-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, FMq2dmf74i2gSf//VQPcwgtGpOylf2a6FNAber63NtE2C3GrxELgn2V/Ie7YEJBm 8TfWwDYaRmDtYqKPARoIJQ== 0000912057-97-010917.txt : 19970401 0000912057-97-010917.hdr.sgml : 19970401 ACCESSION NUMBER: 0000912057-97-010917 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970331 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: HMN FINANCIAL INC CENTRAL INDEX KEY: 0000921183 STANDARD INDUSTRIAL CLASSIFICATION: SAVINGS INSTITUTION, FEDERALLY CHARTERED [6035] IRS NUMBER: 411777397 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-24100 FILM NUMBER: 97568432 BUSINESS ADDRESS: STREET 1: 101 N BROADWAY CITY: SPRING VALLEY STATE: MN ZIP: 55975-1223 BUSINESS PHONE: 5073467345 10-K 1 FORM 10-K SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ----------------- FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] FOR THE TRANSITION PERIOD FROM TO ----- ----- COMMISSION FILE NUMBER 0-24100. HMN FINANCIAL, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 41-1777397 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) 101 NORTH BROADWAY, PO BOX 231 55975-0231 SPRING VALLEY, MINNESOTA (ZIP CODE) (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (507) 346-7345 SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: COMMON STOCK, PAR VALUE $.01 PER SHARE (TITLE OF CLASS) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such requirements for the past 90 days. YES X NO ----- ----- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] As of March 14, 1997, the Registrant had issued and outstanding 4,209,826 shares of the Registrant's Common Stock. The aggregate market value of the voting stock held by non-affiliates of the Registrant as of March 14, 1997 was $76.3 million. (The exclusion from such amount of the market value of the shares owned by any person shall not be deemed an admission by the Registrant that such person is an affiliate of the Registrant.) DOCUMENTS INCORPORATED BY REFERENCE Parts of the Registrant's Annual Report for the year ended December 31, 1996, are incorporated by reference in Parts II and IV of this Form 10-K. Parts of the Registrant's Proxy Statement dated March 13, 1997, are incorporated by reference in Part III of this Form 10-K. Exhibit Index is located on page 47. TABLE OF CONTENTS PART I PAGE ---- Item 1. Business ....................................................... 3 General ................................................... 3 Lending Activities ........................................ 4 Investment Activities ..................................... 19 Sources of Funds .......................................... 23 Other Information Service Corporations ................................. 27 Competition .......................................... 27 Employees ............................................ 27 Executive Officers ................................... 28 Regulation ................................................ 28 Taxation .................................................. 37 Item 2. Properties ..................................................... 40 Item 3. Legal Proceedings .............................................. 41 Item 4. Submission of Matters to a Vote of Security Holders ............ 41 PART II Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters ................................................... 41 Item 6. Selected Financial Data ........................................ 41 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations ..................................... 41 Item 8. Financial Statements and Supplementary Data .................... 41 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure ...................................... 41 PART III Item 10. Directors and Executive Officers of the Registrant ............. 42 Item 11. Executive Compensation ......................................... 42 Item 12. Security Ownership of Certain Beneficial Owners and Management . 42 Item 13. Certain Relationships and Related Transactions ................. 42 PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 43 Signatures .............................................................. 46 Index to Exhibits ....................................................... 47 2 PART I ITEM 1. BUSINESS GENERAL HMN Financial, Inc. ("HMN" or the "Corporation"), was incorporated under the laws of the State of Delaware in March 1994 for the purpose of becoming the savings and loan holding company of Home Federal Savings Bank ("Home Federal" or the "Bank") in connection with the Bank's conversion from a federally chartered mutual savings bank to a federally chartered stock savings bank, pursuant to its plan of conversion. HMN commenced on May 23, 1994, a Subscription and Community Offering (the "Offering") of its shares in connection with the conversion of the Bank. The Offering ended on June 22, 1994, and final approval for the conversion was received from the Office of Thrift Supervision ("OTS") on June 29, 1994. HMN issued 6,085,775 shares of common stock at a price of $10 per share. Total proceeds from the conversion were $59,178,342 net of costs relating to the conversion of $1,679,408, and have been recorded as common stock and additional paid in capital. As a community-oriented financial institution, HMN seeks to serve the financial needs of communities in its market area. HMN's business involves attracting deposits from the general public and using such deposits to originate or purchase one-to-four family residential mortgage loans and, to a much lesser extent, consumer, construction, commercial real estate, commercial business and multi-family loans. HMN also invests in mortgage-backed and related securities, investment securities (consisting primarily of U.S. government and government agency obligations) and other permissible investments. The executive offices of HMN are located at 101 N. Broadway, PO Box 231, Spring Valley, Minnesota 55975-0231. It's telephone number at that address is (507) 346-7345. MARKET AREA HMN serves the Minnesota counties of Fillmore, Freeborn, Houston, Mower, Olmsted and Winona and portions of Steele, Dodge, Goodhue and Wabasha Counties, Minnesota, through its main office located in Spring Valley, Minnesota and its six branch offices located in Albert Lea, Austin, LaCrescent, Rochester and Winona, Minnesota. The portion of HMN's market area consisting of Rochester and the contiguous communities is composed of primarily urban and suburban communities while the balance of HMN's market area consists primarily of rural areas and small towns. Primary industries in HMN's market area include manufacturing, agriculture, health care, wholesale and retail trade, service industries and education. Major employers include IBM, the Mayo Clinic and Hormel, a food processing company, and various small industrial and other companies. HMN's market area is also the home of Winona State University, Rochester Community College, Austin Community College and several vocational/technical schools. Based upon 1990 census information, the population of the six primary counties in the Bank's market area was as follows: Fillmore - 20,800; Freeborn - - 33,000; Houston - 18,500; Mower - 37,300; Olmsted - 101,000; and Winona - 47,900. Based upon 1990 U.S. Department of Commerce information, per capita income in these six counties ranged from approximately $15,000 to $21,000. During the fourth quarter of 1996, HMN opened a mortgage banking office in Edina, Minnesota. The office will primarily purchase loans from third party originators located in the seven county metropolitan area of Minneapolis and St. Paul and sell the loans in the secondary market or place the loans in HMN's loan portfolio. The new office will also purchase mortgage servicing rights from third parties for the purpose of generating loan servicing income. 3 LENDING ACTIVITIES GENERAL. Historically, the Bank originated 30-year, fixed-rate mortgage loans secured by one-to-four family residences. Since 1979, in order to reduce its vulnerability to changes in interest rates, the Bank has emphasized the origination or purchase of mortgage loans having shorter terms to maturity or repricing, such as 15-year, fixed-rate residential loans, Adjustable Rate Mortgage loans ("ARMs") and Graduated Equity Mortgage loans ("GEMs"). Starting in 1995 and throughout 1996 HMN offered a competitive home equity line of credit. HMN also offers consumer loans and, to a much lesser extent, construction, commercial real estate, multi-family and commercial business loans. See "- Originations, Purchases and Sales of Loans and Mortgage-Backed and Related Securities." 4 LOAN PORTFOLIO COMPOSITION. The following information concerning the composition of the HMN's loan portfolio in dollar amounts and in percentages (before deductions for loans in process, deferred fees and discounts and allowances for losses) as of the dates indicated.
December 31, ------------------------------------------------------- 1996 1995 ---------------------- --------------------- (DOLLARS IN THOUSANDS) AMOUNT PERCENT AMOUNT PERCENT ------- ------- ------ ------- - REAL ESTATE LOANS: - ----------------- One-to-four family ............. $ 321,340 90.19% $ 292,497 90.62% Multi-family ................... 280 0.08 361 0.11 Commercial ..................... 7,918 2.22 8,744 2.71 Construction or development .... 3,474 0.98 5,082 1.58 ---------- ---------- ---------- ---------- Total real estate loans ...... 333,012 93.47 306,684 95.02 ---------- ---------- ---------- ---------- OTHER LOANS: - ----------- Consumer loans: Savings account ............... 938 0.26 1,210 0.37 Education ..................... 467 0.13 342 0.11 Automobile .................... 566 0.16 671 0.21 Home equity ................... 17,808 5.00 11,506 3.56 Home improvement .............. 585 0.16 785 0.24 Other ......................... 568 0.16 545 0.17 ---------- ---------- ---------- ---------- Total consumer loans ......... 20,932 5.87 15,059 4.66 Commercial business loans ..... 2,344 0.66 1,018 0.32 ---------- ---------- ---------- ---------- Total other loans ............ 23,276 6.53 16,077 4.98 ---------- ---------- ---------- ---------- Total loans ................. 356,288 100.00% 322,761 100.00% ---------- ---------- ---------- ---------- LESS: - ---- Loans in process ............... 2,814 3,531 Unamortized discounts .......... 417 289 Net deferred loan fees ......... 1,695 1,899 Allowance for losses on loans .. 2,340 2,191 ---------- ---------- Total loans receivable, net . $349,022 $314,851 ---------- ---------- ---------- ---------- December 31, --------------------------------------------------------------------------------- 1994 1993 1992 ----------------------- --------------------- ---------------------- (DOLLARS IN THOUSANDS) AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT ------ ------- ------ ------- ------ ------- REAL ESTATE LOANS: - ----------------- One-to-four family .............. $ 252,943 91.14% $ 233,009 92.18% $ 223,914 89.86% Multi-family .................... 311 0.11 349 0.14 709 0.28 Commercial ...................... 8,316 3.00 4,559 1.80 6,512 2.61 Construction or development ..... 2,799 1.01 3,309 1.31 6,879 2.76 ---------- ---------- ---------- ---------- ---------- ---------- Total real estate loans ....... 264,369 95.26 241,226 95.43 238,014 95.51 ---------- ---------- ---------- ---------- ---------- ---------- OTHER LOANS: - ----------- Consumer loans: Savings account ................ 648 0.23 872 0.34 1,153 0.46 Education ...................... 2,007 0.72 1,819 0.72 1,584 0.64 Automobile ..................... 520 0.19 681 0.27 927 0.37 Home equity .................... 7,716 2.78 5,604 2.22 4,623 1.86 Home improvement ............... 870 0.31 912 0.36 1,044 0.42 Other .......................... 502 0.19 586 0.23 684 0.27 ---------- ---------- ---------- ---------- ---------- ---------- Total consumer loans .......... 12,263 4.42 10,474 4.14 10,015 4.02 Commercial business loans ...... 897 0.32 1,089 0.43 1,160 0.47 ---------- ---------- ---------- ---------- ---------- ---------- Total other loans ............. 13,160 4.74 11,563 4.57 11,175 4.49 ---------- ---------- ---------- ---------- ---------- ---------- Total loans .................. 277,529 100.00% 252,789 100.00% 249,189 100.00% ---------- ---------- ---------- ---------- ---------- ---------- LESS: - ---- Loans in process ................ 2,327 2,333 4,576 Unamortized discounts ........... 162 14 32 Net deferred loan fees .......... 2,147 2,507 2,236 Allowance for losses on loans ... 1,893 1,489 831 ---------- ---------- ---------- Total loans receivable, net .. $ 271,000 $ 246,446 $ 241,514 ---------- ---------- ---------- ---------- ---------- ----------
5 The following table shows the composition of the HMN's loan portfolio by fixed and adjustable rate at the dates indicated.
December 31, -------------------------------------------------- 1996 1995 --------------------- ------------------ (DOLLARS IN THOUSANDS) Amount Percent Amount Percent -------- --------- -------- --------- FIXED-RATE LOANS - ---------------- Real estate: One-to-four family GEM ....................................... $ 48,831 13.71% $ 30,175 9.35% Other ..................................... 187,519 52.63 181,401 56.20 --------- --------- --------- --------- Total one-to-four family ................. 236,350 66.34 211,576 65.55 Multi-family .............................. 223 0.06 302 0.10 Commercial ................................ 1,276 0.36 1,518 0.47 Construction or development ............... 2,970 0.83 4,848 1.50 --------- --------- --------- --------- Total fixed-rate real estate loans ....... 240,819 67.59 218,244 67.62 --------- --------- --------- --------- Consumer loans: Savings .................................. 938 0.26 1,210 0.37 Education ................................ 434 0.12 299 0.09 Automobile ............................... 566 0.16 671 0.21 Home equity .............................. 5,338 1.50 7,254 2.25 Home improvement ......................... 585 0.16 785 0.24 Other .................................... 568 0.16 545 0.17 --------- --------- --------- --------- Total consumer loans .................... 8,429 2.36 10,764 3.33 --------- --------- --------- --------- Commercial business loans ................ 1,344 0.38 1,018 0.32 --------- --------- --------- --------- Total other loans ....................... 9,773 2.74 11,782 3.65 --------- --------- --------- --------- Total fixed-rate loans .................. 250,592 70.33 230,026 71.27 --------- --------- --------- --------- ADJUSTABLE-RATE LOANS - --------------------- Real estate: One-to-four family ........................ 84,990 23.85 80,921 25.07 Multi-family .............................. 57 0.02 59 0.02 Commercial ................................ 6,642 1.87 7,226 2.24 Construction or development ............... 504 0.14 234 0.07 --------- --------- --------- --------- Total adjustable-rate real estate loans... 92,193 25.88 88,440 27.40 Consumer................................... 12,503 3.51 4,295 1.33 Commercial business loans.................. 1,000 0.28 --- --- --------- --------- --------- --------- Total adjustable-rate loans............... 105,696 29.67 92,735 28.73 --------- --------- --------- --------- Total loans............................... 356,288 100.00% 322,761 100.00% --------- --------- --------- --------- --------- --------- LESS - ---- Loans in process............................ 2,814 3,531 Unamortized discounts....................... 417 289 Net deferred loan fees...................... 1,695 1,899 Allowance for losses on loans............... 2,340 2,191 --------- --------- Total loans receivable, net............... $ 349,022 $ 314,851 --------- --------- --------- --------- December 31, --------------------------------------------------------------------------- 1994 1993 1992 ------------------- ------------------- -------------------- (DOLLARS IN THOUSANDS) Amount Percent Amount Percent Amount Percent -------- --------- -------- --------- -------- --------- FIXED-RATE LOANS - ---------------- Real estate: One-to-four family GEM ....................................... $ 24,769 8.93% $ 22,304 8.83% $ 34,987 14.04 Other ..................................... 168,272 60.63 171,503 67.84 152,513 61.20 --------- --------- --------- --------- --------- --------- Total one-to-four family ................. 193,041 69.56 193,807 76.67 187,500 75.24 Multi-family .............................. 311 0.11 349 0.13 709 0.28 Commercial ................................ 1,612 0.58 626 0.25 2,418 0.97 Construction or development ............... 1,008 0.37 2,800 1.11 5,558 2.23 --------- --------- --------- --------- --------- --------- Total fixed-rate real estate loans ....... 195,972 70.62 197,582 78.16 196,185 78.72 --------- --------- --------- --------- --------- --------- Consumer loans: Savings .................................. 648 0.23 872 0.34 1,153 0.46 Education ................................ 1,278 0.46 1,819 0.72 1,584 0.64 Automobile ............................... 520 0.19 681 0.27 927 0.37 Home equity .............................. 7,258 2.62 5,604 2.22 4,623 1.86 Home improvement ......................... 870 0.31 912 0.36 1,044 0.42 Other .................................... 502 0.18 586 0.23 684 0.27 --------- --------- --------- --------- --------- --------- Total consumer loans .................... 11,076 3.99 10,474 4.14 10,015 4.02 --------- --------- --------- --------- --------- --------- Commercial business loans ................ 897 0.32 1,089 0.43 1,160 0.47 --------- --------- --------- --------- --------- --------- Total other loans ....................... 11,973 4.31 11,563 4.57 11,175 4.49 --------- --------- --------- --------- --------- --------- Total fixed-rate loans .................. 207,945 74.93 209,145 82.73 207,360 83.21 --------- --------- --------- --------- --------- --------- ADJUSTABLE-RATE LOANS - --------------------- Real estate: One-to-four family ........................ 59,901 21.58 39,202 15.51 36,414 14.62 Multi-family .............................. --- --- --- --- --- --- Commercial ................................ 6,704 2.42 3,933 1.56 4,094 1.64 Construction or development ............... 1,792 0.64 509 0.20 1,321 0.53 --------- --------- --------- --------- --------- --------- Total adjustable-rate real estate loans... 68,397 24.64 43,644 17.27 41,829 16.79 Consumer................................... 1,187 0.43 --- --- --- --- Commercial business loans.................. --- --- --- --- --- --- --------- --------- --------- --------- --------- --------- Total adjustable-rate loans............... 69,584 25.07 43,644 17.27 41,829 16.79 --------- --------- --------- --------- --------- --------- Total loans............................... 277,529 100.00% 252,789 100.00% 249,189 100.00% --------- --------- --------- --------- --------- --------- --------- --------- --------- LESS - ---- Loans in process............................ 2,327 2,333 4,576 Unamortized discounts....................... 162 14 32 Net deferred loan fees...................... 2,147 2,507 2,236 Allowance for losses on loans............... 1,893 1,489 831 --------- --------- --------- Total loans receivable, net................. $ 271,000 $ 246,446 $ 241,514 --------- --------- --------- --------- --------- ---------
6 The following schedule illustrates the interest rate sensitivity of HMN's loan portfolio at December 31, 1996. Loans which have adjustable or renegotiable interest rates are shown as maturing in the period during which the contract is due. The schedule reflects the effects of estimated prepayments on the loan portfolio.
Real Estate ----------- Multi-family and One-to-four family Commercial Construction ----------------------- ---------------------- ------------------------ Weighted Weighted Weighted Average Average Average (DOLLARS IN THOUSANDS) Amount Rate Amount Rate Amount Rate ------ ------- ------ ------ -------- ------ Due During Years Ending December 31, ---------------- 1997(1) .................... $ 48,641 7.60% $ 1,551 8.21% $ 539 8.04% 1998 ....................... 48,580 7.58 1,136 8.11 428 8.04 1999 ....................... 30,222 7.58 1,137 8.11 427 8.04 2000 and 2001 .............. 58,102 7.57 1,503 8.08 619 8.04 2002 to 2006 ............... 83,497 7.54 1,975 8.41 897 8.04 2007 to 2021 ............... 49,867 7.48 896 8.04 535 8.04 2022 and following ......... 2,431 7.30 --- --- 29 8.15 ------- ----- ----- $ 321,340 $ 8,198 $ 3,474 ------- ----- ----- ------- ----- ----- Commercial Consumer Business Total --------------------- -------------------- --------------------- Weighted Weighted Weighted Average Average Average (DOLLARS IN THOUSANDS) Amount Rate Amount Rate Amount Rate -------- ------- -------- ------ -------- ------ Due During Years Ending December 31, ---------------- 1997(1) .................... $ 4,135 8.91% $ 875 9.65% $ 55,741 7.75% 1998 ....................... 2,466 9.20 476 9.49 53,086 7.71 1999 ....................... 2,466 9.20 476 9.49 34,728 7.71 2000 and 2001 .............. 3,286 9.23 324 9.74 63,834 7.69 2002 to 2006 ............... 4,852 8.90 193 10.09 91,414 7.64 2007 to 2021 ............... 3,727 8.75 --- --- 55,025 7.58 2022 and following ......... --- --- --- --- 2,460 7.31 ------ ----- ------- $ 20,932 $ 2,344 $ 356,288 ------ ----- ------- ------ ----- -------
- ------------- (1) Includes demand loans, loans having no stated maturity, overdraft loans and education loans. The total amount of loans due after December 31, 1997 which have predetermined interest rates is $207 million, while the total amount of loans due after such dates which have floating or adjustable interest rates is $93.5 million. 7 Under the Financial Institutions Reform, Recovery and Enforcement Act of 1989 ("FIRREA"), the aggregate amount of loans that the Bank is permitted to make to any one borrower is generally limited to 15% of unimpaired capital and surplus (25% if the security for such loan has a "readily ascertainable" value or 30% for certain residential development loans). At December 31, 1996, based upon the 15% limitation, the Bank's regulatory loans-to-one borrower limit was approximately $9.1 million. On the same date, the Bank had no borrowers with outstanding balances in excess of this amount. At December 31, 1996, the largest dollar amount outstanding to one borrower or group of related borrowers was $940,000. This loan, which is secured by a motel located in the Bank's market area, was performing in accordance with its terms at December 31, 1996. The Bank's Loan Committee is responsible for review and approval of all loans over $149,999 originated by the Bank. Approval of one member of the Loan Committee is required on all loans ranging from $150,000 to $249,999 and the approval of at least two committee members is required on loans over $250,000 to $400,000. Loans greater than $400,000 must be approved by the Board of Directors of the Bank after review and preliminary approval by the Loan Committee. All loans closed each month are reviewed by the Board of Directors at the monthly meeting. Under the Bank's loan policy, the loan officer processing an application is responsible for ensuring that all documentation is obtained prior to the submission of the application to the Loan Committee. In addition, the loan officer verifies that the application meets the Bank's underwriting guidelines described below. Also, each application is assigned to a reviewing officer who reviews the file to assure its accuracy and completeness. The Branch Manager has the authority to approve all loans up to $149,999. All of the Bank's lending is subject to its written underwriting standards and to loan origination procedures. Decisions on loan applications are made on the basis of detailed applications and property valuations (consistent with the Bank's appraisal policy) by the Bank's staff appraiser or an independent appraiser. The loan applications are designed primarily to determine the borrower's ability to repay and the more significant items on the application are verified through use of credit reports, financial statements, tax returns and/or confirmations. Generally, the Bank requires title insurance on its mortgage loans as well as fire and extended coverage casualty insurance in amounts at least equal to the principal amount of the loan or the value of improvements on the property, depending on the type of loan. The Bank also requires flood insurance to protect the property securing its interest when the property is located in a flood plain. ONE-TO-FOUR FAMILY RESIDENTIAL REAL ESTATE LENDING. The cornerstone of HMN's lending program is the origination of loans secured by mortgages on owner- occupied one-to-four family residences. At December 31, 1996, $321.3 million, or 90.19% of HMN's loan portfolio consisted of mortgage loans on one-to-four family residences. At December 31, 1996, $233.2 million of the one-to-four family residential loan portfolio was secured by properties located in HMN's market area. HMN had $88.1 million of purchased one-to-four family loans in its portfolio which were secured by properties located outside of its market area (primarily located in the Midwestern United States, or the Southeastern United States). Generally mortgage loans originated by the Bank are retained and serviced by it. If a loan has a fixed rate with an original term to maturity of 30 years the loan is generally sold. Prior to 1979, the Bank originated for retention in its own portfolio 30- year, fixed-rate loans secured by one-to-four family residential real estate. Beginning in 1979, the Bank began to emphasize the origination of fixed-rate loans with terms of 15 years or less for retention in its portfolio. In addition, in 1982, the Bank began to originate ARMs, subject to market conditions and consumer preference. Subsequently, the Bank also began to emphasize GEM originations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Asset/Liability Management" in the Annual Report attached as Exhibit 13 hereto (the "Annual Report"). HMN currently offers conventional fixed-rate loans with maximum terms of up to 30 years although HMN generally limits originations of loans with terms longer than 20 years. The interest rate on such loans is generally 8 set based on the FHLMC delivery rates, as well as, competitive factors. At December 31, 1996, HMN had $187.5 million of fixed-rate loans (excluding GEM loans) or 52.63% of HMN's total loan portfolio with a weighted average contractual term to maturity of 12.9 years. HMN also offers one-year ARMs at a margin (generally 275 basis points) over the yield on the Average Monthly One Year U.S. Treasury Constant Maturity Index for terms of up to 30 years. The ARM loans currently offered by HMN allow the borrower to select (subject to pricing) an initial period of one year, three years, or five years between the loan origination and when the first interest rate change occurs. Generally the ARMs provide for an up to 200 basis point annual interest rate change cap and a lifetime cap generally 600 basis points over the initial rate. HMN's one year ARM loan portfolio typically contains interest rate floors which are generally equal to the initial rate of the loan. Initial interest rates offered on the ARM loans during 1996 ranged from 0 to 192 basis points below the fully indexed loan rate. All borrowers are now qualified for the loan at the fully indexed rate. See "-Delinquencies and Non-Performing Assets." In the past, the Bank offered one-year ARMs with a margin of 200 to 235 basis points over a specified index and an average annual cap of 145 basis points. At December 31, 1996, one-to-four family ARMs totaled $85.0 million, or 23.8% of HMN's total loan portfolio. HMN's originated ARMs do not permit negative amortization of principal, do not contain prepayment penalties and generally are not convertible into fixed- rate loans. HMN has $12.7 million of ARM loans purchased from a third party which are convertible at borrowers option into fixed-rate loans. It has an agreement with the third party to repurchase the ARM loans which convert to fixed rates at a stipulated price. The GEM loans carry required payments which increase after the first year. Under the GEM loans, the monthly payments required for the first year are established based on a 30-year amortization schedule. Depending upon the program selected, the payments may increase in the succeeding years by amounts ranging from 0% to 5%. Most of the GEM loans originated by HMN provide for at least three annual payment increases over the first five years of the loan. The increased payments required under GEM loans are applied to principal and have the effect of shortening the term to maturity; the GEM loans do not permit negative amortization. HMN currently offers two GEM programs, one with a contractual maturity of approximately 15 years and one with a contractual maturity of approximately 19 years. The GEMs are generally priced based upon loans with similar contractual maturities. The GEMs have been popular with consumers who anticipate future increases in income and who desire an amortization schedule of less than 30 years. HMN believes that GEMs may increase in popularity in the future if interest rates rise and consumers are less easily able to afford the higher monthly payments required by 15-year, fixed-rate loans. HMN has also originated a limited number of fixed-rate loans with terms up to 30 years which are insured by the Federal Housing Authority ("FHA"). Commencing in 1994, HMN began to sell all 30-year, fixed-rate FHA-insured loans originated with servicing released. See "- Originations, Purchases and Sales of Loans and Mortgage-Backed Securities and Related Securities." In underwriting one-to-four family residential real estate loans, HMN evaluates both the borrower's ability to make principal, interest and escrow payments, the value of the property that will secure the loan and debt to income ratios. Properties securing one-to-four family residential real estate loans made by HMN are appraised by independent fee appraisers or by HMN's staff appraiser. HMN originates residential mortgage loans with loan-to-value ratios of up to 95% for owner-occupied homes and up to 50% for non-owner occupied homes; however, private mortgage insurance is required to reduce HMN's exposure to 80% or less. HMN generally seeks to underwrite its loans in accordance with secondary market standards. HMN's residential mortgage loans customarily include due-on-sale clauses giving the it the right to declare the loan immediately due and payable in the event that, among other things, the borrower sells or otherwise disposes of the property subject to the mortgage and the loan is not repaid. 9 CONSTRUCTION LENDING. HMN makes construction loans to individuals for the construction of their residences, and to a much lesser extent, to builders for the construction of one-to-four family residences. It also makes a very limited number of loans to builders for houses built on speculation. The loan policy limits the total amount of construction loans outstanding at one time to 2.0% of assets. At December 31, 1996, HMN had $3.5 million of construction loans outstanding representing 1.0% of HMN's total loan portfolio. Almost all loans to individuals for the construction of their residences are structured as permanent loans. Such loans are made on the same terms as residential loans, except that during the construction phase, which typically lasts up to seven months, the borrower pays interest only. The borrower also pays a construction fee up to $800 at the time of origination. Residential construction loans are underwritten pursuant to the same guidelines used for originating residential loans on existing properties. Construction loans to builders or developers of one-to-four family residences generally carry terms of up to 15 years with a construction phase of up to seven months. Such loans generally do not permit the payment of interest from loan proceeds. At December 31, 1996, HMN had $134,000 of construction loans to builders or developers. While it anticipates that it will continue to engage in this type of lending from time to time in the future, HMN currently expects that its total volume at any one time will be limited. Construction loans to owner occupants are generally made in amounts of up to 95% of the lesser of cost or appraised value, but no more than 85% of the loan proceeds can be disbursed until the building is completed. The loan-to- value ratios on loans to builders are limited to 70%. Prior to making a commitment to fund a construction loan, HMN requires an appraisal of the property and financial data and verification of income on the borrower. It generally obtains personal guarantees for substantially all of its construction loans to builders. Personal financial statements of guarantors are also obtained as part of the loan underwriting process. All construction loans have been located in HMN's market area. Construction loans are obtained principally through continued business from builders and developers who have previously borrowed from the Bank, as well as referrals from existing customers and walk-in customers. The application process includes a submission to the Bank of accurate plans, specifications and costs of the project to be constructed. These items are used as a basis to determine the appraised value of the subject property. The nature of construction loans is such that they are more difficult to evaluate and monitor. The risk of loss on a construction loan is dependent largely upon the accuracy of the initial estimate of the property's value upon completion of the project and the estimated cost (including interest) of the project. If the estimate of value proves to be inaccurate, HMN may be confronted, at or prior to the maturity of the loan, with a project having a value which is insufficient to assure full repayment and/or the possibility of having to make substantial investments to complete and sell the project. Because defaults in repayment may not occur during the construction period it may be difficult to identify problem loans at an early stage. In such cases, HMN may be required to modify the terms of the loan. COMMERCIAL REAL ESTATE AND MULTI-FAMILY LENDING. HMN originates permanent commercial real estate and multi-family loans secured by properties located in its market area. It also purchases commercial real estate loans outside of its market area that are guaranteed by the Small Business Administration ("SBA") or originated by other third parties. At December 31, 1996, HMN had $7.9 million in commercial real estate loans, representing 2.2% of HMN's total loan portfolio, and $280,000 in multi-family loans, or 0.1% of its total loan portfolio. The commercial real estate and multi-family loan portfolio includes loans secured by motels, apartment buildings, churches, small office buildings, small business facilities, nursing homes and other non-residential building properties, substantially all of which are located within HMN's market area. Permanent commercial real estate and multi-family loans are generally originated for a maximum term of 10 20 years and generally have adjustable interest rates. Prior to 1995 commercial real estate and multi-family loans could have either a fixed interest rate or an adjustable interest rate. Commercial real estate and multi-family loans are written in amounts of up to 70% of the lesser of the appraised value of the property or the purchase price and must have a debt service coverage ratio of at least 125%. The debt service coverage is the ratio of net cash from operations before payment of debt to debt service. HMN does not originate construction loans secured by commercial or multi-family real estate. Appraisals on properties serving commercial real estate and multi-family loans originated by HMN are performed by independent appraisers prior to the time the loan is made. Generally all appraisals on commercial and multi-family real estate are reviewed by a member of the Bank's Loan Committee. The Bank's underwriting procedures require verification of the borrower's credit history, income and financial statements, banking relationships, references and income projections for the property. It also requires personal guarantees from the borrowers. In addition, HMN performs an annual on-site inspection on collateral properties for loans with balances in excess of $250,000. At December 31, 1996, HMN's two largest commercial real estate loans totaled $940,000 and $910,000. The first loan was secured by a motel located in Rochester, Minnesota near the Mayo Clinic. The second commercial real estate loan was also secured by a motel located in HMN's market area. Both of these loans were performing at December 31, 1996. Multi-family and commercial real estate loans generally present a higher level of risk than loans secured by one-to-four family residences. This greater risk is due to several factors, including the concentration of principal in a limited number of loans and borrowers, the effects of general economic conditions on income producing properties and the increased difficulty of evaluating and monitoring these types of loans. Furthermore, the repayment of loans secured by multi-family and commercial real estate is typically dependent upon the successful operation of the related real estate project. If the cash flow from the project is reduced (for example, if leases are not obtained or renewed), the borrower's ability to repay the loan may be impaired. At December 31, 1996, HMN had one commercial real estate loan totaling $83,000 and no multi- family loans which were 90 days or more delinquent. CONSUMER LENDING. HMN originates a variety of different types of consumer loans, including home equity loans (open-end and closed-end), education, automobile, home improvement, deposit account and other loans for household and personal purposes. At December 31, 1996, consumer loans totaled $20.9 million, or 5.9% of total loans outstanding. Consumer loan terms vary according to the type and value of collateral, length of contract and creditworthiness of the borrower. HMN's consumer loans are made at fixed and adjustable interest rates, with terms of up to 20 years for secured loans and up to three years for unsecured loans. HMN's home equity loans are written so that the total commitment amount, when combined with the balance of any other outstanding mortgage liens, may not exceed 90% of the appraised value of the property. The closed-end home equity loans are written with fixed or adjustable rates with terms of up to 15 years. The open-end home equity loans are written with an adjustable rate with terms of up to 20 years, a 10 year draw period which requires "interest only" payments and a 10 year repayment period which fully amortizes the outstanding balance. The consumer may access the open-end home equity loan either by making a withdrawal at the Bank or writing a check on the home equity line of credit account. At December 31, 1996, HMN's equity loans totaled $17.8 million, or 5.0% of the total loan portfolio. 11 The underwriting standards employed by the Bank for consumer loans include a determination of the applicant's payment history on other debts and ability to meet existing obligations and payments on the proposed loan. Although creditworthiness of the applicant is of primary consideration, the underwriting process also includes a comparison of the value of the security, if any, in relation to the proposed loan amount. Consumer loans may entail greater credit risk than do residential mortgage loans, particularly in the case of consumer loans which are unsecured or are secured by rapidly depreciable assets, such as automobiles. In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation. In addition, consumer loan collections are dependent on the borrower's continuing financial stability, and thus are more likely to be affected by adverse personal circumstances. Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans. At December 31, 1996, $7,300 or .03% of the consumer loan portfolio was non-performing. There can be no assurance that delinquencies will not increase in the future. COMMERCIAL BUSINESS LENDING. In order to satisfy the demand for financial services available to individuals and businesses in its market area, HMN has maintained a portfolio of commercial business loans primarily to small retail operations, small manufacturing concerns and professional firms. Most of HMN's commercial business loans have terms ranging from six months to five years and carry fixed interest rates. HMN's commercial business loans generally include personal guarantees and are usually, but not always, secured by business assets such as inventory, equipment, fixtures, real estate and accounts receivables. The underwriting process for commercial business loans includes consideration of the borrower's financial statements, tax returns, projections of future business operations and inspection of the subject collateral, if any. At December 31, 1996, HMN had $2.3 million of commercial business loans outstanding, or 0.7% of the total loan portfolio. In addition, on that date, HMN had $20,000 of letters of credit outstanding. Unlike residential mortgage loans, which generally are made on the basis of the borrower's ability to make repayment from his or her employment and other income, and which are secured by real property whose value tends to be more easily ascertainable, commercial business loans are of higher risk and typically are made on the basis of the borrower's ability to make repayment from the cash flow of the borrower's business. As a result, the availability of funds for the repayment of commercial business loans may be substantially dependent on the success of the business itself. Further, the collateral securing the loans may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business. At December 31, 1996, there was one delinquent commercial business loan totaling $13,000 that was over 90 days delinquent. ORIGINATIONS, PURCHASES AND SALES OF LOANS AND MORTGAGE-BACKED AND RELATED SECURITIES Real estate loans are generally originated by HMN's staff of salaried and commissioned loan officers. Loan applications are taken and processed in all branch offices. While HMN originates both fixed and adjustable-rate loans, its ability to originate loans is dependent upon the relative customer demand for loans in its market. Demand is affected by the interest rate environment. During the last several years, the dollar volume of conventional fixed-rate, one-to-four family loans has exceeded the dollar volume of GEMs and ARMs. Currently, substantially all residential mortgage loans originated are retained in the loan portfolio except 30 year fixed rate loans. From time to time, in order to supplement loan demand in HMN's market area and geographically diversify its loan portfolio, HMN purchases real estate loans from selected sellers, with yields based upon current market rates. HMN carefully reviews and underwrites all loans to be purchased to ensure that they meet HMN's underwriting standards. The seller continues to service these purchased loans. During 1996, HMN originated $56.7 million of real estate and consumer loans and it purchased $55.8 million of single family residential loans originated outside of its market area. The majority of the purchased loans have interest rates that are fixed for a one, three or five year period and then adjust annually thereafter or were seasoned fixed rate loans. All purchased loans are reviewed to determine that each loan meets certain underwriting requirements. Refer to Note 6 of the Notes to Consolidated Financial Statements in the Annual Report for more information on purchased loans. 12 HMN has substantial holdings of mortgage-backed and related securities which are held, depending on the investment intent, in the "available for sale" or "held to maturity" portfolios. During 1996, the Bank purchased $7.3 million of mortgaged-backed securities and $50.3 million of mortgage-related securities, primarily CMOs. See "- Investment Activities." During the same period, HMN sold $81.1 million of mortgage-backed and related securities. 13 The following table shows the loan and mortgage-backed and related securities origination, purchase, sale and repayment activities of HMN for the periods indicated.
(DOLLARS IN THOUSANDS) Year Ended December 31, LOANS 1996 1995 1994 -------------------------------------- ORIGINATIONS BY TYPE: - -------------------- Adjustable-rate: Real estate - one-to-four family...................... $ 5,441 2,117 8,891 - multi-family.................................... --- 58 --- - construction or development..................... 916 691 2,822 Non-real estate - consumer............................ 12,012 4,575 962 -------- -------- -------- Total adjustable-rate............................. 18,369 7,441 12,675 -------- -------- -------- Fixed-rate: Real estate - one-to-four family..................... 27,036 23,565 23,032 - multi-family.................................... 145 --- --- - commercial...................................... 30 150 --- - construction or development..................... 6,181 4,847 3,305 Non-real estate - consumer........................... 4,583 7,267 7,418 - commercial business........................... 430 610 685 -------- -------- -------- Total fixed-rate.................................... 38,405 36,439 34,440 -------- -------- -------- Total loans originated.............................. 56,774 43,880 47,115 -------- -------- -------- PURCHASES: - --------- Real estate - one-to-four family...................... 55,839 47,136 17,213 Commercial real estate guaranteed by SBA.............. --- 946 4,073 Non-real estate - commercial business................. 1,500 --- --- -------- -------- -------- Total purchased................................... 57,339 48,082 21,286 SALES AND REPAYMENTS: - -------------------- Real estate - one-to-four family...................... 2,310 2,414 --- Non-real estate - consumer............................ 176 1,791 --- -------- -------- -------- Total sales....................................... 2,486 4,205 --- Loans securitized and transferred to securities....... 15,441 --- --- -------- -------- -------- Transfers to loans held for sale...................... 1,407 --- --- -------- -------- -------- Principal repayments.................................. 58,262 39,215 39,419 -------- -------- -------- Total reductions.................................. 77,596 43,420 39,419 -------- -------- -------- Decrease in other items, net.......................... (2,990) (3,310) (4,242) -------- -------- -------- Net increase...................................... $ 33,527 45,232 24,740 -------- -------- -------- -------- -------- -------- MORTGAGE-BACKED AND RELATED SECURITIES Loans securitized and transferred to securities...... $15,441 --- --- PURCHASES: - --------- Mortgage-backed securities:(1) Adjustable-rate...................................... --- --- 20,297 Fixed-rate........................................... 7,266 10,139 17,562 CMOs and REMICs: Adjustable-rate...................................... 6,527 55,321 5,483 Fixed-rate........................................... 43,831 11,881 42,725 -------- -------- -------- Total Purchases................................... 57,624 77,341 86,067 -------- -------- -------- SALES: - ----- Mortgage-backed securities:(1) Adjustable-rate...................................... --- 23,073 --- Fixed-rate........................................... 24,786 11,953 8,373 CMOs and REMICs: Adjustable-rate...................................... 23,876 9,008 --- Fixed-rate........................................... 32,487 13,681 7,847 -------- -------- -------- Total Sales....................................... 81,149 57,715 16,220 -------- -------- -------- PRINCIPAL REPAYMENTS: - -------------------- Decrease in other items, net.......................... 28,915 4,440 45,355 -------- -------- -------- Net increase (decrease).............................. $(36,999) 15,186 24,492 -------- -------- -------- -------- -------- -------- (1) Consists of pass-through securities.
14 DELINQUENCIES AND NON-PERFORMING ASSETS DELINQUENCY PROCEDURES. When a borrower fails to make a required payment on a loan, HMN attempts to cure the delinquency by contacting the borrower. A late notice is sent on all loans over 16 days delinquent. Additional written and verbal contacts may be made with the borrower between 30 and 60 days after the due date. If the loan is contractually delinquent 90 days, HMN usually sends a 30-day demand letter to the borrower and, after the loan is contractually delinquent 120 days, institutes appropriate action to foreclose on the property. If foreclosed, the property is sold at a sheriff's sale and may be purchased by HMN. Delinquent consumer loans are generally handled in a similar manner. HMN's procedures for repossession and sale of consumer collateral are subject to various requirements under Minnesota consumer protection laws. Real estate acquired by HMN as a result of foreclosure or by deed in lieu of foreclosure is classified as real estate in judgement for six months to one year and thereafter as real estate owned until it is sold. When property is acquired or expected to be acquired by foreclosure or deed in lieu of foreclosure, it is recorded at the lower of cost or estimated fair value, less the estimated cost of disposition. After acquisition, all costs incurred in maintaining the property are expensed. Costs relating to the development and improvement of the property, however, are capitalized to the extent of fair value less disposition cost. The following table sets forth HMN's loan delinquencies by type, by amount and by percentage of type at December 31, 1996.
Loans Delinquent For: ------------------------------------------------- Total Delinquent 60-89 Days 90 Days and Over Loans ---------------------- -------------------------- -------------------------- Percent Percent Percent of Loan of Loan of Loan (DOLLARS IN THOUSANDS) Number Amount Category Number Amount Category Number Amount Category ------ ------ -------- ------ ------ -------- ------ ------ -------- One-to-four family real estate............ 8 $ 257 0.08% 6 $ 235 0.07% 14 $ 492 0.15% Multi-family........... --- --- --- --- --- --- --- --- --- Commercial............. --- --- --- 1 83 1.05 1 83 1.05 Construction or development........... --- --- --- --- --- --- --- --- --- Consumer............... 2 16 0.08 5 7 0.03 7 23 0.11 Commercial business.............. 1 43 1.83 1 13 0.55 2 56 2.39 ----- ----- ----- ------ ----- ------ Total.............. 11 $ 316 0.09% 13 $ 338 0.09% 24 $ 654 0.18% ----- ----- ----- ------ ----- ------ ----- ----- ----- ------ ----- ------
CLASSIFICATION OF ASSETS. Federal regulations require that each savings institution classify its own assets on a regular basis. In addition, in connection with examinations of savings institutions, OTS and FDIC examiners have authority to identify problem assets and, if appropriate, require them to be classified. There are three classifications for problem assets: Substandard, Doubtful and Loss. Substandard assets have one or more defined weaknesses and are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. Doubtful assets have the weaknesses of Substandard assets, with the additional characteristics that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable, and there is a high possibility of loss. An asset classified as Loss is considered uncollectible and of such little value that continuance as an asset on the balance sheet of the institution is not warranted. Assets classified as Substandard or Doubtful require the institution to establish prudent general allowances for loan losses. If an asset or portion thereof is classified as Loss, the institution must either establish specific allowances for loan losses in the amount of 100% of the portion of the asset classified as Loss, or charge off such amount. If an institution does not agree with an examiner's classification of an asset, it may appeal this determination to the District Director of the OTS. On the basis of management's review of its assets, at December 31, 1996, the Bank had classified a total of $493,000 of its loans and other assets as follows: 15
Commercial Real One-to-Four Construction or Estate and Commercial (DOLLARS IN THOUSANDS) Family Development Multi-Family Consumer Business ---------- --------------- -------------- -------- ---------- Substandard ............. $ 312 --- 83 26 71 Doubtful ................ --- --- --- --- --- Loss .................... --- --- --- 1 --- --- --- --- --- --- Total .............. $ 312 --- 83 27 71 --- --- --- --- ---
The Bank's classified assets consist of the non-performing loans and loans and other assets of concern discussed herein. As of the date hereof, these asset classifications are materially consistent with those of the OTS and FDIC. NON-PERFORMING ASSETS. Loans are reviewed quarterly and any loan whose collectibility is doubtful is placed on non-accrual status. Loans are placed on nonaccrual status when either principal or interest is 90 days or more past due, unless, in the judgment of management, the loan is well collateralized and in the process of collection. Interest accrued and unpaid at the time a loan is placed on non-accrual status is charged against interest income. Subsequent payments are either applied to the outstanding principal balance or recorded as interest income, depending on the assessment of the ultimate collectibility of the loan. Restructured loans include the Bank's troubled debt restructurings (which involved forgiving a portion of interest or principal on any loans or making loans at a rate materially less than the market rate). Foreclosed assets include assets acquired in settlement of loans. The following table sets forth the amounts and categories of non-performing assets in the Bank's portfolio.
December 31, -------------------------------------------------------------------- (DOLLARS IN THOUSANDS) 1996 1995 1994 1993 1992 ------ ------ ------ ------ ------ Non-accruing loans: Real estate: One-to-four family................. $ 235 196 178 80 524 Multi-family....................... --- --- --- --- --- Commercial real estate............. 83 85 --- --- --- Consumer........................... 7 32 57 58 81 Commercial business................ 13 128 --- --- --- --- --- --- --- --- Total............................ 338 441 235 138 605 --- --- --- --- --- Accruing loans delinquent 90 days or more: One-to-four family.................. --- --- --- 23 --- Restructured loans: Multi-family........................ --- 94 199 --- 280 Foreclosed assets: Real estate: One-to-four family................. 23 315 64 316 --- Commercial real estate............. --- --- --- 95 99 Construction or development........ --- --- --- --- 88 Consumer........................... --- --- --- 10 --- ------ ------ ------ ------ ------ Total............................ 23 315 64 421 187 ------ ------ ------ ------ ------ Total non-performing assets........... $ 361 850 498 582 1,072 ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ Total as a percentage of total assets............................... 0.07% 0.16% 0.10% 0.14% 0.26% Total non-performing loans............ $ 338 $ 535 $ 434 $ 161 $ 885 ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ Total as a percentage of total loans receivable, net................ 0.10% 0.17% 0.16% 0.07% 0.37% ------ ------ ------ ------ ------ ------ ------ ------ ------ ------
For the year ended December 31, 1996, gross interest income which would have been recorded had the non-accruing loans been current in accordance with their original terms amounted to $34,638. The amounts that were included in interest income on such loans in 1996 were $21,139. Total non-performing assets were $361,000 at December 31, 1996, a decrease of $489,000, compared to 16 $850,000 at December 31, 1995. The decrease in non-performing assets is the result of the sale of foreclosed assets of $315,000, the charge-off of $72,000 of commercial loans, and the normal inflow and outflow of delinquent loans caused by borrowers getting behind on their payments and then bringing the loans current again. Total non-performing assets were $850,000 at December 31, 1995, an increase of $352,000, compared to $498,000 at December 31, 1994. The increase was principally the result of foreclosing on $315,000 of one-to-four family real estate, troubled commercial business loans of $128,000, and $85,000 of troubled commercial real estate. OTHER LOANS OF CONCERN. In addition to the non-performing assets set forth in the table above, as of December 31, 1996 there were $132,000 loans with respect to which known information about the possible credit problems of the borrowers or the cash flows of the secured properties have caused management to have concerns as to the ability of the borrowers to comply with present loan repayment terms and which may result in the future inclusion of such items in the non-performing asset categories. Management has considered the Bank's non-performing and "of concern" assets in establishing its allowance for loan losses. ALLOWANCE FOR LOSSES ON LOANS. The following table sets forth an analysis of the Bank's allowance for loan losses for the year ended:
(DOLLARS IN THOUSANDS) 1996 1995 1994 1993 1992 ------ ------ ------ ------ ------ Balance at beginning of year .............. $ 2,191 1,893 1,489 831 883 CHARGE-OFFS Real estate: One-to-four family ...................... --- (1) (6) (1) (25) Multi-family ............................ (88) --- --- --- (185) Commercial real estate .................. --- --- --- --- (7) Construction or development ............. --- --- --- --- (70) Consumer ................................ (1) --- --- (1) (1) Commercial business ..................... (61) (1) --- --- --- -------- -------- ------- -------- -------- (150) (2) (6) (2) (288) -------- -------- ------- -------- -------- RECOVERIES Real estate: One-to-four family ...................... --- --- --- --- 2 Commercial real estate .................. --- --- --- --- --- Consumer ................................ --- --- --- --- 1 -------- -------- ------- -------- -------- --- --- --- --- 3 -------- -------- ------- -------- -------- Net charge-offs ........................... (150) (2) (6) (2) (285) Additions charged to operations ........... 300 300 410 660 233 -------- -------- ------- -------- -------- Balance at end of year .................... $2,341 2,191 1,893 1,489 831 -------- -------- ------- -------- -------- -------- -------- ------- -------- -------- Ratio of net charge-offs during the year to average loans outstanding during the year ..................................... 0.05% --- --- --- 0.12% -------- -------- ------- -------- -------- -------- -------- ------- -------- -------- Ratio of allowance for losses on loans to total non-performing loans, at end of year ..................................... 692.60% 409.13% 436.52% 924.84% 93.90% -------- -------- ------- -------- -------- -------- -------- ------- -------- --------
17 The distribution of the Bank's allowance for losses on loans at the dates indicated is summarized as follows:
December 31, ----------------------------------------------------------------------------- 1996 1995 1994 ------------ ------------ ------------ Percent Percent Percent of Loans of Loans of Loans in Each in Each in Each Category Category Category to Total to Total to Total (DOLLARS IN THOUSANDS) Amount Loans Amount Loans Amount Loans ------ ------ ------ ------- ------ ------- Real Estate: One-to-four family .......... $ 496 90.19% $ 452 90.62% $ 475 92.18% Multi-family ................ 8 0.08 21 0.11 21 0.14 Commercial real estate....... 113 2.22 125 2.71 128 1.80 Construction or development . 104 0.98 153 1.58 84 1.31 Consumer .................... 473 5.87 286 4.66 280 4.14 Commercial business ......... 29 0.66 37 0.32 27 0.43 Unallocated ................. 1,118 --- 1,117 --- 878 --- ------ ------ ------ ------ ------ ------ Total .................... $ 2,341 100.00% $ 2,191 100.00% $ 1,893 100.00% ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ December 31, ------------------------------------------------ 1993 1992 ------------ ------------ Percent Percent of Loans of Loans in Each in Each Category Category to Total to Total (DOLLARS IN THOUSANDS) Amount Loans Amount Loans ------ ----- ------ ------- Real Estate: One-to-four family .......... $ 374 92.18% $ 208 89.86% Multi-family ................ 10 0.14 18 0.28 Commercial real estate....... 140 1.80 198 2.61 Construction or development . 1 1.31 2 2.76 Consumer .................... 234 4.14 173 4.02 Commercial business ......... 30 0.43 32 0.47 Unallocated ................. 700 --- 200 --- ------ ------ ------ ------ Total .................... $ 1,489 100.00% $ 831 100.00% ------ ------ ------ ------ ------ ------ ------ ------
18 The allowance for losses on loans is established through a provision for losses on loans charged to earnings based on management's evaluation of the risk inherent in its entire loan portfolio and changes in the nature and volume of its loan activity. Such evaluation, which includes a review of all loans of which full collectibility may not be reasonably assured, considers specific occurrences, general and local economic conditions, loan portfolio composition, historical and local experience and other factors that warrant recognition in providing for an adequate allowance for loan losses. In determining the general reserves under these policies, historical charge-offs and recoveries, changes in the mix and levels of the various types of loans, the general level of non- performing assets and the anticipated net realizable values, the current loan portfolio and current economic conditions are considered. The Bank also requires additional reserves for all classified loans. While management believes that it uses the best information available to determine the allowance for losses on loans, unforeseen market conditions could result in adjustments to the allowance for losses on loans, and net earnings could be significantly affected, if circumstances differ substantially from the assumptions used in making the final determination. INVESTMENT ACTIVITIES HMN and the Bank utilize the available for sale securities portfolio in virtually all aspects of asset/liability management strategy. In making investment decisions, the Investment/Asset - Liability Committee considers, among other things, the yield and interest rate objectives, the credit risk position and the projected cash flow requirements. The Bank must maintain minimum levels of investments that qualify as liquid assets under OTS regulations. Liquidity may increase or decrease depending upon the availability of funds and comparative yields on investments in relation to the return on loans. Cash flow projections are regularly reviewed and updated to assure that adequate liquidity is maintained. At December 31, 1996, the Bank's liquidity ratio (liquid assets as a percentage of net withdrawable savings deposits and current borrowings) was 12.48%. The Bank's level of liquidity is a result of management's asset/liability strategy. See "Regulation - - Liquidity." SECURITIES. Federally chartered savings institutions have the authority to invest in various types of liquid assets, including United States Treasury obligations, securities of various federal agencies, certain certificates of deposit of insured banks and savings institutions, certain bankers' acceptances, repurchase agreements and federal funds. Subject to various restrictions, federally chartered savings institutions may also invest their assets in commercial paper, investment grade corporate debt securities and mutual funds whose assets conform to the investments that a federally chartered savings institution is otherwise authorized to make directly. The investment strategy of HMN and the Bank has been directed toward a mix of high-quality assets (primarily government and agency obligations) with short and intermediate terms to maturity. At December 31, 1996, HMN did not own any investment securities of a single issuer which exceeded 10% of HMN's stockholder's equity other than U.S. government or federal agency obligations. The Bank invests a portion of its liquid assets in interest-earning overnight deposits of the Federal Home Loan Bank ("FHLB") of Des Moines and various money market mutual funds. Other investments include high grade medium- term (up to three years) corporate debt securities, medium-term federal agency notes, and a variety of other types of mutual funds which invest in adjustable- rate, mortgage-backed securities, asset-backed securities, repurchase agreements and U.S. Treasury and agency obligations. HMN invests in the same type of investment securities as the Bank and also invests in taxable and tax exempt municipal obligations and corporate equities such as preferred and common stock. See Notes 4 and 5 of the Notes to Consolidated Financial Statements in the Annual Report for additional information regarding HMN's securities portfolio. On January 1, 1994, the Bank adopted Statement of Financial Accounting Standards No. 115, ACCOUNTING FOR CERTAIN INVESTMENTS IN DEBT AND EQUITY SECURITIES. See Note 2 of the Notes to Consolidated Financial Statements in the Annual Report for the impact of adopting the accounting standard. 19 The following table sets forth the composition of HMN's securities portfolio, excluding mortgage-backed and related securities, at the dates indicated.
December 31, --------------------------------------------------- 1996 ------------------------------------ Amortized Adjusted Market % of (DOLLARS IN THOUSANDS) Cost To Value Total ----- ----- ------ ----- Securities available for sale: U.S. government and agency obligations .......................... $ 29,600 (322) 29,278 49.93% Municipal obligations .............. --- --- --- --- Corporate debt ..................... 1,091 1 1,092 1.86 Corporate equity(1) ................ 7,796 386 8,182 13.96 Stock of federal agencies(1)........ 3,874 49 3,923 6.69 Securities held to maturity: U.S. agency obligations ............ --- --- --- Municipal obligations .............. --- --- --- Corporate debt ..................... 1,000 1,001 1.71 ---------- --------- ------- Subtotal ......................... 43,361 43,476 74.15 FHLB stock ........................... 5,434 5,434 9.27 ---------- --------- ------- Total investment securities and FHLB stock .................. 48,795 48,910 83.42 ---------- --------- ------- Average remaining life of investment securities excluding FHLB stock ...... 3.4 years Other Interest-Earning Assets: Cash equivalents ................... 9,718 9,718 16.58 Total ............................ $ 58,513 58,628 100.00% ---------- --------- ------- ---------- --------- ------- Average remaining life or term to repricing of investment securities and other interest-earning assets, excluding FHLB stock ................ 2.8 years December 31, --------------------------------------------------- 1995 --------------------------------- Amortized Adjusted Market % of (DOLLARS IN THOUSANDS) Cost To Value Total ----- ----- ------ ----- Securities available for sale: U.S. government and agency obligations .......................... $ 21,896 (566) 21,330 50.58% Municipal obligations .............. 1,600 1 1,601 3.80 Corporate debt ..................... 851 9 860 2.04 Corporate equity(1) ................ 6,898 174 7,072 16.77 Stock of federal agencies(1)........ 1,004 37 1,041 2.47 Securities held to maturity: U.S. agency obligations ............ --- --- --- Municipal obligations .............. 228 229 0.54 Corporate debt ..................... 2,999 2,995 7.10 ---------- --------- ------- Subtotal ......................... 35,476 35,128 83.30 FHLB stock ........................... 3,802 3,802 9.02 Total investment securities and FHLB stock .................. 39,278 38,930 92.32 ---------- --------- ------- Average remaining life of investment securities excluding FHLB stock ...... 3.0 years Other Interest-Earning Assets: Cash equivalents ................... 3,238 3,238 7.68 Total ........................... $42,516 42,168 100.00% ---------- --------- ------- ---------- --------- ------- Average remaining life or term to repricing of investment securities and other interest-earning assets, excluding FHLB stock ................ 2.7 years December 31, --------------------------------------------------- 1994 --------------------------------- (DOLLARS IN THOUSANDS) Amortized Adjusted Market % of Cost To Value Total ----- ----- ----- ----- Securities available for sale: U.S. government and agency obligations .......................... $ 23,823 (2,266) $ 21,557 43.20% Municipal obligations .............. 3,001 (36) 2,965 5.94 Corporate debt ..................... 701 (10) 691 1.38 Corporate equity(1) ................ 5,610 (600) 5,010 10.04 Stock of federal agencies(1)........ 1,004 (20) 984 1.97 Securities held to maturity: U.S. agency obligations ............ 2,000 1,945 3.90 Municipal obligations .............. --- --- --- Corporate debt ..................... 6,008 5,875 11.77 ---------- --------- ------- Subtotal ......................... 42,147 39,027 78.20 FHLB stock ........................... 3,039 3,039 6.09 ---------- --------- ------- and FHLB stock .................. 45,186 42,066 84.29 ---------- --------- ------- Average remaining life of investment securities excluding FHLB stock ...... 2.4 years Other Interest-Earning Assets: Cash equivalents ................... 7,842 7,842 15.71% Total ........................... $ 53,028 49,908 100.00% ---------- --------- ------- ---------- --------- ------- Average remaining life or term to repricing of investment securities and other interest-earning assets, excluding FHLB stock ................ 2.0 years
(1)Average life assigned to corporate equity holdings and stock of federal agencies is five years. 20 The composition and maturities of the securities portfolio, excluding FHLB stock, mortgage-backed and other related securities, are indicated in the following table.
December 31, 1996 -------------------------------------------------------------------------- Less Than 1 to 5 5 to 10 No Stated Total 1 Year Years Years Maturity Securities ---------- ---------- ---------- ---------- --------------------------------- Amortized Amortized Amortized Amortized Amortized Adjusted Market (DOLLARS IN THOUSANDS) Cost Cost Cost Cost Cost To Value --------- ---------- ---------- ----------- --------- --------- -------- Securities available for sale: U.S. government securities... $ 2,150 27,450 --- --- 29,600 (322) 29,278 Corporate debt............... 200 476 415 --- 1,091 1 1,092 Corporate equity............. --- --- --- 7,796 7,796 386 8,182 Stock of federal agencies.... --- --- --- 3,874 3,874 49 3,923 Securities held to maturity: Corporate debt............... 1,000 --- --- --- 1,000 1 1,001 ----- ----- ---- ----- ------ ------ Total stock.................... $ 3,350 27,926 415 11,670 43,361 43,476 ----- ------ ----- ------ ------ ------ ----- ------ ----- ------ ------ ------ Weighted average yield......... 5.93% 6.00% 9.02% 5.92% 6.00% ---- ---- ---- ---- ---- ---- ---- ---- ---- ----
21 MORTGAGE-BACKED AND RELATED SECURITIES. In order to supplement loan production (particularly those of interest rate sensitive loans) and achieve its asset/liability management goals, HMN invests in mortgage-backed and related securities. All of the mortgage-backed and related securities owned by HMN are issued, insured or guaranteed either directly or indirectly by a federal agency or are rated "AA" or higher. At December 31, 1996, HMN had $135.2 million of mortgage-backed and related securities (including $133.4 million securities available for sale). At December 31, 1996 HMN had $43.5 million invested in CMOs which have floating interest rates that change either monthly or quarterly compared to $69.8 million at December 31, 1995. HMN decreased its investment in floating rate CMOs in order to invest in mortgage loans and fund the purchase of HMN common stock. The projected weighted average life of the $102.4 million fixed rate CMO and mortgage-backed security portfolio is approximately 4.0 years using median prepayment speeds projected by the Bloomberg security system. The contractual maturities of the mortgage-backed and related securities portfolio without any prepayment assumptions at December 31, 1996 is as follows:
December 31, 1996 5 Years 5 to 10 10 to 20 Over 20 Balance (DOLLARS IN THOUSANDS) or Less Years Years Years Outstanding ------- ------- -------- ------- ------------- Securities available for sale: Federal Home Loan Mortgage Corporation.. $ --- 315 1,081 412 1,808 Federal National Mortgage Association... --- --- 462 522 984 Collateralized Mortgage Obligations..... 2,625 3,483 26,380 98,075 130,563 Securities held to maturity: Federal Home Loan Mortgage Corporation.. 467 194 690 53 1,404 Federal National Mortgage Association... 60 98 --- --- 158 Other mortgage-backed securities........ --- --- --- 244 244 ------- ------ ------- ------- ------- Total................................ $ 3,152 4,090 28,613 99,306 135,161 ------- ------ ------- ------- ------- ------- ------ ------- ------- ------- Weighted average yield.................. 6.72% 7.98% 7.11% 6.93% 6.99% ---- ---- ---- ---- ---- ---- ---- ---- ---- ----
At December 31, 1996, HMN did not have any non-agency mortgage-backed or related securities in excess of 10% of its stockholders' equity, except for an $11.9 million collateralized mortgage obligation issued by Bear Stearns with an AAA rating by Moody's. CMOs are securities derived by reallocating the cash flows from mortgage- backed securities or pools of mortgage loans in order to create multiple classes, or tranches, of securities with coupon rates and average lives that differ from the underlying collateral as a whole. The terms to maturity of any particular tranche is dependent upon the prepayment speed of the underlying collateral as well as the structure of the particular CMO. Although a significant proportion of HMN's CMOs are in tranches which have been structured (through the use of cash flow priority and "support" tranches) to give somewhat more predictable cash flows, the cash flow and hence the value of CMOs is subject to change. To assess price volatility, the Federal Financial Institutions Examination Council ("FFIEC") adopted a policy in 1992 which requires an annual "stress" test of mortgage derivative securities. This policy, which has been adopted by the OTS, requires the Bank to annually test its CMOs and other mortgage-related securities to determine whether they are "high-risk" or "nonhigh-risk securities". At December 31, 1996, the Bank had $17.4 million of CMO's which were classified as high-risk securities under the OTS guidelines. 22 Mortgage-backed and related securities can serve as collateral for borrowings and, through sales and repayments, as a source of liquidity. In addition, mortgage-backed and related securities available for sale can be sold to respond to changes in economic conditions. For information regarding the carrying and market values of HMN's mortgage-backed and related securities portfolio, see Notes 4 and 5 of the Notes to Consolidated Financial Statements in the Annual Report. SOURCES OF FUNDS GENERAL. The Bank's primary sources of funds are deposits, payments (including prepayments) of loan principal, interest earned on loans and securities, repayments of securities, borrowings and other funds provided from operations. DEPOSITS. The Bank offers a variety of deposit accounts having a wide range of interest rates and terms. The Bank's deposits consist of passbook, NOW, money market, non-interest bearing checking and certificate accounts (including individual retirement accounts). The Bank relies primarily on competitive pricing policies and customer service to attract and retain these deposits. The variety of deposit accounts offered by the Bank has allowed it to be competitive in obtaining funds and to respond with flexibility to changes in consumer demand. As customers have become more interest rate conscious, the Bank has become more susceptible to short-term fluctuations in deposit flows. The Bank manages the pricing of its deposits in keeping with its asset/liability management, profitability and growth objectives. Based on its experience, the Bank believes that its passbook and NOW accounts are relatively stable sources of deposits. However, the ability of the Bank to attract and maintain certificate deposits, and the rates paid on these deposits, has been and will continue to be significantly affected by market conditions. The following table sets forth the savings flows at the Bank during the periods indicated.
Year Ended December 31, -------------------------------------- (DOLLARS IN THOUSANDS) 1996 1995 1994 ------- -------- -------- Opening balance................ $ 373,539 350,575 353,581 Deposits....................... 351,330 339,781 384,406 Withdrawals.................... 378,009 331,481 400,090 Interest credited.............. 15,617 14,664 12,678 ------- ------- ------- Ending balance............... 362,477 373,539 350,575 ------- ------- ------- Net increase (decrease)........ $ (11,062) 22,964 (3,006) -------- ------- ------- -------- ------- ------- Percent increase (decrease).... (2.96)% 6.55% (0.85)% -------- ------- ------- -------- ------- -------
23 The following table sets forth the dollar amount of savings deposits in the various types of deposit programs offered by the Bank as of December 31:
1996 1995 1994 -------------------- -------------------- -------------------- Percent Percent Percent (DOLLARS IN THOUSANDS) Amount of Total Amount of Total Amount of Total TRANSACTIONS AND SAVINGS DEPOSITS(1): -------- -------- -------- -------- -------- -------- Non-interest checking . . . . . . . . . $ 2,389 0.66% $ 2,505 0.67% $ 1,767 0.50% NOW Accounts - 2.01%(2) . . . . . . . . 17,589 4.85 15,997 4.28 14,456 4.12 Passbook Accounts - 2.50% . . . . . . . 30,070 8.29 29,384 7.86 32,094 9.15 Money Market Accounts - 2.83% . . . . . 16,533 4.56 18,472 4.95 21,984 6.28 --------- --------- --------- --------- --------- -------- Total Non-Certificates . . . . . . . $ 66,581 18.36% $ 66,358 17.76% $ 70,301 20.05% --------- --------- --------- --------- --------- --------
CERTIFICATES: 3.00 - 3.99% . . . . . . . . . . . . $ 425 0.12% $ 0 0.00% $ 19,431 5.54% 4.00 - 4.99% . . . . . . . . . . . . 22,553 6.22 22,440 6.01 72,449 20.67 5.00 - 5.99% . . . . . . . . . . . . 168,040 46.36 152,971 40.95 111,940 31.93 6.00 - 6.99% . . . . . . . . . . . . 76,704 21.16 89,754 24.03 40,597 11.58 7.00 - 7.99% . . . . . . . . . . . . 28,077 7.75 40,721 10.90 21,700 6.19 8.00 - 8.99% . . . . . . . . . . . . 96 0.03 1,294 0.35 12,061 3.44 9.00 - 9.99% . . . . . . . . . . . . 1 --- 1 0.00 462 0.13 10.00% and over . . . . . . . . . . . --- --- 0 0.00 1,634 0.47 --------- --------- --------- --------- --------- -------- Total Certificates . . . . . . . . . 295,896 81.64 307,181 82.24 280,274 79.95 --------- --------- --------- --------- --------- -------- Total Deposits . . . . . . . . . . $ 362,477 100.00% $ 373,539 100.00% $ 350,575 100.00 --------- --------- --------- --------- --------- --------% --------- --------- --------- --------- --------- --------
- ----------------------- (1)Reflects rates paid on transaction and savings deposits at December 31, 1996. (2)The rate on NOW Accounts for 1995 and 1994 was 2.22%. 24 The following table shows rate and maturity information for the Bank's certificates of deposit as of December 31, 1996.
3.00- 4.00- 5.00- 6.00- (DOLLARS IN THOUSANDS) 3.99% 4.99% 5.99% 6.99% Certificate accounts maturing in quarter ----- ----- ----- ----- ending: March 31, 1996 . . . . . . . . . . . . $ 413 12,324 30,530 7,446 June 30, 1996 . . . . . . . . . . . . . 12 6,593 28,824 6,653 September 30, 1996 . . . . . . . . . . --- 1,406 23,632 7,633 December 31, 1996 . . . . . . . . . . . --- 1,635 14,098 4,257 March 31, 1997 . . . . . . . . . . . . --- 403 13,262 7,952 June 30, 1997 . . . . . . . . . . . . . --- 78 11,894 11,956 September 30, 1997 . . . . . . . . . . --- 32 10,187 9,227 December 31, 1997 . . . . . . . . . . . --- 55 10,568 1,044 March 31, 1998 . . . . . . . . . . . . --- --- 8,426 2,382 June 30, 1998 . . . . . . . . . . . . . --- 27 4,758 2,351 September 30, 1998 . . . . . . . . . . --- --- 3,220 2,221 December 31, 1998 . . . . . . . . . . . --- --- 813 514 Thereafter . . . . . . . . . . . . . . --- --- 7,828 13,068 ------- ------- ------- ------- Total . . . . . . . . . . . . . . . $ 425 22,553 168,040 76,704 ------- ------- ------- ------- ------- ------- ------- ------- Percent of total . . . . . . . . . . 0.14% 7.62% 56.80% 25.92% ------ ------ ------ ------ ------ ------ ------ ------ 7.00- 8.00- 9.00- Percent (DOLLARS IN THOUSANDS) 7.99% 8.99% 9.99% Total of Total Certificate accounts maturing in quarter ----- ----- ----- ----- -------- ending: March 31, 1996 . . . . . . . . . . . . 455 --- --- 51,168 17.28 June 30, 1996 . . . . . . . . . . . . . 277 --- --- 42,359 14.32 September 30, 1996 . . . . . . . . . . 5,386 15 --- 38,072 12.87 December 31, 1996 . . . . . . . . . . . 12,474 --- --- 32,464 10.97 March 31, 1997 . . . . . . . . . . . . 4,734 1 --- 26,352 8.91 June 30, 1997 . . . . . . . . . . . . . 1,801 5 --- 25,734 8.70 September 30, 1997 . . . . . . . . . . 1,322 16 --- 20,784 7.02 December 31, 1997 . . . . . . . . . . . 1,357 20 --- 13,044 4.41 March 31, 1998 . . . . . . . . . . . . 150 27 --- 10,985 3.71 June 30, 1998 . . . . . . . . . . . . . 93 12 1 7,242 2.45 September 30, 1998 . . . . . . . . . . 28 --- --- 5,469 1.85 December 31, 1998 . . . . . . . . . . . --- --- --- 1,327 0.45 Thereafter . . . . . . . . . . . . . . --- --- --- 20,896 7.06 ------- ------- ------- ------- ------- Total . . . . . . . . . . . . . . . 28,077 96 1 295,896 100.00% ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- Percent of total . . . . . . . . . . 9.49% 0.03% 0.00% 100.00% ------ ----- ------ ------ ------ ----- ------ ------
25 The following table indicates the amount of the Bank's certificates of deposit and other deposits by time remaining until maturity as of December 31, 1996.
Maturity -------------------------- Over Over 3 Months 3 to 6 6 to 12 Over or Less Months Months 12 months Total ------- ------ ------- --------- ----- (DOLLARS IN THOUSANDS) Certificates of deposit less than $100,000 . . . . . . . . . . $ 39,365 36,325 62,112 122,832 260,634 Certificates of deposit of $100,000 or more . . . . . . . . . 2,571 1,953 6,241 7,498 18,263 Public funds(1) . . . . . . . . . . 9,232 4,082 2,185 1,500 16,999 ------ ------ ------ ------- ------- Total certificates of deposit . . . . . . . . . . . . $ 51,168 42,360 70,538 131,830 295,896 ------ ------ ------ ------- ------- ------ ------ ------ ------- -------
- --------------- (1)Deposits from governmental and other public entities. For additional information regarding the composition of the Bank's deposits, see Note 11 of the Notes to Consolidated Financial Statements in the Annual Report. For additional information on certificate maturities and the impact on HMN's liquidity see Liquidity Management on page 21 of the Annual Report. BORROWINGS. The Bank's other available sources of funds include advances from the Federal Home Loan Bank ("FHLB") of Des Moines and other borrowings. As a member of the FHLB of Des Moines, the Bank is required to own capital stock in the FHLB of Des Moines and is authorized to apply for advances from the FHLB of Des Moines. Each FHLB credit program has its own interest rate, which may be fixed or variable, and range of maturities. The FHLB of Des Moines may prescribe the acceptable uses for these advances, as well as limitations on the size of the advances and repayment provisions. Consistent with its asset/liability management strategy, the Bank has utilized FHLB advances from time to time to extend the term to maturity of its liabilities. Also, the Bank has used FHLB borrowings to fund loan demand and other investment opportunities and to offset deposit outflows. At December 31, 1996, the Bank had $106.1 million of FHLB advances outstanding. On such date, the Bank had a collateral pledge arrangement with the FHLB of Des Moines pursuant to which the Bank may borrow up to an additional $11.5 million for liquidity purposes. See "Financial Review - Federal Home Loan Bank Advances" and Note 12 of the Notes to Consolidated Financial Statements in the Annual Report. The following table sets forth the maximum month-end balance and average balance of FHLB advances and other borrowings for the periods indicated.
Year Ended December 31, ---------------------------- 1996 1995 1994 -------- -------- -------- (DOLLARS IN THOUSANDS) MAXIMUM BALANCE: FHLB advances . . . . . . . . . . . . . . . . . . . . . . . .$ 106,436 74,534 52,343 FHLB short-term borrowings and open line of credit . . . . . 64,429 42,429 7,329 AVERAGE BALANCE: FHLB advances . . . . . . . . . . . . . . . . . . . . . . . . 89,656 65,069 40,121 FHLB short-term borrowings . . . . . . . . . . . . . . . . . 47,949 20,812 2,719
The following table sets forth certain information as to the Bank's FHLB advances at the dates indicated. 26
December 31, ------------------------------- 1996 1995 1994 -------- -------- -------- (DOLLARS IN THOUSANDS) FHLB short-term borrowings and open line of credit . . . . . . . . $ 46,429 33,429 6,429 Weighted average interest rate of FHLB short-term borrowings and open line of credit . . . . . . . . 5.52% 6.05% 5.75%
SERVICE CORPORATIONS OF THE BANK As a federally chartered savings bank, the Bank is permitted by OTS regulations to invest up to 2% of its assets in the stock of, or loans to, service corporation subsidiaries, and may invest an additional 1% of its assets in service corporations where such additional funds are used for inner-city or community development purposes. In addition to investments in service corporations, federal institutions are permitted to invest an unlimited amount in operating subsidiaries engaged solely in activities which a federal savings bank may engage in directly. Osterud Insurance Agency, Inc. ("OIAI"), a Minnesota corporation, was organized in 1983. OIAI operated as an insurance agency until 1986 when its assets were sold. OIAI remained inactive until 1993 when it began offering credit life insurance, annuity products and mutual fund products to the Bank's customers and others. At December 31, 1996, the Bank's liability related to OIAI was $32,700. OIAI recorded a net loss of $6,560 for the year ended December 31, 1996. COMPETITION The Bank faces strong competition both in originating real estate loans and in attracting deposits. Competition in originating loans comes primarily from mortgage bankers, commercial banks, credit unions and other savings institutions, which also make loans secured by real estate located in the Bank's market area. The Bank competes for loans principally on the basis of the interest rates and loan fees it charges, the types of loans it originates and the quality of services it provides to borrowers. Competition for those deposits is principally from money market and mutual funds, securities firms, commercial banks and other savings institutions located in the same communities. The ability of the Bank to attract and retain deposits depends on its ability to provide an investment opportunity that satisfies the requirements of investors as to rate of return, liquidity, risk, convenient locations and other factors. The Bank competes for these deposits by offering a variety of deposit accounts at competitive rates, convenient business hours and a customer oriented staff. Based upon deposits at June 30, 1994, the latest date such information was available, Home Federal's share of deposits held by thrifts, commercial banks and credit unions in Fillmore, Freeborn, Houston, Mower, Olmsted and Winona Counties, Minnesota was 21.9%, 17.1%, 9.3%, 17.4%, 6.3% and 3.8%, respectively. EMPLOYEES At December 31, 1996, HMN had a total of 109 full-time equivalent employees. None of the employees of HMN or its subsidiaries are represented by any collective bargaining unit. Management considers its employee relations to be good. EXECUTIVE OFFICERS OF THE REGISTRANT WHO ARE NOT DIRECTORS Officers are elected annually by the Board of Directors of HMN and the Bank. The business experience of each executive officer of HMN and the Bank who is not also a director of HMN is set forth below unless otherwise 27 indicated. Such individuals have held their current positions for at least five years. DWAIN C. JORGENSEN. Mr. Jorgensen, age 48, is Vice President, Controller and Chief Accounting Officer of HMN and the Bank. Mr. Jorgensen has held such positions with the Bank since 1989. From 1983 to 1989, Mr. Jorgensen was an Assistant Vice President and Operations Officer with the Bank. SUSAN K. KOLLING. Mrs. Kolling, age 45, is Senior Vice President of HMN and is Senior Vice President of Marketing of the Bank, a position she has held since 1995. Prior to such time, she served as Vice President from 1992 through 1994 and as a Loan Officer from 1981 through 1991. Mrs. Kolling began her career with the Bank in 1969. TIMOTHY P. JOHNSON. Mr. Johnson, age 44, is Treasurer of HMN and the Bank, a position he has held since 1992. From 1983 to 1992, Mr. Johnson was Chief Financial Officer of St. Louis Bank for Savings, Duluth, Minnesota. ROXANNE M. HELLICKSON. Mrs. Hellickson, age 36, is Vice President/Loan Administrator and Corporate Secretary of HMN and the Bank. She served as Assistant Secretary of the Bank from 1992 to 1994 and was secretary to the Bank's President and a loan officer from 1989 to 1992. Mrs. Hellickson began her career with the Bank in 1979. REGULATION GENERAL The Bank is a federally chartered savings bank, the deposits of which are federally insured and backed by the full faith and credit of the United States Government. Accordingly, the Bank is subject to broad federal regulation and oversight extending to all its operations. The Bank is a member of the FHLB of Des Moines and is subject to certain limited regulation by the Federal Reserve Board. The Bank is a member of the Savings Association Insurance Fund ("SAIF") and the deposits of the Bank are insured by the FDIC. As a result, the FDIC has certain regulatory and examination authority over the Bank. As the savings and loan holding company of the Bank, HMN also is subject to federal regulation and oversight. The purpose of the regulation of HMN and other holding companies is to protect subsidiary savings associations. Certain of these regulatory requirements and restrictions are discussed below. FEDERAL REGULATION OF SAVINGS ASSOCIATIONS The OTS has extensive authority over the operations of savings associations. As part of this authority, the Bank is required to file periodic reports with the OTS and is subject to periodic examinations by the OTS and the FDIC. The last regular OTS examination of the Bank was dated April 1996. The Bank has not been scheduled for an examination in 1997. When these examinations are conducted by the OTS and the FDIC, the examiners may require the Bank to provide for higher general or specific loan loss reserves. Financial institutions in various regions of the United States have been called upon by examiners to write down assets and to establish increased levels of reserves, primarily as a result of perceived weaknesses in real estate values and a more restrictive regulatory climate. The OTS has established a schedule for the assessment of fees upon all savings associations to fund the operations of the OTS. The general assessment, to be paid on a semi-annual basis, is computed upon the savings association's total assets as reported in the association's latest quarterly thrift financial report. Savings associations (unlike the Bank) that are classified as "troubled" (I.E., having a supervisory rating of "4" or "5" or subject to a conservatorship) are required to pay a 50% premium over the standard assessment. The Bank's OTS assessment for the year ended December 31, 1996 was approximately $118,000. 28 The OTS also has extensive enforcement authority over all savings institutions and their holding companies, including the Bank and HMN. This enforcement authority includes, among other things, the ability to assess civil money penalties, to issue cease-and-desist or removal orders and to initiate injunctive actions. In general, these enforcement actions may be initiated for violations of laws and regulations and unsafe or unsound practices. Other actions or inactions may provide the basis for enforcement action, including misleading or untimely reports filed with the OTS. Except under certain circumstances, public disclosure of final enforcement actions by the OTS is required. In addition, the investment, lending and branching authority of the Bank is prescribed by federal laws and regulations, and it is prohibited from engaging in any activities not permitted by such laws and regulations. For instance, no savings institution may invest in non-investment grade corporate debt securities. In addition, unless approved by the OTS, the permissible level of investment by federal associations in loans secured by non-residential real property may not exceed 400% of regulatory capital. Federal savings associations are also generally authorized to branch nationwide. The Bank is in compliance with the noted restrictions. The Bank's general permissible lending limit for loans-to-one-borrower is equal to the greater of $500,000 or 15% of unimpaired capital and surplus (except for loans fully secured by certain readily marketable collateral, in which case this limit is increased to 25% of unimpaired capital and surplus). At December 31, 1996, the Bank's lending limit under this restriction was $9.1 million. The Bank is in compliance with the loans-to-one borrower limitation. In December 1991, the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") was enacted into law. FDICIA provides for, among other things, the recapitalization of the Bank Insurance Fund; adoption of safety and soundness standards; enhanced federal supervision of depository institutions, including greater authority for the appointment of a conservator or receiver for undercapitalized institutions; the establishment of risk-based deposit insurance premiums; liberalization of the qualified thrift lender test; greater restrictions on transactions with affiliates; and mandated consumer protection disclosures with respect to deposit accounts. See "- Insurance of Accounts and Regulation by the FDIC," "- Regulatory Capital Requirements" and "- Qualified Thrift Lender Test." The OTS, as well as the other federal banking agencies, have issued proposed safety and soundness standards on matters such as loan underwriting and documentation, internal controls and audit systems, interest rate risk exposure, compensation and other employee benefits. The proposal also establishes the maximum ratio of classified assets to total capital (which for this purpose includes loss allowances exceeding the amount includable for regulatory capital purposes) at 100% and the minimum level of earnings sufficient to absorb losses without impairing capital. Earnings will be sufficient if the net income over the last four quarters is assumed to continue over the next four quarters and the institution would otherwise remain in capital compliance. Any institution which fails to comply with these standards must submit a compliance plan. A failure to submit a plan or to comply with an approved plan will subject the institution to further enforcement action. The proposal also requires savings and loan holding companies to ensure that transactions and relationships with their subsidiary savings associations do not have a detrimental effect on the safe and sound operation of the association. No assurance can be given as to the final form of the proposed regulations. INSURANCE OF ACCOUNTS AND REGULATION BY THE FDIC The Bank is a member of the SAIF, which is administered by the FDIC. Savings deposits are insured up to applicable limits by the FDIC and such insurance is backed by the full faith and credit of the United States Government. As insurer, the FDIC imposes deposit insurance premiums and is authorized to conduct examinations of and to require reporting by FDIC-insured institutions. It also may prohibit any FDIC-insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious risk to the FDIC. The FDIC also has the authority to initiate enforcement actions against savings associations, after giving the OTS an opportunity to take such action, and may terminate the deposit insurance if it determines that the institution has 29 engaged or is engaging in unsafe or unsound practices, or is in an unsafe or unsound condition. FDICIA also requires the FDIC to implement a risk-based deposit insurance assessment system. Pursuant to this requirement, the FDIC adopted a transitional risk-based assessment system, effective January 1, 1993, under which all insured depository institutions are placed into one of nine categories and assessed insurance premiums, ranging from .23% to .31% of deposits, based upon their level of capital and supervisory evaluation. The permanent system, adopted in June 1993 and effective January 1, 1994, continued the risk classification system established under the transitional rule. Under the system, institutions classified as well capitalized (I.E., a core capital ratio of at least 5%, a ratio of Tier 1 or core capital to risk-weighted assets ("Tier 1 risk-based capital") of at least 6% and a risk-based capital ratio of at least 10%) and considered healthy would pay the lowest premium while institutions that are less than adequately capitalized (I.E., core and Tier 1 risk-based capital ratios of less than 4% or a risk-based capital ratio of less than 8%) and considered of substantial supervisory concern would pay the highest premium. Risk classification of all insured institutions will be made by the FDIC for each semi-annual assessment period. The FDIC is authorized to increase assessment rates, on a semi-annual basis, if it determines that the reserve ratio of the SAIF will be less than the designated reserve ratio of 1.25% of SAIF insured deposits. In setting these increased assessments, the FDIC must seek to restore the reserve ratio to that designated reserve level, or such higher reserve ratio as established by the FDIC. In addition, under FDICIA, the FDIC may impose special assessments on SAIF members to repay amounts borrowed from the United States Treasury or for any other reason deemed necessary by the FDIC. The Deposit Insurance Fund Act of 1996 (DIFA) was enacted on September 30, 1996. DIFA addressed the inadequate funding of the (SAIF). In order to recapitalize the SAIF, DIFA imposed a one-time assessment on all thrift institutions. The Bank's assessment was a pretax charge of $2,351,563 and was recognized in the third quarter of 1996. DIFA also addressed the funding for the Financing Corp. (FICO) bonds. Thrifts will pay 6.4 basis points per $100 of deposits from January 1, 1997 to December 31, 1999. From January 1, 2000 until the FICO bonds are retired in 2019, the estimated assessment to retire the FICO bonds is expected to be 2.5 basis points per $100 of deposits. DIFA proposed that the Bank Insurance Fund (BIF) and SAIF be merged on January 1, 1999, provided no insurance depository institution is a savings association on that date. DIFA also directed the Secretary of the Treasury to present recommendations to Congress for establishment of a common depository institution charter by March 31, 1997. At this time, HMN does not know what effect, if any, the proposed legislation or charter revisions will have on future operations. REGULATORY CAPITAL REQUIREMENTS Federally insured savings associations, such as the Bank, are required to maintain a minimum level of regulatory capital. The OTS has established capital standards, including a tangible capital requirement, a leverage ratio (or core capital) requirement and a risk-based capital requirement applicable to such savings associations. These capital requirements must be generally as stringent as the comparable capital requirements for national banks. The OTS is also authorized to impose capital requirements in excess of these standards on individual associations on a case-by-case basis. The capital regulations require tangible capital of at least 1.5% of adjusted total assets (as defined by regulation). Tangible capital generally includes common stockholders' equity and retained earnings, and certain noncumulative perpetual preferred stock. In addition, all intangible assets, other than a limited amount of purchased mortgage servicing rights, must be deducted from tangible capital. At December 31, 1996, the Bank had $289,000 of mortgage servicing rights which were required to be deducted from tangible capital. 30 The OTS regulations establish special capitalization requirements for savings associations that own subsidiaries. Under these regulations certain subsidiaries are consolidated for capital purposes and others are excluded from assets and capital. In determining compliance with the capital requirements, all subsidiaries engaged solely in activities permissible for national banks or engaged in certain other activities solely as agent for its customers are "includable" subsidiaries that are consolidated for capital purposes in proportion to the association's level of ownership, including the assets of includable subsidiaries in which the association has a minority interest that is not consolidated for GAAP purposes. For excludable subsidiaries the debt and equity investments in such subsidiaries are deducted from assets and capital, with a five-year transition period beginning on July 1, 1990, for investments made before April 12, 1989. The subsidiary of the Bank is an includable subsidiary. At December 31, 1996, the Bank had tangible capital of $61.9 million, or 11.5% of adjusted total assets, which is $53.9 million above the minimum requirement of 1.5% of adjusted total assets in effect on that date. The capital standards also require core capital equal to at least 3% of adjusted total assets (as defined by regulation). Core capital generally consists of tangible capital plus certain intangible assets, including supervisory goodwill (which is phased-out over a five-year period) a limited amount of purchased credit card relationships. As a result of the prompt corrective action provisions of FDICIA discussed below, however, a savings association must maintain a core capital ratio of at least 4% to be considered adequately capitalized unless its supervisory condition is such to allow it to maintain a 3% ratio. As required by federal law, the OTS has proposed a rule revising its minimum core capital requirement to be no less stringent than that imposed on national banks. The OTS has proposed that only those savings associations rated a composite one (the highest rating) under the safety and soundness rating system for savings associations will be permitted to operate at or near the regulatory minimum leverage ratio of 3%. All other savings associations will be required to maintain a minimum leverage ratio of 4% to 5%. The OTS will assess each individual savings association through the supervisory process on a case- by-case basis to determine the applicable requirement. No assurance can be given as to the final form of any such regulation, the date of its effectiveness or the requirement applicable to the Bank. At December 31, 1996, the Bank had core capital equal to $61.9 million, or 11.5%, of adjusted total assets, which is $45.8 million above the minimum leverage ratio requirement of 3% as in effect on that date. The OTS risk-based requirement requires savings associations to have total capital of at least 8% of risk-weighted assets. Total capital consists of core capital, as defined above, and supplementary capital. Supplementary capital consists of certain permanent and maturing capital instruments that do not qualify as core capital and general valuation loan and lease loss allowances up to a maximum of 1.25% of risk-weighted assets. Supplementary capital may be used to satisfy the risk-based requirement only to the extent of core capital. At December 31, 1996, the Bank had $2.3 million of general loss reserves, which were included in capital. Certain exclusions from capital and assets are required to be made for the purpose of calculating total capital, in addition to the adjustments required for calculating core capital. Such exclusions consist of equity investments (as defined by regulation) and that portion of land loans and nonresidential construction loans in excess of an 80% loan-to-value ratio and reciprocal holdings of qualifying capital instruments. The Bank had no such exclusions from capital and assets at December 31, 1996. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet items, will be multiplied by a risk weight, ranging from 0% to 100%, based on the risk inherent in the type of asset. For example, the OTS has assigned a risk weight of 50% for prudently underwritten permanent one-to-four family first lien mortgage loans not more than 90 days delinquent and having a loan to value ratio of not more than 80% at origination unless insured to such ratio by an insurer approved by the FNMA or the FHLMC. 31 On December 31, 1996, the Bank had total "risk-based" capital of $64.3 million (including $61.9 million in core capital and $2.3 million in qualifying supplementary capital) and risk-weighted assets of $234.5 million, or total capital of 27.4% of risk-weighted assets. This amount was $45.6 million above the 8% requirement in effect on that date. Under FDICIA, all the federal banking agencies, including the OTS, must revise their risk-based capital requirements to ensure that such requirements account for interest rate risk, concentration of credit risk and the risks of non-traditional activities, and that they reflect the actual performance of and expected loss on multi-family loans. Such standards must be adopted within 18 months of the enactment of FDICIA. The OTS had adopted a rule that required every savings association with more than normal interest rate risk to deduct from its total capital, for purposes of determining compliance with such requirement, an interest rate risk component ("IRR component") equal to 50% of its interest-rate risk exposure multiplied by the present value of its assets. The IRR component is a measure of the potential decline in the net portfolio value ("NPV") of a savings association, greater than 2% of the present value of its assets, based upon a hypothetical 200 basis point increase or decrease in interest rates (whichever results in a greater decline). NPV is the present value of expected cash flows from assets, liabilities and off-balance sheet contracts. The rule provided for a two quarter lag between calculating interest rate risk and recognizing any deduction from capital. The OTS has decided not to require the IRR component to be deducted from the capital calculations of all institutions. It has reserved the right to take the IRR component into account in assessing the capital requirements for an individual institution. Based upon an IRR component analysis at December 31, 1996, the Bank was deemed to have more than "normal" interest rate risk and may, at some time in the future, be required to deduct an amount from capital. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Asset/Liability Management" in the Annual Report. Pursuant to FDICIA, the federal banking agencies, including the OTS, have adopted regulations authorizing the agencies to require a depository institution to maintain an additional amount of total capital to account for concentration of credit risk and the risk of non-traditional activities. The OTS and the FDIC are authorized and, under certain circumstances, required to take certain actions against associations that fail to meet capital requirements. Effective December 19, 1992, the federal banking agencies, including the OTS, were given additional enforcement authority over undercapitalized depository institutions. The OTS is generally required to take action to restrict the activities of an "undercapitalized association" (generally defined to be one with less than either a 4% core ratio, a Tier 1 risked-based capital ratio or an 8% risk-based capital ratio). Any such association must submit a capital restoration plan and until such plan is approved by the OTS may not increase its assets, acquire another institution, establish a branch or engage in any new activities, and generally may not make capital distributions. The OTS is authorized to impose the additional restrictions, discussed below, that are applicable to significantly undercapitalized associations. As a condition to the approval of the capital restoration plan, any company controlling an undercapitalized association must agree that it will enter into a limited capital maintenance guarantee with respect to the institution's achievement of its capital requirements. Any savings association that fails to comply with its capital plan or is "significantly undercapitalized" (I.E., Tier 1 risk-based or core capital ratios of less than 3% or a risk-based capital ratio of less than 6%) must be made subject to one or more additional specified actions and operating restrictions mandated by FDICIA. These actions and restrictions include requiring the issuance of additional voting securities; limitations on asset growth; mandated asset reduction; changes in senior management; divestiture, merger or acquisition of the association; restrictions on executive compensation; and any other action the OTS deems appropriate. An association that becomes "critically undercapitalized" (I.E., a tangible capital ratio of 2% or less) is subject to further mandatory restrictions on its activities in addition to those applicable to significantly undercapitalized associations. In addition, the OTS must appoint a receiver (or conservator with the concurrence of the FDIC) for a savings association, with certain limited exceptions, within 90 days after it becomes critically undercapitalized. 32 Any undercapitalized association is also subject to other possible enforcement actions by the OTS or the FDIC. Such actions could include a capital directive, a cease-and-desist order, civil money penalties, the establishment of restrictions on all aspects of the association's operations, the appointment of a receiver or conservator or a forced merger into another institution. If the OTS determines that an association is in an unsafe or unsound condition, or is engaged in an unsafe or unsound practice, it is authorized to reclassify a well-capitalized association as an adequately capitalized association, and if the association is adequately capitalized, to impose the restrictions applicable to an undercapitalized association. If the association is undercapitalized, the OTS is authorized to impose the restrictions applicable to a significantly undercapitalized association. The imposition by the OTS or the FDIC of any of these measures on the Bank may have a substantial adverse effect on the Bank's operations and profitability and the value of HMN's stock. HMN shareholders do not have preemptive rights, and therefore, if HMN is directed by the OTS or the FDIC to issue additional shares of common stock, such issuance may result in the dilution in the percentage of ownership of existing stockholders of HMN. At December 31, 1996 the Bank would be considered to be "well capitalized" under the prompt corrective actions provisions mentioned above. See Note 16 "Federal Home Loan Bank Investment, Regulatory Liquidity and Regulatory Capital Requirements" in the Notes to Consolidated Financial Statements in the Annual Report for more information on the Bank's capital. LIMITATIONS ON DIVIDENDS AND OTHER CAPITAL DISTRIBUTIONS OTS regulations impose various restrictions or requirements on associations with respect to their ability to pay dividends or make other distributions of capital. OTS regulations prohibit an association from declaring or paying any dividends or from repurchasing any of its stock if, as a result, the regulatory capital of the association would be reduced below the amount required to be maintained for the liquidation account established in connection with its mutual to stock conversion. The OTS utilizes a three-tiered approach to permit associations, based on their capital level and supervisory condition, to make capital distributions which include dividends, stock redemptions or repurchases, cash-out mergers and other transactions charged to the capital account. See "- Regulatory Capital Requirements." Generally, Tier 1 associations, which are associations that before and after the proposed distribution meet their fully phased-in capital requirements, may make capital distributions during any calendar year equal to the greater of 100% of net income for the year-to-date plus 50% of the amount by which the lesser of the association's tangible, core or risk-based capital exceeds its fully phased-in capital requirement for such capital component, as measured at the beginning of the calendar year, or the amount authorized for a Tier 2 association. However, a Tier 1 association deemed to be in need of more than normal supervision by the OTS may be downgraded to a Tier 2 or Tier 3 association as a result of such a determination. The Bank meets the requirements for a Tier 1 association and has not been notified of a need for more than normal supervision. Tier 2 associations, which are associations that before and after the proposed distribution meet their current minimum capital requirements, may make capital distributions of up to 75% of net income over the most recent four quarter period. Tier 3 associations (which are associations that do not meet current minimum capital requirements) that propose to make any capital distribution and Tier 2 associations that propose to make a capital distribution in excess of the noted safe harbor level must obtain OTS approval prior to making such distribution. Tier 2 associations proposing to make a capital distribution within the safe harbor provisions and Tier 1 associations proposing to make any capital distribution need only submit written notice to the OTS 30 days prior to such distribution. As a subsidiary of HMN, the Bank will also be required to give the OTS 30 days' notice prior to declaring any dividend on its stock. The OTS may object to the distribution during that 30-day period based on 33 safety and soundness concerns. See "- Regulatory Capital Requirements." The OTS has proposed regulations that would revise the current capital distribution restrictions. The proposal eliminates the current tiered structure and the safe-harbor percentage limitations. Under the proposal a savings association may make a capital distribution without notice to the OTS (unless it is a subsidiary of a holding company) provided that it has a CAMELS 1 or 2 rating, is not in troubled condition and would remain adequately capitalized (as defined in the OTS prompt corrective action regulations) following the proposed distribution. Savings associations that would remain adequately capitalized following the proposed distribution but do not meet the other noted requirements must notify the OTS 30 days prior to declaring a capital distribution. The OTS stated it will generally regard as permissible that amount of capital distributions that do not exceed 50% of the institution's excess regulatory capital plus net income to date during the calendar year. A savings association may not make a capital distribution without prior approval of the OTS and the FDIC if it is undercapitalized before, or as a result of, such a distribution. A savings association will be considered in troubled condition if it has a CAMELS rating of 4 or 5, is subject to an enforcement action relating to its safety and soundness or financial viability or has been informed in writing by the OTS that it is in troubled condition. As under the current rule, the OTS may object to a capital distribution if it would constitute an unsafe or unsound practice. No assurance may be given as to whether or in what form the regulations may be adopted. LIQUIDITY All savings associations, including the Bank, are required to maintain an average daily balance of liquid assets equal to a certain percentage of the sum of its average daily balance of net withdrawable deposit accounts and borrowings payable in one year or less. For a discussion of what the Bank includes in liquid assets, see "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity Management" in the Annual Report. This liquid asset ratio requirement may vary from time to time (between 4% and 10%) depending upon economic conditions and savings flows of all savings associations. At the present time, the minimum liquid asset ratio is 5%. In addition, short-term liquid assets (E.G., cash, certain time deposits, certain bankers acceptances and short-term United States Treasury obligations) currently must constitute at least 1% of the association's average daily balance of net withdrawable deposit accounts and current borrowings. Penalties may be imposed upon associations for violations of either liquid asset ratio requirement. At December 31, 1996, the Bank was in compliance with both requirements, with an overall liquid asset ratio of 7.4% and a short-term liquid asset ratio of 1.9%. ACCOUNTING An OTS policy statement applicable to all savings associations clarifies and re-emphasizes that the investment activities of a savings association must be in compliance with approved and documented investment policies and strategies, and must be accounted for in accordance with GAAP. Under the policy statement, management must support its classification of and accounting for loans and securities (I.E., whether held to maturity, sale or trading) with appropriate documentation. The Bank is in compliance with these amended rules. The OTS has adopted an amendment to its accounting regulations, which may be made more stringent than GAAP, to require that transactions be reported in a manner that best reflects their underlying economic substance and inherent risk and that financial reports must incorporate any other accounting regulations or orders prescribed by the OTS. QUALIFIED THRIFT LENDER TEST All savings associations, including the Bank, are required to meet a qualified thrift lender ("QTL") test to 34 avoid certain restrictions on their operations. This test requires a savings association to have at least 65% of its portfolio assets (which consists of total assets less intangibles, properties used to conduct the savings association's business and liquid assets not exceeding 20% of total assets) in qualified thrift investments on a monthly average for nine out of every 12 months on a rolling basis. Such assets primarily consist of residential housing related loans and investments. At December 31, 1996, the Bank met the test and has always met the test since its effectiveness. Any savings association that fails to meet the QTL test must convert to a national bank charter, unless it requalifies as a QTL and thereafter remains a QTL. If an association does not requalify and converts to a national bank charter, it must remain SAIF-insured until the FDIC permits it to transfer to the Bank Insurance Fund. If an association that fails the test has not yet requalified and has not converted to a national bank, its new investments and activities are limited to those permissible for both a savings association and a national bank, and it is limited to national bank branching rights in its home state. In addition, the association is immediately ineligible to receive any new FHLB borrowings and is subject to national bank limits for payment of dividends. If such association has not requalified or converted to a national bank within three years after the failure, it must divest of all investments and cease all activities not permissible for a national bank. In addition, it must repay promptly any outstanding FHLB borrowings, which may result in prepayment penalties. If any association that fails the QTL test is controlled by a holding company, then within one year after the failure, the holding company must register as a bank holding company and become subject to all restrictions on bank holding companies. See "- Holding Company Regulation." TRANSACTIONS WITH AFFILIATES Generally, transactions between a savings association or its subsidiaries and its affiliates are required to be on terms as favorable to the association as transactions with non-affiliates. In addition, certain of these transactions are restricted to a percentage of the association's capital. Affiliates of the Bank include HMN and any company which is under common control with the Bank. In addition, a savings association may not lend to any affiliate engaged in activities not permissible for a bank holding company or acquire the securities of most affiliates. The Bank's subsidiaries are not deemed affiliates, however, the OTS has the discretion to treat subsidiaries of savings associations as affiliates on a case by case basis. Certain transactions with directors, officers or controlling persons are also subject to conflict of interest regulations enforced by the OTS. These conflict of interest regulations and other statutes also impose restrictions on loans to such persons and their related interests. Among other things, such loans must be made on terms substantially the same as for loans to unaffiliated individuals. HOLDING COMPANY REGULATION HMN is a unitary savings and loan holding company subject to regulatory oversight by the OTS. As such, HMN is registered and required to file reports with and subject to regulation and examination by the OTS. In addition, the OTS has enforcement authority over HMN and its non-savings association subsidiaries which also permits the OTS to restrict or prohibit activities that are determined to be a serious risk to the subsidiary savings association. As a unitary savings and loan holding company, HMN generally is not subject to activity restrictions. If HMN acquires control of another savings association as a separate subsidiary, it would become a multiple savings and loan holding company, and the activities of HMN and any of its subsidiaries (other than the Bank or any other SAIF-insured savings association) would become subject to such restrictions unless such other associations which qualify as a QTL and were acquired in a supervisory acquisition. If the Bank fails the QTL test, HMN must obtain the approval of the OTS prior to continuing after such failure, directly or through its other subsidiaries, any business activity other than those approved for multiple 35 savings and loan holding companies or their subsidiaries. In addition, within one year of such failure HMN must register as, and will become subject to, the restrictions applicable to bank holding companies. The activities authorized for a bank holding company are more limited than are the activities authorized for a unitary or multiple savings and loan holding company. See "- Qualified Thrift Lender Test." HMN must obtain approval from the OTS before acquiring control of any other SAIF-insured association. Such acquisitions are generally prohibited if they result in a multiple savings and loan holding company controlling savings associations in more than one state. However, such interstate acquisitions are permitted based on specific state authorization or in a supervisory acquisition of a failing savings association. FEDERAL SECURITIES LAW The stock of HMN is registered with the SEC under the Securities Exchange Act of 1934, as amended (the "Exchange Act"). HMN is subject to the information, proxy solicitation, insider trading restrictions and other requirements of the SEC under the Exchange Act. HMN stock held by persons who are affiliates (generally officers, directors and principal stockholders) of HMN may not be resold without registration or unless sold in accordance with certain resale restrictions. If HMN meets specified current public information requirements, each affiliate of HMN is able to sell in the public market, without registration, a limited number of shares in any three-month period. FEDERAL RESERVE SYSTEM The Federal Reserve Board requires all depository institutions to maintain non-interest bearing reserves at specified levels against their transaction accounts (primarily checking, NOW and Super NOW checking accounts). At December 31, 1996, the Bank was in compliance with these reserve requirements. The balances maintained to meet the reserve requirements imposed by the Federal Reserve Board may be used to satisfy liquidity requirements that may be imposed by the OTS. See "- Liquidity." Savings associations are authorized to borrow from the Federal Reserve Bank "discount window," but Federal Reserve Board regulations require associations to exhaust other reasonable alternative sources of funds, including FHLB borrowings, before borrowing from the Federal Reserve Bank. FEDERAL HOME LOAN BANK SYSTEM The Bank is a member of the FHLB of Des Moines, which is one of 12 regional FHLBs, that administers the home financing credit function of savings associations. Each FHLB serves as a reserve or central bank for its members within its assigned region. It is funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB System. It makes loans to members (I.E., advances) in accordance with policies and procedures established by the board of directors of the FHLB. These policies and procedures are subject to the regulation and oversight of the Federal Housing Finance Board. All advances from the FHLB are required to be fully secured by sufficient collateral as determined by the FHLB. In addition, all long-term advances are required to provide funds for residential home financing. As a member, the Bank is required to purchase and maintain stock in the FHLB of Des Moines. At December 31, 1996, the Bank had $5.4 million in FHLB stock, which was in compliance with this requirement. In past years, the Bank has received substantial dividends on its FHLB stock. Over the past five calendar years such dividends have averaged 7.95% and were 7.01% for calendar year 1996. For the year ended December 31, 1996, dividends paid by the FHLB of Des Moines to the Bank totaled $327,000, which constitute a $74,000 increase from the amount of dividends received in 1995. Under federal law the FHLBs are required to provide funds for the resolution of troubled savings 36 associations and to contribute to low and moderately priced housing programs through direct loans or interest subsidies on advances targeted for community investment and low- and moderate-income housing projects. These contributions have affected adversely the level of FHLB dividends paid and could continue to do so in the future. These contributions could also have an adverse effect on the value of FHLB stock in the future. A reduction in value of the Bank's FHLB stock may result in a corresponding reduction in the Bank's capital. FEDERAL AND STATE TAXATION FEDERAL TAXATION. Savings associations such as the Bank that meet certain definitional tests relating to the composition of assets and other conditions prescribed by the Internal Revenue Code of 1986, as amended (the "Code"), are permitted to establish reserves for bad debts and to make annual additions thereto which may, within specified formula limits, be taken as a deduction in computing taxable income for federal income tax purposes. The amount of the bad debt reserve deduction for "non-qualifying loans" is computed under the experience method. For the year ended December 31, 1996 the amount of the bad debt reserve deduction for "qualifying real property loans" (generally loans secured by improved real estate) may be computed only under the experience method. Prior to January 1, 1996 the bad debt reserve was allowed to be calculated on either the experience method or the percentage of taxable income method (based on an annual election). Under the experience method, the bad debt reserve deduction is an amount determined under a formula based generally upon the bad debts actually sustained by the savings association over a period of years. The percentage of specially computed taxable income that is used to compute a savings association's bad debt reserve deduction under the percentage of taxable income method (the "percentage bad debt deduction") is 8%. The percentage bad debt deduction thus computed is reduced by the amount permitted as a deduction for non-qualifying loans under the experience method. The availability of the percentage of taxable income method permits qualifying savings associations to be taxed at a lower current federal income tax rate than that applicable to corporations (generally approximately 32% assuming the maximum percentage bad debt deduction). If an association's specified assets (generally, loans secured by residential real estate or deposits, educational loans, cash and certain government obligations) constitute less than 60% of its total assets, the association may not deduct any addition to a bad debt reserve and generally must include existing reserves in income over a four-year period. No representation can be made as to whether the Bank will meet the 60% test for subsequent taxable years. In addition to the regular income tax, corporations, including savings associations such as the Bank, generally are subject to a minimum tax. An alternative minimum tax is imposed at a minimum tax rate of 20% on alternative minimum taxable income, which is the sum of a corporation's regular taxable income (with certain adjustments) and tax preference items, less any available exemption. The alternative minimum tax is imposed to the extent it exceeds the corporation's regular income tax and net operating losses can offset no more than 90% of alternative minimum taxable income. For taxable years beginning after 1986 and before 1996, corporations, including savings associations such as the Bank, are also subject to an environmental tax equal to 0.12% of the excess of alternative minimum taxable income for the taxable year (determined without regard to net operating losses and the deduction for the environmental tax) over $2 million. To the extent earnings appropriated to a savings association's bad debt reserves for "qualifying real property loans" and deducted for federal income tax purposes exceed the allowable amount of such reserves computed under the experience method and to the extent of the association's supplemental reserves for losses on loans ("Excess"), such Excess may not, without adverse tax consequences, be utilized for the payment of cash dividends or other distributions to a shareholder (including distributions on redemption, dissolution or liquidation) or for any other purpose (except to absorb bad debt losses). As of December 31, 1996, the Bank's Excess for tax 37 purposes totaled approximately $6.6 million. HMN and its subsidiaries file consolidated federal income tax returns on a fiscal year basis using the accrual method of accounting. Savings associations, such as the Bank, that file federal income tax returns as part of a consolidated group are required by applicable Treasury regulations to reduce their taxable income for purposes of computing the percentage bad debt deduction for losses attributable to activities of the non-savings association members of the consolidated group that are functionally related to the activities of the savings association member. HMN was incorporated in 1994 and filed its first consolidated Federal income tax return with its subsidiaries for the year ended December 31, 1994 during 1995. The return required to be filed for 1996 has been extended and will be filed by August 1997. The Bank and its consolidated subsidiaries have been audited by the IRS with respect to consolidated federal income tax returns through December 31, 1983. With respect to years examined by the IRS, either all deficiencies have been satisfied or sufficient reserves have been established to satisfy asserted deficiencies. In the opinion of management, any examination of still open returns (including returns of subsidiaries and predecessors of, or entities merged into, the Bank) would not result in a deficiency which could have a material adverse effect on the consolidated financial condition of HMN. MINNESOTA TAXATION. HMN and its subsidiaries that operate in Minnesota are subject to Minnesota state taxation. A Minnesota corporation's income or loss is allocated based on a three-factor apportionment of the corporation's Minnesota gross receipts, payroll and property over the total gross receipts, payroll and property of all corporations in the unitary group. The corporate tax rate in Minnesota is 9.8%. In 1990, Minnesota changed its alternative minimum tax system. The tax is now based upon Minnesota Alternative Minimum Taxable Income as opposed to the Minnesota Apportionment Factors method which was in effect from 1987 through 1989. The Minnesota Alternative Minimum Tax rate is 5.8%. The Bank and it subsidiaries have not been audited by the Minnesota taxation authorities. DELAWARE TAXATION. As a Delaware holding company, HMN is exempted from Delaware corporate income tax but is required to file an annual report with and pay an annual fee to the State of Delaware. HMN is also subject to an annual franchise tax imposed by the State of Delaware. 38 ITEM 2. PROPERTIES The following table sets forth information concerning the main office and each branch office of the Bank at December 31, 1996. At December 31, 1996, the Bank's premises had an aggregate net book value of approximately $2.8 million. YEAR OWNED OR NET BOOK VALUE AT LOCATION ACQUIRED LEASED DECEMBER 31, 1996(1) - -------------------------- -------- -------- -------------------- (In Thousands) MAIN OFFICE: 101 North Broadway 1975 Owned 371 Spring Valley, Minnesota FULL SERVICE BRANCHES: 201 Oakland Avenue 1960 Owned 195 Austin, Minnesota Crossroads Shopping Center 1962 Owned 490 Rochester, Minnesota 4th & Center 1973 Owned 135 Winona, Minnesota 208 South Walnut 1975 Owned 94 LaCrescent, Minnesota 1110 6th St., NW 1982 Owned 882 Rochester, Minnesota 143 West Clark Street 1993 Owned 598 Albert Lea, Minnesota MORTGAGE BROKERAGE OFFICE: 9973 Valley View Road 1996 Leased --- Eden Prairie, Minnesota - ------------------------ (1) Does not include $727,248 of net furniture and equipment distributed between all the above offices or its subsidiary. During 1997 the Bank plans to build two retail banking facilities, one in Spring Valley and the other in Winona, at an estimated cost of $2.5 million. The facilities will replace the existing retail facilities in both locations. HMN and the Bank believe that their remaining facilities are adequate to meet their present needs. The Bank's depositor and borrower customer files are maintained by an independent data processing company. The net book value of the data processing and computer equipment utilized by the Bank at December 31, 1996 was approximately $405,000. 39 ITEM 3. LEGAL PROCEEDINGS From time to time, the Bank and HMN are involved as plaintiff or defendant in various legal proceedings arising in the normal course of its business. While the ultimate outcome of these various legal proceedings cannot be predicted with certainty, it is the opinion of management that the resolution of these legal actions should not have a material effect on HMN's consolidated financial condition or results of operations. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SECURITY HOLDER MATTERS The information on pages 3, 24 and 48 of the Annual Report to Security Holders for the year ended December 31, 1996 is incorporated herein by reference. ITEM 6. SELECTED FINANCIAL DATA The information on page 12 of the Annual Report to Security Holders for the year ended December 31, 1996 is incorporated herein by reference. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The information on pages 13 through 24 of the Annual Report to Security Holders for the year ended December 31, 1996 is incorporated herein by reference. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The information on pages 25 through 47 of the Annual Report to Security Holders for the year ended December 31, 1996 is incorporated herein by reference. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. 40 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information on pages 4 through 7 of the Registrant's definitive Proxy Statement dated March 13, 1997 is incorporated herein by reference. See "Business - Executive Officers" in Part I of the Form 10-K for information regarding executive officers. ITEM 11. EXECUTIVE COMPENSATION The information on pages 8 through 14 of the Registrant's definitive Proxy Statement dated March 13, 1997 is incorporated herein be reference, except for information contained under the heading "Compensation Committee Report on Executive Compensation" and "Stockholder Return Performance Presentation". ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information on pages 2 through 4 of the Registrant's definitive Proxy Statement dated March 13, 1997 is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS None. 41 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) FINANCIAL STATEMENTS, FINANCIAL STATEMENT SCHEDULES AND EXHIBITS 1. Financial Statements The following information appearing in the Registrant's Annual Report to Security Holders for the year ended December 31, 1996, is incorporated by reference in this Form 10-K Annual Report as Exhibit 13. Pages in 1996 Annual Annual Report Section Report --------------------- ----------- Five Year Consolidated Financial Highlights 12 Consolidated Balance Sheets -- December 31, 1996 and 1995 25 Consolidated Statements of Income -- Each of the Years in the Three-Year Period Ended December 31, 1996 26 Consolidated Statement of Stockholders' Equity -- Each of the Years in the Three-Year Period Ended December 31, 1996 27 Consolidated Statements of Cash Flows -- Each of the Years in the Three-Year Period Ended December 31, 1996 28 Notes to Consolidated Financial Statements 29 - 43 Independent Auditors' Report 44 Other Financial Data 45 Selected Quarterly Financial Data 46 - 47 2. Financial Statement Schedules All financial statement schedules have been omitted as information is not required under the related instructions, is not applicable or has been included in the Notes to Consolidated Financial Statements. 42
3. Exhibits Reference Sequential to Prior Page Numbering Filing or Where Attached Exhibit Exhibits Are Regulation S-K Number Located in This Exhibit Number Document Attached Hereto Form 10-K Report - -------------- -------------------------------------------- --------------- ---------------- 2 Plan of acquisition, reorganization, Not applicable Not applicable arrangement, liquidation or succession 3 (i) Articles of Incorporation * Not applicable (ii) By-laws * Not applicable 4 Instruments defining the rights of security * Not applicable holders, including indentures 9 Voting trust agreement Not applicable Not applicable 10.1 Employment agreement for Mr. Weise ** Not applicable dated June 29, 1994 10.2 Employment agreement for Mr. Gardner ** Not applicable dated June 29, 1994 10.3 Directors Deferred Compensation Plan ** Not applicable 10.4 1995 Recognition and Retention Plan *** Not applicable 10.5 1995 Stock Option and Incentive Plan *** Not applicable 11 Statement re: Computation of per share 11 Filed electronically earnings 12 Statement re: Computation of ratios Not applicable Not applicable 13 Annual Report to Security Holders 13 Filed electronically 16 Letter re: Change in certifying accountant Not applicable Not applicable 18 Letter re: Change in accounting principles Not applicable Not applicable 21 Subsidiaries of Registrant 21 Filed electronically
43
Reference Sequential to Prior Page Numbering Filing or Where Attached Exhibit Exhibits Are Regulation S-K Number Located in This Exhibit Number Document Attached Hereto Form 10-K Report - -------------- -------------------------------------------- --------------- ---------------- 22 Published report regarding matters Not applicable Not applicable submitted to vote of security holders 23 Consent of KPMG Peat Marwick LLP 23 Filed electronically dated March 25, 1997 24 Power of Attorney Not applicable Not applicable 27 Financial Data Schedule 27 Filed electronically 28 Information from reports furnished to None Not applicable state insurance regulatory authorities 99 Additional exhibits None Not applicable ----------------
* Filed April 1, 1994, as exhibits to the Registrant's Form S-1 registration statement (Registration No. 33-77212) pursuant to the Securities Act of 1933. All of such previously filed documents are hereby incorporated herein by reference in accordance with Item 601 of Regulation S-K. ** Filed as an exhibit to the Registrant's Form 10-K for 1994 (file no. 0- 24100). All previously filed documents are hereby incorporated by reference in accordance with Item 601 of Regulation S-K. *** Filed as an exhibit to the Registrant's Form 10-K for 1995 (file no. 0- 24100). All previously filed documents are hereby incorporated by reference in accordance with Item 601 of Regulation S-K. 44 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. HMN FINANCIAL, INC. Date: March 28, 1997 By: /s/ Roger P. Weise ---------------------------- -------------------------- Roger P. Weise (Duly Authorized Representative) Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. By: /s/ Roger P. Weise By: /s/ Keith A. Hagen ---------------------------- -------------------------- Roger P. Weise, Chairman of the Board, Keith A. Hagen, Director President and Chief Executive Officer (Principal Executive and Operating Officer) Date: March 28, 1997 Date: March 28, 1997 ---------------------------- ------------------------- By: /s/ Irma R. Rathbun By: /s/ Timothy R. Geisler ---------------------------- -------------------------- Irma R. Rathbun, Director Timothy R. Geisler, Director Date: March 28, 1997 Date: March 28, 1997 ---------------------------- ------------------------- By: /s/ M. F. Schumann By: /s/ James B. Gardner ---------------------------- -------------------------- M.F. Schumann, Director James B. Gardner, Executive Vice President and Director (Principal Financial Officer) Date: March 28, 1997 Date: March 28, 1997 ---------------------------- ------------------------- By: /s/ Dwain C. Jorgensen Dwain C. Jorgensen, Vice President and Controller (Principal Accounting Officer) Date: March 28, 1997 ---------------------------- 45 INDEX TO EXHIBITS
Sequential Page Numbering Where Attached Exhibits Are Regulation S-K Located in This Exhibit Number Document Form 10-K Report - -------------- ----------------------------------- ---------------- 11 Statement re: Computation of per share earnings Filed electronically 13 Annual Report to Security Holders Filed electronically 21 Subsidiaries of Registrant Filed electronically 23 Consent of KPMG Peat Marwick LLP Filed electronically dated March 25, 1997 27 Financial Data Schedule Filed electronically
46 EX-11 2 COMPUTATION OF PER SHARE EARNINGS Exhibit 11 Statement Re: Computation of per share earnings Exhibit 11 HMN Financial, Inc. Computation of Earnings Per Common Share
Year Ended December 31, 1996 1995 ------------ ----------- Computation of Earnings Per Common Share for Statements of Operations: Net income............................................................ $ 4,274,349 5,620,377 ----------- ----------- Weighted average number of common and common share equivalents: Weighted average common shares outstanding.......................... 4,381,937 5,152,320 Dilutive effect of stock option plans after application of treasury stock method....................................................... 54,896 19,062 ----------- ----------- 4,436,833 5,171,382 ----------- ----------- Earnings per common share and common share equivalent................. $0.96 1.09 ----------- ----------- ----------- ----------- Computation of Fully Diluted Earnings Per Common Share and Common Share Equivalent: (1) Net income............................................................ $ 4,274,349 5,620,377 ----------- ----------- Weighted average number of common and common share equivalents: Weighted average common shares outstanding.......................... 4,381,937 5,152,320 Dilutive effect of stock option plans after application of treasury stock method............................................. 127,629 74,968 ----------- ----------- 4,509,566 5,227,288 ----------- ----------- Earnings per common share and common share equivalent $ 0.95 1.08 ----------- ----------- ----------- -----------
(1) This calculation is submitted in accordance with Regulation S-K Item 601(b)(11) although not required by footnote 2 of paragraph 14 of APB Opinion No. 15 because it results in dilution of less than 3%. EX-13 3 ANNUAL REPORT TO SHAREHOLDERS Five-Year Consolidated Financial Highlights - ------------------------------------------------------------------------------- Selected Operations Data:(1)
Year Ended December 31, (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) 1996 1995 1994 1993 1992 - ----------------------------------------------------------------------------------------------------------------------- Total interest income........................................... $ 39,864 38,328 32,277 32,427 34,739 Total interest expense.......................................... 24,194 22,555 18,067 18,399 21,018 --------- --------- --------- --------- --------- Net interest income........................................... 15,670 15,773 14,210 14,028 13,721 Provision for loan losses....................................... 300 300 410 660 233 --------- --------- --------- --------- --------- Net interest income after provision for loan losses........... 15,370 15,473 13,800 13,368 13,488 --------- --------- --------- --------- --------- Fees and service charges........................................ 359 325 311 305 265 Securities gains, net........................................... 1,030 416 65 1,180 544 Gain on sales of loans.......................................... 39 102 3 0 0 Other non-interest income....................................... 495 155 216 152 118 --------- --------- --------- --------- --------- Total non-interest income..................................... 1,923 998 595 1,637 927 SAIF assessment................................................. 2,352 0 0 0 0 Other non-interest expense...................................... 8,157 7,470 6,574 5,976 5,612 --------- --------- --------- --------- --------- Total non-interest expense.................................... 10,509 7,470 6,574 5,976 5,612 Income tax expense.............................................. 2,510 3,381 3,116 3,799 3,494 --------- --------- --------- --------- --------- Net income.................................................... $ 4,274 5,620 4,705 5,230 5,309 --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- Per common share: Earnings per common share and common share equivalents(2)..... $ 0.96 1.09 0.48 Pro forma earnings per share(3)................................. 0.86 Selected Financial Condition Data:(1) December 31, (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) 1996 1995 1994 1993 1992 - ------------------------------------------------------------------------------------------------------------------ Total assets.............................................. $ 554,732 537,949 494,868 430,782 418,779 Securities held for sale.................................. 0 0 0 7,598 0 Securities available for sale............................. 175,830 190,320 183,512 71,868 67,831 Securities held to maturity............................... 2,806 16,972 12,678 85,672 94,553 Loans held for sale....................................... 739 0 0 0 0 Loans receivable, net..................................... 349,022 314,851 271,000 246,446 241,514 Deposits.................................................. 362,477 373,539 350,575 353,581 361,913 Federal Home Loan Bank advances........................... 106,079 68,877 51,986 33,964 18,393 Stockholders' equity...................................... 82,099 91,687 89,047 40,046 34,816 Book value per shares excluding net unrealized loss on securities available for sale........................... $ 18.65 17.34 16.14 Book value per share...................................... 18.52 17.29 14.63 Number of full service offices............................ 7 7 7 7 7 Number of mortgage origination offices.................... 1 Key Ratios(4) Stockholders' equity to total assets at year end.......... 14.80% 17.04% 17.99% 9.30% 8.31% Average stockholders' equity to average assets............ 16.12 18.24 14.57 8.82 7.92 Return on stockholders' equity (ratio of net income to average equity)......................................... 4.82 5.86 6.86 13.79 16.40 Return on assets (ratio of net income to average assets)................................................. 0.78 1.07 1.00 1.22 1.30
(1) HMN Financial, Inc. (HMN) completed a public stock offering on June 29, 1994, which generated net proceeds of $59.2 million. HMN purchased all of the stock of Home Federal Savings Bank (the Bank) with a portion of the conversion proceeds.The information reflected above represents the financial condition and the results of operations for the consolidated HMN for 1996, 1995 and 1994 and Bank only information for prior years. (2) Earnings per common share and common share equivalents for 1994 represents the period from June 29, 1994 through December 31, 1994. (3) Pro forma earnings per common share represents the period from January 1, 1994 through December 31, 1994. (4) Average balances were calculated based upon amortized cost without the market value impact of SFAS 115. - -------------------------------------------------------------------------------- 12 FINANCIAL REVIEW The financial review presents management's discussion and analysis of the consolidated financial condition and results of operations of HMN Financial, Inc. and subsidiaries (HMN). This review should be read in conjunction with the consolidated financial statements and other financial data beginning on page 25. HMN was incorporated under the laws of the State of Delaware for the purpose of becoming the savings and loan holding company of Home Federal Savings Bank (the Bank) in connection with the Bank's conversion from a federally chartered mutual savings bank to a federally chartered stock savings bank, pursuant to its plan of conversion. The conversion was completed on June 29, 1994. Refer to Note 15 of the Notes to Consolidated Financial Statements for more information regarding the Bank's stock conversion. Information presented for years ended prior to December 31, 1994 reflect the financial condition and the results of operations of only the consolidated Bank. RESULTS OF OPERATIONS HMN reported net income of $4.3 million, or $0.96 per share for 1996 compared to $5.6 million, or $1.09 per share, for 1995 and $4.7 million, or $0.86 pro forma earnings per share, for 1994. Net income for 1996 compared to 1995 decreased by $1.3 million, or 24%, primarily due to a one time Savings Association Insurance Fund (SAIF) assessment of $2.35 million which reduced after tax earnings by $1.46 million and caused annualized earnings per share to decrease by $0.33 per share. Other changes noted when comparing 1996 to 1995 were net interest income decreased by $103,000, non-interest income increased by $924,000 due to security gains and other non-recurring income, and was partially offset by increased non-interest expenses of $687,000 related to compensation and benefit expenses, occupancy costs and other costs. Net income for 1995 compared to 1994 increased by $916,000, or 19%, principally due to an increase in net interest income after provision for loan losses of $1.7 million, an increase in net security gains of $351,000 and a $99,000 increase in gain on the sale of loans. The increased revenue was partially offset by an $896,000 increase in non-interest expense, a $60,000 decrease in non-interest income and an increase in income tax expense of $265,000. The increase in earnings per share between 1995 and 1994 was also enhanced by HMN's purchase of its own common stock in the open market during 1995. Return on average assets was 0.78% for 1996, compared to 1.07% for 1995 and 1.00% for 1994. The return on average assets for 1996 excluding the SAIF assessment was 1.04%. The return on average assets was also impacted by the amount of net securities gains recorded in each year. NET INTEREST INCOME HMN's net income is dependent primarily on its net interest income, which is the difference between interest earned on securities, loans and other interest-earning assets (interest income) and interest paid on deposits and Federal Home Loan Bank advances (interest expense). Net interest margin is calculated by dividing net interest income by the average interest-earning assets. The arithmetic difference between the yield on interest-earning assets and the cost of interest-bearing liabilities expressed as a percentage is referred to as the net interest rate spread. 13 The following table presents the total dollar amount of interest income from average interest-earning assets and the resultant yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and rates. Non-accruing loans have been included in the table as loans carrying a zero yield.
- ----------------------------------------------------------------------------------------------------------------------------------- Year Ended December 31, ---------------------------------------------------------------------------------------------------- 1996 1995 1994 -------------------------------- -------------------------------- -------------------------------- Average Interest Average Interest Average Interest Outstanding Earned/ Yield/ Outstanding Earned/ Yield/ Outstanding Earned/ Yield/ (DOLLARS IN THOUSANDS) Balance Paid Rate Balance Paid Rate Balance Paid Rate - ----------------------------------------------------------------------------------------------------------------------------------- INTEREST-EARNING ASSETS: Securities held for sale...... $ 0 0 0.00% $ 0 0 0.00% $ 645 25 3.94% Securities available for sale: Mortgage-backed and related securities................ 148,400 10,029 6.76 153,150 10,294 6.72 145,561 9,001 6.18 Other marketable securities(1)............. 40,549 2,424 5.98 47,289 2,858 6.04 28,122 1,455 5.17 Securities held to maturity: Mortgage-backed and related securities................ 10,160 765 7.53 9,242 746 8.07 5,115 449 8.78 Other marketable securities................ 1,861 104 5.61 6,145 390 6.34 10,615 625 5.89 Loans receivable, net(2)...... 324,958 25,721 7.92 290,243 23,375 8.05 253,044 20,051 7.92 Federal Home Loan Bank stock....................... 4,671 327 7.01 3,485 253 7.25 3,039 255 8.40 Other including cash equivalents................. 11,039 494 4.48 8,611 412 4.78 13,995 416 2.98 ----------- --------- ----------- --------- ----------- --------- Total interest-earning assets...................... $ 541,638 39,864 7.36 $ 518,165 38,328 7.40 $ 460,136 32,277 7.01 ----------- --------- -------- ----------- --------- -------- ----------- --------- -------- ----------- --------- ----------- --------- ----------- --------- INTEREST-BEARING LIABILITIES: Non-interest checking......... $ 2,016 0 0.00% $ 1,735 0 0.00 $ 1,562 0 0.00% NOW accounts.................. 16,051 323 2.01 14,361 311 2.17 14,628 317 2.17 Passbooks..................... 30,295 760 2.51 30,378 759 2.50 34,504 862 2.50 Money market accounts......... 17,724 501 2.83 19,499 548 2.81 24,892 672 2.70 Certificate accounts.......... 299,903 17,366 5.79 293,844 16,961 5.77 275,801 13,989 5.07 Federal Home Loan Bank advances.................... 89,656 5,244 5.85 65,069 3,976 6.11 40,121 2,227 5.55 ----------- --------- ----------- --------- ----------- --------- Total interest-bearing liabilities................. $ 455,645 24,194 5.31 $ 424,886 22,555 5.31 $ 391,508 18,067 4.61 ----------- --------- -------- ----------- --------- -------- ----------- --------- -------- ----------- --------- ----------- --------- ----------- --------- Net interest income........... 15,670 15,773 14,210 --------- --------- --------- --------- --------- --------- Net interest rate spread...... 2.05% 2.09% 2.40% -------- -------- -------- -------- -------- -------- Net earning assets............ $ 85,993 $ 93,279 $ 68,628 ----------- ----------- ----------- ----------- ----------- ----------- Net interest margin........... 2.89% 3.04% 3.09% -------- -------- -------- -------- -------- -------- Average interest-earning assets to average interest-bearing liabilities................. 118.87% 121.95% 117.53% -------- -------- -------- -------- -------- --------
(1) Tax exempt income was not significant; therefore, the yield was not presented on a tax equivalent basis. There was no tax exempt income earned in 1996. The tax exempt income was $87,474 in 1995, and $39,000 in 1994. (2) Calculated net of deferred loan fees, loan discounts, loans in process and loss reserve. The average balance for 1996 includes $107,000 of loans held for sale. - -------------------------------------------------------------------------------- 14 Net interest income for 1996 was $15.7 million, a decrease of $103,000, or 0.7%, from $15.8 million for 1995. Interest income for 1996 was $39.9 million, an increase of $1.5 million, or 4.0%, compared to $38.3 million for 1995. The average interest-earning assets for 1996 were $23.5 million higher than average interest-earning assets for 1995. The increase in average interest-earning assets caused HMN to earn additional interest income of $2.0 million which was partially offset by a decrease in interest income of $483,000 due to a decrease in the yield earned on interest-earning assets. During 1996 HMN decreased its weighted average securities portfolio by $14.9 million in order to increase its loan portfolio. HMN purchased $55.8 million of single-family residential loans with a weighted average interest rate of 6.96%. It originated $56.8 million of mortgage and consumer loans with a weighted average rate of 8.18%. The net impact of the loan purchases and originations on the loan portfolio after taking into account total loan payments and payoffs was a $34.7 million increase in the average outstanding loan portfolio for 1996 compared to 1995. The combined weighted average interest rate for purchased and originated loans was 7.58% which lowered the yield on the existing loan portfolio during 1996. Included in the loans purchased during 1996 were $34.2 million of adjustable rate loans with a weighted average interest rate of 6.56%. Interest rates in general were lower during 1996 compared to 1995, therefore new loan originations and purchases had lower interest rates during 1996 compared to 1995 which caused the yield on interest-earning assets to decline during 1996. Interest expense for 1996 was $24.2 million, an increase of $1.6 million, or 7.3%, compared to $22.6 million for 1995. Interest expense increased $1.7 million due to a $30.8 million increase in the average outstanding interest-bearing liabilities and was partially offset by a $121,000 decrease in interest expense due to lower interest rates. During 1996 HMN had to pay higher interest rates in order to maintain its certificate accounts, therefore interest expense on certificate accounts increased despite the fact that interest rates during 1996 were generally lower than interest rates were during 1995. Average outstanding FHLB advances increased by $24.6 million during 1996 primarily due to the purchase of additional interest-earning assets and the stock repurchase program. The increased average FHLB advances caused interest expense during 1996 to increase by $1.3 million over the interest expense recognized during 1995. HMN's average net earning assets were $86.0 million at December 31, 1996, a decrease of $7.3 million, or 7.8%, compared to $93.3 million for December 31, 1995. The decrease in net interest-earning assets was primarily due to HMN's stock repurchase program. Stock repurchases temporarily reduced interest-earning assets when investments were sold to repurchase HMN's stock. Other replacement interest-earning assets were purchased later by borrowing funds from the FHLB. The decrease in net interest-earning assets coupled with the lower interest rates experienced during 1996 caused HMN's net interest margin to decline to 2.89% at December 31, 1996 from 3.04% at December 31, 1995. Net interest income for 1995 was $15.8 million, an increase of $1.6 million, or 11%, from $14.2 million for 1994. Interest income for 1995 was $38.3 million, an increase of $6.0 million, or 19%, compared to $32.3 million for 1994. Interest income increased by $4.6 million due to an increase in total average interest-earning assets of $58.0 million in 1995 from 1994. The increase in interest-earning assets was primarily due to having invested the proceeds of the public offering for the entire year of 1995, versus only a portion of 1994. Interest income increased by $1.4 million due to a 39 basis point increase in the yield on interest-earning assets. The increase in yield was the result of changing the mix of securities in the securities portfolio and the increased yield in the loan portfolio. Interest expense for 1995 was $22.6 million, an increase of $4.5 million, or 25%, compared to $18.1 million for 1994. Interest expense on deposits increased by $2.0 million due to an increase in the rates paid on deposits and it increased by $696,000 due to an increase in the average outstanding balance of deposits. Interest expense increased by $1.5 million due to an increase of $24.9 million in the average outstanding balance of FHLB advances and it increased by $244,000 due to increased borrowing rates from the FHLB. The net interest margin was 3.04% for the year ended December 31, 1995 compared to 3.09% for the year ended December 31, 1994. The decline in margin is the result of pricing changes made to certificate accounts in order to increase its deposit base during 1995 and the increased borrowings from the FHLB. The following schedule presents the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities. It distinguishes between the increase related to higher outstanding balances and that due to the levels and volatility of interest rates. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in volume (i.e., changes in volume multiplied by old rate) and (ii) changes in rate (i.e., changes in rate multiplied by old volume). 15
- ----------------------------------------------------------------------------------------------------------------------------- Year Ended December 31, ---------------------------------------------------------------------------- 1995 vs. 1996 1994 vs. 1995 ------------------------------------- ------------------------------------- Increase (Decrease) Increase (Decrease) Due to Total Due to Total ------------------------ Increase ------------------------ Increase (DOLLARS IN THOUSANDS) Volume(1) Rate(1) (Decrease) Volume(1) Rate(1) (Decrease) - ----------------------------------------------------------------------------------------------------------------------------- INTEREST-EARNING ASSETS: Securities held for sale..................... $ (25) 0 (25) Securities available for sale: Mortgage-backed and related securities..... (323) 57 (266) 484 809 1,293 Other marketable securities................ (403) (31) (434) 1,125 278 1,403 Securities held to maturity: Mortgage-backed and related securities..... 59 (40) 19 330 (33) 297 Other marketable securities................ (244) (41) (285) (290) 55 (235) Loans receivable, net........................ 2,740 (394) 2,346 2,990 334 3,324 Federal Home Loan Bank stock................. 83 (9) 74 (25) 23 (2) Other including cash equivalents............. 107 (25) 82 7 (11) (4) ----------- --- ----------- ----- ----- ----------- Total interest-earning assets.............. $ 2,019 (483) 1,536 4,596 1,455 6,051 ----------- --- ----------- ----- ----- ----------- ----------- --- ----------- ----- ----- ----------- INTEREST-BEARING LIABILITIES: Non-interest checking........................ $ 0 0 0 0 0 0 NOW accounts................................. 30 (18) 12 (6) 0 (6) Passbooks.................................... (2) 3 1 (102) (1) (103) Money market accounts........................ (50) 3 (47) (152) 28 (124) Certificates................................. 351 54 405 956 2,016 2,972 Federal Home Loan Bank advances.............. 1,431 (163) 1,268 1,503 246 1,749 ----------- --- ----------- ----- ----- ----------- Total interest-bearing liabilities......... $ 1,760 (121) 1,639 2,199 2,289 4,488 ----------- --- ----------- ----- ----- ----------- ----------- --- ----------- ----- ----- ----------- Net interest income............................ $ 15,670 15,773 ----------- ----------- ----------- -----------
(1) For purposes of this table, changes attributable to both rate and volume which cannot be segregated, have been allocated proportionately to the change due to volume and the change due to rate. The following table sets forth the weighted average yields on the Bank's interest-earning assets, the weighted average interest rates on interest-bearing liabilities and the interest rate spread between the weighted average yields and rates as of the date indicated. Non-accruing loans have been included in the table as loans carrying a zero yield.
- -------------------------------------------------------------------------------- AT DECEMBER 31, 1996 - -------------------------------------------------------------------------------- WEIGHTED AVERAGE YIELD ON: Securities available for sale: Mortgage-backed and related securities................................................ 6.62% Other marketable securities........................................................... 6.08 Securities held to maturity: Mortgage-backed and related securities................................................ 8.66 Other marketable securities........................................................... 5.65 Loans receivable, net................................................................... 7.98 Federal Home LoanBank stock............................................................. 7.00 Other interest-earning assets........................................................... 4.62 Combined weighted average yield on interest-earning assets.............................. 7.42 WEIGHTED AVERAGE RATE PAID ON: Noninterest checking.................................................................... 0.00% NOW accounts............................................................................ 2.01 Passbooks............................................................................... 2.50 Money market accounts................................................................... 2.83 Certificates............................................................................ 5.76 Federal Home Loan Bank advances......................................................... 5.64 Combined weighted average rate paid on interest-bearing liabilities..................... 5.25 Interest rate spread...................................................................... 2.17
PROVISION FOR LOSSES ON LOANS The provision for losses on loans is the result of management's evaluation of the loan portfolio including its evaluation of national and regional economic indicators (including the possibility at each year end that there would be an increase in general interest rates), such as national and regional unemployment data, single family loan delinquency as reported separately by the Federal National Mortgage Association (FNMA) and the Federal Home Loan Bank Mortgage Corporation (FHLMC), local single family con- 16 struction permits and local economic growth rates and the current regulatory and general economic environment. HMN will continue to monitor and modify its allowance for losses as these conditions dictate. Although HMN maintains its allowance for losses at a level it considers adequate to provide for probable losses, there can be no assurance that such losses will not exceed the estimated amount or that additional provisions for loan losses will not be required in future periods. The provision for losses on loans for 1996 was $300,000, the same provision that was recognized for 1995. Based upon management's evaluation of the loan portfolio and its understanding of the economic conditions in the areas where it has a concentration of loans, a provision of $300,000 was deemed adequate for 1996. HMN incurred $150,000 of loan charge-offs during 1996 which were primarily related to two loans which were not single-family residential loans. The charge-offs were not deemed to be indicative of a trend that would call for a higher loan loss provision. The provision for losses on loans for 1995 was $300,000, a decrease of $110,000, or 27%, from $410,000 for 1994. Based upon management's evaluation of the loan portfolio and its understanding of the economic conditions in the areas where it has a concentration of loans, the $300,000 provision for 1995 was deemed adequate. NON-INTEREST INCOME Non-interest income was $1.9 million for 1996, an increase of $924,000, or 92.6% compared to $998,000 for 1995 and $595,000 for 1994. The following table presents certain components of non-interest income:
- ------------------------------------------------------------------------------------------------------------------------- Percentage Year ended December 31, Increase (Decrease) ----------------------------------- ------------------------ (DOLLARS IN THOUSANDS) 1996 1995 1994 1996/1995 1995/1994 - ------------------------------------------------------------------------------------------------------------------------- Fees and service charges.................................. $ 359 325 311 10.5% 4.5% Securities gains, net..................................... 1,030 416 65 147.6 540.0 Gain on sales of loans.................................... 39 102 3 (61.8) 3,300.0 Other non-interest income................................. 495 155 216 219.4 (28.2) --------- --- --- Total non-interest income............................... $ 1,923 998 595 92.7 67.7 --------- --- --- --------- --- --- - -------------------------------------------------------------------------------------------------------------------------
The ability to realize gains on the sale of securities is dependent on the type of securities in the securities portfolio and upon changes in the general interest rate environment. During 1996 economic conditions existed which allowed HMN to sell mortgage-backed securities and common stock in other financial institutions at a net gain of $1.0 million. Many of the proceeds of the sales were invested in the loan portfolio. During 1995 interest rates were declining, therefore HMN was able to sell many of its fixed rate securities at a profit. During 1994 there was little opportunity to sell securities at a profit, therefore net security gains were only $65,000. During 1996 HMN had $1.7 million in proceeds from the sale of primarily 30 year fixed rate loans and recognized a $39,000 gain. During 1995 HMN sold $2.4 million of fixed rate 30 year loans and $1.8 million of student loans at a gain of $102,000. Periodically HMN evaluates its loan portfolio and sells loans that do not meet its long-term asset/liability goals. The $340,000 increase in other non-interest income recognized in 1996 compared to 1995 represents a $169,000 increase in commissions earned on the sale of uninsured products, a $71,000 gain on the sale of an equity interest in a data processing center, and $100,000 of other non-recurring income. NON-INTEREST EXPENSE The following table presents the components of non-interest expense:
- ------------------------------------------------------------------------------------------------------------------------- Percentage Year ended December 31, Increase (Decrease) ------------------------------- ------------------------ (DOLLARS IN THOUSANDS) 1996 1995 1994 1996/1995 1995/1994 - ------------------------------------------------------------------------------------------------------------------------- Compensation and benefits............................ $ 4,591 4,160 3,473 10.4% 19.8% Occupancy............................................ 826 698 678 18.3 2.9 Federal deposit insurance premiums................... 800 811 811 (1.4) 0.0 SAIF assessment...................................... 2,352 0 0 N/A N/A Advertising.......................................... 308 312 270 (1.3) 15.6 Data processing...................................... 489 476 458 2.7 3.9 Provision for real estate losses..................... 2 9 0 (77.8) N/A Other................................................ 1,141 1,004 884 13.6 13.6 --------- --------- --------- Total non-interest expense......................... $ 10,509 7,470 6,574 40.7 13.6 --------- --------- --------- --------- --------- --------- - -------------------------------------------------------------------------------------------------------------------------
17 Non-interest expense was $10.5 million for 1996, an increase of $3.0 million, or 40.7%, from $7.5 million for 1995. The majority of the increase is the result of a $2.4 million SAIF assessment made during the third quarter of 1996. Compensation and benefit expense increased by $431,000, or 10.4%, and was the result of adding new employees, normal merit and salary increases, a full year's impact of stock awards granted under the Recognition and Retention Plan granted in June of 1995 and the increased expense of the employee stock option plan related to recognizing benefit expense based upon the fair value of the shares being awarded in the plan. Occupancy expense for 1996 increased by $128,000, or 18.3%, partly due to building improvements made during 1995 being depreciated for a full year in 1996 and partly due to HMN opening a mortgage banking office in Edina, Minnesota during the fourth quarter of 1996. Other expense increased by $137,000, or 13.6% from 1995 to 1996. The increase is the result of professional fees and other non-recurring expenses recognized during 1996. Non-interest expense was $7.5 million for 1995, an increase of $0.9 million, or 13.6%, compared to $6.6 million for 1994. Compensation and benefits expense increased by $687,000, or 19.8%, in 1995 from 1994. In June of 1995 HMN initiated a management Recognition and Retention Plan which awarded 84,486 shares of HMN restricted common stock to management and directors. The stock awards vest over a period of five years and increased benefits expense by $117,000 for 1995. The Bank awarded employees a one time cash bonus totaling $115,000 at December 31, 1995. The employee stock ownership plan (ESOP) was started in June of 1994 and it allocated 33,989 shares to participants during 1994. In 1995 the ESOP allocated 40,973 shares to participants. The increased number of shares being allocated and an increase in the fair value of HMN common stock during 1995 caused benefits expense to increase by $162,000 over the amount expensed in 1994. Compensation and benefits expense increased by $293,000 from 1994 to 1995 due to new staff, raises and merit increases given to employees and management. Advertising expense for 1995 was $312,000, an increase of $42,000, or 15.6%, from $270,000 for 1994. The increase is the result of increased advertising efforts. Other expenses increased by $120,000, or 13.6%, from 1994 to 1995 due primarily to the increased costs of being a public company for a full year. INCOME TAXES HMN recorded income tax expense of $2.5 million in 1996, compared to $3.4 million and $3.1 million for 1995 and 1994, respectively. The decrease in income tax expense from 1995 to 1996 and the increase from 1994 to 1995 is primarily the result of changes in taxable income between the years. For more information on income taxes refer to Note 13 of the Notes to Consolidated Financial Statements. FINANCIAL CONDITION HMN's total assets were $554.7 million at December 31, 1996, compared to $537.9 million at December 31, 1995. The increase in total assets during 1996 of $16.8 million was primarily due to growth through the origination or purchase of loans and the purchase of a $2.8 million partnership interest in mortgage servicing rights. SECURITIES AVAILABLE FOR SALE Securities available for sale were $175.8 million at December 31, 1996 a decrease of $14.5 million, or 7.6%, compared to $190.3 million at December 31, 1995. During 1996 HMN reduced its securities available for sale portfolio in order to increase its outstanding loan portfolio. For more information on securites available for sale refer to Notes 2 and 4 of the Notes to Consolidated Financial Statements. SECURITIES HELD TO MATURITY Securities held to maturity were $2.8 million at December 31, 1996 a decrease of $14.2 million, or 83.4%, compared to $17.0 million at December 31, 1995. The decrease in securities held to maturity during 1996 was primarily due to the contractual obligation of several County Housing and Redevelopment Authorities (HRAs) to repurchase $10.4 million of FNMA mortgage-backed securities from HMN on September 1, 1996. The proceeds from the HRAs repurchase of the securities and the maturities of the held to maturity porfolio were used to increase the loan portfolio or reinvested back into the securities portfolio. For more information on securities held to maturity refer to Notes 2 and 5 of the Notes to Consolidated Financial Statements. 18 LOANS RECEIVABLE, NET The following table sets forth the information on HMN's loan portfolio in dollar amounts and in percentages (before deductions for loans in process, deferred fees and discounts and allowances for losses) as of the dates indicated.
- ----------------------------------------------------------------------------------------------------------------------------------- December 31, ------------------------------------------------------------------------------------------------ 1996 1995 1994 1993 1992 (DOLLARS IN THOUSANDS) Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent - ---------------------------------------------------------------------------------------------------------------------------------- REAL ESTATE LOANS: One-to-four family............. $ 321,340 90.19% $ 292,497 90.62% $ 252,943 91.14% $ 233,009 92.18% $ 223,914 89.86% Multi-family................... 280 0.08 361 0.11 311 0.11 349 0.14 709 0.28 Commercial..................... 7,918 2.22 8,744 2.71 8,316 3.00 4,559 1.80 6,512 2.61 Construction or development.... 3,474 0.98 5,082 1.58 2,799 1.01 3,309 1.31 6,879 2.76 --------- ------ --------- ------ --------- ------ --------- ------ --------- ------ Total real estate.......... 333,012 93.47 306,684 95.02 264,369 95.26 241,226 95.43 238,014 95.51 --------- ------ --------- ------ --------- ------ --------- ------ --------- ------ OTHER LOANS: Consumer Loans: Savings account.............. 938 0.26 1,210 0.37 648 0.23 872 0.34 1,153 0.46 Education.................... 467 0.13 342 0.11 2,007 0.72 1,819 0.72 1,584 0.64 Automobile................... 566 0.16 671 0.21 520 0.19 681 0.27 927 0.37 Home equity.................. 17,808 5.00 11,506 3.56 7,716 2.78 5,604 2.22 4,623 1.86 Home improvement............. 585 0.16 785 0.24 870 0.31 912 0.36 1,044 0.42 Other........................ 568 0.16 545 0.17 502 0.19 586 0.23 684 0.27 --------- ------ --------- ------ --------- ------ --------- ------ --------- ------ Total consumer loans....... 20,932 5.87 15,059 4.66 12,263 4.42 10,474 4.14 10,015 4.02 Commercial business loans...... 2,344 0.66 1,018 0.32 897 0.32 1,089 0.43 1,160 0.47 --------- ------ --------- ------ --------- ------ --------- ------ --------- ------ Total other loans.......... 23,276 6.53 16,077 4.98 13,160 4.74 11,563 4.57 11,175 4.49 --------- ------ --------- ------ --------- ------ --------- ------ --------- ------ Total loans................ 356,288 100.00% 322,761 100.00% 277,529 100.00% 252,789 100.00% 249,189 100.00% ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ LESS: Loans in process............... 2,814 3,531 2,327 2,333 4,576 Unamortized discounts.......... 417 289 162 14 32 Net deferred loan fees......... 1,695 1,899 2,147 2,507 2,236 Allowance for losses........... 2,340 2,191 1,893 1,489 831 --------- --------- --------- --------- --------- Total loans receivable, net...................... $ 349,022 $ 314,851 $ 271,000 $ 246,446 $ 241,514 --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- - ---------------------------------------------------------------------------------------------------------------------------------
One-to-four family real estate loans were $321.3 million at December 31, 1996, an increase of $28.8 million, or 9.8%, compared to $292.5 million for December 31, 1995. During 1996 HMN had the following one-to-four family real estate loan activity: originated $32.5 million, purchased $55.8 million, securitized $15.4 million, sold $2.3 million and received principal repayments of $41.7 million. One-to-four family real estate loans increased $39.6 million to $292.5 million at December 31, 1995 from $252.9 million at December 31, 1994. During 1995 HMN had the following one-to-four family real estate loan activity: originated $25.7 million, purchased $47.1 million, sold $2.4 million and received principal repayments of $30.8 million. One-to-four family real estate loans increased $19.9 million to $252.9 million at December 31, 1994 from $233 million at December 31, 1993. During 1994 HMN originated $31.9 million, purchased $17.2 million and received principal repayments of $29.9 million. Home equity loans were $17.8 million at December 31, 1996 an increase of $6.3 million, or 54.8%, compared to $11.5 million for December 31, 1995. The increase in the home equity loans is due to increased marketing and competitive pricing of the product in HMN's local markets. During the second half of 1995 HMN introduced a revolving home equity line of credit which will loan up to 90% of the equity in a home to the borrower. The interest rate is prime plus 0.5% for the first three years adjusting to a market rate thereafter. During 1995 $4.0 million was drawn on these lines by borrowers. Commercial real estate loans increased $3.8 million to $8.3 million at December 31, 1994 from $4.6 million at December 31, 1993. During 1994 HMN purchased $4.0 million of commercial real estate loans guaranteed by the Small Business Administration (the SBA) and received principal repayments of $200,000. The SBA loans adjust either monthly or quarterly at prime minus 1.0% or 1.25%. 19 ALLOWANCES FOR LOAN AND REAL ESTATE LOSSES HMN recognizes that credit losses will be experienced and that the risk of loss will vary with, among other things, the type of loans being made, the creditworthiness of the borrower over the term of the loan, general economic conditions and, in the case of a secured loan, the quality of the collateral. It is management's policy to maintain an allowance for loan losses based on, among other things, the Bank's and the industry's historical loan loss experience, evaluation of economic conditions, regular reviews of delinquencies and loan portfolio quality and evolving standards imposed by OTS examiners. HMN increases its allowance for loan losses by charging provision for loan losses against income. The methodology for establishing the allowance for loan losses takes into consideration probable losses that have been identified in connection with specific loans as well as losses in the loan portfolio that have not yet been identified but can be expected to occur. Management conducts quarterly reviews of the loan portfolio and evaluates the need to establish general allowances on the basis of these reviews. Management continues to actively monitor the asset quality and to charge off loans against the allowance for loan losses when appropriate. Although management believes it uses the best information available to make determinations with respect to the allowance for loan losses, future adjustments may be necessary if economic conditions differ substantially from the economic conditions in the assumptions used to determine the size of the allowance for losses. The allowance for loan losses was $2.3 million, or 0.66% of total loans at December 31, 1996, compared to $2.2 million, or 0.68% of total loans at December 31, 1995, and $1.9 million, or 0.68% of total loans at December 31, 1994. The following table reflects the activity in the allowance for loan losses and selected statistics:
- -------------------------------------------------------------------------------------------------------------------------- December 31, ----------------------------------------------------- (DOLLARS IN THOUSANDS) 1996 1995 1994 1993 1992 - -------------------------------------------------------------------------------------------------------------------------- Balance at the beginning of year................................... $ 2,191 1,893 1,489 831 883 Provision for losses............................................. 300 300 410 660 233 Charge-offs...................................................... (150) (2) (6) (2) (288) Recoveries....................................................... 0 0 0 0 3 --------- --------- --------- --------- --- Net charge-offs................................................ (150) (2) (6) (2) (285) --------- --------- --------- --------- --- Balance at end of year............................................. $ 2,341 2,191 1,893 1,489 831 --------- --------- --------- --------- --- --------- --------- --------- --------- --- Year end allowance for loan losses as a percent of year end gross loan balance..................................................... 0.66% 0.68% 0.68% 0.59% 0.33% Ratio of net loan charge-offs to average loans outstanding......... 0.05 0.00 0.00 0.00 0.12 Allowance for loan losses as a percentage of total assets at year end.............................................................. 0.42 0.41 0.38 0.35 0.20 - --------------------------------------------------------------------------------------------------------------------------
The ratio of net loan charge-offs to average loans outstanding for each of the past five years has been very low due to the credit quality of the loan portfolio. The following table reflects the activity of the allowance for real estate losses:
- -------------------------------------------------------------------------------------------------------- December 31, -------------------------------------------------- (DOLLARS IN THOUSANDS) 1996 1995 1994 1993 1992 - -------------------------------------------------------------------------------------------------------- Balance at the beginning of year.................. $ 35 37 126 100 0 Provision for losses............................ 2 9 0 45 100 Charge-offs..................................... 0 (11) 0 (19) 0 Recoveries...................................... 0 0 0 0 0 ------ --- ----- ---- --- Net charge-offs............................... 0 (11) 0 (19) 0 ------ --- ----- ---- --- Other........................................... (35) 0 (89) 0 0 ------ --- ----- ---- --- Balance at end of year............................ $ 2 35 37 126 100 ------ --- ----- ---- --- ------ --- ----- ---- ---
Real estate properties acquired or expected to be acquired through loan foreclosures are initially recorded at the lower of the related loan balance, less any specific allowance for loss, or fair value less estimated selling costs. Valuations are periodically performed by management and an allowance for losses is established if the carrying value of a property exceeds its fair value less estimated selling costs. NON-PERFORMING ASSETS Non-performing assets (comprised of non-accrual loans, restructured loans, and real estate acquired through foreclosure) totaled $361,000 at December 31, 1996, a decrease of $489,000 compared to $850,000 at December 31, 1995. Non-performing assets had the following activity during 1996: sales of $314,000, charge-offs of $61,000, pay- 20 ments of $128,000, and net transfers to non-performing assets of $14,000. Non-performing assets are summarized in the following table:
- --------------------------------------------------------------------------------------------------------------------- December 31, ----------------------------------------------------- (DOLLARS IN THOUSANDS) 1996 1995 1994 1993 1992 - --------------------------------------------------------------------------------------------------------------------- Non-accrual loans........................................... $ 338 441 235 138 605 Accruing loans delinquent 90 days or more................... 0 0 0 23 0 Restructured loans.......................................... 0 94 199 0 280 Foreclosed assets........................................... 23 315 64 421 187 --------- --------- --------- --------- --------- Total non-performing assets............................... $ 361 850 498 582 1,072 --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- Non-performing assets as a percentage of total assets......... 0.07% 0.16% 0.10% 0.14% 0.26% Total non-performing loans.................................... $ 338 535 434 161 885 Non-performing loans as a percentage of loans receivable, net......................................................... 0.10% 0.17% 0.16% 0.07% 0.37% Allowance for loan losses to non-performing loans............. 691.84% 409.13% 436.52% 924.84% 93.90%
The non-performing assets reflected above primarily consist of one-to-four family mortgage loans or consumer loans except restructured loans in 1992 were loans secured by multi-family real estate. DEPOSITS Deposits were $362.5 million at December 31, 1996, a decrease of $11.1 million, or 3.0%, compared to $373.5 million at December 31, 1995. The decrease in deposits was all related to the certificate accounts. During 1996 some depositors were attracted by the higher returns offered by nontraditional bank products and therefore closed their certificates. Refer to Note 11 of the Notes to Consolidated Financial Statements for more information on deposits. FEDERAL HOME LOAN BANK ADVANCES Advances were $106.1 million at December 31, 1996, an increase of $37.2 million, or 54.0%, compared to $68.9 million at December 31, 1995. During 1996 advances were obtained in order to purchase loans and assist in repurchasing the stock of HMN in the open market. For additional information refer to Stockholders' Equity, Asset/Liability Management and Note 12 of the Notes to Consolidated Financial Statements for information on advances. STOCKHOLDERS' EQUITY Stockholders' equity was $82.1 million on December 31, 1996, a decrease of $9.6 million, or 10.5% from $91.7 million at December 31, 1995. During 1996 HMN purchased 869,785 shares of its own common stock for a total cost of $14.4 million. The shares were all purchased at a price less than the current book value of HMN. In June of 1995 the Board of Directors approved a management Recognition and Retention Plan (RRP) which awarded 84,486 shares of restricted HMN common stock to management and directors. The restricted stock used for the RRP was issued from treasury stock and vests over a five year period. As the RRP participants earn their awards stockholders' equity is credited and compensation is expensed. On June 29, 1994, HMN completed a public stock Offering which generated net proceeds of $59.2 million net of costs of $1.7 million. An ESOP was established which borrowed $6.1 million from HMN. The loan is treated as a reduction of stockholders' equity. For more information refer to the Consolidated Statement of Stockholders' Equity and Note 15 of the Notes to Consolidated Financial Statements. REGULATORY CAPITAL REQUIREMENTS Federal savings institutions are required to satisfy three capital requirements: (i) a requirement that "tangible capital" equal or exceed 1.5% of adjusted total assets, (ii) a requirement that "core capital" equal or exceed 3% of adjusted total assets, and (iii) a requirement that "risk-based capital" equal or exceed 8% of risk-weighted assets. With certain exceptions, all three capital standards must generally conform to and be no less stringent than, the capital standards published by the Comptroller of the Currency for national banks. As a result of the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA), banking and thrift regulators are required to take prompt regulatory action against institutions which are undercapitalized. FDICIA requires banking and thrift regulators to categorize institutions as "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized," or "critically undercapitalized". A savings institution will be deemed to be well capitalized if it: (i) has a total risk-based capital ratio of 10% or greater, (ii) has a Tier 1 (core) risk-based capital ratio of 6% or greater, (iii) has a leverage (core) ratio of 5% or greater, and (iv) is not subject to any order or written directive by the OTS to meet and maintain a specific capital level for any capital measure. The Bank is of the opinion that it is considered well capitalized at December 31, 1996. Refer to Note 15 of the Notes to Consolidated Financial Statements for a table which reflects the Bank's capital requirements. LIQUIDITY MANAGEMENT HMN manages its liquidity position to ensure that the funding needs of borrowers and depositors are met timely and in the most cost effective manner. Asset liquidity is the ability to convert assets to cash through the maturity of the 21 asset or the sale of the asset. Liability liquidity results from the ability of the Bank to attract depositors or borrow funds from third party sources such as the FHLB. The Bank is required by regulation to maintain a monthly average minimum asset liquidity ratio of 5%. The Bank has maintained an average monthly liquidity ratio in excess of the 5% requirement and does not anticipate that it will fall below the requirement in the future. The primary investing activities are the origination or purchase of loans and the purchase of securities. Principal and interest payments on mortgages and securities are a primary source of cash for HMN. Additional cash can be obtained by selling securities from the available for sale portfolio or by selling loans. Loans could also be securitized by FNMA or FHLMC and used as collateral for additional borrowing with the FHLB. The primary financing activity is the attraction of retail deposits. The Bank has the ability to borrow additional funds from the FHLB by pledging additional securities or loans. Refer to Note 12 of the Notes to Consolidated Financial Statements for more information on undrawn open lines of credit with the FHLB and advance maturity. HMN anticipates that its liquidity requirements for 1997 will be similar to the cash flows it experienced in 1996 with the exception of $2.5 million for the construction of two new retail banking facilities and cash needed to fund the mortgage banking activities located in Edina, Minnesota. The cash required to fund the mortgage banking activities is anticipated to range from $5.0 million to $10.0 million at any given time. HMN's most liquid assets are cash and cash equivalents, which consist of short-term highly liquid investments with original maturities of less than three months that are readily convertible to known amounts of cash and interest-bearing deposits. The level of these assets is dependent on the operating, financing, and investing activities during any given period. Cash and cash equivalents at December 31, 1996 were $10.6 million, an increase of $6.3 million compared to $4.3 million at December 31, 1995. Net cash provided from operating activities during 1996 was $5.8 million. HMN conducted the following major investing activities during 1996: proceeds from the sale of securities available for sale were $101.2 million, principal received on payments and maturities of securities available for sale was $37.0 million, purchases were $107.9 million of securities available for sale, principal received on payments and maturities of securities held to maturity were $14.9 million, purchases of securities held to maturity were $710,000, purchase of interest in limited partnership was $2.9 million, proceeds from sale of loans were $1.4 million, purchase of FHLB stock was $1.6 million and net increase in loans receivable was due primarily to loan originations and loan purchases of $53.2 million. Net cash used by investing activities during 1996 was $11.7 million. HMN conducted the following major financing activities during 1996: decrease in deposits of $11.1 million, purchase of treasury stock $14.0 million, proceeds from FHLB advances $130.0 million and repayments of FHLB advances totaled $92.8 million. Net cash provided from financing activities was $12.2 million. HMN has certificates of deposit with outstanding balances of $163.6 million that come due during 1997. Based upon past experience management anticipates that the majority of the deposits will renew for another term. Any deposits which do not renew will be replaced with deposits from other customers, or funded with advances from the FHLB, or will be funded through the sale of securities. Management does not anticipate that it will have a liquidity problem with the deposit maturities. ASSET/LIABILITY MANAGEMENT The interest rate sensitivity of assets and liabilities may be analyzed by examining the extent to which such assets and liabilities will mature or reprice within the same period. The interest rate sensitivity gap is defined as the difference between the amount of interest-earning assets maturing or repricing within a specific time period and the amount of interest-bearing liabilities maturing or repricing within a specific time period. A gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities, and is considered negative when the amount of interest rate sensitive liabilities exceeds the amount of interest rate sensitive assets. Generally, during a period of rising interest rates, a negative gap would adversely affect net interest income while a positive gap would result in an increase in net interest income. Conversely, during a period of falling interest rates, a negative gap would result in an increase in net income and a positive gap would adversely affect 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. 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 22 of its asset and liability portfolios can, during periods of declining or stable interest rates, provide high enough returns to justify the increased exposure to sudden and unexpected increases in interest rates. To the extent consistent with its interest rate spread objectives, the Bank attempts to reduce its interest rate risk and has taken a number of steps to restructure its assets and liabilities. The Bank has primarily focused its fixed rate one-to-four family residential lending program on loans with contractual terms of 20 years or less. The following table sets forth the interest rate sensitivity of HMN's assets and liabilities at December 31, 1996, using certain assumptions that are described in more detail below:
- ----------------------------------------------------------------------------------------------------------------------------------- Maturing or Repricing ------------------------------------------------------------------------------------- Over 6 6 Months Months to Over 1-3 Over 3-5 Over 5 No Stated (DOLLARS IN THOUSANDS) or Less 1 Year Years Years Years Maturity Total - ----------------------------------------------------------------------------------------------------------------------------------- Cash equivalents............................ $ 9,584 0 0 0 0 0 9,584 Securities available for sale: Mortgage-backed and related securities(1)........................... 48,391 4,848 19,384 15,570 46,281 0 134,474 Other marketable securities............... 17,510 2,886 8,160 5,951 57 7,796 42,360 Securities held to maturity: Mortgage-backed and related securities(1)........................... 201 399 532 357 317 0 1,806 Other marketable securities............... 1,000 0 0 0 0 0 1,000 Loans held for sale......................... 739 0 0 0 0 0 739 Loans receivable, net:(1)(2) Fixed rate one-to-four family(3).......... 20,658 18,857 62,481 44,134 88,538 0 234,668 Adjustable rate one-to-four family(3)..... 31,059 18,948 17,280 19,382 663 0 87,332 Multi-family.............................. 6 4 47 0 0 0 57 Fixed rate commercial real estate......... 173 135 418 269 505 0 1,500 Adjustable rate commercial real estate.... 6,547 94 0 0 0 0 6,641 Commercial business....................... 1,353 220 567 140 65 0 2,345 Consumer loans............................ 14,341 1,266 2,211 855 147 0 18,820 Federal Home Loan Bank stock................ 0 0 0 0 0 5,434 5,434 ----------- ----------- ----------- ----------- --------- ----------- --------- Total interest-earning assets......... 151,562 47,657 111,080 86,658 136,573 13,230 546,760 ----------- ----------- ----------- ----------- --------- ----------- --------- Non-interest checking....................... 2,389 0 0 0 0 0 2,389 NOW accounts................................ 17,589 0 0 0 0 0 17,589 Passbooks................................... 3,174 2,840 8,660 5,543 9,853 0 30,070 Money market accounts....................... 1,745 1,562 4,761 3,047 5,418 0 16,533 Certificates................................ 92,535 71,077 111,329 20,955 0 0 295,896 Federal Home Loan Bank advances............. 59,714 5,714 6,251 34,400 0 0 106,079 ----------- ----------- ----------- ----------- --------- ----------- --------- Total interest-bearing liabilities.... 177,146 81,193 131,001 63,945 15,271 0 468,556 ----------- ----------- ----------- ----------- --------- ----------- --------- Interest-earning assets less interest-bearing liabilities.............. $ (25,584) (33,536) (19,921) 22,713 121,302 13,230 78,204 ----------- ----------- ----------- ----------- --------- ----------- --------- ----------- ----------- ----------- ----------- --------- ----------- --------- Cumulative interest-rate sensitivity gap.... $ (25,584) (59,120) (79,041) (56,328) 64,974 78,204 78,204 ----------- ----------- ----------- ----------- --------- ----------- --------- ----------- ----------- ----------- ----------- --------- ----------- --------- Cumulative interest-rate gap as a percentage of total assets at December 31, 1996...... (4.61)% (10.66)% (14.25)% (10.15)% 11.71% 14.10% 14.10% ----------- ----------- ----------- ----------- --------- ----------- --------- ----------- ----------- ----------- ----------- --------- ----------- --------- Cumulative interest-rate gap as a percentage of interest-earning assets at December 31, 1995...................................... (1.07) (7.53) ----------- ----------- ----------- ----------- Cumulative interest-rate gap as a percentage of interest-earning assets at December 31, 1994...................................... (2.47) (2.26) ----------- ----------- ----------- -----------
(1) Schedule prepared based upon the earlier of contractual maturity or repricing date, if applicable, adjusted for scheduled repayments of principal and projected prepayments of principal based upon experience. (2) Loans receivable are presented net of loans in process and deferred loan fees. (3) Construction and development loans are all one-to-four family loans and therefore have been included in the fixed rate one-to-four family and adjustable rate one-to-four family lines. - -------------------------------------------------------------------------------- 23 The preceding table was prepared utilizing the following 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 5% to 24%, depending on the coupon and period to maturity. ARMs were assumed to prepay at annual rates of between 3% and 12%, depending the on coupon and the period to maturity. Growing Equity Mortgage (GEM) loans were assumed to prepay at annual rates of between 8% and 27% depending on the coupon and the period to maturity. Mortgage-backed securities and Collateralized Mortgage Obligations (CMOs) were projected to have prepayments based upon the underlying collateral securing the instrument. Certificate accounts were assumed not to be withdrawn until maturity. Passbook and money market accounts were assumed to decay at an annual rate of 20%. Certain shortcomings are inherent in the method of analysis presented in the foregoing table. Although certain assets and liabilities may have similar maturities and periods of repricing, they may react in different degrees to changes in market interest rates. The interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types of assets and liabilities may lag behind changes in market interest rates. Certain assets, such as adjustable-rate mortgages, have features which restrict changes in interest rates on a short-term basis and over the life of the asset. In the event of a change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed in calculating the foregoing table. The ability of many borrowers to service their debt may decrease in the event of an interest rate increase. Refer to Regulatory Capital Requirements above for a discussion of Bank's interest rate risk component. DIVIDENDS HMN has not paid any dividends since its incorporation in March 1994. However, the Board of Directors may consider a policy of paying cash dividends in the future. The declaration of dividends are subject to, among other things, HMN's financial condition and results of operations, the Bank's compliance with its regulatory capital requirements, including the fully phased-in capital requirements, tax considerations, industry standards, economic conditions, regulatory restrictions, general business practices and other factors. Refer to Note 15 of the Notes to Consolidated Financial Statements for information on regulatory limitations on dividends from the Bank to HMN. IMPACT OF INFLATION AND CHANGING PRICES The Consolidated Financial Statements and Notes presented herein have been prepared in accordance with generally accepted accounting principles, which require the measurement of financial position and operation results primarily in terms of historical dollars without considering the changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of operations. Unlike most industrial companies, nearly all of the assets and liabilities of HMN are monetary in nature. As a result, interest rates have a greater impact on HMN's performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services. MERGER AND ACQUISITIONS From time to time HMN reviews the possibility of acquiring or merging with different companies which would complement the business conducted by HMN. HMN's Board of Directors has adopted the policy of not disclosing to the public its intent to acquire or merge until a formal definitive agreement has been signed by all parties involved with the transaction. OUTLOOK The statements contained in this Outlook are based upon current expectations. These statements are forward looking, and actual results may differ materially. During 1996 HMN opened a mortgage banking office in Edina, Minnesota. The office will purchase mortgage loans from third party originators for HMN's loan portfolio or sell the loans in the secondary market. The office will keep the mortgage loan servicing rights on many of the loans that are sold to the secondary market and it also intends to purchase mortgage servicing rights from third parties. The addition of the mortgage banking office is anticipated to increase the operating expense ratio for HMN to a range of 1.50% to 1.60% of average total assets. The office is also anticipated to generate income from loan servicing and from the sale of loans which should, for the first full year of operation, offset a majority of its operating expenses. In the future, to the extent that HMN invests in mortgage servicing assets, its mortgage servicing income will increase but its interest margin may decline due to the purchase of non-interest earning assets. 24 Consolidated Balance Sheets - -------------------------------------------------------------------------------- DECEMBER 31, 1996 AND 1995
1996 1995 ASSETS ------------------------------ Cash and cash equivalents......................................................... $ 10,583,717 4,334,694 Securities available for sale: Mortgage-backed and related securities (amortized cost $134,474,167 and $158,517,548)................................................................. 133,355,278 158,416,201 Other marketable securities (amortized cost $42,360,499 and $32,247,959)........ 42,474,810 31,903,566 -------------- ------------- 175,830,088 190,319,767 -------------- ------------- Securities held to maturity: Mortgage-backed and related securities (fair value $1,904,993 and $13,931,879).................................................................. 1,805,744 13,744,063 Other marketable securities (fair value $1,000,550 and $3,224,263).............. 999,812 3,227,729 -------------- ------------- 2,805,556 16,971,792 -------------- ------------- Loans held for sale............................................................... 739,316 0 Loans receivable, net............................................................. 349,022,236 314,850,684 Federal Home Loan Bank stock, at cost............................................. 5,434,000 3,801,900 Real estate, net.................................................................. 20,610 279,851 Premises and equipment, net....................................................... 3,581,497 3,645,536 Accrued interest receivable....................................................... 3,415,152 3,381,507 Prepaid expenses and other assets................................................. 3,299,427 362,928 -------------- ------------- Total assets.................................................................. $ 554,731,599 537,948,659 -------------- ------------- -------------- ------------- LIABILITIES AND STOCKHOLDERS' EQUITY Deposits.......................................................................... $ 362,476,944 373,539,468 Federal Home Loan Bank advances................................................... 106,078,589 68,876,978 Accrued interest payable.......................................................... 1,542,773 1,562,347 Advance payments by borrowers for taxes and insurance............................. 518,911 550,990 Accrued expenses and other liabilities............................................ 2,014,938 1,732,193 -------------- ------------- Total liabilities............................................................... 472,632,155 446,261,976 -------------- ------------- Commitments and contingencies Stockholders' equity: Serial preferred stock ($.01 par value): authorized 500,000 shares; issued and outstanding none.............................................................. 0 0 Common stock ($.01 par value): authorized 7,000,000; issued shares 6,085,775.... 60,858 60,858 Additional paid-in capital...................................................... 59,428,768 59,285,581 Retained earnings, subject to certain restrictions.............................. 54,645,387 50,371,038 Net unrealized loss on securities available for sale............................ (598,045) (265,358) Unearned employee stock ownership plan shares................................... (4,938,520) (5,336,150) Unearned compensation restricted stock awards................................... (793,289) (1,050,305) Treasury stock, at cost 1,651,615 and 783,850 shares............................ (25,705,715) (11,378,981) -------------- ------------- Total stockholders' equity.................................................... 82,099,444 91,686,683 -------------- ------------- Total liabilities and stockholders' equity.................................... $ 554,731,599 537,948,659 -------------- ------------- -------------- -------------
See accompanying notes to consolidated financial statements. 25 Consolidated Statements of Income - -------------------------------------------------------------------------------- YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
1996 1995 1994 ----------------------------------------- Interest income: Loans receivable.................................................... $ 25,721,042 23,375,334 20,050,650 Securities available for sale: Mortgage-backed and related....................................... 10,027,438 10,294,056 9,000,995 Other marketable.................................................. 2,424,628 2,857,884 1,545,302 Securities held to maturity: Mortgage-backed and related....................................... 765,120 746,100 448,909 Other marketable.................................................. 104,448 389,381 534,523 Cash equivalents.................................................... 494,129 412,259 441,733 Other............................................................... 327,520 253,170 255,122 ------------- ------------ ------------ Total interest income........................................... 39,864,325 38,328,184 32,277,234 ------------- ------------ ------------ Interest expense: Deposits............................................................ 18,949,937 18,578,744 15,840,739 Federal Home Loan Bank advances..................................... 5,243,853 3,976,353 2,226,733 ------------- ------------ ------------ Total interest expense............................................ 24,193,790 22,555,097 18,067,472 ------------- ------------ ------------ Net interest income............................................... 15,670,535 15,773,087 14,209,762 Provision for loan losses............................................. 300,000 300,000 410,000 ------------- ------------ ------------ Net interest income after provision for loan losses................. 15,370,535 15,473,087 13,799,762 ------------- ------------ ------------ Noninterest income: Fees and service charges............................................ 359,249 324,492 311,042 Securities gains, net............................................... 1,029,638 415,955 65,027 Gain on sales of loans.............................................. 39,306 102,368 3,219 Other............................................................... 494,507 155,434 215,425 ------------- ------------ ------------ Total noninterest income........................................ 1,922,700 998,249 594,713 ------------- ------------ ------------ Noninterest expense: Compensation and benefits........................................... 4,591,367 4,160,248 3,472,955 Occupancy........................................................... 825,609 697,602 678,105 Federal deposit insurance premiums.................................. 799,890 810,432 811,023 SAIF assessment..................................................... 2,351,563 0 0 Advertising......................................................... 308,464 312,366 270,001 Data processing..................................................... 489,045 476,402 458,112 Provision for real estate losses.................................... 2,000 9,327 0 Other............................................................... 1,140,948 1,003,682 883,853 ------------- ------------ ------------ Total noninterest expense......................................... 10,508,886 7,470,059 6,574,049 ------------- ------------ ------------ Income before income tax expense.................................. 6,784,349 9,001,277 7,820,426 Income tax expense.................................................... 2,510,000 3,380,900 3,115,767 ------------- ------------ ------------ Net income........................................................ $ 4,274,349 5,620,377 4,704,659 ------------- ------------ ------------ ------------- ------------ ------------ Earnings per common share and common share equivalents................ $ 0.96 1.09 0.48 Pro forma earnings per common share................................... $ N/A N/A 0.86
- ------------------------ N/A Not applicable for the period. See accompanying notes to consolidated financial statements. 26 Consolidated Statement of Stockholders' Equity - -------------------------------------------------------------------------------- YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
Net Unrealized Gain (Loss) Unearned on Employee Unearned Additional Securities Stock Compensation Total Common Paid-In Retained Available Ownership Restricted Treasury Stockholders' Stock Capital Earnings For Sale Plan Shares Stock Awards Stock Equity ----------------------------------------------------------------------------------------------------------- Balance, December 31, 1993.......... $ 40,046,002 40,046,002 Cumulative effect of change in accounting for securities available for sale, net of tax effect, at January 1, 1994............ 566,495 566,495 Net income........ 4,704,659 4,704,659 Change in unrealized loss on securities available for sale, net of tax effect.......... (9,741,118) (9,741,118) Sale of stock..... 60,858 59,117,484 59,178,342 Adoption of employee stock ownership plan............ (6,085,770) (6,085,770) Earned employee stock ownership plan shares..... 38,511 339,890 378,401 -------- ----------- ----------- ----------- ----------- -------------- ----------- -------------- Balance, December 31, 1994.......... 60,858 59,155,995 44,750,661 (9,174,623) (5,745,880) 89,047,011 Net income........ 5,620,377 5,620,377 Change in unrealized loss on securities available for sale............ 8,909,265 8,909,265 Treasury stock purchases....... (12,509,667) (12,509,667) Unearned compensation restricted stock awards.......... 36,319 (1,167,005) 1,130,686 0 Amortization of restricted stock awards.......... 116,700 116,700 Earned employee stock ownership plan shares..... 93,267 409,730 502,997 -------- ----------- ----------- ----------- ----------- -------------- ----------- -------------- Balance, December 31, 1995.......... 60,858 59,285,581 50,371,038 (265,358) (5,336,150) (1,050,305) (11,378,981) 91,686,683 Net income........ 4,274,349 4,274,349 Change in unrealized loss on securities available for sale............ (332,687) (332,687) Treasury stock purchases....... (14,364,754) (14,364,754) Stock options exercised....... (10,817) 63,180 52,363 Restricted stock awards cancelled....... (808) 25,968 (25,160) 0 Amortization of restricted stock awards.......... 231,048 231,048 Restricted stock awards tax benefit......... 13,677 13,677 Earned employee stock ownership plan shares..... 141,135 397,630 538,765 -------- ----------- ----------- ----------- ----------- -------------- ----------- -------------- Balance, December 31, 1996.......... $60,858 59,428,768 54,645,387 (598,045) (4,938,520) (793,289) (25,705,715) 82,099,444 -------- ----------- ----------- ----------- ----------- -------------- ----------- -------------- -------- ----------- ----------- ----------- ----------- -------------- ----------- --------------
See accompanying notes to consolidated financial statements. 27 Consolidated Statements of Cash Flows - -------------------------------------------------------------------------------- YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
1996 1995 1994 ----------------------------------------------------- Cash flows from operating activities: Net income................................................ $ 4,274,349 5,620,377 4,704,659 Adjustments to reconcile net income to cash provided by operating activities: Purchase of securities held for sale...................... 0 0 (3,000,000) Proceeds from sale of securities held for sale.......... 0 0 10,586,091 Provision for loan losses............................... 300,000 300,000 410,000 Provision for real estate losses........................ 2,000 9,327 0 Depreciation............................................ 378,753 352,580 303,193 Amortization of (discounts) premiums, net............... (129,636) (272,862) 54,279 Amortization of deferred loan fees...................... (440,580) (613,037) (520,752) Provision for deferred income taxes..................... 110,400 568,050 138,212 Federal Home Loan Bank stock dividend................... 0 (75,100) 0 Securities gains, net................................... (1,029,638) (415,955) (65,027) Gain on sales of real estate............................ (46,625) (14,241) 0 Gain on sales of loans.................................. (39,306) (102,368) (3,219) Proceeds from sales of loans originated for sale........ 1,779,361 260,848 0 Amortization of restricted stock awards................. 231,048 116,700 0 Decrease in unearned ESOP shares........................ 397,630 409,730 0 Earned employee stock ownership shares priced above original cost.......................................... 141,135 93,267 38,511 Increase in accrued interest receivable................. (33,645) (100,280) (663,822) Increase (decrease) in accrued interest payable......... (19,574) 561,969 89,165 Equity earnings of limited partnership.................. (7,400) 0 0 Increase in other assets................................ (48,974) (173,133) (5,023) Increase (decrease) in other liabilities................ 35,995 (540,164) (24,633) Other, net.............................................. (56,470) (35,803) (106,551) --------------- --------------- --------------- Net cash provided by operating activities............. 5,798,823 5,949,905 11,935,083 --------------- --------------- --------------- Cash flows from investing activities: Proceeds from sales of securities available for sale...... 101,157,643 85,454,779 23,165,770 Principal collected on securities available for sale...... 16,530,585 15,427,074 31,346,252 Proceeds collected on maturity of securities available for sale.................................................... 20,500,000 18,815,000 200,000 Purchases of securities available for sale................ (107,860,451) (110,993,058) (108,913,073) Principal collected on securities held to maturity........ 2,276,661 1,076,805 1,949,181 Proceeds collected on maturity of securities held to maturity................................................ 12,652,343 5,000,000 11,000,000 Purchase of securities held to maturity................... (709,765) (10,993,313) (12,204,562) Purchase interest in limited partnership.................. (2,880,125) 0 0 Proceeds from sales of loans receivable................... 1,408,015 3,996,710 130,670 Purchase of Federal Home Loan Bank stock.................. (1,632,100) (688,100) 0 Net increase in loans receivable.......................... (53,214,798) (47,904,546) (24,363,821) Proceeds from sale of real estate......................... 379,789 199,020 144,577 Purchases of premises and equipment....................... (314,714) (458,666) (931,557) --------------- --------------- --------------- Net cash used by investing activities................. (11,706,917) (41,068,295) (78,476,563) --------------- --------------- --------------- Cash flows from financing activities: (Decrease) increase in deposits........................... (11,062,524) 22,964,821 (3,006,512) Purchase of treasury stock................................ (14,002,254) (12,509,667) 0 Increase in unearned ESOP shares.......................... 0 0 (5,745,880) Stock options exercised................................... 52,363 0 0 Proceeds from sale of common stock........................ 0 0 59,178,342 Proceeds from Federal Home Loan Bank advances............. 130,000,000 82,150,000 25,900,000 Repayment of Federal Home Loan Bank advances.............. (92,798,389) (65,258,747) (7,878,568) Increase (decrease) in advance payments by borrowers for taxes and insurance..................................... (32,079) 9,521 39,014 --------------- --------------- --------------- Net cash provided by financing activities............. 12,157,117 27,355,928 68,486,396 --------------- --------------- --------------- Increase (decrease) in cash and cash equivalents...... 6,249,023 (7,762,462) 1,944,916 Cash and cash equivalents, beginning of year................ 4,334,694 12,097,156 10,152,240 --------------- --------------- --------------- Cash and cash equivalents, end of year...................... $ 10,583,717 4,334,694 12,097,156 --------------- --------------- --------------- --------------- --------------- --------------- Supplemental cash flow disclosures: Cash paid for interest.................................... $ 24,213,364 21,993,128 17,978,307 Cash paid for income taxes................................ 2,725,433 2,994,755 2,849,148 Supplemental noncash flow disclosures: Loans securitized and transferred to securities available for sale................................................ $ 15,411,803 0 0 Securities held to maturity transferred to securities available for sale...................................... 0 651,594 72,374,853 Loans transferred to loans held for sale.................. 2,491,820 254,912 0 Transfer of loans to real estate.......................... 188,054 413,853 153,913 Transfer of real estate to loans.......................... 161,954 0 361,054 Treasury stock purchased with liability due to broker..... 362,500 0 0
See accompanying notes to consolidated financial statements. 28 Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- DECEMBER 31, 1996, 1995 AND 1994 (1) DESCRIPTION OF THE BUSINESS HMN Financial, Inc. (HMN) was incorporated under the laws of the State of Delaware for the purpose of becoming the savings and loan holding company of Home Federal Savings Bank (the Bank) in connection with the Bank's conversion from a federally chartered mutual savings bank to a federally chartered stock savings bank, pursuant to its Plan of Conversion. HMN commenced on May 23, 1994, a Subscription and Community Offering of its shares in connection with the conversion of the Bank (the Offering). The Offering was closed on June 22, 1994, and the conversion was consummated on June 29, 1994. The consolidated financial statements included herein are for HMN, the Bank and the Bank's wholly owned subsidiaries, Security Finance Corporation (SFC) and Osterud Insurance Agency, Inc. On December 29, 1995 the Bank sold all outstanding shares of common stock in SFC to HMN at SFC's fair value. All significant intercompany accounts and transactions have been eliminated in consolidation. All financial information prior to June 29, 1994, contained herein relates solely to the Bank and its subsidiaries. (2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The consolidated financial statements have been prepared in conformity with generally accepted accounting principles. The following items set forth the significant accounting policies which HMN follows in presenting its financial statements. MATERIAL ESTIMATES In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to change relate to the determination of the allowance for losses on loans and the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans. In connection with the determination of the allowances for loan and real estate losses, management obtains independent appraisals for significant properties. Management believes that the allowances for losses on loans and real estate are adequate. While management uses available information to recognize losses on loans and real estate, future additions to the allowances may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the allowances for losses on loans and real estate. Such agencies may require additions to the allowances based on their judgement about information available to them at the time of their examination. CASH EQUIVALENTS For purposes of the statements of cash flows, HMN considers highly liquid investments with original maturities of three months or less to be cash equivalents. SECURITIES The Bank adopted the provisions of Statement of Financial Accounting Standards (SFAS) No. 115, ACCOUNTING FOR CERTAIN INVESTMENTS IN DEBT AND EQUITY SECURITIES as of January 1, 1994. The adoption of SFAS No. 115 increased stockholders' equity by $566,495 at January 1, 1994. HMN classifies its debt and equity securities in one of three categories: trading, available for sale, or held to maturity. Trading securities are bought and held principally for the purpose of selling them in the near term. Securities available for sale include securities that management intends to use as part of its asset/liability strategy or that may be sold in response to changes in interest rate, changes in prepayment risk, or similar factors. Securities available for sale are carried at market value. Net unrealized gains and losses, net of tax effect, are included as a separate component of stockholders' equity. Securities held to maturity are carried at cost, adjusted for amortization of premiums and discounts, as management has the ability and intent to hold them to maturity. Premiums and discounts are amortized using the level-yield method over the period to maturity. Gains and losses on the sale of securities are determined using the specific-identification method. During December 1995, HMN transferred securities with an amortized cost of $651,594 from securities held to maturity to securities available for sale. The transfer was made in conformity with A GUIDE TO IMPLEMENTATION OF STATEMENT 115 ON ACCOUNTING FOR CERTAIN INVESTMENTS IN DEBT AND EQUITY SECURITIES issued by the Financial Accounting Standards Board (FASB) in November of 1995. LOANS HELD FOR SALE Mortgage loans originated or purchased which are intended for sale in the secondary market are carried at the lower of cost or estimated market value in the aggregate. Net unrealized losses are recognized through a valuation allowance by charges to income. LOANS RECEIVABLE, NET Loans receivable, net are considered long-term investments and, accordingly are carried at amortized cost. Loan origination fees received, net of certain loan origination costs, are deferred as an adjustment to the carrying value of the related loans, and are amortized into income using the interest method over the estimated life of the loans. Discounts on loans are amortized into interest income using the interest method over the period to contractual maturity, adjusted for estimated prepayments. The allowance for loan losses is maintained at an amount considered adequate to provide for probable losses. The allowance for losses on loans is based on periodic analysis of the loan portfolio by management. In this analysis, management considers factors including, but not limited to, specific occurrences which include loan impairment, gen- 29 eral economic conditions, loan portfolio composition and historical experience. Loans are charged off to the extent they are deemed to be uncollectible. Interest income is recognized on an accrual basis except when collectibility is in doubt. When loans are placed on a nonaccrual basis, previously accrued but unpaid interest is reversed from income. Interest is subsequently recognized as income to the extent cash is received when, in management's judgement, principal is collectible. Effective January 1, 1995, HMN adopted SFAS No. 114, ACCOUNTING BY CREDITORS FOR IMPAIRMENT OF A LOAN, and SFAS No. 118, ACCOUNTING BY CREDITORS FOR IMPAIRMENT OF A LOAN--INCOME RECOGNITION AND DISCLOSURES. SFAS No. 114 requires that impaired loans, including all loans that are restructured in a troubled debt restructuring involving a modification of terms, be measured at the present value of expected future cash flows discounted at the loan's initial effective interest rate. The fair value of the collateral of an impaired collateral-dependent loan or an observable market price, if one exists, may be used as an alternative to discounting. If the measure of the impaired loan is less than the recorded investment in the loan, impairment is to be recognized through the allowance for loan losses. A loan is considered impaired when, based on current information and events, it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. SFAS No. 118 amends SFAS No. 114 to allow a creditor to use existing methods for recognizing interest income on impaired loans and to clarify disclosure requirements. The adoption of SFAS No. 114 and SFAS No. 118 did not impact HMN's results of operations for 1995 or any prior period. In accordance with SFAS No. 114 and SFAS No. 118, prior period financial statements have not been restated to reflect the change in accounting method. For purposes of SFAS No. 114 and SFAS No. 118 impaired loans are all loans which are delinquent as to principal and interest for 120 days or greater and all loans that are restructured in a troubled debt restructuring involving a modification of terms. All portfolio loans are reviewed on an individual basis. MORTGAGE SERVICING RIGHTS Effective January 1, 1996, HMN adopted SFAS No. 122, ACCOUNTING FOR MORTGAGE SERVICING RIGHTS. HMN recognizes as a separate asset the rights to service mortgage loans for others whether the servicing rights are acquired through loan origination or purchase. The fair value of capitalized mortgage servicing rights is based upon the present value of estimated future cash flows. Based upon current fair values capitalized mortgage servicing rights are periodically assessed for impairment, which is recognized in the statement of income during the period in which the impairment occurs as an adjustment to the corresponding valuation allowance. For purposes of performing its impairment evaluation, the corporation stratifies its portfolio on the basis of certain risk characteristics including loan type and note rate. Capitalized mortgage servicing rights are amortized over the estimated remaining life of the underlying loans and take into account appropriate prepayment assumptions. The effect of adopting SFAS No. 122 did not have a material impact on HMN's financial condition or the results of its operations during 1996. REAL ESTATE, NET Real estate properties acquired through loan foreclosures are initially recorded at the lower of the related loan balance, less any specific allowance for loss, or fair value less estimated selling costs. Valuations are periodically performed by management and an allowance for losses is established if the carrying value of a property exceeds its fair value less estimated selling costs. PREMISES AND EQUIPMENT Land is carried at cost. Office buildings, improvements, furniture and equipment are carried at cost less accumulated depreciation. Depreciation is computed on a straight-line basis over estimated useful lives of 10 to 40 years for office buildings and improvements and 3 to 12 years for furniture and equipment. IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF Effective January 1, 1996, HMN adopted SFAS No. 121, ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF. HMN reviews long-lived assets and certain identifiable intangibles for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The effect of adopting SFAS No. 121 on January 1, 1996 did not have a material impact on HMN's financial condition or the results of its operations. STOCK-BASED COMPENSATION Effective January 1, 1996, HMN adopted SFAS No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION. It elected to continue using the accounting methods prescribed by Accounting Principles Board (APB) Opinion No. 25 and related interpretations which measure compensation cost using the intrinsic value method. HMN has included in Note 14, "Employee Benefits" the impact of the fair value of employee stock-based compensation plans on net income and earnings per share on a pro forma basis for awards granted after January 1, 1995. INCOME TAXES Deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. NEW ACCOUNTING STANDARDS In June 1996, the Financial Accounting Standards Board (FASB) issued SFAS No. 125, ACCOUNTING FOR TRANSFERS AND 30 SERVICING OF FINANCIAL ASSETS AND EXTINGUISHMENT OF LIABILITIES. SFAS No. 125 applies to transfers and servicing of financial assets and extinguishments of liabilities. It requires a financial-components approach that focuses on control. Under the approach, after a transfer of financial assets, an entity recognizes the financial and servicing assets it controls and the liabilities it has incurred, derecognizes financial assets when control has been surrendered, and derecognizes liabilities when extinguished. In December 1996, the FASB issued SFAS No. 127 which postpones the effective date by one year for certain provisions of SFAS No. 125. The sections dealing with secured borrowings and collateral are deferred for all transfers of financial assets until after December 31, 1997. Likewise transfers related to repurchase agreements, dollar-rolls, securities lending and similar transactions are deferred until after December 31, 1997. The effect of adopting SFAS No. 125 as amended by SFAS No. 127 will not have a material impact on HMN's financial condition or the results of its operations. EARNINGS PER SHARE Earnings per common share and common share equivalents for 1996 and 1995 were computed by dividing net income ($4,274,349 and $5,620,377) respectively, for the years then ended by the weighted average common shares and common share equivalents outstanding (4,436,833 and 5,171,382), respectively. The earnings per share for 1994 was computed by dividing net income ($2,646,788) from the date of conversion, June 29, 1994, by the weighted average common shares outstanding (5,484,414) for the period. Pro forma earnings per common share were computed by dividing net income ($4,704,659) for the year ended December 31, 1994, by the weighted average common shares outstanding (5,484,414) for the period. RECLASSIFICATIONS Certain amounts in the consolidated financial statements for prior years have been reclassified to conform with the current-year presentation. (3) SECURITIES HELD FOR SALE Proceeds from securities held for sale which were sold during 1994 were $10,586,091, resulting in gross losses of $27,676 and gross gains of $2,568. During 1996 and 1995 there were no securities classified as securities held for sale. (4) SECURITIES AVAILABLE FOR SALE A summary of securities available for sale at December 31, 1996 and 1995 is as follows:
- -------------------------------------------------------------------------------------------------------------- Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value - -------------------------------------------------------------------------------------------------------------- DECEMBER 31, 1996: Mortgage-backed securities: FHLMC................................................. $ 1,776,252 32,567 0 1,808,819 FNMA.................................................. 968,924 14,833 0 983,757 Collateralized mortgage obligations: FNMA.................................................. 45,236,461 113,800 596,858 44,753,403 FHLMC................................................. 56,867,103 98,316 1,162,269 55,803,150 Other................................................. 29,625,427 449,747 69,025 30,006,149 -------------- ---------- ---------- ------------- 134,474,167 709,263 1,828,152 133,355,278 -------------- ---------- ---------- ------------- Other marketable securities: U.S. Government and agency obligations................ 29,599,717 33,566 355,602 29,277,681 Corporate debt........................................ 1,090,420 1,218 0 1,091,638 Corporate equity...................................... 11,670,362 555,608 120,479 12,105,491 -------------- ---------- ---------- ------------- 42,360,499 590,392 476,081 42,474,810 -------------- ---------- ---------- ------------- $ 176,834,666 1,299,655 2,304,233 175,830,088 -------------- ---------- ---------- ------------- -------------- ---------- ---------- ------------- DECEMBER 31, 1995: Mortgage-backed securities: FHLMC................................................. $ 4,977,613 18,820 38,036 4,958,397 FNMA.................................................. 535,740 7,672 0 543,412 Collateralized mortgage obligations: FNMA.................................................. 51,665,922 389,226 556,569 51,498,579 FHLMC................................................. 79,290,840 361,835 988,110 78,664,565 Other................................................. 22,047,433 734,232 30,417 22,751,248 -------------- ---------- ---------- ------------- 158,517,548 1,511,785 1,613,132 158,416,201 -------------- ---------- ---------- ------------- Other marketable securities: U.S. Government and agency obligations................ 21,894,709 61,494 627,527 21,328,676 Municipal obligations................................. 1,600,000 1,260 0 1,601,260 Corporate debt........................................ 851,275 8,943 0 860,218 Corporate equity...................................... 7,901,975 382,731 171,294 8,113,412 -------------- ---------- ---------- ------------- 32,247,959 454,428 798,821 31,903,566 -------------- ---------- ---------- ------------- $ 190,765,507 1,966,213 2,411,953 190,319,767 -------------- ---------- ---------- ------------- -------------- ---------- ---------- ------------- - ---------------------------------------------------------------------------------------------------------------
31 Proceeds from securities available for sale which were sold during 1996 were $101,157,643, resulting in gross gains of $1,235,754 and gross losses of $206,116. Proceeds from securities available for sale which were sold during 1995 were $85,454,779, resulting in gross gains of $565,441 and gross losses of $149,486. Proceeds from securities available for sale which were sold during 1994 were $23,165,770, resulting in gross gains of $188,594 and gross losses of $96,043. The following table indicates amortized cost and estimated fair value of securities available for sale at December 31, 1996, based upon contractual maturity adjusted for scheduled repayments of principal and projected prepayments of principal based upon current economic conditions and interest rates. Actual maturities may differ from the maturities in the following table because obligors may have the right to call or prepay obligations with or without call or prepayment penalties:
- ------------------------------------------------------------------------------------------------------- Amortized Fair Cost Value - ------------------------------------------------------------------------------------------------------- Due less than one year.................................................. $ 25,830,291 25,753,962 Due after one year through five years................................... 55,385,109 54,729,225 Due after five years through ten years.................................. 36,737,671 36,372,992 After ten years......................................................... 47,211,233 46,868,418 No stated maturity...................................................... 11,670,362 12,105,491 -------------- ------------- Total................................................................. $ 176,834,666 175,830,088 -------------- ------------- -------------- ------------- - -------------------------------------------------------------------------------------------------------
The allocation of mortgage-backed securities and collateralized mortgage obligations in the table above is based upon the anticipated future cash flow of the securities using estimated mortgage prepayment speeds. (5) SECURITIES HELD TO MATURITY A summary of securities held to maturity at December 31, 1996 and 1995 is as follows:
- -------------------------------------------------------------------------------------------------------------------- Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value - -------------------------------------------------------------------------------------------------------------------- DECEMBER 31, 1996: Mortgage-backed securities: FHLMC...................................................... $ 1,403,866 90,477 0 1,494,343 FNMA....................................................... 158,425 9,941 0 168,366 Other...................................................... 243,453 0 1,169 242,284 ------------- ----------- ----- ------------ 1,805,744 100,418 1,169 1,904,993 ------------- ----------- ----- ------------ Other marketable securities: Corporate debt............................................. 999,812 738 0 1,000,550 ------------- ----------- ----- ------------ $ 2,805,556 101,156 1,169 2,905,543 ------------- ----------- ----- ------------ ------------- ----------- ----- ------------ DECEMBER 31, 1995: Mortgage-backed securities: FHLMC...................................................... $ 2,801,354 162,879 0 2,964,233 FNMA....................................................... 10,616,401 15,071 0 10,631,472 Other...................................................... 326,308 9,866 0 336,174 ------------- ----------- ----- ------------ 13,744,063 187,816 0 13,931,879 ------------- ----------- ----- ------------ Other marketable securities: Municipal obligations...................................... 228,432 337 0 228,769 Corporate debt............................................. 2,999,297 627 4,430 2,995,494 ------------- ----------- ----- ------------ 3,227,729 964 4,430 3,224,263 ------------- ----------- ----- ------------ $ 16,971,792 188,780 4,430 17,156,142 ------------- ----------- ----- ------------ ------------- ----------- ----- ------------ - --------------------------------------------------------------------------------------------------------------------
There were no sales of securities held to maturity in 1996, 1995 or 1994. During 1994, HMN entered into an agreement with several County Housing and Redevelopment Authorities (HRAs) to purchase FNMA mortgage-backed securities collateralized by single family loans within the HRAs. The mortgage-backed securities were required by the agreement to be repurchased by the HRAs on September 1, 1996. At December 31, 1995, HMN owned $10,386,249 of FNMA securities purchased under the agreement. In conformity with the agreement the HRAs purchased all the FNMA securities originally purchased by HMN on September 1, 1996. The HRAs purchase of the FNMA securities is the major reason for the $11.9 million decrease in mortgage-backed securities between 1995 and 1996. The following table indicates amortized cost and estimated fair value of securities held to maturity at December 31, 1996, based upon contractual maturities adjusted for scheduled repayments of principal and projected prepayments of principal based upon current economic conditions and interest rates. Actual maturities may differ from 32 the maturities in the table because obligors may have the right to call or prepay obligations with or without call or prepayment penalties:
- ------------------------------------------------------------------------------------------------------- Amortized Fair Cost Value - ------------------------------------------------------------------------------------------------------- Due in one year or less...................................................... $ 1,593,959 1,615,999 Due after one year through five years........................................ 891,215 946,814 Due after five years through ten years....................................... 279,645 298,584 Over ten years............................................................... 40,737 44,146 ------------ ---------- Total...................................................................... $ 2,805,556 2,905,543 ------------ ---------- ------------ ---------- - -------------------------------------------------------------------------------------------------------
The allocation of mortgage-backed securities in the table above is based upon the anticipated future cash flow of the securities using estimated mortgage prepayment speeds. (6) LOANS RECEIVABLE, NET A summary of loans receivable at December 31 is as follows:
- ----------------------------------------------------------------------------------------------------- 1996 1995 - ----------------------------------------------------------------------------------------------------- Residential real estate loans: Conventional........................................................ $ 320,317,356 291,173,665 FHA................................................................. 2,203,983 3,137,876 VA.................................................................. 2,572,878 3,628,306 -------------- ------------- 325,094,217 297,939,847 -------------- ------------- Other loans: Commercial real estate.............................................. 7,917,882 8,744,027 Consumer............................................................ 18,743,939 12,518,535 Commercial business................................................. 2,344,421 1,017,508 Savings............................................................. 938,308 1,210,058 Education........................................................... 466,576 342,210 Other............................................................... 782,885 988,579 -------------- ------------- 31,194,011 24,820,917 -------------- ------------- Total loans....................................................... 356,288,228 322,760,764 Less: Unamortized discounts............................................... 417,031 289,129 Net deferred loan fees.............................................. 1,694,730 1,898,859 Allowance for losses................................................ 2,340,585 2,190,664 Loans in process.................................................... 2,813,646 3,531,428 -------------- ------------- $ 349,022,236 314,850,684 -------------- ------------- -------------- ------------- Weighted average contractual interest rate............................ 7.67% 7.72% Commitments to originate, fund or purchase loans...................... $ 24,504,320 7,359,134 - -----------------------------------------------------------------------------------------------------
Included in total commitments to originate or purchase loans are fixed rate loans aggregating approximately $2,861,025 and $1,081,900 as of December 31, 1996 and 1995, respectively. The interest rates on these commitments ranged from 7.11% to 8.375% at December 31, 1996 and from 6.86% to 7.375% at December 31, 1995. At December 31, 1996 and 1995, loans on nonaccrual status totaled $338,310 and $441,400, respectively. Had the loans performed in accordance with their original terms throughout 1996, the Bank would have recorded gross interest income of $34,638 for these loans. Interest income of $21,139 has been recorded on these loans for the year ended December 31, 1996. At December 31, 1996 there were no loans included in loans receivable, net with terms that had been modified in troubled debt restructuring. Included in loans receivable, net are loans with terms that have been modified in troubled debt restructurings of $94,050 at December 31, 1995. There were no material commitments to lend additional funds to customers whose loans were classified as restructured or nonaccrual at December 31, 1996. At December 31, 1996 and 1995, the recorded investment in loans that are considered to be impaired under the criteria established by SFAS No. 114 and SFAS No. 118 were $338,310 and $535,450, respectively, for which the related allowance for credit losses were $17,571 and $70,097, respectively. The average investment in impaired loans during 1996 and 1995 were $423,042 and $466,288, respectively. For the years ended December 31, 1996 and 1995, HMN recognized interest income on impaired loans of $24,662 and $40,553, respectively. All of the interest income that was recognized during 1996 and 1995 for impaired loans was recognized using the cash basis method of income recognition. The aggregate amount of loans to executive officers and directors of HMN were $385,023, $169,489 and $90,217 at December 31, 1996, 1995 and 1994, respectively. During 1996 repayments on loans to executive officers and directors aggregated $29,509 and loans originated or added due to change in directors aggregated $245,043. At December 31, 1996, 1995 and 1994, the Bank was servicing real estate loans for others with aggregate unpaid principal balances of approximately $1,417,954, $1,130,649 and $1,484,848, respectively. The Bank originates residential and commercial real estate and other loans primarily in southern Minnesota. The Bank also purchases loans from a third party broker located in the Southeastern United States. At December 31, 1996, the Bank owned single family residential loans located in the following states:
- ---------------------------------------------------------------------------------------------------------- Percent Amount of Total - ---------------------------------------------------------------------------------------------------------- Alabama...................................................................... $ 4,266,231 1.3% Georgia...................................................................... 48,252,600 14.9 Minnesota.................................................................... 233,192,887 71.7 North Carolina............................................................... 14,869,445 4.6 South Carolina............................................................... 7,762,524 2.4 Tennessee.................................................................... 3,349,121 1.0 Other states................................................................. 13,401,409 4.1 -------------- ----- Total...................................................................... $ 325,094,217 100.0% -------------- ----- -------------- ----- - ----------------------------------------------------------------------------------------------------------
33 (7) ALLOWANCE FOR LOAN AND REAL ESTATE LOSSES The allowance for losses is summarized as follows:
- -------------------------------------------------------------------------------------------------------- Loans Real Estate Total - -------------------------------------------------------------------------------------------------------- Balance, December 31, 1993....................................... $ 1,489,082 125,818 1,614,900 Provision for losses........................................... 410,000 0 410,000 Charge-offs.................................................... (5,959) (3) (5,962) Recoveries..................................................... 20 0 20 Other.......................................................... 0 (88,818) (88,818) ------------ ----------- ---------- Balance, December 31, 1994....................................... 1,893,143 36,997 1,930,140 Provision for losses........................................... 300,000 9,327 309,327 Charge-offs.................................................... (2,612) (11,324) (13,936) Recoveries..................................................... 133 0 133 ------------ ----------- ---------- Balance, December 31, 1995....................................... 2,190,664 35,000 2,225,664 Provision for losses........................................... 300,000 2,000 302,000 Charge-offs.................................................... (150,136) 0 (150,136) Recoveries..................................................... 57 0 57 Other.......................................................... 0 (35,000) (35,000) ------------ ----------- ---------- Balance, December 31, 1996....................................... $ 2,340,585 2,000 2,342,585 ------------ ----------- ---------- ------------ ----------- ---------- - --------------------------------------------------------------------------------------------------------
(8) REAL ESTATE A summary of real estate at December 31 is as follows:
- -------------------------------------------------------------------------------------------------------- 1996 1995 - -------------------------------------------------------------------------------------------------------- Real estate in judgement subject to redemption.................................... $ 22,610 314,851 Real estate acquired through foreclosure.......................................... 0 0 --------- --------- 22,610 314,851 Allowance for losses.............................................................. 2,000 35,000 --------- --------- $ 20,610 279,851 --------- --------- --------- --------- - --------------------------------------------------------------------------------------------------------
(9) PREMISES AND EQUIPMENT A summary of premises and equipment at December 31 is as follows:
- ------------------------------------------------------------------------------------------------------- 1996 1995 - ------------------------------------------------------------------------------------------------------- Land......................................................................... $ 726,923 656,845 Office buildings and improvements............................................ 3,704,146 3,651,715 Furniture and equipment...................................................... 1,966,130 1,799,420 ------------ ---------- 6,397,199 6,107,980 Less accumulated depreciation................................................ 2,815,702 2,462,444 ------------ ---------- $ 3,581,497 3,645,536 ------------ ---------- ------------ ---------- - --------------------------------------------------------------------------------------------------------
During 1997 HMN will build new retail banking facilities in Spring Valley and Winona at an estimated total cost of $2,500,000. (10) ACCRUED INTEREST RECEIVABLE Accrued interest receivable at December 31 is summarized as follows:
- ------------------------------------------------------------------------------------------------------- 1996 1995 - ------------------------------------------------------------------------------------------------------- Securities available for sale................................................ $ 1,256,214 1,370,568 Securities held to maturity.................................................. 41,730 144,546 Loans receivable............................................................. 2,117,208 1,866,393 ------------ ---------- $ 3,415,152 3,381,507 ------------ ---------- ------------ ---------- - -------------------------------------------------------------------------------------------------------
34 (11) DEPOSITS Deposits and their weighted average interest rates at December 31 are summarized as follows:
- ----------------------------------------------------------------------------------------------------------------------------- 1996 1995 -------------------------------------------- -------------------------------------------- Weighted Percent of Weighted Percent of average rate Amount total average rate Amount total ------------------------------------------------------------------------------------------ Non-interest checking............ 0.00% $ 2,389,034 0.7% 0.00% $ 2,505,217 0.7% NOW accounts..................... 2.01 17,588,877 4.8 2.22 15,997,598 4.3 Passbooks........................ 2.50 30,070,326 8.3 2.50 29,383,919 7.8 Money market accounts............ 2.83 16,532,806 4.6 2.83 18,471,841 5.0 -------------- ----- -------------- ----- 66,581,043 18.4 66,358,575 17.8 -------------- ----- -------------- ----- Certificates: 3-3.99%.......................... 425,284 0.1 0 0.0 4-4.99%.......................... 22,552,550 6.2 22,440,013 6.0 5-5.99%.......................... 168,040,084 46.4 152,971,210 40.9 6-6.99%.......................... 76,703,716 21.2 89,753,208 24.0 7-7.99%.......................... 28,077,048 7.7 40,721,309 10.9 Over 8.00%....................... 97,219 0.0 1,295,153 0.4 -------------- ----- -------------- ----- Total certificates............... 5.76 295,895,901 81.6 5.89 307,180,893 82.2 -------------- ----- -------------- ----- Total deposits................... 5.14 $ 362,476,944 100.0% 5.27 $ 373,539,468 100.0% -------------- ----- -------------- ----- -------------- ----- -------------- ----- - -----------------------------------------------------------------------------------------------------------------------------
At December 31, 1996 and 1995, the Bank had $38,226,676 and $41,942,458, respectively, of deposit accounts with balances at $100,000 or more. Certificates had the following maturities at December 31:
- ------------------------------------------------------------------------------------------------------------- 1996 1995 ------------------------------ ------------------------------ Amount Amount (in Weighted (in Weighted REMAINING TERM TO MATURITY thousands) average rate thousands) Average Rate - --------------------------------------------- ------------- --------------- ------------- --------------- 1-6 months................................... $ 92,495 5.38% $ 119,305 5.60% 7-12 months.................................. 71,077 5.95 63,347 5.80 13-36 months................................. 111,369 5.91 109,867 6.25 37-60 months................................. 20,955 6.02 14,195 5.89 Over 60 months............................... 0 0.00 467 6.07 ------------- ------------- $ 295,896 5.76 $ 307,181 5.89 ------------- ------------- ------------- ------------- - -------------------------------------------------------------------------------------------------------------
At December 31, 1996 mortgage loans and mortgage-backed and related securities with an amortized cost of approximately $49,731,000 were pledged as collateral for certain deposits and $2,243,000 of letters of credit from the Federal Home Loan Bank (FHLB) which were pledged as additional collateral on Bank deposits. Interest expense on deposits is summarized as follows for the years ended December 31:
- ------------------------------------------------------------------------------------------------------- 1996 1995 1994 ----------------------------------------- NOW......................................................... $ 323,311 311,359 315,538 Passbook.................................................... 760,083 759,167 862,681 Money Market................................................ 500,811 547,412 673,527 Certificates................................................ 17,365,732 16,960,806 13,988,993 ------------- ------------ ------------ $ 18,949,937 18,578,744 15,840,739 ------------- ------------ ------------ ------------- ------------ ------------ - -------------------------------------------------------------------------------------------------------
35 (12) FEDERAL HOME LOAN BANK ADVANCES Federal Home Loan Bank advances consisted of the following at December 31, 1996 and 1995:
- -------------------------------------------------------------------------------------------------------------- 1996 1995 ------------------------- ------------------------ YEAR OF MATURITY Amount Rate Amount Rate - -------------------------------------------------------------------------------------------------------------- 1996..................................................... $ 33,428,568 6.05% 1997..................................................... $ 46,428,568 5.52% 9,498,389 5.86 1998..................................................... 1,250,021 6.55 1,250,021 6.55 1999..................................................... 5,000,000 5.16 0 0.00 2000..................................................... 19,000,000 6.00 19,000,000 6.00 2001..................................................... 24,000,000 5.51 0 0.00 2003..................................................... 10,400,000 5.89 5,000,000 5.52 -------------- ------------- 106,078,589 5.64 68,176,978 5.98 -------------- ------------- Open line of credit...................................... 0 0.00 700,000 5.92 -------------- ------------- $ 106,078,589 5.64 $ 68,876,978 5.98 -------------- ------------- -------------- ------------- - --------------------------------------------------------------------------------------------------------------
At December 31, 1996, of the $24,000,000 maturing in the year 2001, $10,000,000 could be called on a semi-annual basis starting in 1997 and $9,000,000 could be called on a semi-annual basis starting in 1998. At December 31, 1996 the advances, the open line of credit, and $2,243,000 of letters of credit from the FHLB were collateralized by the Bank's FHLB stock, mortgage loans with unamortized principal balances of approximately $155,435,000 and securities having a carrying value of $17,300,000. The Bank has a $5,000,000 open line of credit from the FHLB which was not drawn at December 31, 1996. The Bank also has the ability to draw additional borrowings of $6,470,000 based upon the securities which are currently pledged. (13) INCOME TAXES Income tax expense for the years ended December 31 is as follows:
- ------------------------------------------------------------------------------------------------------ 1996 1995 1994 ------------------------------------ Current: Federal....................................................... $ 1,838,158 2,152,628 2,255,581 State......................................................... 561,442 660,222 721,974 ------------ ---------- ---------- Total current............................................... 2,399,600 2,812,850 2,977,555 ------------ ---------- ---------- Deferred: Federal....................................................... 83,833 439,945 103,649 State......................................................... 26,567 128,105 34,563 ------------ ---------- ---------- Total deferred.............................................. 110,400 568,050 138,212 ------------ ---------- ---------- $ 2,510,000 3,380,900 3,115,767 ------------ ---------- ---------- ------------ ---------- ---------- - ------------------------------------------------------------------------------------------------------
The reasons for the difference between "expected" income tax expense utilizing the federal corporate tax rate of 34% and the actual income tax expense are as follows:
- ------------------------------------------------------------------------------------------------------ 1996 1995 1994 ------------------------------------ Federal expected income tax expense............................. $ 2,306,677 3,060,434 2,658,945 Items affecting federal income tax: State income taxes, net of federal income tax benefit......... 388,086 520,296 499,314 Other, net.................................................... (184,763) (199,830) (42,492) ------------ ---------- ---------- $ 2,510,000 3,380,900 3,115,767 ------------ ---------- ---------- ------------ ---------- ---------- - ------------------------------------------------------------------------------------------------------
36 The tax effects of temporary differences that give rise to the deferred tax assets and deferred tax liabilities are as follows at December 31:
- ------------------------------------------------------------------------------------------------------- 1996 1995 ------------------------ Deferred tax assets: Net unrealized loss on market value adjustment to securities available for sale..................................................................... $ 406,600 180,382 Deferred loan fees......................................................... 377,100 565,597 Allowances for loan and real estate losses................................. 947,200 886,519 Deferred compensation and pension costs.................................... 172,500 118,741 ------------ ---------- Total gross deferred tax assets.......................................... 1,903,400 1,751,239 Valuation allowance........................................................ 0 0 ------------ ---------- Net deferred tax assets.................................................. 1,903,400 1,751,239 ------------ ---------- Deferred tax liabilities: Tax bad debt reserve over base year........................................ 1,462,000 1,448,548 FHLB stock................................................................. 359,700 359,747 Unamortized discount on loan sale.......................................... 136,200 200,823 Deferred loan costs........................................................ 250,600 138,653 Premises and equipment basis difference.................................... 106,600 139,472 Other...................................................................... 26,200 17,764 ------------ ---------- Total gross deferred tax liabilities..................................... 2,341,300 2,305,007 ------------ ---------- Net deferred tax liabilities............................................. $ (437,900) (553,768) ------------ ---------- ------------ ---------- - ------------------------------------------------------------------------------------------------------
As the result of recent tax legislation the deferred tax liability related to the tax bad debt reserve over the base year will be required to be paid in six equal annual installments of $243,667 starting in 1998. Retained earnings at December 31, 1996 included approximately $6,559,846 for which no provision for income taxes has been made. This amount represents allocations of income to bad debt deductions for tax purposes. Reduction of amounts so allocated for purposes other than absorbing losses will create income for tax purposes, which will be subject to the then-current corporate income tax rate. (14) EMPLOYEE BENEFITS Substantially all full-time employees of the Bank are included in a trusteed noncontributory retirement plan sponsored by the Financial Institutions Retirement Fund. The actuarial present value of accumulated plan benefits and net assets available for benefits relating to the Bank's employees is not available because such information is not accumulated for each participating institution. No contributions were required in 1996, 1995, or 1994 because the retirement plan is fully funded. The Bank's policy is to fund retirement plan costs accrued and there are no unfunded past service costs. For the years ended December 31, 1996, 1995, and 1994 the amounts charged to operating expenses were $5,100, $4,222, and $6,084, respectively. The Bank has a qualified, tax-exempt savings plan with a cash or deferred feature qualifying under Section 401(k) of the Internal Revenue Code (the 401(k) Plan). All employees who have attained age 21 and completed one year of employment, during which they worked at least 1,000 hours, are eligible to participate. Participants are permitted to make salary reduction contributions to the 401(k) Plan of up to 12% of the participant's annual salary. Each participant's salary reduction is matched by the Bank in an amount equal to 25% of the participant's salary reduction up to a maximum contribution of 8%. Contributions above 8% are not matched by the Bank. Generally all participant and Bank contributions and earnings are fully and immediately vested. Effective January 1, 1997, for new employees the Bank's contributions are vested on a five year cliff basis. The Bank's matching contributions are expensed when made. The Bank's contributions to the 401(k) Plan were $41,804, $41,324 and $36,587 in 1996, 1995 and 1994, respectively. During 1994 HMN adopted an Employee Stock Ownership Plan (the ESOP) which met the requirements of Section 4975(e)(7) of the Internal Revenue Code and Section 407(d)(6) of the Employee Retirement Income Security Act of 1974, as amended (ERISA), and, as such the ESOP was empowered to borrow in order to finance purchases of the common stock of HMN. The ESOP borrowed $6,085,770 from HMN to purchase 608,577 shares of common stock of HMN on the date of the conversion. The ESOP debt requires quarterly payments of principal plus interest at 7.52%. HMN has committed to make quarterly contributions to the ESOP necessary to repay the loan including interest. HMN contributed $713,656, $735,383 and $532,300 to the ESOP, respectively, during 1996, 1995 and 1994. As the debt is repaid, ESOP shares which were initially pledged as collateral for its debt, are released from collateral and allocated to active employees, based on the proportion of debt service paid in the year. HMN accounts for its ESOP in accordance with Statement of Position 93-6, EMPLOYERS' ACCOUNTING FOR EMPLOYEE STOCK OWNERSHIP PLANS. Accordingly, the shares pledged as collateral are reported as unearned ESOP shares in stockholders' equity. As shares are determined to be ratably released from collateral, HMN reports compensation expense equal to the cur- 37 rent market price of the shares, and the shares become outstanding for earnings per share computations. ESOP compensation benefit expense was $634,702, $566,395 and $404,580, respectively, for 1996, 1995 and 1994. All employees of HMN are eligible to participate in the ESOP after they attain age 21 and complete one year of service during which they worked at least 1,000 hours. A summary of the ESOP share allocation is as follows for the years ended:
- ------------------------------------------------------------------------------------------------------- 1996 1995 ------------------------ Shares allocated beginning of year........................................... 74,962 33,989 Shares allocated during year................................................. 39,763 40,973 Shares distributed to participants........................................... (5,361) 0 Unreleased shares............................................................ 493,852 533,615 ------------ ---------- Total ESOP shares............................................................ 603,216 608,577 ------------ ---------- ------------ ---------- Fair value of unreleased shares at December 31............................... $ 8,951,067 8,537,840 - -------------------------------------------------------------------------------------------------------
In June of 1995, HMN as part of a Recognition and Retention Plan (RRP) awarded 84,486 shares of restricted common stock to its officers and directors. The shares vest over a five year period and were issued from treasury stock. Compensation and benefit expense related to the RRP was $231,048 for 1996 and $116,700 for 1995. No RRP was in effect for 1994, therefore no compensation and benefit expense for the RRP was incurred in 1994. In June 1995, HMN adopted its only stock option plan, the 1995 Stock Option and Incentive Plan (the SOP). During 1995, options exercisable for 547,713 shares of HMN common stock were granted to certain officers and directors at an exercise price of $13.81 per share. The options vest over a five year period and may be exercised within 10 years of the grant date. In December 1996, options exercisable for 1,000 shares of common stock were granted to officers at an exercise price of $18.125. HMN uses the intrinsic value method as described in APB Opinion No. 25 and related interpretations to account for its stock incentive plans. Accordingly, no compensation cost has been recognized for the fixed option plan. Proceeds from stock options exercised are credited to common stock and additional paid-in capital. There are no charges or credits to expense with respect to the granting or exercise of options since the options were issued at fair value on the respective grant dates. Had compensation cost for HMN's stock-based plan been determined in accordance with the fair value method recommended by SFAS No. 123, HMN's net income and earnings per share would have been reduced to the pro forma amounts indicated below:
- ------------------------------------------------------------------------------------------------------- 1996 1995 ------------------------ Net income: As reported................................................................ $ 4,274,349 5,620,377 Pro forma.................................................................. 3,085,217 4,728,898 Earnings per common share and common share equivalent: As reported................................................................ $ 0.96 1.09 Pro forma.................................................................. 0.70 0.91 - -------------------------------------------------------------------------------------------------------
The above disclosed pro forma effects of applying SFAS No. 123 to compensation costs, may not be representative of the effects on reported pro forma net income for future years. The fair value for each option grant for the SOP is estimated on the date of the grant using the Option Designer Model. The model incorporates the following assumptions:
- ------------------------------------------------------------------------------------------------------- 1996 1995 -------------------- Risk-free interest rate.......................................................... 6.21% 6.28% Expected life.................................................................... 10 years 10 years Expected volatility.............................................................. 18.00% 20.00% Expected dividends............................................................... None None - -------------------------------------------------------------------------------------------------------
The fair value of the options granted in 1996 was $8.32 per option. The fair value of the options granted June 21, 1995 was $6.73 per option. A summary of stock option activity under the SOP is detailed as follows:
- ------------------------------------------------------------------------------------------------------ Weighted Options average available Options exercise for grant outstanding price ------------------------------------- December 31, 1994............................................... 0 0 Plan adopted.................................................... 608,577 Granted June 21, 1995........................................... (547,713) 547,713 $ 13.810 ---------- ----------- ------------ December 31, 1995............................................... 60,864 547,713 13.810 Exercised....................................................... (4,699) 13.810 Forfeited....................................................... 12,172 (12,172) 13.810 Granted December 11, 1996....................................... (1,000) 1,000 18.125 ---------- ----------- ------------ December 31, 1996............................................... 72,036 531,842 $ 13.818 ---------- ----------- ------------ ---------- ----------- ------------ - -------------------------------------------------------------------------------------------------------
38 The following table summarizes information about stock options outstanding at December 31, 1996:
- ----------------------------------------------------------------------- Options Outstanding - ------------------------------------------------- Weighted average Options Exercisable Exercise Number remaining contractual -------------------- price outstanding life in years Number Price - --------- ----------- ------------------------- --------- --------- $ 13.810 530,842 8.4 104,843 $ 13.81 18.125 1,000 9.9 ----------- 531,842 ----------- ----------- - -----------------------------------------------------------------------
(15) STOCKHOLDERS' EQUITY HMN was incorporated for the purpose of becoming the savings and loan holding company of the Bank in connection with the Bank's conversion from a federally chartered mutual savings bank to a federally chartered stock savings bank, pursuant to a Plan of Conversion adopted on February 10, 1994. HMN commenced on May 23, 1994, a Subscription and Community Offering of its shares in connection with the conversion of the Bank (the Offering). The Offering was closed on June 22, 1994, and the conversion was consummated on June 29, 1994, with the issuance of 6,085,775 shares of HMN's common stock at a price of $10 per share. Total proceeds from the conversion of $59,178,342 net of costs relating to the conversion of $1,679,408, have been recorded as common stock and additional paid-in capital. HMN received all of the capital stock of the Bank in exchange for 50% of the net proceeds of the conversion. Starting in 1995 and continuing throughout 1996, with Board authorization and approval from the Office of Thrift Supervision (OTS), HMN purchased a total of 869,785 shares during 1996 and 868,336 shares during 1995 of its own common stock from the open market for $14,364,754 and $12,509,667, respectively. The shares were placed in treasury stock. In June of 1995, 84,486 shares were issued out of treasury stock for restricted stock Retention and Recognition awards. HMN's certificate of incorporation authorized the issuance of up to 500,000 shares of preferred stock, but to date no shares have been issued. In order to grant a priority to eligible account holders in the event of future liquidation, the Bank, at the time of conversion established a liquidation account equal to its regulatory capital as of September 30, 1993. In the event of future liquidation of the Bank, an eligible account holder who continues to maintain their deposit account shall be entitled to receive a distribution from the liquidation account. The total amount of the liquidation account will be decreased as the balance of eligible account holders are reduced subsequent to the conversion, based on an annual determination of such balance. The Bank may not declare or pay a cash dividend to HMN in excess of 100% of its net income to date during the current calendar year plus the amount that would reduce by one-half the Bank's surplus capital ratio at the beginning of the calendar year without prior notice to the OTS. Additional limitations on dividends declared or paid on, or repurchases of, the Bank's capital stock are tied to the Bank's level of compliance with its regulatory capital requirements. At December 31, 1996 the Bank had received approval from the OTS to pay a $10,000,000 dividend to HMN. At December 31, 1996 the Bank's board of directors had not declared the payment of the dividend to HMN. (16) FEDERAL HOME LOAN BANK INVESTMENT, REGULATORY LIQUIDITY AND REGULATORY CAPITAL REQUIREMENTS The Bank, as a member of the Federal Home Loan Bank System, is required to hold a specified number of shares of capital stock, which is carried at cost, in the Federal Home Loan Bank of Des Moines. In addition, the Bank is required to maintain cash and other liquid assets in an amount equal to 5% of its deposit accounts and other obligations due within one year. The Bank has met these requirements as of December 31, 1996. The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on HMN's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulations to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the following table) of Tangible, Core, and Risk-based capital (as defined in the regulations) to total assets (as defined). Management believes, as of December 31, 1996, that the Bank meets all capital adequacy requirements to which it is subject. Management believes that based upon the Bank's capital calculations at December 31, 1996 and other conditions consistent with the Prompt Corrective Actions Provisions of the OTS regulations, the Bank would be categorized as well capitalized. 39 At December 31, 1996 the Bank's capital amounts and ratios are also presented for actual capital, required capital, and excess capital including amounts and ratios in order to qualify as being well capitalized under the Prompt Corrective Actions regulations:
- ------------------------------------------------------------------------------------------------------------------------------- To Be Well Capitalized Under Prompt Corrective Actions Actual Required Excess Capital Provisions ----------------------- ----------------------- ----------------------- ----------------------- Percent of Percent of Percent of Percent of (IN THOUSANDS) Amount Assets(1) Amount Assets(1) Amount Assets(1) Amount Assets(1) - ------------------------------------------------------------------------------------------------------------------------------- Bank stockholder's equity................. $ 60,841 Plus: Net unrealized loss on certain securities available for sale... 1,441 Less: Excess mortgage servicing rights..... 289 --------- Tangible capital......... 61,993 11.50% $ 8,085 1.50% $ 53,908 10.00% --------- Tangible capital to adjusted total assets.. 11.50% $ 26,951 5.00% Core capital (Tier I).... 61,993 11.50% 16,179 3.00% 45,814 8.50% Tier I capital to risk-weighted assets... 26.43% 14,071 6.00% Plus: Allowable allowance for loan losses.......... 2,340 --------- Risk-based capital....... $ 64,333 27.43% 18,761 8.00% 45,572 19.43% 23,452 10.00% --------- ---------
(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. (17) RECENT LEGISLATION AND REGULATORY DEVELOPMENTS The Deposit Insurance Fund Act of 1996 (DIFA) was enacted on September 30, 1996. DIFA addressed the inadequate funding of the Savings Association Insurance Fund (SAIF). In order to recapitalize the SAIF, DIFA imposed a one-time assessment on all thrift institutions. The Bank's assessment was a pretax charge of $2,351,563 and was recognized in the third quarter of 1996. DIFA also addressed the funding for the Financing Corp. (FICO) bonds. Thrifts will pay 6.4 basis points per $100 of deposits from January 1, 1997 to December 31, 1999. From January 1, 2000 until the FICO bonds are retired in 2019, the estimated assessment to retire the FICO bonds is expected to be 2.5 basis points per $100 of deposits. DIFA proposed that the Bank Insurance Fund (BIF) and SAIF be merged on January 1, 1999, provided no insurance depository institution is a savings association on that date. DIFA also directed the Secretary of the Treasury to present recommendations to Congress for establishment of a common depository institution charter by March 31, 1997. (18) FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK The Bank is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the balance sheet. The contract amounts of these instruments reflect the extent of involvement by the Bank. The Bank's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit is represented by the contract amount of these commitments. The Bank uses the same credit policies in making commitments as it does for on-balance sheet instruments.
- --------------------------------------------------------------------------------------------------------- Contract amount -------------------- (IN THOUSANDS) 1996 1995 -------------------- Financial instruments whose contract amount represents credit risk: Commitments to extend credit..................................................... $ 24,524 7,394 Commitment of counter party to repurchase FNMA securities........................ 0 10,446 Financial instruments whose contract amount represents interest rate risk: Commitment to purchase limited partnership interest in mortgage loan servicing rights......................................................................... 2,120 0 Commitments to purchase FNMA mortgage-backed securities.......................... 0 3,995 - ---------------------------------------------------------------------------------------------------------
40 Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since a portion of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on the loan type and on management's credit evaluation of the borrower. Collateral consists primarily of residential real estate and personal property. Commitments to purchase FNMA securities as they are originated by certain Minnesota county HRAs are entered into in the normal course of business for the Bank. The obligations to purchase are recognized when the HRAs originate the FNMA securities. The securities provide a net yield of 6.91% at the time of funding. In a rising interest rate environment the interest rate risk is the possibility that the cost of funds used to purchase the FNMA securities would become greater than the net yield on the securities. The securities were repurchased by the HRAs at a specified price on September 1, 1996. (19) FAIR VALUE OF FINANCIAL INSTRUMENTS SFAS No. 107, DISCLOSURES ABOUT FAIR VALUES OF FINANCIAL INSTRUMENTS, requires disclosure of estimated fair values of the Bank's financial instruments, including assets, liabilities and off-balance sheet items for which it is practicable to estimate fair value. The fair value estimates are made as of December 31, 1996, and 1995 based upon relevant market information, if available, and upon the characteristics of the financial instruments themselves. Because no market exists for a significant portion of the Bank's financial instruments, fair value estimates are based upon judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. The estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates. Fair value estimates are based only on existing financial instruments without attempting to estimate the value of anticipated future business or the value of assets and liabilities that are not considered financial instruments. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on the fair value estimates and have not been considered in any of the estimates. The estimated fair value of the Bank's financial instruments are shown below. Following the table, there is an explanation of the methods and assumptions used to estimate the fair value of each class of financial instruments.
- -------------------------------------------------------------------------------------------------------------------- December 31, --------------------------------------------------------------------- 1996 1995 ---------------------------------- --------------------------------- Carrying Estimated Contract Carrying Estimated Contract (IN THOUSANDS) amount fair value amount amount fair value amount - -------------------------------------------------------------------------------------------------------------------- Financial assets: Cash and cash equivalents.................. $ 10,584 10,584 4,335 4,335 Securities available for sale.............. 175,830 175,830 190,320 190,320 Securities held to maturity................ 2,806 2,906 16,972 17,156 Loans held for sale........................ 739 739 0 0 Loans receivable, net...................... 349,022 358,039 314,851 329,970 Federal Home Loan Bank stock............... 5,434 5,434 3,802 3,802 Accrued interest receivable................ 3,415 3,415 3,382 3,382 Financial liabilities: Deposits................................... 362,477 358,215 373,539 373,152 Federal Home Loan Bank advances............ 106,079 105,484 68,877 69,197 Accrued interest payable................... 1,543 1,543 1,562 1,562 Off-balance sheet financial instruments: Commitments to extend credit............... 0 16 24,524 0 4 7,394 - --------------------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS The carrying amount of cash and cash equivalents approximates their fair value. SECURITIES AVAILABLE FOR SALE AND SECURITIES HELD TO MATURITY The fair values of securities are based upon quoted market prices. LOANS HELD FOR SALE The fair value of loans held for sale were based upon quoted market prices for loans with similar interest rates and terms to maturity. LOANS RECEIVABLE The fair values of loans receivable were estimated for groups of loans with similar characteristics. The fair value of the loan 41 portfolio, with the exception of the adjustable rate portfolio, was calculated by discounting the scheduled cash flows through the estimated maturity using anticipated prepayment speeds and using discount rates that reflect the credit and interest rate risk inherent in each loan portfolio. The fair value of the adjustable loan portfolio was estimated by grouping the loans with similar characteristics and comparing the characteristics of each group to the prices quoted for similar types of loans in the secondary market. FEDERAL HOME LOAN BANK STOCK The carrying amount of FHLB stock approximates its fair value. ACCRUED INTEREST RECEIVABLE The carrying amount of accrued interest receivable approximates its fair value since it is short-term in nature and does not present unanticipated credit concerns. DEPOSITS Under SFAS No. 107, the fair value of deposits with no stated maturity such as checking, savings and money market accounts, is equal to the amount payable on demand. The fair value of certificates of deposit is based on the discounted value of contractual cash flows using as discount rates the rates that were offered by the Bank as of December 31, 1996 and 1995 for deposits with maturities similar to the remaining maturities of the existing certificates of deposit. The fair value estimate for deposits does not include the benefit that results from the low cost funding provided by the Bank's existing deposits and long-term customer relationships compared to the cost of obtaining different sources of funding. This benefit is commonly referred to as the core deposit intangible. ACCRUED INTEREST PAYABLE The carrying amount of accrued interest payable approximates its fair value since it is short-term in nature. FEDERAL HOME LOAN BANK ADVANCES The fair values of advances payable with fixed maturities are estimated based on discounted cash flow analysis using as discount rates the interest rates charged by the FHLB at December 31, 1996 and 1995 for borrowings of similar remaining maturities. COMMITMENTS TO EXTEND CREDIT The fair value of commitments to extend credit is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counter parties. (20) HMN FINANCIAL, INC. FINANCIAL INFORMATION (PARENT COMPANY ONLY) The parent company's principal assets are its investment in the Bank and securities. The following are the condensed financial statements for the parent company only as of December 31, 1996 and 1995 and for the years ended December 31, 1996, 1995, and for the period from June 29, 1994 to December 31, 1994. CONDENSED BALANCE SHEET
- ------------------------------------------------------------------------------------------------------------------ 1996 1995 ----------------------------- ASSETS: Cash and cash equivalents........................................................ $ 3,655,598 1,578,130 Securities available for sale.................................................... 10,187,092 16,281,995 Loans receivable from subsidiaries............................................... 7,334,000 0 Investment in subsidiaries....................................................... 61,458,395 73,678,260 Accrued interest receivable...................................................... 215,959 152,888 Prepaid expenses and other assets................................................ 17,950 161,271 -------------- ------------- Total assets................................................................... $ 82,868,994 91,852,544 -------------- ------------- -------------- ------------- LIABILITIES AND STOCKHOLDERS' EQUITY: Accrued expenses and other liabilities........................................... $ 769,550 165,861 -------------- ------------- Total liabilities.............................................................. 769,550 165,861 -------------- ------------- Serial preferred stock........................................................... 0 0 Common stock..................................................................... 60,858 60,858 Additional paid-in capital....................................................... 59,428,768 59,285,581 Retained earnings................................................................ 54,645,387 50,371,038 Net unrealized loss on securities available for sale............................. (598,045) (265,358) Unearned employee stock option plan shares....................................... (4,938,520) (5,336,150) Unearned compensation restricted stock awards.................................... (793,289) (1,050,305) Treasury stock, at cost, 1,651,615 and 783,850 shares............................ (25,705,715) (11,378,981) -------------- ------------- Total stockholders' equity..................................................... 82,099,444 91,686,683 -------------- ------------- Total liabilities and stockholders' equity..................................... $ 82,868,994 91,852,544 -------------- ------------- -------------- -------------
42
- ---------------------------------------------------------------------------------------------------------------- 1996 1995 1994 ----------------------------------- Interest income............................................................ $ 1,105,218 1,474,107 810,273 Interest expense........................................................... (4,943) (1,083) 0 Securities gains, net...................................................... 229,002 53,058 2,988 Equity in earnings of subsidiary........................................... 3,565,441 4,755,138 4,284,783 Compensation and benefits.................................................. (17,233) (21,775) (4,433) Occupancy.................................................................. (6,868) (6,353) (3,072) Advertising................................................................ (670) (276) 0 Data processing............................................................ (1,271) (1,200) (600) Other...................................................................... (475,127) (380,039) (200,836) ----------- ---------- ----------- Income before income tax expense......................................... 4,393,549 5,871,577 4,889,103 Income tax expense......................................................... 119,200 251,200 184,444 ----------- ---------- ----------- Net income............................................................... $ 4,274,349 5,620,377 4,704,659 ----------- ---------- ----------- ----------- ---------- ----------- CONDENSED STATEMENT OF CASH FLOWS Cash flows from operating activities: Net income............................................................... $ 4,274,349 5,620,377 4,704,659 Adjustments to reconcile net income to cash provided by operating activities: Equity in earnings of subsidiary....................................... (3,565,441) (4,755,138) (4,284,783) Amortization of premiums (discounts), net.............................. 9,727 (21,328) (6,590) Securities gains, net.................................................. (229,002) (53,058) (2,988) Provision for deferred income taxes.................................... (1,400) (2,500) 0 Earned employee stock ownership shares priced above original cost...... 141,135 93,267 38,511 Decrease in restricted stock awards.................................... 231,048 116,700 0 Decrease in unearned ESOP shares....................................... 397,630 409,730 0 (Increase) decrease in accrued interest receivable..................... (63,071) 76,510 (229,398) Increase (decrease) in accrued expenses and other liabilities.......... 172,831 (81,860) 163,845 Decrease (increase) in other assets.................................... 143,321 (75,550) (85,721) Other, net............................................................. 9,737 0 0 ----------- ---------- ----------- Net cash provided by operating activities............................ 1,520,864 1,327,150 297,535 ----------- ---------- ----------- Cash flows from investing activities: Proceeds from sales of securities available for sale..................... 5,412,430 8,523,675 377,987 Principal collected on securities available for sale..................... 5,027,241 1,624,106 1,092,087 Proceeds collected on maturity of securities available for sale.......... 1,500,000 4,000,000 0 Purchases of securities available for sale............................... (5,449,176) (7,754,954) (23,847,489) Purchase of Security Finance Corporation stock........................... 0 (388,762) 0 Investment in HMN Mortgage Services, Inc................................. (250,000) 0 0 Net increase in loans receivable from subsidiaries....................... (7,334,000) 0 0 ----------- ---------- ----------- Net cash (used) provided by investing activities..................... (1,093,505) 6,004,065 (22,377,415) ----------- ---------- ----------- Cash flows from financing activities: Increase in unearned ESOP shares......................................... 0 0 (5,745,880) Proceeds from sale of common stock....................................... 0 0 59,178,342 Purchase of treasury stock............................................... (14,002,254) (12,509,667) 0 Stock options exercised.................................................. 52,363 0 0 Purchase of Bank stock................................................... 0 0 (29,596,000) Proceeds from dividends on Bank stock.................................... 15,600,000 4,000,000 1,000,000 ----------- ---------- ----------- Net cash provided (used) by financing activities..................... 1,650,109 (8,509,667) 24,836,462 ----------- ---------- ----------- Increase (decrease) in cash and cash equivalents..................... 2,077,468 (1,178,452) 2,756,582 Cash and cash equivalents, beginning of period............................. 1,578,130 2,756,582 0 ----------- ---------- ----------- Cash and cash equivalents, end of period................................... $ 3,655,598 1,578,130 2,756,582 ----------- ---------- ----------- ----------- ---------- ----------- - --------------------------------------------------------------------------------------------------------------------
43 Independent Auditors' Report - -------------------------------------------------------------------------------- KPMG Peat Marwick LLP 4200 Norwest Center 90 South Seventh Street Minneapolis, MN 55402 The Board of Directors HMN Financial, Inc. Spring Valley, Minnesota We have audited the accompanying consolidated balance sheets of HMN Financial, Inc. and subsidiaries (the Company) as of December 31, 1996 and 1995, and the related consolidated statements of income, stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 1996. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of HMN Financial, Inc. and subsidiaries at December 31, 1996 and 1995, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1996, in conformity with generally accepted accounting principles. /s/ KPMG Peat Marwick LLP January 31, 1997 44 Other Financial Data - -------------------------------------------------------------------------------- The following table sets forth the maximum month-end balance and average balance of FHLB advances.
- -------------------------------------------------------------------------------------------------------------------- Year Ended December 31, -------------------------------- (DOLLARS IN THOUSANDS) 1996 1995 1994 - -------------------------------------------------------------------------------------------------------------------- Maximum Balance: Federal Home Loan Bank advances................................................. $ 106,436 74,534 52,343 Federal Home Loan Bank short-term borrowings and open line of credit............ 64,429 42,429 7,329 Average Balance: Federal Home Loan Bank advances................................................. 89,656 65,069 40,121 Federal Home Loan Bank short-term borrowings.................................... 47,949 20,812 2,719 - --------------------------------------------------------------------------------------------------------------------
The following table sets forth certain information as to the Bank's FHLB advances.
- -------------------------------------------------------------------------------------------------------------------- December 31, -------------------------------------------------------------------------- 1996 1995 1994 ------------------------ ----------------------- ----------------------- Weighted Weighted Weighted Average Average Average (DOLLARS IN THOUSANDS) Amount Rate Amount Rate Amount Rate ---------- ------------ --------- ------------ --------- ------------ Federal Home Loan Bank short-term borrowings and open line of credit............................. $ 46,429 5.52% 33,429 6.05% 6,429 5.75% Federal Home Loan Bank long-term advances......... 59,650 5.74 35,448 5.91 45,557 5.98 ---------- --- --------- --- --------- --- Total........................................... $ 106,079 5.64 68,877 5.98 51,986 5.95 ---------- --- --------- --- --------- --- ---------- --- --------- --- --------- --- - --------------------------------------------------------------------------------------------------------------------
At December 31, 1996 there are $10,000,000 of long-term advances which could be called on a semi-annual basis starting in 1997. 45 Selected Quarterly Financial Data - --------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------- December 31, September 30, June 30, (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) 1996 1996 1996 - ---------------------------------------------------------------------------------------------------- Selected Operations Data (3 MONTHS ENDED) Interest income...................................... $ 10,111 10,014 9,944 Interest expense..................................... 6,174 6,191 5,949 ------------- ------------- ------------- Net interest income................................ 3,937 3,823 3,995 Provision for loan losses............................ 75 75 75 ------------- ------------- ------------- Net interest income after provision for loan losses........................................... 3,862 3,748 3,920 ------------- ------------- ------------- Noninterest income: Fees and service charges........................... 105 95 82 Securities gains (losses), net..................... 68 192 268 Gain on sale of loans.............................. 22 10 1 Other noninterest income........................... 129 115 134 ------------- ------------- ------------- Total noninterest income......................... 324 412 485 ------------- ------------- ------------- Noninterest expense: Compensation and benefits.......................... 1,211 1,176 1,099 Occupancy.......................................... 230 203 195 Federal deposit insurance premiums................. 163 212 215 SAIF assessment.................................... 0 2,352 0 Advertising........................................ 79 77 79 Data processing.................................... 121 119 121 Provision for real estate losses................... 2 0 0 Other noninterest expense.......................... 341 256 275 ------------- ------------- ------------- Total noninterest expense........................ 2,147 4,395 1,984 ------------- ------------- ------------- Income before income tax expense................... 2,039 (235) 2,421 Income tax expense................................... 740 (90) 888 ------------- ------------- ------------- Net income......................................... $ 1,299 (145) 1,533 ------------- ------------- ------------- ------------- ------------- ------------- Per common share: Net income......................................... $ 0.31 (0.03) 0.34 ------------- ------------- ------------- ------------- ------------- ------------- Financial Ratios: Return on average assets(1).......................... 0.93% (0.10) 1.13 Return on average equity(1).......................... 6.06 (0.67) 6.77 Average equity to average assets..................... 15.32 15.48 16.64 Net interest margin(1)(2)............................ 2.86 2.77 2.98 (DOLLARS IN THOUSANDS) - ---------------------------------------------------------------------------------------------------- Selected Financial Condition Data: Total assets......................................... $ 554,732 565,385 554,979 Securities held for sale............................. 0 0 0 Securities available for sale: Mortgage-backed and related securities............. 133,355 135,191 148,706 Other marketable securities........................ 42,475 52,516 40,442 Securities held to maturity: Mortgage-backed and related securities............. 1,806 2,338 13,835 Other marketable securities........................ 1,000 1,000 999 Loans held for sale.................................. 739 0 0 Loans receivable, net................................ 349,022 343,736 331,650 Deposits............................................. 362,477 363,963 363,195 Federal Home Loan Bank advances...................... 106,079 101,833 101,053 Stockholder's equity................................. 82,099 83,669 87,263 - ---------------------------------------------------------------------------------------------------- (1) Annualized. (2) Net interest income divided by average interest-earning assets. 46 - ---------------------------------------------------------------------------------------------------------------------------------- March 31, December 31, September 30, June 30, March 31, 1996 1995 1995 1995 1995 - ---------------------------------------------------------------------------------------------------------------------------------- Selected Operations Data (3 MONTHS ENDED) Interest income...................................... 9,795 9,779 9,805 9,636 9,108 Interest expense..................................... 5,880 5,904 5,873 5,657 5,121 ------------- ------------- ------------- ------------- ------------- Net interest income................................ 3,915 3,875 3,932 3,979 3,987 Provision for loan losses............................ 75 75 75 75 75 ------------- ------------- ------------- ------------- ------------- Net interest income after provision for loan losses........................................... 3,840 3,800 3,857 3,904 3,912 ------------- ------------- ------------- ------------- ------------- Noninterest income: Fees and service charges........................... 77 82 89 79 74 Securities gains (losses), net..................... 501 280 148 (5) (7) Gain on sale of loans.............................. 6 3 22 77 0 Other noninterest income........................... 117 56 33 30 37 ------------- ------------- ------------- ------------- ------------- Total noninterest income......................... 701 421 292 181 104 ------------- ------------- ------------- ------------- ------------- Noninterest expense: Compensation and benefits.......................... 1,106 1,114 1,108 978 960 Occupancy.......................................... 197 140 192 186 180 Federal deposit insurance premiums................. 210 208 206 198 198 SAIF assessment.................................... 0 0 0 0 0 Advertising........................................ 73 100 74 67 71 Data processing.................................... 128 117 116 121 123 Provision for real estate losses................... 0 9 0 0 0 Other noninterest expense.......................... 269 227 211 287 279 ------------- ------------- ------------- ------------- ------------- Total noninterest expense........................ 1,983 1,915 1,907 1,837 1,811 ------------- ------------- ------------- ------------- ------------- Income before income tax expense................... 2,558 2,306 2,242 2,248 2,205 Income tax expense................................... 972 869 827 844 841 ------------- ------------- ------------- ------------- ------------- Net income......................................... 1,586 1,437 1,415 1,404 1,364 ------------- ------------- ------------- ------------- ------------- ------------- ------------- ------------- ------------- ------------- Per common share: Net income......................................... 0.33 0.30 0.28 0.27 0.25 ------------- ------------- ------------- ------------- ------------- ------------- ------------- ------------- ------------- ------------- Financial Ratios: Return on average assets(1).......................... 1.18 1.07 1.05 1.07 1.08 Return on average equity(1).......................... 6.91 6.18 5.87 5.82 5.58 Average equity to average assets..................... 17.09 17.38 17.93 18.37 19.34 Net interest margin(1)(2)............................ 2.97 2.94 2.98 3.05 3.21 (DOLLARS IN THOUSANDS) - ------------------------------------------------------------------------------------------------------------------------------------ Selected Financial Condition Data: Total assets......................................... 542,012 537,949 529,599 536,742 507,741 Securities held for sale............................. 0 0 0 0 0 Securities available for sale: Mortgage-backed and related securities............. 163,273 158,416 139,885 154,154 151,407 Other marketable securities........................ 32,245 31,904 51,294 54,091 43,812 Securities held to maturity: Mortgage-backed and related securities............. 14,115 13,744 10,944 8,623 6,314 Other marketable securities........................ 3,227 3,228 4,652 7,653 7,659 Loans held for sale.................................. 0 0 0 0 0 Loans receivable, net................................ 307,658 314,851 301,866 287,644 278,261 Deposits............................................. 368,393 373,539 363,596 360,844 357,293 Federal Home Loan Bank advances...................... 72,493 68,877 68,900 69,617 56,305 Stockholder's equity................................. 90,879 91,687 92,104 96,127 90,261 - ------------------------------------------------------------------------------------------------------------------------------------
(1) Annualized. (2) Net interest income divided by average interest-earning assets. 47 Shareholder Information - ------------------------------------------------------------------------------- EXECUTIVE OFFICE ANNUAL MEETING HMN Financial, Inc. The annual meeting of shareholders 101 North Broadway will be held on Tuesday, April 22, Spring Valley, MN 55975 1997 at 10:00 a.m. (Central Time) (507) 346-7345 at the Best Western Apache Hotel 1517 16th St. S.W. TRANSFER AGENT & REGISTRAR Rochester, MN 55902 Inquiries regarding change of address, transfer requirements, DIVIDENDS and lost certificates should be directed to the transfer agent. No dividends were declared in 1996. For First National Bank of Boston more information refer to Dividends on c/o Boston EquiServe page 24 PO Box 8040 Boston, MA 02266-8040 FORM 10-K (617) 575-3170 HMN Financial's Form 10-K is filed INVESTOR INFORMATION with the Securities and Exchange HMN Financial, Inc. Commission and is available without Attn: Investor Relations charge upon request from 101 North Broadway HMN Financial, Inc. Spring Valley, MN 55975 Attn: Investor Relations (507) 346-7345 101 North Broadway Spring Valley, MN 55975 HMN FINANCIAL, INC. SHARES The Common Stock of HMN Financial, INDEPENDENT AUDITORS Inc. is listed on the Nasdaq Stock Market KPMG Peat Marwick LLP Symbol: HMNF 4200 Norwest Center Common shares outstanding 6,085,775, 90 South Seventh St. of which 1,651,615 are in treasury Minneapolis, MN 55402-3900 stock. Stockholders of record: 926* LEGAL COUNSEL Estimated beneficial Faegre & Benson LLP stockholders: 1,500* 2200 Norwest Center *As of December 31, 1996 90 South Seventh St. Minneapolis, MN 55402-3901 48 Directors and Officers - --------------------------------------------------------------------------------------- DIRECTORS EXECUTIVE OFFICERS ROGER P. WEISE IRMA R. RATHBUN ROGER P. WEISE Chairman of the Board Director President and Chief President and Chief Retired Vice President Executive Officer Executive Officer of Home Federal Savings Bank JAMES B. GARDNER KEITH A. HAGEN M.F. SCHUMANN Executive Vice President Director Director and Chief Financial Officer Retired President of Retired Public Accountant Home Federal Savings Bank DWAIN C. JORGENSEN TIMOTHY R. GEISLER Vice President and JAMES B. GARDNER Director Controller Director Manager Corporate Tax Unit Executive Vice President Mayo Clinic, Rochester, MN SUSAN K. KOLLING and Chief Financial Officer Senior Vice President ROXANNE M. HELLICKSON Vice President and Corporate Secretary TIMOTHY P. JOHNSON Treasurer Corporate Office - --------------------------------------------------------------------------------------- HMN Financial, Inc. 101 North Broadway Spring Valley, MN 55975 (507) 346-7345 Branch Offices of Bank - --------------------------------------------------------------------------------------- ALBERT LEA ROCHESTER WINONA 143 West Clark St. Crossroads Shopping Center 4th and Center Albert Lea, MN 56007 Rochester, MN 55901 Winona, MN 55987 (507) 377-3330 (507) 289-4025 (507) 454-4912 AUSTIN 1110 6th Street NW EDEN PRAIRIE 201 Oakland Avenue West Rochester, MN 55901 Mortgage Origination Office Austin, MN 55912 (507) 285-1707 9973 Valley View Road (507) 433-2355 Eden Prairie, MN 55344 SPRING VALLEY LACRESCENT 101 North Broadway 208 South Walnut Spring Valley, MN 55975 LaCrescent, MN 55947 (507) 346-7345 (507) 895-4090
EX-21 4 SUBSIDIARIES OF REGISTRANT Exhibit 21 Subsidiaries of Registrant SUBSIDIARIES OF REGISTRANT EXHIBIT 21
Date and % of Voting Shares, Partnership Interests, Voting Trust Year & Certificates, Capital Name & Address State Inc. Contributions Description of Activity -------------- ---------- ------------- ----------------------- Home Federal Savings Bank 1934 6/29/94 Federal Chartered Stock 101 North Broadway MN HMN owns 100% of voting Savings Bank Spring Valley, MN 55975 shares Osterud Insurance Agency, Inc. 1983 Bank owns 100% Offers credit life and annuity 101 North Broadway MN products to the Bank's Spring Valley, MN 55975 customers and others Security Finance Corporation 1929 12/29/95 Dormant development 101 North Broadway MN HMN owns 100% of voting corporation holding Spring Valley, MN 55975 shares investments in securities and loans HMN Mortgage Services, Inc. 1996 7/08/96 Mortgage Banking 9973 Valley View Road MN HMN owns 100% of Eden Prairie, MN 55344 voting shares
Home Federal Savings Bank sold six shares of Security Finance Corporation stock to HMN Financial, Inc. on December 29, 1995. The six shares sold to HMN Financial, Inc. represents 100% of the total voting shares of Security Finance Corporation at the time of sale. EX-23 5 CONSENT OF KPMG PEAT MARWICK LLP Exhibit 23 Consent of KPMG Peat Marwick LLP dated March 25, 1997 KPMG Peat Marwick LLP 4200 Norwest Center 90 South Seventh Street Minneapolis, MN 55402 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS The Board of Directors HMN Financial, Inc.: We consent to incorporation by reference of our report dated January 31, 1997, relating to the consolidated balance sheets of HMN Financial, Inc. as of December 31, 1996 and 1995, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1996, which report appears in the December 31, 1996 Form 10-K of HMN Financial, Inc. in the following Registration Statements of HMN Financial, Inc.: Nos. 33-88228, 33-94388, and 33-94386 on Form S-8. /s/ KPMG Peat Marwick LLP KPMG PEAT MARWICK LLP Minneapolis, Minnesota March 25, 1997 54 EX-27 6 EXHIBIT 27 FDS
9 This schedule contains summary Financial information extracted from The Consolidated balance sheets at December 31, 1996 and consolidated statements of income for the twelve months ended December 31, 1996. 1,000 YEAR DEC-31-1996 JAN-01-1996 DEC-31-1996 856 9,727 0 0 175,830 2,806 2,906 349,762 2,341 554,732 362,477 46,429 4,077 59,650 0 0 61 82,038 554,732 25,721 13,815 328 39,864 18,950 24,194 15,670 300 1,030 10,509 6,784 6,784 0 0 4,274 0.96 0.96 7.36 338 0 0 132 2,190 (150) 0 2,341 1,224 0 1,117
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