held for sale 245,261 1,149,595
Transfer of loans to real estate 49,653 0
</TABLE>
See accompanying notes to consolidated financial statements.
6
<PAGE>
HMN FINANCIAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(unaudited)
March 31, 2000 and 1999
(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. All significant
intercompany accounts and transactions have been eliminated in consolidation.
(2) BASIS OF PREPARATION
The accompanying unaudited consolidated financial statements were prepared in
accordance with instructions for Form 10-Q and therefore, do not include all
disclosures necessary for a complete presentation of the consolidated balance
sheets, consolidated statements of income, consolidated statements of
comprehensive income, consolidated statements of stockholders' equity and
consolidated statements of cash flows in conformity with generally accepted
accounting principles. However, all adjustments consisting of only normal
recurring adjustments which are, in the opinion of management, necessary for
the fair presentation of the interim financial statements have been included.
The statement of income for the three month period ended March 31, 2000 is not
necessarily indicative of the results which may be expected for the entire
year.
Certain amounts in the consolidated financial statements for prior periods have
been reclassified to conform with the current period presentation.
(3) NEW ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards (SFAS) No. 133, ACCOUNTING FOR DERIVATIVE
INSTRUMENTS AND HEDGING ACTIVITIES, which establishes accounting and reporting
standards for derivative instruments, including certain derivative instruments
embedded in other contracts (collectively referred to as derivatives), and for
hedging activities. It requires that an entity recognize all derivatives as
either assets or liabilities in the statement of financial position and measure
those instruments at fair value. If certain conditions are met, a derivative
may be specifically designated as (a) a hedge of the exposure to changes in the
fair value of a recognized asset or liability or an unrecognized firm
commitment, (b) a hedge of the exposure to variable cash flows of a forecasted
transaction, or (c) a hedge of the foreign currency exposure of a net
investment in a foreign operation, an unrecognized firm commitment, an
available-for-sale security, or a foreign-currency-denominated forecasted
transaction.
The accounting for changes in the fair value of a derivative (that is, gains
and losses) depends on the intended use of the derivative and the resulting
designation.
7
<PAGE>
- (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.
(4) COMPREHENSIVE INCOME
Comprehensive income is defined as the change in equity during a period from
transactions and other events from nonowner sources. Comprehensive income is
the total of net income and other comprehensive income, which for HMN is
comprised entirely of unrealized gains and losses on securities available for
sale.
The gross unrealized holding losses for the first quarter of 2000 were $1.2
million, the income tax benefit would have been $452,500 and therefore, the net
loss was $731,500. The gross reclassification adjustment for the first quarter
of 2000 was a loss of $68,800, the income tax benefit would have been $26,500
and therefore, the net reclassification adjustment was a loss of $42,300. The
gross unrealized holding gains for the first quarter of 1999 were $167,200, the
income tax expense would have been $58,500 and therefore, the net gain was
$108,700. The gross reclassification adjustment for the first quarter of 1999
was $139,600, the income tax expense would have been $53,800 and therefore, the
net reclassification adjustment was $85,800.
8
<PAGE>
(5) CASH DIVIDEND
On April 25, 2000 HMN's Board of Directors announced a cash dividend of $0.10
per share, payable on June 12, 2000 to stockholders of record on May 25, 2000.
(6) INVESTMENT IN MORTGAGE SERVICING RIGHTS
A summary of mortgage servicing activity is as follows:
- ----------------------------------------------------------------
<TABLE>
<CAPTION>
2000 1999
-------------- ---------------
<S> <C> <C>
Mortgage servicing rights
Balance, beginning of period $ 1,148,774 1,117,193
Originations 57,030 172,145
Purchases 0 12,729
Amortization (72,779) (200,217)
---------- ----------
Balance, March 31 1,133,025 1,101,850
---------- ----------
Valuation reserve
Balance, beginning of period (25,100) (111,500)
Additions 0 0
Reductions 11,500 43,400
---------- ----------
Balance, March 31 (13,600) (68,100)
---------- ----------
Mortgage servicing rights, net $ 1,119,425 1,033,750
========== ==========
Fair value of mortgage
servicing rights $ 1,364,000 1,033,750
========== ==========
</TABLE>
- -----------------------------------------------------------------
All of the loans being serviced were single family loans serviced for FNMA
under the mortgage-backed security program or the individual loan sale program.
The following is a summary of the risk characteristics of the loans being
serviced at March 31, 2000.
- -----------------------------------------------------------------------------
<TABLE>
<CAPTION>
Weighted Weighted
Loan Average Average Number
Principal Interest Remaining of
Balance Rate Term Loans
------------- --------- ---------- ----------
<S> <C> <C> <C> <C>
Original term
30 year fixed rate $ 57,171,000 7.50% 332 814
Original term
15 year fixed rate 64,438,000 6.75% 158 1,159
Seven year balloon 692,000 7.00% 339 7
Adjustable rate 7,025,000 7.74% 327 56
</TABLE>
- -----------------------------------------------------------------------------
9
<PAGE>
(7) INVESTMENT IN LIMITED PARTNERSHIPS
Investments in limited partnerships were as follows:
- ---------------------------------------------------------------------
<TABLE>
<CAPTION>
Primary partnership activity March 31, 2000 December 31, 1999
- ------------------------------ -------------- -----------------
<S> <C> <C>
Mortgage servicing rights $ 2,270,439 2,222,094
Common stock of
financial institutions 411,437 415,576
Low to moderate income housing 325,030 337,468
------------- -------------
$ 3,006,906 2,975,138
============= =============
</TABLE>
- ---------------------------------------------------------------------
During the first quarter of 2000 HMN's proportionate revenue from a mortgage
servicing partnership was $48,346, its proportionate share of losses from
common stock investments in financial institutions was $4,139 and it recognized
$7,218 of losses on low income housing partnerships. During 2000 HMN
anticipates receiving low income housing credits totaling $80,000 of which
$20,000 were credited to current income tax benefits.
During the first quarter of 1999 HMN's proportionate revenue from a mortgage
servicing partnership was $61,172, its proportionate share of losses from the
common stock investments in financial institutions was $13,696 and it did not
recognize any revenue or loss on the low income housing partnerships. During
1999 HMN received low income housing credits totaling $80,000 of which $20,000
were credited to current income tax benefits.
8) EARNINGS PER SHARE
The following table reconciles the weighted average shares outstanding and the
income available to common shareholders used for basic and diluted EPS:
<TABLE>
<CAPTION>
Three months ended March 31,
----------------------------
2000 1999
-------------------------
<S> <C> <C>
Weighted average number of common shares
outstanding used in basic earnings per
common share calculation 3,998,038 4,509,368
Net dilutive effect of:
Options 114,964 186,223
Restricted stock awards 1,953 26,551
--------- ---------
Weighted average number of shares
outstanding adjusted for effect of
dilutive securities 4,114,955 4,722,142
========= =========
Income available to common shareholders $1,529,714 1,602,000
Basic earnings per common share $ 0.38 0.36
Diluted earnings per common share $ 0.37 0.34
</TABLE>
(9) REGULATORY CAPITAL
The Bank is subject to various regulatory capital requirements administered by
the federal banking agencies. Failure to meet minimum capital requirements can
initiate certain mandatory and possibly additional discretionary actions by
regulators that, if undertaken, could have a direct material effect on HMN's
financial statements. Under capital adequacy guidelines and the regulatory
framework for prompt corrective action, the Bank must meet specific capital
guidelines that involve quantitative measures of the Bank's assets,
liabilities, and certain off-balance sheet items as calculated under regulatory
accounting practices. The Bank's capital amounts and classification are also
subject to qualitative judgments by the regulators about components, risk
weightings, and other factors.
10
<PAGE>
Quantitative measures established by regulations to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth in the
following table) of Tier I or Core capital, and Risk-based capital (as defined
in the regulations) to total assets (as defined). Management believes, as of
March 31, 2000, that the Bank meets all capital adequacy requirements to which
it is subject.
Management believes that based upon the Bank's capital calculations at March
31, 2000 and other conditions consistent with the Prompt Corrective Actions
Provisions of the OTS regulations, the Bank would be categorized as well
capitalized.
On March 31, 2000 the Bank's tangible assets and adjusted total assets were
$688.5 million and its risk-weighted assets were $401.7 million. The following
table presents the Bank's capital amounts and ratios at March 31, 2000 for
actual capital, required capital and excess capital including ratios in order
to qualify as being well capitalized under the Prompt Corrective Actions
regulations.
<TABLE>
<CAPTION>
Required to be
Adequately
Actual Capitalized
-------------------------- --------------------------
(in thousands) Percent Percent
Amount of Assets(1) Amount of Assets (1)
------------ -------------- ------------- -------------
<S> <C> <C> <C> <C>
Bank stockholder's
equity $ 48,673
Plus:
Net unrealized
loss (gain) on
certain securities
available for sale 2,664
Less:
Goodwill and
other intangibles 5,085
Excess mortgage
servicing rights 227
-------
Tier I or core
capital 46,025
-------
Tier I capital to
adjusted total
assets 6.68% $27,540 4.00%
Tier I capital to
risk-weighted assets 11.46% $16,068 4.00%
Less:
Equity investments &
other assets required
to be deducted 11
Plus:
Allowable allowance
for loan losses 3,261
-------
Risk-based capital $ 49,275 $32,136
=======
Risk-based capital
to risk-weighted
assets 12.27% 8.00%
<CAPTION>
To Be Well Capitalized
Under Prompt
Corrective Actions
Excess Capital Provisions
-------------------------- --------------------------
Percent Percent
(in thousands) Amount of Assets(1) Amount of Assets (1)
----------- -------------- ------------ --------------
<S> <C> <C> <C> <C>
Bank stockholder's
equity $
Plus:
Net unrealized
loss (gain) on
certain securities
available for sale
Less:
Goodwill and
other intangibles
Excess mortgage
servicing rights
Tier I or core
capital
Tier I capital to
adjusted total
assets $18,485 2.68% $34,425 5.00%
Tier I capital to
risk-weighted assets $29,957 7.46% $24,102 6.00%
Less:
Equity investments &
other assets required
to be deducted
Plus:
Allowable allowance
for loan losses
Risk-based capital $17,139 $40,170
Risk-based capital
to risk-weighted
assets 4.27% 10.00%
</TABLE>
(1) Based upon the Bank's adjusted total assets for the purpose of the tangible
and core capital ratios and risk-weighted assets for the purpose of the
risk-based capital ratio.
The tangible capital of the Bank was in excess of the minimum 2% required at
March 31, 2000 but is not reflected in the table above.
(10) BUSINESS SEGMENTS
HMN's wholly owned subsidiaries, Home Federal Savings Bank, and Mortgage
Services, Inc. have been identified as reportable operating segments in
accordance with the provisions of SFAS 131. MSI was deemed to be a segment
because it is a separate corporation which operates independently from the Bank
and it is not regulated by the Office of Thrift Supervision. MSI has been
segmented further into Mortgage Servicing Rights and Mortgage Banking
activities. The mortgage servicing segment owns servicing rights on loans
which have either been sold to FNMA or securitized into mortgage backed
instruments which were issued by FNMA. MSI receives a servicing fee which is
based upon the outstanding balance of the loan being serviced and pays a
subservicer a monthly fee to
11
<PAGE>
service the loan. MSI's mortgage banking activity includes an origination
function and it also purchases loans from other loan originators. All loans
acquired either by origination or by purchase are intended to be resold in the
secondary loan market.
Security Finance Corporation and HMN, the holding company, did not meet the
quantitative thresholds for determining reportable segments and therefore are
included in the "Other" category.
HMN evaluates performance and allocates resources based on the segments net
income or loss, return on average assets and return on average equity. Each
corporation is managed separately with its own president, who reports directly
to HMN's chief operating decision maker, and board of directors.
The following table sets forth certain information about the reconciliations of
reported profit or loss and assets for each of HMN's reportable segments.
<TABLE>
<CAPTION>
HMN Mortgage Services, Inc.
---------------------------
Home
Federal Mortgage Total
Savings Servicing Mortgage Reportable
(DOLLARS IN THOUSANDS) Bank Rights Banking Segments
- --------------------------------------------------------------------------
<S> <C> <C> <C> <C>
At or for the quarter
ended March 31, 2000:
Interest income -
external customers $12,421 0 48 12,469
Non-interest income -
external customers 452 22 100 574
Earnings (loss) on
limited partnerships 41 0 0 41
Intersegment interest
income 0 0 0 0
Intersegment non-
interest income 86 0 0 86
Interest expense 7,705 0 33 7,738
Amortization of
mortgage servicing
rights and net val-
uation adjustments 55 6 0 61
Other non-interest
expense 2,691 8 247 2,946
Income tax expense
(benefit) 981 3 (53) 931
Net income (loss) 1,523 5 (79) 1,449
Total assets 691,147 216 3,650 695,013
Net interest margin 2.85 % NM NM NM
Return on average assets 0.89 % 8.76% (10.68)% NM
Return on average
realized common equity 11.80 % 21.35% (26.02)% NM
At or for the quarter
ended March 31, 1999:
Interest income -
external customers $ 11,326 0 77 11,403
Non-interest income -
external customers 816 32 278 1,126
Earnings (loss) on
limited partnerships 31 0 0 31
Intersegment interest
income 2 0 0 2
Intersegment non-
interest income 80 0 0 80
Interest expense 7,164 0 78 7,242
Amortization of mortgage
servicing rights
and net valuation
adjustments 57 109 0 166
Other non-interest
expense 2,434 3 282 2,719
Income tax expense
(benefit) 987 (31) (3) 953
Net income (loss) 1,539 (49) (2) 1,488
Total assets 661,985 302 7,339 669,626
Net interest margin 2.64 % NM NM NM
Return on average assets 0.94 % (57.81)% (0.14)% NM
Return on average
realized common equity 12.79 % (121.22)% (0.30)% NM
<CAPTION>
Consolidated
(Dollars in thousands) Other Eliminations Total
- -----------------------------------------------------------------------
<S> <C> <C> <C>
At or for the quarter ended
March 31, 2000:
Interest income -
external customers $192 0 12,661
Non-interest income -
external customers 2 0 576
Earnings (loss) on
limited partnerships (4) 0 37
Intersegment interest
income 63 (63) 0
Intersegment non-
interest income 1,461 (1,547) 0
Interest expense 30 (63) 7,705
Amortization of mortgage
servicing rights and
net valuation adjustments 0 0 61
Other non-interest
expense 110 (86) 2,970
Income tax expense
(benefit) 32 0 963
Net income (loss) 1,542 (1,461) 1,530
Total assets 66,150 (55,459) 705,704
Net interest margin NM NM 2.93%
Return on average assets NM NM 0.87%
Return on average
realized common equity NM NM 9.00%
At or for the quarter ended
March 31, 1999:
Interest income -
external customers $ 200 0 11,603
Non-interest income -
external customers 43 0 1,169
Earnings (loss) on
limited partnerships (14) 0 17
Intersegment interest
income 108 (110) 0
Intersegment non-
interest income 1,506 (1,586) 0
Interest expense 39 (110) 7,171
Amortization of mortgage
servicing rights
and net valuation
adjustments 0 0 166
Other non-interest
expense 129 (80) 2,768
Income tax expense
(benefit) 55 0 1,008
Net income (loss) 1,620 (1,506) 1,602
Total assets 72,705 (60,395) 681,936
Net interest margin NM NM 2.73%
Return on average assets NM NM 0.95%
Return on average
realized common equity NM NM 9.31%
</TABLE>
NM - Not meaningful
12
<PAGE>
HMN FINANCIAL, INC.
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
HMN's net income is dependent primarily on its net interest income, which is
the difference between interest earned on its loans and investments and the
interest paid on interest-bearing liabilities. Net interest income is
determined by (i) the difference between the yield earned on interest-earning
assets and rates paid on interest-bearing liabilities (interest rate spread)
and (ii) the relative amounts of interest-earning assets and interest-bearing
liabilities. HMN's interest rate spread is affected by regulatory, economic
and competitive factors that influence interest rates, loan demand and deposit
flows. Net interest margin is calculated by dividing net interest income by
the average interest-earning assets and is normally expressed as a percentage.
Net interest income and net interest margin are affected by changes in interest
rates, the volume and the mix of interest-earning assets and interest-bearing
liabilities, and the level of non-performing assets. HMN's net income is also
affected by the generation of non-interest income, which primarily consists of
gains from the sale of securities, gains from sale of loans, service charges,
fees and other income. In addition, net income is affected by the level of
operating expenses, provisions made for loan losses and impairment reserve
adjustments required on mortgage servicing assets.
The operations of financial institutions, including the Bank, are significantly
affected by prevailing economic conditions, competition and the monetary and
fiscal policies of governmental agencies. Lending activities are influenced by
the demand for and supply of housing, competition among lenders, the level of
interest rates and the availability of funds. Deposit flows and costs of funds
are influenced by prevailing market rates of interest primarily on competing
investments, account maturities and the levels of personal income and savings
in the market area of the Bank.
NET INCOME
HMN's net income for the first quarter of 2000 was $1.5 million, a decrease of
$72,000, compared to net income of $1.6 million for the first quarter of 1999.
Basic earnings per share were $0.38 for the quarter ended March 31, 2000, an
increase of $0.02 per share, from $0.36 basic earnings per share for the same
quarter of 1999. Diluted earnings per share were $0.37 for the first quarter
of 2000, an increase of $0.03 from $0.34 diluted earnings per share for the
first quarter of 1999. Earnings per share increased from the first quarter of
1999 to the first quarter of 2000 even though net income declined due to HMN's
treasury stock purchase program. The average number of outstanding shares for
the basic earnings per share calculation declined by 511,330 shares from
4,509,368 at March 31, 1999 to 3,998,038 at March 31, 2000. The average number
of outstanding shares for the diluted earnings per share calculation declined
by 607,187 shares from 4,722,142 at March 31, 1999, to 4,114,955 at March 31,
2000.
NET INTEREST INCOME
Net interest income for the first quarter of 2000 was $5.0 million, an increase
of $523,000, or 11.8%, compared to $4.4 million for the first quarter of 1999.
Interest income for the first quarter of 2000 was $12.7 million, an increase of
$1.1 million, or 9.1%, compared to $11.6 million for the first quarter of 1999.
Interest income increased by $432,000 due to a $21.7 million net increase in
average interest-earning assets from the first quarter of 1999 to the first
quarter of 2000. The increase in average interest-earning assets is the result
of HMN's emphasis on originating and/or purchasing commercial real estate
loans, commercial business loans and consumer loans which generally have higher
interest rates and shorter terms to maturity than single family fixed-rate
residential loans. Interest income increased by $625,000 due to higher
interest rates being earned on the types of loans being added to the portfolio
and also due to a general increase in interest rates from the first quarter of
1999 to the first quarter of 2000. The yield earned on interest-earning assets
increased from 7.14% at March 31, 1999, to 7.48% at March 31, 2000.
Interest expense was $7.7 million for the first quarter of 2000, an increase of
$535,000, or 7.5%, compared to $7.2 million for the same quarter of 1999.
Interest expense on Federal Home Loan Bank (FHLB) advances was $3.4 million for
the first quarter of 2000, an increase of $827,000, or 32.6%, from $2.5 million
for the first quarter of 1999. Interest expense
13
<PAGE>
increased by $696,000 due to a $47.2 million increase in the average
outstanding advances from the FHLB. The advances were used to fund the growth
in loans and replace funds lost to deposit outflows. Interest expense
increased by $131,000 due to an increase in the cost of borrowing from the FHLB
due to rising interest rates between the two periods. The average interest rate
paid on the average interest-bearing liabilities was 4.92% during the first
quarter of 2000, compared to 4.79% for the first quarter of 1999.
Net interest margin (net interest income divided by average interest earning
assets) for the first quarter of 2000 was 2.93%, an increase of 20 basis
points, compared to 2.73% for the first quarter of 1999.
PROVISION FOR LOAN LOSSES
*The provision for loan losses for the first quarter ended March 31, 2000 was
$45,000, a decrease of $30,000, or 40.0%, compared to $75,000 for the first
quarter of 1999. 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 Mortgage Corporation (FHLMC),
local single family construction permits and local economic growth rates.
Management's evaluation of probable losses inherent in the loan portfolio
revealed conditions that resulted in decreasing the first quarter of 2000 loan
loss provision compared to the provision for the first quarter of 1999. 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:
2000 1999
----------- ----------
Balance at January 1, $ 3,273,311 3,041,485
Provision 45,000 75,000
Recoveries 0 841
----------- ----------
Balance at March 31, $ 3,318,311 3,117,326
=========== ==========
NON-INTEREST INCOME
Non-interest income was $613,000 for the first quarter of 2000, a decrease of
$574,000, or 48.4%, from $1.2 million for the first quarter of 1999. The
decrease in non-interest income was primarily due to a $512,000 decline in
gains recognized on the sale of loans and a $208,000 decline in net gains
(losses) on the sale of securities. Due to a general increase in interest
rates which started in 1999 and carried over into the first quarter 2000,
single family conforming loan production declined from the first quarter of
1999, compared to the first quarter of 2000. The lower conforming loan
production equated to a lower gain on the sale of loans being recorded between
the two quarters. The increase in interest rates has also affected the ability
of HMN to sell securities from its available for sale portfolio at a gain.
The decrease in non-interest income was partially offset by an increase of
$130,000 in fees and service charges on deposit related accounts and loans.
NON-INTEREST EXPENSE
Non-interest expense was $3.0 million for the first quarter of 2000, an
increase of $97,000, or 3.3%, from $2.9 million for the first quarter of 1999.
Compensation and benefits expense increased by $268,000, or 18.7%, due to
annual payroll increases and increased claims experience for self funded health
benefits. Amortization of mortgage servicing rights, net of valuation
adjustments and servicing costs decreased by $99,000 due to a change in the
estimated time over which the servicing fees will be collected. FDIC premiums
and advertising expenses decreased a total of $77,000 between the two quarters.
* This paragraph contains a forward-looking statement(s). Refer to information
regarding Forward-looking Information on page 20 of this discussion.
14
<PAGE>
INCOME TAX EXPENSE
Income tax expense was $963,000 for the first quarter of 2000, a decrease of
$46,000 compared to $1.0 million for the first quarter of 1999. The decrease
is primarily due to a decrease in taxable income between the two quarters.
NON-PERFORMING ASSETS
The following table sets forth the amounts and categories of non-performing
assets in the Bank's portfolio at March 31, 2000 and December 31, 1999.
<TABLE>
<CAPTION>
March 31, December 31,
(Dollars in Thousands) 2000 1999
-------------- -------------
<S> <C> <C>
Non-Accruing Loans
One-to-four family real estate $ 392 164
Nonresidential real estate 0 0
Consumer 136 178
----- -----
Total 528 342
----- -----
Accruing loans delinquent 90
days or more 208 476
----- -----
Foreclosed Assets
Real estate:
One-to-four family 52 0
----- -----
Total non-performing assets $ 788 $ 818
===== =====
Total as a percentage of total
assets 0.11% 0.12%
===== =====
Total non-performing loans $ 736 $ 818
===== =====
Total as a percentage of total
loans receivable, net 0.15% 0.17%
===== =====
Total non-performing assets at March 31, 2000 were $788,000, a decrease of
$30,000, from $818,000 at December 31, 1999. The net decrease of $30,000 was
the result of a $186,000 increase in non-accruing loans and a $52,000 increase
in foreclosed assets which were offset by a $268,000 decrease in accruing loans
delinquent 90 days or more.
DIVIDENDS
On April 25, 2000 HMN declared a cash dividend of $.10 per share, payable on
June 12, 2000 to shareholders of record on May 25, 2000.
During the first quarter of 2000, HMN declared and paid dividends as follows:
Record date Payable date Dividend per share Dividend Payout Ratio
- ----------------- -------------- ------------------ ---------------------
February 24, 2000 March 10, 2000 $0.10 27.8%
The annualized dividend payout ratio for the past four quarters, ending with
the June 12, 2000 payment will be 23.6%.
The declaration of dividends are subject to, among other things, HMN's
financial condition and results of operations, the Bank's compliance with its
regulatory capital requirements, including the fully phased-in capital
requirements, tax considerations, industry standards, economic conditions,
regulatory restrictions, general business practices and other factors.
LIQUIDITY
For the quarter ended March 31, 2000, the net cash provided by operating
activities was $4.4 million. HMN collected $6.0 million from the sale of
securities, and $3.6 million in principal repayments or on the maturity of
securities during the quarter. HMN also collected $105,000 on the sale of
loans receivable during the quarter. It purchased $987,000 of securities, FHLB
stock of $320,000, premises and equipment of $353,000 and it funded a net
increase in loans receivable
15
<PAGE>
of $17.1 million. HMN received $1.1 million due to a net increase in deposit
balances during the quarter. It received net proceeds of $4.5 million from net
additional advances from the FHLB and $244,000 from increased advance payments
from borrowers for taxes and insurance. HMN purchased $1.6 million of HMN
treasury stock and paid $396,000 in dividends to its shareholders.
*HMN has certificates of deposits with outstanding balances of $199.6 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 $10.0 million of FHLB advances which mature in 2001 but have call
features which can be exercised by the FHLB on a semiannual basis during 2000.
If the call features are exercised HMN has the option of requesting any advance
otherwise available to it pursuant to the Credit Policy of the FHLB. Since HMN
has the ability to request another advance to replace the advance that is being
called, management does not anticipate that it will have a liquidity problem
due to advances being called by the FHLB during 2000.
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 the projected changes in net interest income that occur if interest
rates were to suddenly change up or down. The Rate Shock Table located below
in the Asset/Liability Management section of this report discloses HMN's
projected changes in net interest income based upon immediate interest rate
changes called rate shocks.
*HMN utilizes a model which uses the discounted cash flows from its
interest-earning assets and its interest-bearing liabilities to calculate the
current market value of those assets and liabilities. The model also
calculates the changes in market value of the interest-earning assets and
interest-bearing liabilities due to different interest rate changes. HMN
believes that over the next twelve months interest rates could conceivably
fluctuate in a range of 200 basis points up or down from where the rates were
at March 31, 2000. HMN does not have a trading portfolio. The following table
discloses the projected changes in market value to HMN's interest-earning
assets and interest-bearing liabilities based upon incremental 100 basis point
changes in interest rates from interest rates in effect on March 31, 2000.
* This paragraph contains a forward-looking statement(s). Refer to information
regarding Forward-looking Information on page 20 of this discussion.
16
<PAGE>
</TABLE>
<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 and cash
equivalents $8,254 8,247 8,240 8,234 8,227
Securities available
for sale:
Fixed-rate CMOs 30,570 29,800 27,986 25,847 23,911
Variable-rate CMOs 63,067 62,580 62,331 62,026 58,958
Fixed-rate available
for sale mortgage-
backed and related
securities 5,188 5,058 4,891 4,713 4,532
Variable-rate available
for sale mortgage-
backed and related
securities 1,957 1,944 1,930 1,917 1,904
Fixed-rate available
for sale other
marketable
securities 72,342 70,969 68,092 65,457 63,028
Variable-rate
available
for sale other
marketable
securities 1,296 1,295 1,293 1,292 1,290
Federal Home Loan
Bank stock 11,801 11,791 11,782 11,772 11,762
Fixed-rate loans
held for sale 3,403 3,400 3,397 3,395 3,392
Loans receivable, net:
Fixed-rate real
estate loans 277,373 271,068 262,906 254,247 245,750
Variable-rate
real estate loans 140,431 137,849 134,815 131,851 128,584
Fixed-rate other
loans 49,504 48,857 47,988 46,990 46,107
Variable-rate
other loans 32,564 31,026 28,756 28,953 28,027
Mortgage servicing
rights, net 728 1,041 1,119 1,181 1,209
Investment in limited
partnerships 1,941 2,722 3,007 3,103 3,168
----------------------------------------------------
Total market risk
sensitive assets 700,419 687,647 668,533 650,978 329,849
----------------------------------------------------
NOW deposits 33,281 33,490 32,285 32,346 31,927
Passbook deposits 34,595 34,239 33,354 32,657 32,031
Money market deposits 30,734 30,861 29,940 29,291 28,730
Certificate deposits 304,614 302,291 301,252 299,987 298,663
Fixed-rate Federal
Home Loan Bank
advances 185,874 179,381 177,576 174,177 170,872
Variable-rate Federal
Home Loan Bank
advances 50,596 50,555 50,515 50,474 50,434
----------------------------------------------------
Total market risk
sensitive
liabilities 639,694 630,817 625,462 618,932 612,658
Off-balance sheet
financial instruments:
Commitments to extend
credit 77 75 72 69 66
----------------------------------------------------
Net market risk $60,648 56,755 42,999 31,977 17,126
====================================================
Percentage change
from current
market value 41.05% 31.99% 0.00% (25.63%) (60.17%)
====================================================
</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 7% to 44%, depending on the coupon and period
to maturity. Adjustable rate mortgages ("ARMs") were assumed to prepay at
annual rates of between 10% and 30%, depending on coupon and the period to
maturity. Growing Equity Mortgage (GEM) loans were assumed to prepay at annual
rates of between 18% and 54% 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.
17
<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 March 31,
2000 to determine if its current level of interest rate risk is acceptable.
The following table projects the estimated annual impact on net interest income
of immediate interest rate changes called rate shocks.
Rate Shock Net Interest Percentage
in Basis Points Income Change
--------------- ------------- ------------
+200 17,479 (5.89) %
+100 18,232 (1.83) %
0 18,572 0.00 %
-100 18,789 1.17 %
-200 18,556 (0.09) %
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 20 of this discussion.
18
<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 which conform to the
secondary market guidelines. HMN has focused its portfolio lending during 1999
and throughout 2000 on the origination of commercial loan products and consumer
loans which generally have shorter weighted average terms to maturity and/or
interest rates which adjust at least every three 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.
FORWARD-LOOKING INFORMATION
The following paragraphs within Management's Discussion and Analysis of
Financial Condition and Results of Operations contain forward-looking
statements and actual results may differ materially from the expectations
disclosed within this Discussion and Analysis. These forward-looking
statements are subject to risks and uncertainties, including those discussed
below. HMN assumes no obligations to publicly release results of any revision
or updates to these forward-looking statements to reflect future events or
unanticipated occurrences.
PROVISION FOR LOAN LOSSES
The provision for loan losses for the first quarter ended March 31, 2000
was $45,000, a decrease of $30,000, or 40.0%, compared to $75,000 for the
first quarter of 1999. 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 Mortgage Corporation (FHLMC), local single family
construction permits and local economic growth rates. Management's
evaluation of probable losses inherent in the loan portfolio revealed
conditions that resulted in decreasing the first quarter of 2000 loan loss
provision compared to the provision for the first quarter of 1999. 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 $199.6
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 $10.0 million of FHLB advances which mature in 2001 but have call
features which can be exercised by the FHLB on a semiannual basis during
2000. If the call features are exercised HMN has the option of requesting
any advance otherwise available to it pursuant to the Credit Policy of the
FHLB. Since HMN has the ability to request another advance to replace the
advance that is being called, management does not anticipate that it will
have a liquidity problem due to advances being called by the FHLB during
2000.
Competitive pricing by other institutions, the desire of a competitor to
pay interest rates on deposits that are above the current rates paid by
HMN, or the desire by customers to put more of their funds into
nontraditional bank products such as stocks and bonds could be
circumstances that would cause the maturing certificates to become a
liquidity problem.
MARKET RISK
HMN utilizes a model which uses the discounted cash flows from its
interest-earning assets and its interest-bearing liabilities to calculate
the current market value of those assets and liabilities. The model also
calculates the
19
<PAGE>
changes in market value of the interest-earning assets and
interest-bearing liabilities due to different interest rate changes. HMN
believes that over the next twelve months interest rates could conceivably
fluctuate in a range of 200 basis points up or down from where the rates
were at March 31, 2000. HMN does not have a trading portfolio. The table
in the Market Risk section discloses the projected changes in market value
to HMN's interest-earning assets and interest-bearing liabilities based
upon incremental 100 basis point changes in interest rates from interest
rates in effect on March 31, 2000.
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 lifetime interest rate
caps could be different from the values disclosed in the table. In the
event of a change in interest rates, prepayment and early withdrawal
levels may deviate significantly from those assumed in calculating the
foregoing table. The ability of many borrowers to service their debt may
decrease in the event of an interest rate increase.
ASSET/LIABILITY MANAGEMENT
HMN's management reviews the impact that changing interest rates will have
on its net interest income projected for the twelve months following March
31, 2000 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.
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.
20
<PAGE>
HMN FINANCIAL, INC.
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings.
None.
ITEM 2. Changes in Securities.
Not applicable.
ITEM 3. Defaults Upon Senior Securities.
Not applicable.
ITEM 4. Submission of Matters to a Vote of Security Holders.
None.
ITEM 5. Other Information.
ITEM 6. Exhibits and Reports on Form 8-K.
(a) Exhibits. See Index to Exhibits on page 27 of this report.
(b) Reports on Form 8-K - None.
21
<PAGE>
SIGNATURES
Pursuant to the requirement of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HMN FINANCIAL, INC.
Registrant
Date: May 12, 2000 /s/ Roger P. Weise
-------------------
Roger P. Weise,
Chairman, President and
Chief Executive Officer
(Principal Executive Officer)
Date: May 12, 2000 /s/ James B. Gardner
--------------------
James B. Gardner,
Executive Vice President
(Principal Financial Officer)
22
<PAGE>
HMN FINANCIAL, INC.
INDEX TO EXHIBITS
FOR FORM 10-Q
Reference Sequential
to Prior Page Numbering
Filing or Where Attached
Exhibit Exhibits Are
Regulation S-K Number Located in This
Exhibit Number Document Attached Hereto Form 10-Q 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 *3 N/A
Including indentures
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
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).
23
<PAGE>
Exhibit 11
HMN Financial, Inc.
Computation of Earnings Per Share
<TABLE>
<CAPTION>
Three months ended March 31,
----------------------------
2000 1999
-------------------------
<S> <C> <C>
Weighted average number of common shares
outstanding used in basic earnings per
common share calculation 3,998,038 4,509,368
Net dilutive effect of:
Options 114,964 186,223
Restricted stock awards 1,953 26,551
--------- ---------
Weighted average number of shares
outstanding adjusted for effect of
dilutive securities 4,114,955 4,722,142
========= =========
Income available to common shareholders $1,529,714 1,602,000
Basic earnings per common share $ 0.38 0.36
Diluted earnings per common share $ 0.37 0.34
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEETS AT MARCH 31, 2000 AND DECEMBER 31, 1999 AND THE
CONSOLIDATED STATEMENTS OF INCOME FOR THE THREE MONTHS ENDED MARCH 31, 2000 AND
IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<CIK> 0000921183
<NAME> HMN FINANCIAL, INC.
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-2000
<PERIOD-START> JAN-01-2000
<PERIOD-END> MAR-31-2000
<CASH> 2,662
<INT-BEARING-DEPOSITS> 5,592
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 97,190
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 489,950
<ALLOWANCE> 3,318
<TOTAL-ASSETS> 705,704
<DEPOSITS> 401,453
<SHORT-TERM> 65,000
<LIABILITIES-OTHER> 6,799
<LONG-TERM> 168,900
0
0
<COMMON> 91
<OTHER-SE> 63,461
<TOTAL-LIABILITIES-AND-EQUITY> 705,704
<INTEREST-LOAN> 9,443
<INTEREST-INVEST> 2,988
<INTEREST-OTHER> 230
<INTEREST-TOTAL> 12,661
<INTEREST-DEPOSIT> 4,337
<INTEREST-EXPENSE> 7,705
<INTEREST-INCOME-NET> 4,956
<LOAN-LOSSES> 45
<SECURITIES-GAINS> (69)
<EXPENSE-OTHER> 3,031
<INCOME-PRETAX> 2,493
<INCOME-PRE-EXTRAORDINARY> 1,530
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,530
<EPS-BASIC> .38
<EPS-DILUTED> .37
<YIELD-ACTUAL> 2.93
<LOANS-NON> 528
<LOANS-PAST> 208
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 3,273
<CHARGE-OFFS> 0
<RECOVERIES> 0
<ALLOWANCE-CLOSE> 3,318
<ALLOWANCE-DOMESTIC> 1,944
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 1,374
</TABLE>
