-----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, D10GFqlyeghPKMDo4vRSbvJ8N92aKgs7IkA1sjMtSEHrKuj0IVBTDxdeTjmb5rFw oQIqtSPrmJcWJjF49kEgdg== 0000921183-98-000014.txt : 19981123 0000921183-98-000014.hdr.sgml : 19981123 ACCESSION NUMBER: 0000921183-98-000014 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19980930 FILED AS OF DATE: 19981116 DATE AS OF CHANGE: 19981120 FILER: COMPANY DATA: COMPANY CONFORMED NAME: HMN FINANCIAL INC CENTRAL INDEX KEY: 0000921183 STANDARD INDUSTRIAL CLASSIFICATION: 6035 IRS NUMBER: 411777397 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-24100 FILM NUMBER: 98752829 BUSINESS ADDRESS: STREET 1: 101 N BROADWAY CITY: SPRING VALLEY STATE: MN ZIP: 55975-1223 BUSINESS PHONE: 5073461100 10-Q 1 FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------------------------------------ FORM 10-Q /x/ QUARTERLY REPORT PURSUANT TO SECTION 13 OF 15 (d) OF the SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 1998 OR / / TRANSITION REPORT PURSUANT TO SECTION 13 OF 15 (d) FOR THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _________ to _________ Commission File Number 0-24100 HMN FINANCIAL, INC. ------------------------------------------------------ (Exact name of Registrant as specified in its Charter) Delaware 41-1777397 -------------------------------------- ----------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 101 North Broadway, Spring Valley, Minnesota 55975-0231 --------------------------------------------- ----------------- (Address of principal executive offices) (ZIP Code) Registrant's telephone number, including area code: (507) 346-1100 --------------- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes /x/ No / / Indicate the number of shares outstanding of each of the issuer's classes of common stock as of the latest practicable date. Class Outstanding at November 6, 1998 - - ---------------------------------- ---------------------------------- Common stock, $0.01 par value 5,387,404 1 HMN FINANCIAL, INC. CONTENTS PART I - FINANCIAL INFORMATION Page ---- Item 1: Financial Statements (unaudited) Consolidated Balance Sheets at September 30, 1998 and December 31, 1997 3 Consolidated Statements of Income for the Three Months Ended and Nine Months Ended September 30, 1998 and 1997 4 Consolidated Statements of Comprehensive Income for the Three Months and Nine Months Ended September 30, 1998 and 1997 5 Consolidated Statement of Stockholders' Equity for the Nine Month Period Ended September 30, 1998 5 Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 1998 and 1997 6-7 Notes to Consolidated Financial Statements 8 Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations 15 Item 3: Quantitative and Qualitative Disclosures about Market Risk Discussion included in Item 2 under Market Risk 20 PART II - OTHER INFORMATION Item 1: Legal Proceedings 29 Item 2: Changes in Securities 29 Item 3: Defaults Upon Senior Securities 29 Item 4: Submission of Matters to a Vote of Security Holders 29 Item 5: Other Information 29 Item 6: Exhibits and Reports on Form 8-K 29 Signatures 30 2 PART I - FINANCIAL STATEMENTS
HMN FINANCIAL, INC. AND SUBSIDIARIES Consolidated Balance Sheets (unaudited) ASSETS September 30, December 31, 1998 1997 ----------- ----------- Cash and cash equivalents $ 7,476,007 9,364,635 Securities available for sale: Mortgage-backed and related securities (amortized cost $138,279,816 and $135,598,404) 137,315,620 135,935,482 Other marketable securities (amortized cost $56,008,248 and $68,356,926) 56,326,132 69,923,477 ----------- ----------- 193,641,752 205,858,959 ----------- ----------- Loans held for sale 6,881,986 2,287,265 Loans receivable, net 466,470,932 442,068,600 Federal Home Loan Bank stock, at cost 9,403,800 7,432,200 Real estate, net 10,067 133,939 Premises and equipment, net 7,496,711 5,880,710 Accrued interest receivable 3,903,926 4,038,131 Investment in limited partnerships 2,556,453 5,989,399 Goodwill 4,386,192 4,500,873 Core deposit intangible 1,331,002 1,546,273 Investment in mortgage servicing rights 877,824 781,005 Prepaid expenses and other assets 1,832,575 1,349,521 ----------- ----------- Total assets $ 706,269,227 691,231,510 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Deposits $ 446,332,538 467,347,688 Federal Home Loan Bank advances 184,578,583 127,650,021 Other borrowed money 100,000 0 Accrued interest payable 1,699,726 1,365,064 Advance payments by borrowers for taxes and insurance 762,726 786,619 Accrued expenses and other liabilities 4,655,001 6,056,356 Due to stockholders of Marshalltown Financial Corporation 48,082 3,555,352 ----------- ----------- Total liabilities 638,176,656 606,761,100 ----------- ----------- Commitments and contingencies Stockholders' equity: Serial preferred stock: authorized 500,000 shares; issued and outstanding none 0 0 Common stock ($.01 par value): authorized 11,000,000 shares; issued 9,128,568 shares 91,286 91,286 Additional paid-in capital 59,870,621 59,698,662 Retained earnings, subject to certain restrictions 61,652,939 60,224,253 Accumulated other comprehensive income (loss) (403,216) 1,129,818 Unearned employee stock ownership plan shares (5,753,839) (4,554,280) Unearned compensation restricted stock awards (394,361) (600,668) Treasury stock, at cost 3,752,509 and 2,912,111 shares (46,970,859) (31,518,661) ----------- ----------- Total stockholders' equity 68,092,571 84,470,410 ----------- ----------- Total liabilities and stockholders' equity $ 706,269,227 691,231,510 =========== ===========
See accompanying notes to consolidated financial statements. 3 HMN FINANCIAL, INC. AND SUBSIDIARIES Consolidated Statements of Income (unaudited)
Three Months Ended Nine Months Ended September 30, September 30, 1998 1997 1998 1997 ----------------------- ----------------------- Interest Income: Loans receivable $ 8,905,981 6,939,224 26,346,061 20,730,094 Securities available for sale: Mortgage-backed and related 2,188,930 2,092,964 6,566,267 6,458,996 Other marketable 952,855 1,119,452 3,138,830 2,621,762 Securities held to maturity: Mortgage-backed and related 0 0 0 33,400 Other marketable 0 0 0 10,032 Cash equivalents 90,067 55,643 362,014 225,237 Other 158,825 107,187 430,383 304,159 ---------- ---------- ---------- ---------- Total interest income 12,296,658 10,314,470 36,843,555 30,383,680 ---------- ---------- ---------- ---------- Interest expense: Deposits 5,613,824 4,749,737 17,038,627 13,993,332 Federal Home Loan Bank advances 2,625,181 1,714,642 7,164,278 4,792,552 ---------- ---------- ---------- ---------- Total interest expense 8,239,005 6,464,379 24,202,905 18,785,884 ---------- ---------- ---------- ---------- Net interest income 4,057,653 3,850,091 12,640,650 11,597,796 Provision for loan losses 85,000 75,000 235,000 225,000 ---------- ---------- ---------- ---------- Net interest income after provision for loan losses 3,972,653 3,775,091 12,405,650 11,372,796 ---------- ---------- ---------- ---------- Non-interest income (loss): Fees and service charges 254,333 121,489 745,678 318,346 Securities gains, net 348,025 487,547 1,982,104 872,159 Gain on sales of loans 518,570 117,302 1,236,706 334,367 Earnings (loss) in limited partnerships (2,676,458) 67,109 (3,614,071) 179,595 Other 128,341 85,121 403,265 278,191 ---------- ---------- ---------- ---------- Total non-interest income (loss) (1,427,189) 878,568 753,682 1,982,658 ---------- ---------- ---------- ---------- Non-interest expense: Compensation and benefits 1,581,907 1,431,853 5,314,221 4,106,699 Occupancy 361,191 245,202 1,083,951 718,801 Federal deposit insurance premiums 72,608 57,478 219,047 175,379 Advertising 124,067 62,763 353,020 214,557 Data processing 167,003 129,100 505,561 372,432 Provision for real estate losses 0 0 0 3,000 Other 929,928 302,449 2,457,387 879,374 --------- ---------- ---------- ----------- Total non-interest expense 3,236,704 2,228,845 9,933,187 6,470,242 --------- ---------- ---------- ---------- Income (loss) before income tax expense (691,240) 2,424,814 3,226,145 6,885,212 Income taxes (257,000) 900,703 1,213,000 2,554,400 --------- ---------- ---------- ---------- Net income (loss) $ (434,240) 1,524,111 2,013,145 4,330,812 ========= ========== ========== ========== Basic earnings (loss) per share $ (0.09) 0.28 0.40 0.78 ========= ========== ========== ========== Diluted earnings (loss) per share$ (0.09) 0.26 0.37 0.73 ========= ========== ========== ==========
See accompanying notes to consolidated financial statements. 4 HMN FINANCIAL, INC. AND SUBSIDIARIES Consolidated Statements of Comprehensive Income (unaudited)
Three Months Ended September 30, 1998 1997 --------------------- -------------------- Net income (loss) $ (434,240) 1,524,111 Other comprehensive income, net of tax: Unrealized gains (losses) on securities: Unrealized holding gains (losses) arising during period (1,063,613) 1,275,488 Less: reclassification adjustment for gains included in net income 213,939 290,877 --------- --------- Other comprehensive income (loss) (1,277,552) 984,611 --------- --------- Comprehensive income (loss) $ (1,711,792) 2,508,722 ========= ========= Nine Months Ended September 30, 1998 1997 ---------------------- -------------------- Net income (loss) $ 2,013,145 4,330,812 Other comprehensive income, net of tax: Unrealized gains (losses) on securities: Unrealized holding gains (losses) arising during period (314,587) 2,010,631 Less: reclassification adjustment for gains included in net income 1,218,447 520,342 --------- --------- Other comprehensive income (loss) (1,533,034) 1,490,289 --------- --------- Comprehensive income (loss) $ 480,111 5,821,101 ========= =========
See accompanying notes to consolidated financial statements. HMN FINANCIAL, INC. AND SUBSIDIARIES Consolidated Statement of Stockholders' Equity For the Nine Month Period Ended September 30, 1998 (unaudited)
Accumulated Additional Other Common Paid-in Retained Comprehensive Stock Capital Earnings Income (Loss) -------------------------------------------------------- Balance, December 31, 1997 $ 91,286 59,698,662 60,224,253 1,129,818 Net income 2,013,145 Other comprehensive income (loss) (1,533,034) Treasury stock purchases Amortization of restricted stock awards Restricted stock awards cancelled Tax benefits of restricted stock awards 70,639 Shares purchased for employee stock ownership plan Earned employee stock ownership plan shares 218,777 Employee stock options exercised (143,170) Tax benefit of exercised stock options 27,438 Dividends paid (584,459) Fractional shares purchased (1,725) --------- ---------- ----------- ---------- Balance, September 30, 1998 $ 91,286 59,870,621 61,652,939 (403,216) ========= ========== =========== ========== Unearned Employee Stock Unearned Ownership Compensation Total Plan Restricted Treasury Stockholders' Shares Stock Awards Stock Equity ------------------------------------------------------- Balance, December 31, 1997 $ (4,554,280) (600,668) (31,518,661) 84,470,410 Net income 2,013,145 Other comprehensive income (loss) (1,533,034) Treasury stock purchases (15,685,962) (15,685,962) Amortization of restricted stock awards 177,185 177,185 Restricted stock awards cancelled 29,122 (29,122) 0 Tax benefits of restricted stock awards 70,639 Shares purchased for employee stock ownership plan (1,476,000) (1,476,000) Earned employee stock ownership plan shares 276,441 495,218 Employee stock options exercised 262,877 119,707 Tax benefit of exercised stock options 27,438 Dividends paid (584,459) Fractional shares purchased 9 (1,716) ---------- ---------- ----------- ----------- Balance, September 30, 1998 $ (5,753,839) (394,361) (46,970,859) 68,092,571 ========== ========== =========== ===========
See accompanying notes to consolidated financial statements. 5 HMN FINANCIAL, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows (unaudited)
Nine Months Ended September 30, 1998 1997 ---------------------------- Cash flows from operating activities: Net income $ 2,013,145 4,330,812 Adjustments to reconcile net income to cash provided by operating activities: Provision for loan losses 235,000 225,000 Provision for real estate losses 0 3,000 Depreciation 455,195 314,248 Amortization of (discounts) premiums, net (99,108) (175,404) Amortization of deferred loan fees (469,874) (297,964) Amortization of goodwill 135,477 0 Amortization of core deposit intangible 215,271 0 Amortization of other purchase accounting adjustments 582,961 0 Amortization of mortgage servicing rights 616,896 0 Provision for deferred income taxes 255,000 294,750 Securities gains, net (1,982,104) (872,159) Gain on sales of real estate (21,777) (3,743) Gain on sales of loans (1,236,706) (334,366) Proceeds from sale of loans held for sale 108,788,891 14,425,602 Disbursements on loans held for sale (81,539,946) (11,548,571) Amortization of restricted stock awards 177,185 173,472 Amortization of unearned ESOP shares 276,441 288,180 Earned employee stock ownership shares priced above original cost 218,777 207,238 Decrease in accrued interest receivable 134,205 234,627 Increase (decrease) in accrued interest payable 334,662 (395,504) Equity (earnings) loss of limited partnerships 3,614,071 (179,596) Increase in other assets (483,054) (133,526) Increase (decrease) in other liabilities (541,372) 377,696 Other, net (173,639) 11,970 ----------- ----------- Net cash provided by operating activities 31,505,597 6,945,762 ----------- ----------- Cash flows from investing activities: Proceeds from sales of securities available for sale 119,137,787 63,095,246 Principal collected on securities available for sale 27,152,425 10,496,126 Proceeds collected on maturity of securities available for sale 32,674,876 27,618,412 Purchases of securities available for sale (165,638,598) (95,055,935) Proceeds from sales of securities held to maturity 0 348,871 Principal collected on securities held to maturity 0 240,441 Proceeds collected on maturity of securities held to maturity 0 1,000,000 Proceeds from sales of loans receivable 3,252,274 22,819,187 Purchases of mortgage servicing rights (550,532) (400,008) Purchase of interest in limited partnerships (181,125) (2,438,750) Purchase of Federal Home Loan Bank stock (1,971,600) (802,700) Net increase in loans receivable (60,381,549) (40,150,202) Proceeds from sale of real estate 152,415 35,627 Purchases of premises and equipment (2,071,196) (963,474) Decrease in due to stockholders of Marshalltown Financial Corporation (3,507,270) 0 ----------- ---------- Net cash used by investing activities (51,932,093) (14,157,159) ----------- ---------- Cash flows from financing activities: Increase (decrease) in deposits (20,838,371) 4,205,405 Purchase of treasury stock (15,685,962) (4,109,637) Increase in unearned ESOP shares (1,476,000) 0 Stock options exercised 119,707 138 Dividends to stockholders (584,459) 0 Fractional shares purchased from stock split (1,716) 0 Proceeds from Federal Home Loan Bank advances 125,500,000 121,500,000 Repayment of Federal Home Loan Bank advances (68,571,438) (115,571,426) Increase in other borrowed money 100,000 0 Decrease (increase) in advance payments by borrowers for taxes and insurance (23,893) 239,156 ----------- ---------- Net cash provided by financing activities 18,537,868 6,263,636 ----------- ---------- Decrease in cash and cash equivalents (1,888,628) (947,761) Cash and cash equivalents, beginning of period 9,364,635 10,583,717 ----------- ---------- Cash and cash equivalents, end of period $ 7,476,007 9,635,956 =========== ========== 6 Supplemental cash flow disclosures: Cash paid for interest $ 18,451,222 18,390,380 Cash paid for income taxes 1,724,441 2,255,500 Supplemental noncash flow disclosures: Loans securitized and transferred to securities available for sale $ 1,930,846 9,608,294 Securities held to maturity transferred to securities available for sale 0 1,295,147 Loans transferred to loans held for sale 30,617,345 4,071,410 Transfer of loans to real estate 17,105 188,776 Transfer of real estate to loans 0 84,772
See accompanying notes to consolidated financial statements. 7 HMN FINANCIAL, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (Unaudited) September 30, 1998 and 1997 (1) HMN FINANCIAL, INC. HMN Financial, Inc. (HMN) is a stock savings bank holding company which owns 100 percent of Home Federal Savings Bank (the Bank or Home Federal). Home Federal has a community banking philosophy and operates retail banking facilities in Minnesota and Iowa. The Bank has two wholly owned subsidiaries, Osterud Insurance Agency, Inc. (OAI) and MSL Financial Corporation (MSL), which offer financial planning products and services. HMN has two other wholly owned subsidiaries, Security Finance Corporation (SFC) and HMN Mortgage Services, Inc. (MSI). SFC invests in commercial loans and commercial real-estate loans located throughout the United States which were originated by third parties. MSI operates mortgage banking and mortgage brokerage facilities located in Eden Prairie and Brooklyn Park, Minnesota. The consolidated financial statements included herein are for HMN, SFC, MSI, the Bank and the Bank's wholly owned subsidiaries, OAI and MSL. All significant intercompany accounts and transactions have been eliminated in consolidation. (2) BASIS OF PREPARATION The accompanying unaudited consolidated financial statements were prepared in accordance with instructions for Form 10-Q and therefore, do not include all disclosures necessary for a complete presentation of the consolidated balance sheets, consolidated statements of income, consolidated statements of comprehensive income, consolidated statements of stockholders' equity and consolidated statements of cash flows in conformity with generally accepted accounting principles. However, all adjustments, consisting of only normal recurring adjustments, which are, in the opinion of management, necessary for the fair presentation of the interim financial statements have been included. The statements of income for the three month and nine month periods ended September 30, 1998 are not necessarily indicative of the results which may be expected for the entire year. Certain amounts in the consolidated financial statements for prior periods have been reclassified to conform with the current period presentation. (3) NEW ACCOUNTING STANDARDS Effective January 1, 1998 HMN adopted Statement of Financial Accounting Standards ("SFAS") No. 130, REPORTING COMPREHENSIVE INCOME. The statement establishes standards for reporting and display of comprehensive income and its components in a full set of general-purpose financial statements. The statement requires that all items that are required to be recognized under accounting standards as components of comprehensive income be disclosed in the financial statements. Comprehensive income is defined as the change in equity during a period from transactions and other events from nonowner sources. Comprehensive income is the total of net income and other comprehensive income, which for HMN is comprised entirely of unrealized gains and losses on securities available for sale. The gross unrealized holding losses for the third quarter of 1998 were $1.73 million, the income tax benefit would have been $667,000 and therefore, the net losses were $1.06 million. The gross 8 reclassification adjustment for the third quarter of 1998 was $348,000, the income tax expense would have been $134,000 and therefore, the net reclassification adjustment was $214,000. The gross unrealized holding gains for the third quarter of 1997 were $2.14 million, the income tax expense would have been $863,000 and therefore, the net gain was $1.28 million. The gross reclassification adjustment for the third quarter of 1997 was $488,000, the income tax expense would have been $197,000 and therefore, the net reclassification adjustment was $291,000. The gross unrealized holding losses for the nine month period ended September 30, 1998 were $568,000, the income tax benefit would have been $253,000 and therefore, the net losses were $315,000. The gross reclassification adjustment for the first nine months of 1998 was $1.98 million, the income tax expense would have been $764,000 and therefore, the net reclassification adjustment was $1.22 million. The gross unrealized holding gains for the nine month period ended September 30, 1997 were $3.37 million, the income tax expense would have been $1.36 million and therefore, the net gain was $2.01 million. The gross reclassification adjustment for the first nine months of 1997 was $872,000, the income tax expense would have been $352,000 and therefore, the net reclassification adjustment was $520,000. In February 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No. 132, EMPLOYERS' DISCLOSURES ABOUT PENSIONS AND OTHER POSTRETIREMENT BENEFITS which revises employers' disclosures about pension and other postretirement benefit plans. It does not change the measurement or recognition of those plans. It standardizes the disclosure requirements for pensions and other postretirement benefits to the extent practicable, requires additional information on changes in the benefit obligation and fair values of plan assets that will facilitate financial analysis, and eliminates certain disclosures that are no longer as useful as they were when FASB Statements No. 87, EMPLOYERS' ACCOUNTING FOR PENSIONS, NO. 88, EMPLOYERS' ACCOUNTING FOR SETTLEMENT AND CURTAILMENTS OF DEFINED BENEFIT PENSION PLANS AND FOR TERMINATION BENEFITS, AND NO. 106, EMPLOYERS' ACCOUNTING FOR POSTRETIREMENT BENEFITS OTHER THAN PENSIONS, were issued. SFAS No. 132 suggests combined formats for presentation of pension and other postretirement benefit disclosures. It is effective for fiscal years beginning after December 15, 1997. Restatement of disclosures for earlier periods provided for comparative purposes is required unless the information is not readily available. Adopting the disclosure requirements of SFAS No. 132 will not have a material impact on HMN's financial condition or the results of its operations. In June 1998, the FASB issued SFAS No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES, which establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, (collectively referred to as derivatives) and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. If certain conditions are met, a derivative may be specifically designated as (a) a hedge of the exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment, (b) a hedge of the exposure to variable cash flows of a forecasted transaction, or (c) a hedge of the foreign currency exposure of a net investment in a foreign operation, an unrecognized firm commitment, an available-for-sale security, or a foreign-currency-denominated forecasted transaction. The accounting for changes in the fair value of a derivative (that is, gains and losses) depends on the intended use of the derivative and the resulting designation. - - - For a derivative designated as hedging the exposure to changes in the fair value of a recognized asset or liability or a firm commitment (referred to as a fair value hedge), the gain or loss is recognized in earnings in the period of change together with the offsetting loss or gain on the hedged item attributable to the risk being hedged. The effect of that accounting is to reflect in earnings the extent to which the hedge is not effective in achieving offsetting changes in fair value. - - - For a derivative designated as hedging the exposure to variable cash flows of a forecasted 9 transaction (referred to as a cash flow hedge), the effective portion of the derivative's gain or loss is initially reported as a component of other comprehensive income (outside earnings) and subsequently reclassified into earnings when the forecasted transaction affects earnings. The ineffective portion of the gain or loss is reported in earnings immediately. - - - For a derivative designated as hedging the foreign currency exposure of a net investment in a foreign operation, the gain or loss is reported in other comprehensive income (outside earnings) as part of the cumulative translation adjustment. The accounting for a fair value hedge described above applies to a derivative designated or an available-for-sale security. Similarly, the accounting for a cash flow hedge described above applies to a derivative designated as a hedge of the foreign currency exposure of a foreign-currency- denominated forecasted transaction. - - - For a derivative not designated as a hedging instrument, the gain or loss is recognized in earnings in the period of change. Under SFAS No. 133, an entity that elects to apply hedge accounting is required to establish at the inception of the hedge the method it will use for assessing the effectiveness of the hedging derivative and the measurement approach for determining the ineffective aspect of the hedge. Those methods must be consistent with the entity's approach to managing risk. SFAS No. 133 precludes designating a nonderivative financial instrument as a hedge of an asset, liability, unrecognized firm commitment, or forecasted transaction except that a nonderivative instrument denominated in a foreign currency may be designated as a hedge of the foreign currency exposure of an unrecognized firm commitment denominated in a foreign currency or a net investment in a foreign operation. SFAS No. 133 is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. Initial application should be as of the beginning of an entity's fiscal quarter; on that date, hedging relationships must be designated anew and documented pursuant to the provisions of FASB No. 133. HMN is anticipating that it will adopt SFAS No. 133 in the first quarter of 2000 and is currently studying the impact of adopting the statement on its financial statements. In October 1998, the FASB issued SFAS No. 134, ACCOUNTING FOR MORTGAGE-BACKED SECURITIES RETAINED AFTER THE SECURITIZATION OF MORTGAGE LOANS HELD FOR SALE BY A MORTGAGE BANKING ENTERPRISE, which amends SFAS No. 65 to require that after the securitization of mortgage loans held for sale, an entity engaged in mortgage banking activities classify the resulting mortgage-backed securities or other retained interests based on its ability and intent to sell or hold those investments. SFAS No. 134 is effective for the first fiscal quarter beginning after December 15, 1998. Early application is encouraged and is permitted as of October of 1998. HMN anticipates adopting SFAS No. 134 in the first quarter of 1999 and believes that it will not have a material impact on HMN's financial condition or the results of its operations. (4) STOCK SPLIT AND CASH DIVIDEND In February of 1998 HMN authorized a three-for-two stock split in the form of a fifty percent stock dividend subject to stockholder approval to increase HMN's authorized common stock from 7.0 million shares to 11.0 million shares. At the annual meeting on April 28, 1998 the stockholders approved the increase in authorized common stock. The Board of Directors then declared that the stock dividend be distributed on May 22, 1998 to stockholders of record on May 8, 1998. The stock split increased HMN's outstanding common shares from 6,085,775 to 9,128,568 shares. Stockholders' equity has been restated to give retroactive effect to the stock split for all periods presented by reclassifying from additional paid-in capital to common stock the par value of the additional shares arising from the stock split. In addition all references in the Consolidated Financial 10 Statements and Notes thereto to number of shares, per-share amounts, stock option data and market prices of HMN's common stock have been restated giving retroactive recognition to the stock split. Cash dividends of $0.06 per share were paid on June 12, 1998 and September 10, 1998 to stockholders of record on May 27, 1998 and August 27, 1998, respectively. (5) MERGERS AND ACQUISITIONS On December 5, 1997 HMN, through its wholly owned subsidiary, Home Federal, completed its merger (the Merger) with Marshalltown Financial Corporation (MFC) pursuant to a merger agreement dated July 1, 1997. The aggregate consideration per the merger agreement was $24.8 million, consisting of $23.7 million for 1.35 million outstanding shares of MFC stock, or $17.51 per share, and $1.1 million for the outstanding MFC options. HMN owned 60,000 shares of MFC stock with a historical cost of $1.0 million which were cancelled upon the completion of the merger. The following Unaudited Pro Forma Condensed Combined Statements of Income for the three months and nine months ended September 30, 1997 combine HMN's income statement with MFC's income statement. The statement is presented as if the Merger had been effective at the beginning of the period presented, after giving effect to certain pro forma adjustments described in the accompanying notes. The Unaudited Pro Forma Condensed Combined Statements of Income and notes thereto (the Information) reflect the application of the purchase method of accounting for the Merger. Under this method, the assets acquired and liabilities assumed from MFC and its subsidiaries are recorded at their fair market values on the date of the Merger. The amount of the purchase price in excess of the fair market value of the tangible and identifiable intangible assets acquired less the fair market value of the liabilities assumed is recorded as goodwill. Certain historical information of the consolidated MFC has been reclassified to conform to HMN's financial statement presentation. The Information is not necessarily indicative of the results of future operations of the combined entity or the actual results that would have been achieved had the Merger of MFC been consummated prior to the period indicated. UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENTS OF INCOME Three months ended September 30, 1997
Pro Forma ------------------------------ HMN MFC Adjustments Combined ----------- ---------- ---------- ---------- Total interest income $ 10,314,470 2,235,881 (497,550) (1)(2) 12,052,801 Total interest expense 6,464,378 1,389,101 106,685 (3)(4) 7,960,164 ---------- ---------- --------- ---------- Net interest income 3,850,092 846,780 (604,235) 4,092,637 Provision for loan losses 75,000 2,500 77,500 Non-interest income 878,567 4,412 882,979 Non-interest expense 2,228,845 582,195 123,560 (5)(6) 2,934,600 ---------- ---------- --------- ---------- Income before income tax expense 2,424,814 266,497 (727,795) 1,963,516 Income tax expense 900,703 86,022 (258,751) 727,974 ---------- ---------- --------- ---------- Net income $ 1,524,111 180,475 (469,044) 1,235,542 ========== ========== ========= ========== Basic earnings per share $ 0.28 0.13 0.22 Diluted earnings per share $ 0.26 0.12 0.21 Weighted average shares outstanding: Basic 5,533,211 1,411,475 5,533,211 Diluted 5,955,258 1,470,860 5,955,258
11 UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENTS OF INCOME Nine months ended September 30, 1997
Pro Forma ---------------------------- HMN MFC Adjustments Combined ----------- --------- ------------ --------- Total interest income $ 30,383,679 6,644,813 (1,510,160) (1)(2) 35,518,332 Total interest expense 18,785,884 4,115,712 271,990 (3)(4) 23,173,586 ---------- ---------- ----------- ---------- Net interest income 11,597,795 2,529,101 (1,782,150) 12,344,746 Provision for loan losses 225,000 7,500 232,500 Non-interest income 1,982,659 72,385 2,055,044 Non-interest expense 6,470,244 1,720,196 370,680 (5)(6) 8,561,120 ---------- ---------- ----------- ---------- Income before income tax expense 6,885,210 873,790 (2,152,830) 5,606,170 Income tax expense 2,554,400 246,526 (722,439) 2,078,488 ---------- ---------- ----------- ---------- Net income $ 4,330,810 627,264 (1,430,392) 3,527,682 ========== ========== =========== ========== Basic earnings per share$ 0.78 0.44 0.64 Diluted earnings per share$ 0.73 0.43 0.60 Weighted average shares outstanding: Basic 5,532,155 1,411,475 5,532,155 Diluted 5,904,637 1,470,717 5,904,637
Description of adjustments: (1) Represents amortization of MFC mark-to-market adjustments under the purchase method of accounting for loans. (2) Represents amortization of MFC mark-to-market adjustments under the purchase method of accounting for securities, and the forgone interest income resulting from the planned sale of $15.8 million of securities. (3) Represents amortization of MFC mark-to-market adjustments under the purchase method of accounting for deposits. (4) Represents the net interest cost of borrowing $10.0 million to fund the MFC acquisition. (5) Represents amortization of goodwill and core deposit intangible. (6) Represents the additional depreciation on premises and equipment related to the MFC mark-to-market adjustments. Pursuant to the Merger and consistent with generally accepted accounting principles (GAAP), certain adjustments were recorded, primarily to accrue for specific, identified costs related to the merger of MFC. The amounts of the Merger related costs are subject to revisions as economic conditions change or as more information becomes available. HMN expects to achieve operating cost savings primarily through reductions in staff and the consolidation of certain functions such as data processing, investments and other back office operations at MFC. The operating cost savings are expected to be achieved in various amounts at various times during the years subsequent to the acquisition of MFC and not ratably over, or at the beginning or end of, such periods. No adjustment has been reflected in the Unaudited Pro Forma Condensed Combined Statement of Income for the three months and nine months ended September 30, 1997 for the anticipated cost savings. (6) INVESTMENT IN LIMITED PARTNERSHIP AND MORTGAGE SERVICING IMPAIRMENT RESERVES During the third quarter of 1998 HMN increased valuation reserves on mortgage servicing assets by $287,000 and recognized a $2.5 million decline in its partnership investment as its proportionate share of losses after the partnership increased valuation reserves on its mortgage servicing assets; resulting in an aggregate pretax charge to HMN's third quarter income of $2.8 million. For the nine months ended September 30, 1998 year to date pretax income was reduced by $421,000 related to 12 establishing valuation reserves on mortgage servicing assets and pretax income was reduced by a $3.5 million charge which recognized HMN's proportionate share of losses on its partnership investment after the partnership established valuation reserves on its mortgage servicing assets. (7) EARNINGS PER SHARE The following table reconciles the weighted average shares outstanding and the income available to common shareholders used for basic and diluted EPS:
Three months Nine Months ended Sept 30, ended Sept 30, --------------------- --------------------- 1998 1997 1998 1997 ---------- ---------- ---------- ---------- Weighted average number of common shares outstanding used in basic earnings per common share calculation 4,625,803 5,533,211 5,038,496 5,532,155 Net dilutive effect of: Options 0 348,039 358,514 293,476 Restricted stock awards 0 74,009 54,344 79,007 ---------- --------- ---------- ---------- Weighted average number of shares outstanding adjusted for effect of dilutive securities 4,625,803 5,955,259 5,451,354 5,904,637 ========== ========= ========== ========== Income (loss) available to common shareholders $ (434,240) 1,524,111 2,013,145 4,330,812 Basic earnings (loss) per common share $ (0.09) 0.28 0.40 0.78 Diluted earnings (loss) per common share $ (0.09) 0.26 0.37 0.73
The earnings per share calculations reflected above are presented as if the split had been completed at the beginning of each period presented for the weighted average number of shares outstanding for each period. (8) REGULATORY CAPITAL The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on HMN's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulations to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the following table) of Tangible, Tier I (Core), and Risk-based capital (as defined in the regulations) to adjusted total assets and risk-weighted assets (as defined). Management believes, as of September 30, 1998, that the Bank meets all capital adequacy requirements to which it is subject. Management believes that based upon the Bank's capital calculations at September 30, 1998 and other conditions consistent with the Prompt Corrective Actions Provisions of the OTS regulations, the Bank would be categorized as well capitalized. On September 30, 1998 the Bank's tangible assets and adjusted total assets were $678.7 million and its risk-weighted assets were $335.2 million. The following table presents the Bank's capital amounts and ratios at September 30, 1998 for actual capital, required capital and excess capital including ratios in order to qualify as being well capitalized under the Prompt Corrective Actions regulations. 13
- - ----------------------------------------------------------------------------- Required to be Adequately Actual Capitalized ------------------------ ----------------------- (IN THOUSANDS) Amount Percent Amount Percent ------------------------------------------------ Bank stockholder's equity $ 46,377 Plus: Net unrealized loss (gain) on certain securities available for sale 89 Less: Goodwill and other intangibles 5,717 Excess mortgage servicing rights 238 ------ Tier I or core capital 40,511 $27,148 ------ Tier I capital to adjusted total assets 5.97% 4.00% Tier I capital to risk- weighted assets 12.08% Less: Equity investments and other assets required to be deducted 22 Plus: Allowable allowance for loan losses 2,966 ------- Risk-based capital $ 43,455 $26,819 ======= Risk-based capital to risk- weighted assets 12.96% 8.00% - - ------------------------------------------------------------------------------- - - ------------------------------------------------------------------------------ To Be Well Capitalized Under Prompt Corrective Excess Capital Actions Provisions ------------------------------------------------ (IN THOUSANDS) Amount Percent Amount Percent ------------------------------------------------ Bank stockholder's equity $ Plus: Net unrealized loss (gain) on certain securities available for sale Less: Goodwill and other intangibles Excess mortgage servicing rights Tier I or core capital 13,363 $33,936 Tier I capital to adjusted total assets 1.97% 5.00% Tier I capital to risk- weighted assets 6.00% Less: Equity investments and other assets required to be deducted Plus: Allowable allowance for loan losses Risk-based capital $ 16,636 33,524 Risk-based capital to risk- weighted assets 4.96% 10.00% - - -------------------------------------------------------------------------------
The tangible capital of the Bank was in excess of the minimum 2% required at September 30, 1998, but is not reflected in the table above. 14 HMN FINANCIAL, INC. Item 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL HMN's net income is dependent primarily on its net interest income, which is the difference between interest earned on its loans and investments and the interest paid on interest-bearing liabilities. Net interest income is determined by (i) the difference between the yield earned on interest-earning assets and rates paid on interest-bearing liabilities (interest rate spread) and (ii) the relative amounts of interest-earning assets and interest-bearing liabilities. HMN's interest rate spread is affected by regulatory, economic and competitive factors that influence interest rates, loan demand and deposit flows. Net interest margin is calculated by dividing net interest income by the average interest-earning assets and is normally expressed as a percentage. Net interest income and net interest margin are affected by changes in interest rates, the volume and the mix of interest-earning assets and interest-bearing liabilities, and the level of non-performing assets. HMN's net income is also affected by the generation of non-interest income, which primarily consists of gains from the sale of securities, gains from sale of loans, service charges, fees and other income. In addition, net income is affected by the level of operating expenses and establishment of a provision for loan losses. The operations of financial institutions, including the Bank, are significantly affected by prevailing economic conditions, competition and the monetary and fiscal policies of governmental agencies. Lending activities are influenced by the demand for and supply of housing, competition among lenders, the level of interest rates and the availability of funds. Deposit flows and costs of funds are influenced by prevailing market rates of interest primarily on competing investments, account maturities and the levels of personal income and savings in the market area of the Bank. STOCK SPLIT In February of 1998 HMN announced that its Board of Directors had authorized a three-for-two stock split in the form of a fifty percent stock dividend subject to stockholder approval at the annual meeting of stockholders held on April 28, 1998 to increase HMN's authorized common stock from 7.0 million shares to 11.0 million shares. At the annual meeting the stockholders approved the increase in authorized common stock. The Board of Directors then declared that the split would be distributed on May 22, 1998 to shareholders of record on May 8, 1998. The financial statements included in this Form 10-Q for the quarter and nine month periods ended September 30, 1997 and the nine month period ended September 30, 1998 have been presented assuming that the stock split had taken place at the beginning of those periods. Earnings per share calculations included in the financial statements were based upon post split weighted average outstanding share information. NET INCOME (LOSS) HMN's net loss for the third quarter of 1998 was $434,000, a decrease in earnings of $1.96 million, compared to net income of $1.5 million for the third quarter of 1997. The decrease in net income was primarily the result of a $2.3 million decline in non-interest income and a $1.0 million increase in non- interest expense which was partially offset by a $208,000 increase in net interest income. During the third quarter of 1998, HMN incurred a pretax charge of $287,000 when it adjusted its valuation reserves on mortgage servicing assets. HMN also incurred a pretax charge of $2.5 million when it recognized its proportionate share of losses on a partnership investment after the partnership 15 adjusted valuation reserves on its mortgage servicing assets. The combined charges totalling $2.8 million decreased both basic earnings per share and diluted earnings per share by $0.38 for the third quarter of 1998. Basic loss per share for the third quarter of 1998 was $0.09, a decrease of $0.37, compared to $0.28 basic earnings per share for the third quarter of 1997. Diluted loss per share for the third quarter of 1998 was $0.09, a decrease of $0.35, compared to $0.26 diluted earnings per share for the third quarter of 1997. Net income for the nine-month period ended September 30, 1998 was $2.0 million, a decrease of $2.3 million, compared to $4.3 million for the same nine month period of 1997. The decrease in net income was the result of a $1.2 million decrease in non-interest income and a $3.5 million increase in non-interest expense which was partially offset by a $1.0 million increase in net interest income. During the nine month period ended September 30, 1998, HMN recognized an aggregate pretax charge of $421,000 relating to adjusting valuation reserves on its mortgage servicing assets. HMN also recognized an aggregate pretax charge of $3.5 million on its partnership investment after the partnership adjusted the partnership's valuation reserves on its mortgage servicing assets. The charges related to mortgage servicing assets decreased basic earning per share and diluted earnings per share for the nine month period ended September 30, 1998 by $0.49 and $0.45, respectively. Basic earnings per share for the nine month period ended September 30, 1998 were $0.40, compared to $0.78 for the same nine month period in 1997. Diluted earnings per share for the nine month period ended September 30, 1998 were $0.37, compared to $0.73 for the same period of 1997. NET INTEREST INCOME Net interest income for the third quarter of 1998 was $4.1 million, an increase of $208,000, or 5.4%, compared to $3.9 million for the same quarter of 1997. Interest income for the third quarter of 1998 was $12.3 million, an increase of $2.0 million, or 19.2%, compared to $10.3 million for the same quarter of 1997. Interest income increased primarily due to the Marshalltown Financial Corporation ("MFC") merger which occurred on December 5, 1997 and the additional interest earning assets which were purchased with the proceeds from a $66.5 million increase in average outstanding Federal Home Loan Bank advances from the third quarter of 1997 to the third quarter of 1998. The average outstanding balances for interest-earning assets during the third quarter of 1998 compared to the third quarter of 1997 increased by $136.5 million. The average outstanding balance for loans receivable including loans held for sale increased by $124.2 million and the average outstanding balances for securities, FHLB stock, and other interest-earning assets increased by $13.3 million. The increase in interest-earning assets caused interest income to increase by $2.4 million and was partially offset by a decrease of $407,000 in interest income due to declining yields earned on interest earning assets. Interest expense for the third quarter of 1998 was $8.2 million, an increase of $1.8 million, or 27.5%, compared to $6.5 million for the same quarter of 1997. Average interest-bearing liabilities for the third quarter of 1998 were $639.0 million, an increase of $158.3 million, or 32.9%, compared to $480.7 million for the third quarter of 1997. The majority of the funds received from the increase in interest-bearing liabilities were used to purchase the net increase in average interest-earning assets, facilitate the HMN treasury stock purchases, and purchase loan servicing assets. The increase in interest- bearing liabilities caused interest expense for the third quarter of 1998 to increase by $2.0 million and was partially offset by a $254,000 decline in interest expense caused by a decline in the interest rates paid on borrowings and deposits. Net interest income for the nine months ended September 30, 1998 was $12.6 million, an increase of $1.0 million, or 9.0%, from $11.6 million for the same period of 1997. Interest income for the nine month period ended September 30, 1998 was $36.8 million, an increase of $6.5 million, or 21.3%, compared to $30.4 million for the same period of 1997. Interest income increased primarily due to the MFC merger which occurred on December 5, 1997 and the additional interest earning assets which were purchased with the proceeds from a $57.4 million increase in average outstanding Federal Home Loan Bank advances from the first nine months of 1997 to the same period of 1998. The 16 average outstanding balances for interest-earning assets during the first nine months of 1998 compared to the same period of 1997 increased by $139.6 million. The average outstanding balance for loans receivable including loans held for sale increased by $111.9 million and the average outstanding balances for securities, FHLB stock, and other interest-earning assets increased by $27.7 million. The increase in interest-earning assets caused interest income to increase by $7.5 million and was partially offset by a decrease of $995,000 in interest income due to declining yields earned on interest earning assets. Interest expense for the nine months ended September 30, 1998 was $24.2 million, an increase of $5.4 million, or 28.8%, compared to $18.8 million for the same nine month period of 1997. Average interest-bearing liabilities for the nine months ended September 30, 1998 were $626.9 million, an increase of $153.8 million, or 32.5%, compared to $473.1 million for the same period of 1997. The majority of the funds received from the increase in interest-bearing liabilities were used to purchase the net increase in average interest-earning assets, facilitate the HMN treasury stock purchases, and purchase loan servicing assets. The increase in interest-bearing liabilities caused interest expense for the nine month period of 1998 to increase by $5.9 million and was partially off set by a $506,000 decrease in interest expense caused by a decline in the interest rates paid on borrowings and deposits. PROVISION FOR LOAN LOSSES *The provision for loan losses for the third quarter ended September 30, 1998 was $85,000, an increase of $10,000, compared to $75,000 for the third quarter of 1997. The provision for loan losses for the nine months ended September 30, 1998 was $235,000, an increase of $10,000, compared to $225,000 for the same nine month period of 1997. The provision is the result of management's evaluation of the loan portfolio, a historically low level of non-performing loans, minimal loan charge-off experience, and management's assessment of the general economic conditions in the geographic area where properties securing the loan portfolio are located. Management's evaluation did not reveal conditions that would cause it to significantly increase the provision for loan losses during 1998 compared to 1997. Future economic conditions and other unknown factors may impact the need for future provisions for loan losses. As a result, no assurances can be given that increases in the allowance for loan losses will not be required during future periods. A reconciliation of HMN's allowance for loan losses is summarized as follows: 1998 1997 ------------- ------------ Balance at January 1, $ 2,748,219 2,340,585 Provision 235,000 225,000 Charge-offs (18,599) (19,577) Recoveries 1,615 7,500 Balance at September 30, $ 2,966,235 2,553,508 NON-INTEREST INCOME (LOSS) Non-interest loss for the third quarter of 1998 was $1.4 million, a decrease of $2.3 million from $879,000 of non-interest income for the same quarter of 1997. The $2.3 million decrease in non-interest income was principally due to a $2.7 million decline in earnings from partnership investments and a $140,000 decline in securities gains that were recognized. These declines were partially offset by an aggregate increase in fees, service charges, recognized gains on the sale of loans and other income of $577,000. During the third quarter of 1998, HMN recognized a pretax charge of $2.5 million on a partnership investment after the partnership adjusted the valuation reserves on its mortgage servicing assets. Due to the substantial increase in seasoned mortgage loan prepayments experienced during 1998 and the lack of buyers of seasoned mortgage servicing assets, the value of many seasoned mortgage servicing assets declined at September 30, 1998. HMN also recognized a $190,000 loss on a * This paragraph contains a forward-looking statement(s). Refer to information regarding Forward-looking Information on page 25 of this discussion. 17 partnership investment which invests primarily in the stock of other financial institutions. At September 30, 1998, the market value of the common stock of many financial institutions declined due to market conditions which caused a general decline in the market value of the stock of many public companies. Non-interest income for the nine months ended September 30, 1998 was $754,000, a decrease of $1.2 million, or 62.0%, from $2.0 million for the same period of 1997. The decrease in non-interest income was principally due to a $3.8 million decline in earnings from partnership investments that were partially offset by an increase of $427,000 in fees and service charges earned, an increase of $1.1 million in securities gains, an increase of $902,000 in recognized gains on the sale of loans and an increase of $125,000 in other income. For the nine months ended September 30, 1998, HMN recognized an aggregate pretax charge of $3.5 million on a partnership investment after the partnership adjusted the valuation reserves on its mortgage servicing assets. Due to the substantial increase in seasoned mortgage loan prepayments experienced during 1998 and the lack of buyers of seasoned mortgage servicing assets, the value of many seasoned mortgage servicing assets declined at September 30, 1998. During the same nine month period in 1998, HMN also recognized a $67,000 loss on a partnership investment which invests primarily in the stock of other financial institutions. At September 30, 1998, the market value of the common stock of many financial institutions declined due to market conditions which caused a general decline in the market value of the stock of many public companies. The increase in fees is principally related to an increase in mortgage servicing assets between the two periods and the increase in service charge income is principally due to the additional deposit accounts that were acquired through the MFC merger. The increase in the security gains is the result of the favorable interest rate environment during the first two quarters of 1998 which allowed HMN to sell many securities at a gain. The general decline in interest rates during 1998 also enticed many borrowers to purchase homes or refinance their existing home loans. The increased loan activity when coupled with the fact that the Bank is now selling the majority of its fixed rate 15 year and 30 year loan production has caused the gain on the sale of loans to increase from 1997 to 1998. NON-INTEREST EXPENSE Non-interest expense was $3.2 million for the third quarter of 1998, an increase of $1.0 million from $2.2 million for the third quarter of 1997. Compensation and benefit expense increased by $150,000 primarily due to an increase in HMN's work force as a result of the MFC merger, increased staff added to the mortgage banking operations of MSI and the Bank and normal annual compensation increases to Bank employees. Occupancy costs increased by $116,000 due to three buildings added by the MFC merger, the addition of a mortgage banking office in Brooklyn Park, Minnesota and increased occupancy costs related to opening a new retail facility in Spring Valley. Other non- interest expense increased by $627,000 due to additional operating costs incurred related to the MFC merger, the mortgage banking expansion in Brooklyn Park, amortization of goodwill and core deposit intangibles of $117,000 related to the MFC merger and an aggregate charge of $287,000 in mortgage servicing amortization or adjustments to impairment reserves on mortgage servicing assets. Non-interest expense for the nine months ended September 30, 1998 was $9.9 million, an increase of $3.4 million from $6.5 million for the nine months ended September 30, 1997. Compensation and benefit expense increased by $1.2 million primarily due to an increase in HMN's work force as a result of the MFC merger, increased staff added to the mortgage banking operations of MSI and the Bank and normal annual compensation increases to Bank employees. Occupancy costs increased by $365,000 due to three buildings added by the MFC merger, the addition of a mortgage banking office in Brooklyn Park, Minnesota and increased occupancy costs related to opening a new retail facility in Spring Valley. Federal deposit insurance, advertising expense and data processing expense all increased as a result of the MFC merger. Other non-interest expense increased by $1.5 million partly due to additional operating costs incurred related to the MFC merger, the mortgage banking 18 expansion in Brooklyn Park, amortization of goodwill and core deposit intangibles of $351,000 related to the MFC merger and aggregate charges of $570,000 for mortgage servicing asset amortization or adjustments to the related impairment reserves. In an effort to reduce operating costs, during the period from August 1, 1998 through October 30, 1998, HMN reduced its number of full-time equivalent employees by 17%. The work force reduction was achieved through attrition and layoffs. INCOME TAX EXPENSE (BENEFIT) Income tax benefit for the third quarter of 1998 was $257,000, a decrease of $1.2 million, from income tax expense of $901,000 for the third quarter of 1997. The decrease is primarily due to a decrease in taxable income between the two quarters. Income tax expense was $1.2 million for the nine month period ended September 30, 1998, a decrease of $1.3 million, from $2.6 million for the same period in 1997. The decrease is primarily due to a decrease in taxable income between the two nine month periods. NON-PERFORMING ASSETS The following table sets forth the amounts and categories of non-performing assets in the Bank's portfolio at September 30, 1998 and December 31, 1997.
September 30, December 31, (DOLLARS IN THOUSANDS) 1998 1997 --------------- -------------- Non-Accruing Loans One-to-four family real estate $ 216 177 Nonresidential real estate 75 79 Commercial business 27 0 Consumer 86 7 ---- ---- Total 404 263 ---- ---- Accruing loans delinquent 90 days or more 309 402 Foreclosed Assets Real estate: One-to-four family 18 142 ---- ---- Total non-performing assets $ 731 $ 807 ==== ==== Total as a percentage of total assets 0.10% 0.12% ==== ==== Total non-performing loans $713 $665 ==== ==== Total as a percentage of total loans receivable, net 0.15% 0.15% ==== ====
Total non-performing assets at September 30, 1998 were $731,000, a decrease of $76,000 from $807,000 at December 31, 1997. The decrease was the result of a $141,000 increase in non-accruing loans, a $93,000 decrease in accruing loans delinquent 90 days or more, and the sale or redemption of foreclosed residential homes. DIVIDENDS In February of 1998, the Board of Directors of HMN authorized a stock split in the form of a 50% stock dividend subject to HMN stockholder approval of an increase in the number of authorized shares of common stock from 7.0 million to 11.0 million. At the annual meeting of stockholders on April 28, 1998 the stockholders approved the stock split. Cash dividends of $0.06 per share were paid on June 12, 1998 and September 10, 1998 to 19 stockholders of record on May 27, 1998 and August 27, 1998, respectively. LIQUIDITY For the nine month period ended September 30, 1998, the net cash provided by operating activities was $31.5 million. HMN collected $119.1 million from the sale of securities and it collected $59.8 million in principal repayments or on the maturity of securities during the period. HMN also collected $3.3 million on the sale of loans receivable during the period. It purchased $165.6 million of securities, funded a net increase in loans receivable of $60.4 million, purchased $2.0 million of FHLB stock, purchased premises and equipment of $2.1 million and paid $3.5 million to the MFC stockholders related to the MFC merger. HMN experienced a net decrease in its deposit base of $20.8 million. It had additional net borrowing from the FHLB of $56.9 million and loaned $1.48 million to its employee stock ownership plan to repurchase HMN stock for the purpose of providing a benefit to the employees added as a result of the MFC merger. HMN paid $15.7 million to purchase its own common stock during the first nine months of 1998. *HMN has certificates of deposits with outstanding balances of $227.7 million that come due over the next 12 months. HMN has also changed its approach to pricing its deposit products which has resulted in a net outflow of deposits during 1998. Despite the net outflow, based upon past experience management anticipates that the majority of the deposits will renew for another term. HMN believes that deposits which do not renew will be replaced with deposits from other customers, or funded with advances from the FHLB, or will be funded through the sale of securities. Management does not anticipate that it will have a liquidity problem due to maturing deposits. MARKET RISK Market risk is the risk of loss from adverse changes in market prices and rates. HMN's market risk arises primarily from interest rate risk inherent in its investing, lending and deposit taking activities. Management actively monitors and manages its interest rate risk exposure. HMN's profitability is affected by fluctuations in interest rates. A sudden and substantial increase in interest rates may adversely impact HMN's earnings to the extent that the interest rates borne by assets and liabilities do not change at the same speed, to the same extent, or on the same basis. HMN monitors how its assets will mature or reprice in comparison to how its liabilities will mature or reprice. The MATURITY OR REPRICING TABLE located in the Asset/Liability Management section of this report is used as part of the monitoring process. HMN also monitors the projected changes in net interest income that would occur if interest rates were to suddenly change up or down. The RATE SHOCK TABLE located in the Asset/Liability Management section of this report discloses HMN's projected changes in net interest income based upon immediate interest rate changes called rate shocks. *HMN utilizes a model which uses the discounted cash flows from its interest- earning assets and its interest-bearing liabilities to calculate the current market value of those assets and liabilities. The model also calculates the changes in market value of the interest-earning assets and interest-bearing liabilities due to different interest rate changes. HMN believes that over the next twelve months interest rates could conceivably fluctuate in a range of 200 basis points up or down from where the rates were at on September 30, 1998. HMN does not have a trading portfolio. The following table discloses the projected changes in market value to HMN's interest-earning assets and interest-bearing liabilities based upon incremental 100 basis point changes in interest rates from interest rates in effect on September 30, 1998. * This paragraph contains a forward-looking statement(s). Refer to information regarding Forward-looking Information on page 25 of this discussion. 20
- - ------------------------------------------------------------------------------ Other than trading portfolio Market Value -------------------------------------------- (DOLLARS IN THOUSANDS) Basis point change in interest rates -200 -100 0 +100 +200 - - ------------------------------------------------------------------------------ Cash equivalents $ 6,484 6,479 6,473 6,468 6,463 Fixed-rate CMOs 59,644 59,499 59,410 58,545 56,794 Variable-rate CMOs 70,599 70,764 71,315 70,393 68,603 Fixed-rate available for sale mortgage-backed and related securities 4,738 4,688 4,649 4,591 4,466 Variable-rate available for sale mortgage-backed and related securities 2,207 2,158 2,091 2,012 1,969 Fixed-rate available for sale other marketable securities 74,636 71,874 69,157 66,555 64,068 Variable-rate available for sale other marketable securities 857 855 853 851 849 Fixed-rate loans held for sale 6,898 6,893 6,887 6,881 6,876 Fixed-rate real estate loans 344,902 343,211 339,674 331,136 319,957 Variable-rate real estate loans 89,087 88,296 86,755 84,668 82,248 Fixed-rate other loans 28,542 28,305 28,033 27,650 27,304 Variable-rate other loans 37,359 37,320 37,355 37,466 37,540 Mortgage servicing 688 828 1,145 1,434 1,568 Limited partnerships 1,169 1,443 2,075 2,683 3,281 ------- ------- ------- ------- ------- Total market risk sensitive assets 727,810 722,613 715,872 701,333 681,986 ------- ------- ------- ------- ------- NOW deposits 30,014 29,989 29,965 29,940 29,915 Passbook deposits 37,603 35,922 34,385 32,974 31,674 Money market deposits 29,194 27,901 26,717 25,629 24,626 Certificate deposits 363,981 360,189 356,482 352,854 349,309 Fixed-rate Federal Home Loan Bank advances 172,474 166,870 161,491 156,326 151,367 Variable-rate Federal Home Loan Bank advances 29,054 29,029 29,006 28,981 28,957 Other borrowings 100 100 100 100 100 ------- ------- ------- ------- ------- Total market risk sensitive liabilities 662,420 650,000 638,146 626,804 615,948 ------- ------- ------- ------- ------- Off-balance sheet financial instruments: Commitments to extend credit 61 61 60 58 57 ------- ------- ------- ------- ------- Net market risk $ 65,451 72,674 77,786 74,587 66,095 ======= ======= ======= ======= ======= Percentage change from current market value (15.86)% (6.57)% 0.00% (4.11)% (15.03)% ======= ======== ======= ======= ======= - - ------------------------------------------------------------------------------
The preceding table was prepared utilizing the following assumptions (the "Model Assumptions") regarding prepayment and decay ratios which were determined by management based upon their review of historical prepayment speeds and future prepayment projections. Fixed rate loans were assumed to prepay at annual rates of between 8% to 45%, depending on the coupon and period to maturity. Adjustable rate mortgages ("ARMs") were assumed to prepay at annual rates of between 12% and 30%, depending on coupon and the period to maturity. Growing Equity Mortgage (GEM) loans were assumed to prepay at annual rates of between 18% and 50% 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. The 21 interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types of assets and liabilities may lag behind changes in market interest rates. The model assumes that the difference between the current interest rate being earned or paid compared to a treasury instrument or other interest index with a similar term to maturity (the "Interest Spread") will remain constant over the interest changes disclosed in the table. Changes in Interest Spread could impact projected market value changes. Certain assets, such as ARMs, have features which restrict changes in interest rates on a short-term basis and over the life of the assets. The market value of the interest-bearing assets which are approaching their lifetime interest rate caps could be different from the values disclosed in the table. In the event of a change in interest rates, prepayment and early withdrawal levels may deviate significantly from those assumed in calculating the foregoing table. The ability of many borrowers to service their debt may decrease in the event of an interest rate increase. ASSET/LIABILITY MANAGEMENT *HMN's management reviews the impact that changing interest rates will have on its net interest income projected for the twelve months following September 30, 1998 to determine if its current level of interest rate risk is acceptable. The following table projects the estimated annual impact on net interest income of immediate interest rate changes called rate shocks. Rate Shock Net Interest Percentage in Basis Points Income Change --------------- ------------- ---------- +200 20,112,000 2.52% +100 20,006,000 1.98% 0 19,617,000 0.00% -100 19,177,000 -2.24% -200 18,105,000 -7.71% The preceding table was prepared utilizing the Model Assumptions regarding prepayment and decay ratios which were determined by management based upon their review of historical prepayment speeds and future prepayment projections. Certain shortcomings are inherent in the method of analysis presented in the foregoing table. In the event of a change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed in calculating the foregoing table. The ability of many borrowers to service their debt may decrease in the event of a substantial increase in interest rates and could impact net interest income. In an attempt to manage its exposure to changes in interest rates, management closely monitors interest rate risk. The Bank has an Asset/Liability Committee consisting of executive officers which meets at least quarterly to review the interest rate risk position and projected profitability. The committee makes recommendations for adjustments to the asset liability position of the Bank to the Board of Directors of the Bank. This committee also reviews the Bank's portfolio, formulates investment strategies and oversees the timing and implementation of transactions to assure attainment of the Board's objectives in the most effective manner. In addition, the Board reviews on a quarterly basis the Bank's asset/liability position, including simulations of the effect on the Bank's capital of various interest rate scenarios. In managing its asset/liability mix, the Bank, at times, depending on the relationship between long- and short-term interest rates, market conditions and consumer preference, may place more emphasis on managing net interest margin than on better matching the interest rate sensitivity of its assets and liabilities in an effort to enhance net interest income. Management believes that the increased net *This paragraph contains a forward-looking statement(s). Refer to information regarding Forward-looking Information on page 25 of this discussion. 22 interest income resulting from a mismatch in the maturity of its asset and liability portfolios can, during periods of declining or stable interest rates, provide high enough returns to justify the increased exposure to sudden and unexpected increases in interest rates. To the extent consistent with its interest rate spread objectives, the Bank attempts to reduce its interest rate risk and has taken a number of steps to restructure its assets and liabilities. The Bank has primarily focused its fixed rate one-to-four family residential lending program on loans with contractual terms of 20 years or less. The Bank generally follows the practice of selling all of its fixed rate single family loans with contractual maturities of thirty years. During the third quarter of 1998 the Bank started selling the majority of its 15 year fixed rate loan production in order to reduce its interest rate risk. 23 *The following table sets forth the interest rate sensitivity of HMN's assets and liabilities at September 30, 1998, 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 (DOLLARS IN THOUSANDS) or Less One Year Years Years - - ------------------------------------------------------------------------------- Cash equivalents $ 6,476 0 0 0 Securities available for sale: Mortgage-backed and related securities 96,916 15,674 14,805 4,227 Other marketable securities 4,639 857 7,407 34,800 Securities held to maturity: Mortgage-backed and related securities 0 0 0 0 Other marketable securities 0 0 0 0 Loans held for sale, net 6,882 0 0 0 Loans receivable, net: Fixed rate one-to-four family 37,808 33,446 99,411 59,730 Adjustable rate one-to-four family 25,785 15,743 21,735 26,809 Multi family 3,199 593 1,698 668 Fixed rate commercial real estate 7,473 524 907 240 Adjustable rate commercial real estate 4,560 491 689 0 Commercial business 3,124 1,370 2,816 674 Consumer loans 25,865 1,708 4,253 2,198 Federal Home Loan Bank stock 0 0 0 0 -------- -------- --------- -------- Total interest-earning assets 222,727 70,406 153,721 129,346 -------- -------- --------- -------- Non-interest checking 8,395 0 0 0 NOW accounts 21,644 0 0 0 Passbooks 3,636 3,636 10,472 6,702 Money market accounts 2,851 2,851 8,213 5,257 Certificates 154,340 73,393 103,217 18,109 Federal Home Loan Bank advances 34,279 0 34,000 111,000 -------- -------- --------- -------- Total interest-bearing liabilities 225,145 79,880 155,902 141,068 -------- -------- --------- -------- Interest-earning assets less interest-bearing liabilities $ (2,418) (9,474) (2,181) (11,722) ======== ======== ========= ======== Cumulative interest-rate sensitivity gap $ (2,418) (11,892) (14,073) (25,795) ======== ======== ========= ======== Cumulative interest-rate gap as a percentage of total assets at September 30, 1998 (0.34)% (1.68)% (1.99)% (3.65)% ======== ======== ========= ======== Cumulative interest-rate gap as a percentage of interest -earning assets at December 31, 1997 (6.36) (15.38) ======== ======== 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. Loans receivable are presented net of loans in process and deferred loan fees. 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. - - ------------------------------------------------------------------------------ Maturity or Repricing ------------------------------------------------------ Over 5 No Stated (DOLLARS IN THOUSANDS) Years Maturity Total - - ------------------------------------------------------------------------------ Cash equivalents $ 0 0 6,476 Securities available for sale: Mortgage-backed and related securities 6,658 0 138,280 Other marketable securities 34 8,271 56,008 Securities held to maturity: Mortgage-backed and related securities 0 0 0 Other marketable securities 0 0 0 Loans held for sale, net 0 0 6,882 Loans receivable, net: Fixed rate one-to-four family 81,931 0 312,326 Adjustable rate one-to- four family 2,655 0 92,727 Multi family 522 0 6,680 Fixed rate commercial real estate 18 0 9,162 Adjustable rate commercial real estate 0 0 5,740 Commercial business 72 0 8,056 Consumer loans 722 0 34,746 Federal Home Loan Bank stock 0 9,404 9,404 ------- ------- -------- Total interest-earning assets 92,612 17,675 686,487 ------- ------- -------- Non-interest checking 0 0 8,395 NOW accounts 0 0 21,644 Passbooks 11,914 0 36,360 Money market accounts 9,344 0 28,516 Certificates 2,360 0 351,419 Federal Home Loan Bank advances 5,400 0 184,679 ------- ------- -------- Total interest-bearing liabilities 29,018 0 631,013 ------- ------- -------- Interest-earning assets less interest-bearing liabilities $ 63,594 17,675 55,474 ======= ======= ======== Cumulative interest-rate sensitivity gap $ 37,799 55,474 55,474 ======= ======= ======== Cumulative interest-rate gap as a percentage of total assets at September 30, 1998 5.35% 7.85% 7.85 % ======= ======= ======== Cumulative interest-rate gap as a percentage of interest-earning assets at December 31, 1997 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. Loans receivable are presented net of loans in process and deferred loan fees. 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.
*This paragraph contains a forward-looking statement(s). Refer to information regarding Forward-looking Information on page 25 of this discussion. 24 The preceding table was prepared utilizing the Model Assumptions regarding prepayment and decay ratios which were determined by management based upon their review of historical prepayment speeds and future prepayment projections. Certain shortcomings are inherent in the method of analysis presented in the foregoing table. Although certain assets and liabilities may have similar maturities and periods of repricing, they may react in different degrees to changes in market interest rates. The interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types of assets and liabilities may lag behind changes in market interest rates. Certain assets, such as adjustable- rate mortgages, have features which restrict changes in interest rates on a short-term basis and over the life of the asset. In the event of a change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed in calculating the foregoing table. The ability of many borrowers to service their debt may decrease in the event of an interest rate increase. Refer to Regulatory Capital Requirements above for a discussion of the Bank's interest rate risk component. YEAR 2000 ISSUES *HMN has inventoried its computer hardware, computer software, third party vendors and its other non-computer equipment and has assessed or is in the process of assessing whether the items are year 2000 compliant. The hardware testing has been completed and all non-compliant hardware is scheduled for replacement during the fourth quarter of 1998 at a total estimated cost of $75,000. The computer software inventory indicated that certain programs were not compliant and those programs are scheduled to be replaced with year 2000 compliant software during the remainder of 1998 and through the second quarter of 1999 at an anticipated cost of $80,000. HMN will also test all computer software to determine that the software is year 2000 compliant. Actual testing of the software is scheduled to be completed during December of 1998. The assessment of non-computer equipment for year 2000 compliance indicated that HMN did not have any significant issues in this area. *The majority of the Bank's loan and deposit data is supported by a third party data processing center. Other third party providers support the automated teller machines owned by the Bank and process the check clearings for the Bank's negotiable order of withdrawal accounts ("checking accounts"). The Bank is also reliant upon the Federal Home Loan Bank of Des Moines and the Federal Reserve System to properly and efficiently conduct its business. Notwithstanding the Bank's efforts, the failure of any of these third party vendors to address their year 2000 issues in a timely fashion may have an adverse effect on the Bank's ability to conduct its business. The Bank's Year 2000 Committee (the "Committee") is working very closely with its data processing center to ascertain that all software applications and hardware will be year 2000 compliant by the second quarter of 1999. The Committee is also monitoring the progress that other key third party providers are making toward becoming year 2000 compliant. *The Committee is in the process of developing a contingency plan which incorporates the actions the Bank will take in situations where the data processing center or other key third party providers are not able to become year 2000 compliant and it will have a major impact on the Bank's business. The contingency plan is anticipated to be completed in the fourth quarter of 1998. FORWARD-LOOKING INFORMATION The following paragraphs within Management's Discussion and Analysis of Financial Condition and *This paragraph contains a forward-looking statement(s). Refer to information regarding Forward-looking Information on page 25 of this discussion. 25 Results of Operations contain forward-looking statements and actual results may differ materially from the expectations disclosed within this Discussion and Analysis. These forward-looking statements are subject to risks and uncertainties, including those discussed below. HMN assumes no obligations to publicly release results of any revision or updates to these forward-looking statements to reflect future events or unanticipated occurrences. PROVISION FOR LOAN LOSSES The provision for loan losses for the third quarter ended September 30, 1998 was $85,000 an increase of $10,000, compared to $75,000 for the third quarter of 1997. The provision for loan losses for the nine months ended September 30, 1998 was $235,000, an increase of $10,000, compared to $225,000 for the same nine month period of 1997. The provision is the result of management's evaluation of the loan portfolio, a historically low level of non-performing loans, minimal loan charge-off experience, and management's assessment of the general economic conditions in the geographic area where properties securing the loan portfolio are located. Management's evaluation did not reveal conditions that would cause it to significantly increase the provision for loan losses during 1998 compared to 1997. Future economic conditions and other unknown factors will impact the need for future provisions for loan losses. As a result, no assurances can be given that increases in the allowance for loan losses will not be required during future periods. LIQUIDITY HMN has certificates of deposits with outstanding balances of $227.7 million that come due over the next 12 months. HMN has also changed its approach to pricing its deposit products which has resulted in a net outflow of deposits during 1998. Based upon past experience management anticipates that the majority of the deposits will renew for another term. HMN believes that deposits which do not renew will be replaced with deposits from other customers, or funded with advances from the FHLB, or will be funded through the sale of securities. Management does not anticipate that it will have a liquidity problem due to maturing deposits. Competitive pricing by other institutions, the desire of a competitor to pay interest rates on deposits that are above the current rates paid by HMN, or desire by customers to put more of their funds into nontraditional bank products such as stocks and bonds could be circumstances that would cause the maturing certificates to become a liquidity problem. MARKET RISK HMN utilizes a model which uses the discounted cash flows from its interest-earning assets and its interest-bearing liabilities to calculate the current market value of those assets and liabilities. The model also calculates the changes in market value of the interest-earning assets and interest-bearing liabilities due to different interest rate changes. HMN believes that over the next twelve months interest rates could conceivably fluctuate in a range of 200 basis points up or down from where the rates were at September 30, 1998. HMN does not have a trading portfolio. The following table discloses the projected changes in market value to HMN's interest-earning assets and interest-bearing liabilities based upon incremental 100 basis point changes in interest rates from interest rates in effect on September 30, 1998. Interest rates could fluctuate in a range of more than 200 basis points up or down from where the rates were on September 30, 1998 due to the influence of many unforeseen factors not 26 now known to HMN's management. HMN's actual market value changes for interest earnings assets and interest bearing liabilities may differ from the projected market values disclosed in the table mentioned above. Certain shortcomings are inherent in the method of analysis in the table. The interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types of assets and liabilities may lag behind changes in market interest rates. The model assumes that the difference between the current interest rate being earned or paid compared to a treasury instrument or other interest rate index with a similar term to maturity (the Interest Spread) will remain constant over the interest changes disclosed in the table. Changes in Interest Spread could impact projected market value changes. Certain assets, such as ARMs, have features which restrict changes in interest rates on a short-term basis and over the life of the assets. The market value of the interest-bearing assets which are approaching their life time interest rate caps could be different from the values disclosed in the table. In the event of a change in interest rates, prepayment and early withdrawal levels may deviate significantly from those assumed in calculating the foregoing table. The ability of many borrowers to service their debt may decrease in the event of an interest rate increase. ASSET/LIABILITY MANAGEMENT HMN's management reviews the impact that changing interest rates will have on its net interest income projected for the twelve months following September 30, 1998 to determine if its current level of interest rate risk is acceptable. The following table projects the estimated impact on the net interest income of immediate interest rate changes called rate shock. HMN's actual net interest income caused by interest rate changes may differ from the amounts reflected in the table which projects the estimated impact on net interest income of immediate interest rate changes called rate shocks. Certain shortcomings are inherent in the method of analysis presented in the table. In the event of a change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed in calculating the foregoing table. The ability of many borrowers to service their debt may decrease in the event of a substantial increase in interest rates and could impact net interest income. The table sets forth the interest rate sensitivity of HMN's assets and liabilities at September 30, 1998, using certain assumptions that described in more detail below: (A Maturity or Repricing table is presented in the Asset/Liability Management section.) HMN's actual maturity and repricing results of its interest-earning assets and interest-bearing liabilities may differ from the amounts reflected in the gap table. Certain shortcomings are inherent in the method of analysis presented in the table. In the event of a change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed in calculating the foregoing table. The ability of many borrowers to service their debt may decrease in the event of a substantial increase in interest rates and could impact the payment streams on loans. Substantial changes in interest rates could also impact the early withdrawal assumptions on certificates and other deposit accounts. YEAR 2000 ISSUES HMN has inventoried its computer hardware, computer software, third party vendors and its other non-computer equipment and has assessed or is in the process of assessing whether the items are year 2000 compliant. The hardware testing has been completed and all non- 27 compliant hardware is scheduled for replacement during the fourth quarter of 1998 at a total estimated cost of $75,000. The computer software inventory indicated that certain programs were not compliant and those programs are scheduled to be replaced with year 2000 compliant software during the remainder of 1998 and through the second quarter of 1999 at an anticipated cost of $80,000. HMN will also test all computer software to determine that the software is year 2000 compliant. Actual testing of the software is scheduled to be completed during December of 1998. The assessment of non-computer equipment for year 2000 compliance indicated that HMN did not have any issues in this area. The majority of the Bank's loan and deposit data is supported by a third party data processing center. Other third party providers support the automated teller machines owned by the Bank and process the check clearings for the Bank's negotiable order of withdrawal accounts ("checking accounts"). The Bank is also reliant upon the Federal Home Loan Bank of Des Moines and the Federal Reserve System to properly and efficiently conduct its business. Notwithstanding the Bank's efforts, the failure of any of these third party vendors to address their year 2000 issues in a timely fashion may have an adverse effect on the Bank's ability to conduct its business. The Bank's Year 2000 Committee (the "Committee") is working very closely with its data processing center to ascertain that all software applications and hardware will be year 2000 compliant by the second quarter of 1999. The Committee is also monitoring the progress that other key third party providers are making toward becoming year 2000 compliant. The Committee is in the process of developing a contingency plan which incorporates the actions the Bank will take in situations where the data processing center or other key third party providers are not able to become year 2000 compliant and it will have a major impact on the Banks business. The contingency plan is anticipated to be completed in the fourth quarter of 1998. While HMN has inventoried and assessed its hardware, software and other non-computer equipment other unforeseen issues may come to light in the future with the above mentioned items that would cause HMN to incur additional costs in order to become year 2000 compliant. While HMN has identified and assessed the year 2000 risks related to each of its major third party vendors and providers, it is monitoring their activities related to becoming year 2000 compliant. It is still possible that the vendors and providers may not be year 2000 compliant and the contingency plan that HMN is developing would not have anticipated the problem. An example of this situation would be if all the telephone communication lines became in operative because of a year 2000 issue on September 9, 1999, the Bank would not be able to process its daily activity and servicing its customers would be difficult without the communication lines for any extended period of time. It would be difficult to have a contingency plan that would allow the Bank to conduct its business without using the communication lines to transmit its business activity. 28 HMN FINANCIAL, INC. PART II - OTHER INFORMATION ITEM 1. Legal Proceedings. None. ITEM 2. Changes in Securities. Not applicable ITEM 3. Defaults Upon Senior Securities. Not applicable. ITEM 4. Submission of Matters to a Vote of Security Holders. None. ITEM 5. Other Information. At its Board of Directors meeting held on July 29, 1998 the Board amended the HMN Financial, Inc. 1995 Stock Option and Incentive Plan (the "Incentive Plan") and the HMN Financial, Inc. 1995 Recognition and Retention Plan (the "Retention Plan") to provide the Board of Directors with the discretion to grant options or awards, as applicable, to newly elected directors. Prior to its amendment, the Incentive Plan provided that each newly elected director would receive as of the date of such director's election to the Board of Directors a non-qualified stock option to purchase 12,000 shares of Common Stock of the Company and the Retention Plan provided that each newly elected director would receive as of the date of such director's election to the Board of Directors an award of 2,000 shares of restricted stock of the Company. At its Board of Directors meeting held on August 17, 1998 the Board authorized the change of transfer agents from Bank of Boston to Norwest Transfer Services. Inquiries by shareholders should be directed to Norwest Shareowner Services, PO Box 64854, St. Paul, MN 55164-0854, phone 800-468-9716. This change became effective November 2, 1998. At its Board of Directors meeting held on October 27, 1998 the date for the next annual meeting of shareholders was set for Tuesday, April 27, 1999 at 10:00 a.m. at the Best Western Apache Hotel, 1517 16th St. S.W., Rochester, Minnesota. ITEM 6. Exhibits and Reports on Form 8-K. (a) Exhibits. See Index to Exhibits on page 31 of this report. 29 SIGNATURES Pursuant to the requirement of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. HMN FINANCIAL, INC. Registrant Date: 11/16/98 /s/ Roger P. Weise -------------------- ----------------------------- Roger P. Weise, Chairman, President and Chief Executive Officer (Duly Authorized Officer) Date: 11/16/98 /s/ James B. Gardner -------------------- ---------------------------- James B. Gardner, Executive Vice President (Principal Financial Officer) 30 HMN FINANCIAL, INC. INDEX TO EXHIBITS FOR FORM 10-Q Sequential Page Numbering Regulation Reference Where Attached S-K to Prior Exhibits Are Exhibit Filing if Located in This Number Document Applicable Form 10-Q Report - - ----------------------------------------------------------------------------- 3(a) Articles of Incorporation *4 N/A 3(b) By-laws *3 N/A 4 Instruments defining the rights *1 N/A of security holders, Including indentures 5(a) Amendment to the Home Federal Savings *2 N/A Bank Employees' Savings & Profit Sharing Plan dated January 28, 1997. 5(b) Amendment to the Adoption Agreement for *2 N/A Home Federal Savings Bank Employees' Savings & Profit Sharing Plan and Trust effective June 17, 1997. 10.1(a)Amended Recognition and Retention Plan Filed electronically 10.1(b)Amended Stock Option and Incentive Plan Filed electronically 11 Computation of Earnings Per Common Share Filed electronically 27 Financial Data Schedule Filed electronically *1 Filed April 1, 1994, as exhibits to the Registrant's Form S-1 registration statement (Registration No. 33-77212) pursuant to the Securities Act of 1933. All of such previously filed documents are hereby incorporated herein by reference in accordance with Item 601 of Regulation S-K. *2 Filed as an exhibit to the Registrant's Form 10-Q for June 30, 1997 (file no. 0-24100). All previously filed documents are hereby incorporated by reference in accordance with Item 601 of Regulation S-K. *3 Filed as an exhibit to Registrant's Form 10-Q for September 30, 1997 (file no. 0-24100). All previously filed documents are hereby incorporated by reference in accordance with Item 601 of Regulation S-K. *4 Filed as an exhibit to Registrant's Form 10-Q for March 31, 1998 (file no. 0-24100). All previously filed documents are hereby incorporated by reference in accordance with Item 601 of Regulation S-K. 32 EX-10.1(A) 2 HMN FINANCIAL, INC. 1995 RECOGNITION AND RETENTION PLAN AS AMENDED JULY 29, 1998 1. PLAN PURPOSE. The purpose of the Plan is to promote the long-term interests of the Corporation and its stockholders by providing a means for attracting and retaining directors, executive officers and employees of the Corporation and its Affiliates. 2. DEFINITIONS. The following definitions are applicable to the Plan: "Award" - means the grant of Restricted Stock pursuant to the terms of Section 13 of the Plan or by the Committee, as provided in the Plan. "Affiliate" - means any "parent corporation" or "subsidiary corporation" of the Corporation, as such terms are defined in Section 424(e) and (f), respectively, of the Code. "Bank" - means Home Federal Savings Bank, a savings institution and its successors. "Beneficiary"- means the person or persons designated by a Participant to receive any benefits payable under the Plan in the event of such Participant's death. Such person or persons shall be designated in writing on forms provided for this purpose by the Committee and may be changed from time to time by similar written notice to the Committee. In the absence of a written designation, the Beneficiary shall be the Participant's surviving spouse, if any, or if none, his estate. "Code" - means the Internal Revenue Code of 1986, as amended. "Committee" - means the committee of the Board of Directors of the Corporation referred to in Section 7 hereof. "Continuous Service" - means the absence of any interruption or termination of service as a director, director emeritus, advisory director, executive officer or employee of the Corporation or any Affiliate. Service shall not be considered interrupted in the case of sick leave, military leave or any other leave of absence approved by the Corporation or any Affiliate or in the case of transfers between payroll locations of the Corporation or between the Corporation, its subsidiaries or its successor. With respect to any director emeritus or advisory director, continuous service shall mean availability to perform such functions as may be required of such individuals. "Conversion" - means the conversion of the Bank from the mutual to the stock form of organization. "Corporation" - means HMN Financial, Inc., a Delaware corporation. "Disability" - means any physical or mental impairment which qualifies an employee, director, director emeritus or advisor director for disability benefits under any applicable long-term disability plan maintained by the Bank or an Affiliate, or, if no such plan applies, which would render such employee or director, in the judgment of the Committee, unable to perform his customary duties and responsibilities. "Disinterested Person" - means any member of the Board of Directors of the Corporation who is not being and within the prior year has not been granted any awards related to the shares under this Plan or any other plan of the Corporation or any of its Affiliates except for awards which (i) are calculated in accordance with a formula as contemplated in paragraph (c)(2)(ii) of Rule 16b-3 ("Rule 16b-3") under the Securities Exchange Act of 1934, as amended; (ii) result from participation in an ongoing securities acquisition plan meeting the conditions of paragraph (d)(2) of Rule 16b-3; or (iii) arise from an election by a director to receive all or part of his board fees in securities. No Participant of an Award granted pursuant to Section 13 shall fail to meet the definition of Disinterested Person solely by reason of such Award. "ERISA" - means the Employee Retirement Income Security Act of 1974, as amended. "Participant" - means any director, director emeritus or advisory director who is granted an award pursuant to Section 13 or a director, executive officer, employee of the Corporation or any Affiliate who is selected by the Committee to receive an Award. "Plan" - means the 1995 Recognition and Retention Plan of the Corporation. "Restricted Period" - means the period of time selected by the Committee in accordance with applicable Office of Thrift Supervision Regulations for the purpose of determining when restrictions are in effect under Section 3 hereof with respect to Restricted Stock awarded under the Plan. "Restricted Stock" - means Shares which have been contingently awarded to a Participant by the Committee subject to the restrictions referred to in Section 3 hereof, so long as such restrictions are in effect. "Shares" - means the common stock, par value $0.01 per share, of the Corporation. 3. TERMS AND CONDITIONS OF RESTRICTED STOCK. The Committee shall have full and complete authority, subject to the limitations of the Plan and applicable Office of Thrift Supervision Regulations, to grant Awards and, in addition to the terms and conditions contained in paragraphs (a) through (f) of this Section 3, to provide such other terms and conditions (which need not be identical among Participants) in respect of such Awards, and the vesting thereof, as the Committee shall determine. (a) At the time of an Award, the Committee shall establish for each Participant a Restricted Period which shall not be less than 12 months, during which or at the expiration of which, as the Committee shall determine and provide in the agreement referred to in paragraph (d) of this Section 3, the Shares awarded as Restricted Stock shall vest, and subject to any such other terms and conditions as the Committee shall provide, Shares of Restricted Stock may not be sold, assigned, transferred, pledged, voted or otherwise encumbered by the Participant, except as hereinafter provided, during the Restricted Period. Except for such restrictions, and subject to paragraphs (c) and (e) of this Section 3 and Section 4 hereof, the Participant as owner of such shares shall have all the rights of a stockholder. Subject to compliance with applicable Office of Thrift Supervision Regulations, the Committee shall have the authority, in its discretion, to accelerate the time at which any or all of the restrictions shall lapse with respect thereto, or to remove any or all of such restrictions, whenever it may determine that such action is appropriate by reason of changes in applicable tax or other laws or other changes in circumstances occurring after the commencement of such Restricted Period. (b) Except as provided in Section 5, hereof, if a Participant ceases to maintain Continuous Service for any reason (other than death or disability), unless the Committee shall otherwise determine, all Shares of Restricted Stock theretofore awarded to such Participant and which at the time of such termination of Continuous Service are subject to the restrictions imposed by paragraph (a) of this Section 3 shall upon such termination of Continuous Service be forfeited and returned to the Corporation. If a Participant ceases to maintain Continuous Service by reason of death or disability, Restricted Stock then still subject to restrictions imposed by paragraph (a) of this Section 3 will be free of those restrictions. (c) Each certificate in respect of Shares of Restricted Stock awarded under the Plan shall be registered in the name of the Participant and deposited by the Participant, together with a stock power endorsed in blank, with the Corporation and shall bear the following (or a similar) legend: The transferability of this certificate and the shares of stock represented hereby are subject to the terms and conditions (including forfeiture) contained in the 1995 Recognition and Retention Plan of HMN Financial, Inc. Copies of such Plan are on file in the offices of the Secretary of HMN Financial, Inc., 101 North Broadway, Spring Valley, MN 55975. (d) At the time of any Award, the Participant shall enter into an Agreement with the Corporation in a form specified by the Committee, agreeing to the terms and conditions of the Award and such other matters as the Committee, in its sole discretion, shall determine (the "Restricted Stock Agreement"). (e) The payment to the Participant of any dividends declared or paid by the Corporation on any Restricted Stock shall be deferred and held by the Corporation for the account of the Participant until the earlier to occur of (i) the lapsing of the restrictions imposed under paragraph (a) of this Section 3 or (ii) the forfeiture of such shares under paragraph (b) of this Section 3. There shall be credited at the end of each year (or portion thereof) interest on the amount of the Participant's account at the beginning of the year at a rate per annum as the Committee, in its discretion, may determine. Payment of deferred dividends, together with interest accrued thereon, shall be made upon the earlier to occur of the events specified in (i) and (ii) of the immediately preceding sentence. (f) At the expiration of the restrictions imposed by paragraph (a) of this Section 3, the Corporation shall redeliver to the Participant (or where the relevant provision of paragraph (b) of this Section 3 applies in the case of a deceased Participant, to his legal representative, beneficiary or heir) the certificate(s) and stock power deposited with it pursuant to paragraph (c) of this Section 3 and the Shares represented by such certificate(s) shall be free of the restrictions referred to in paragraph (a) of this Section 3. 4. ADJUSTMENTS UPON CHANGES IN CAPITALIZATION. In the event of any change in the outstanding Shares subsequent to the effective date of the Plan by reason of any reorganization, recapitalization, stock split, stock dividend, combination or exchange of shares, merger, consolidation or any change in the corporate structure or Shares of the Corporation, the maximum aggregate number and class of shares as to which Awards may be granted under the Plan and the number and class of shares with respect to which Awards theretofore have been granted under the Plan shall be appropriately adjusted by the Committee, whose determination shall be conclusive. Any shares of stock or other securities received, as a result of any of the foregoing, by a Participant with respect to Restricted Stock shall be subject to the same restrictions and the certificate(s) or other instruments representing or evidencing such shares or securities shall be legended and deposited with the Corporation in the manner provided in Section 3 hereof. 5. EFFECT OF CHANGE IN CONTROl. Each of the events specified in the following clauses (i) through (iii) of this Section 5 shall be deemed a "change of control": (i) any third person, including a "group" as defined in Section 13(d)(3) of the Securities Exchange Act of 1934, shall become the beneficial owner of shares of the Corporation with respect to which 25% or more of the total number of votes may be cast for the election of the Board of Directors of the Corporation, (ii) as a result of, or in connection with, any cash tender offer, exchange offer, merger or other business combination, sale of assets or contested election, or combination of the foregoing, the persons who were directors of the Corporation shall cease to constitute a majority of the Board of Directors of the Corporation, or (iii) the shareholders of the Corporation shall approve an agreement providing either for a transaction in which the Corporation will cease to be an independent publicly owned entity or for a sale or other disposition of all or substantially all the assets of the Corporation. If the Continuous Service of any Participant of the Corporation is involuntarily terminated for whatever reason, at any time within 18 months after a change in control, unless the Committee shall have otherwise provided, any Restricted Period with respect to Restricted Stock theretofore awarded to such Participant shall lapse upon such termination and all Shares awarded as Restricted Stock shall become fully vested in the Participant to whom such Shares were awarded. 6. ASSIGNMENTS AND TRANSFERS. During the Restricted Period, no Award nor any right or interest of a Participant under the Plan in any instrument evidencing any Award under the Plan may be assigned, encumbered or transferred except (i) in the event of the death of a Participant, by will or the laws of descent and distribution, or (ii) pursuant to a qualified domestic relations order as defined in the Code or Title I of ERISA or the rules thereunder. 7. ADMINISTRATION. The Plan shall be administered by a Committee consisting of three or more members, each of whom shall be a Disinterested Person; provided, however, that with respect to Awards granted to or held by any director of the corporation who is not a full-time employee of the corporation, the Plan shall be administered by the Board of Directors of the corporation. The members of the Committee shall be appointed by the Board of Directors of the corporation. The Committee or the Board of Directors, as the case may be, shall have sole and complete authority and discretion to (i) select Participants and grant Awards; (ii) determine the number of Shares to be subject to types of Awards generally as well as to individual Awards granted under the Plan; (iii) determine the terms and conditions upon which Awards shall be granted under the Plan; (iv) describe the form and terms of instruments evidencing such grants; and (v) establish from time to time regulations for the administration of the Plan, interpret the Plan and make all determinations deemed necessary or advisable for the administration of the Plan. A majority of the Committee or the Board of Directors, as the case may be, shall constitute a quorum, and the acts of a majority of the members present at any meeting at which a quorum is present, or acts approved in writing by a majority of the Committee or the Board of Directors, as the case may be, without a meeting shall be acts of the Committee or Board of Directors. 8. SHARES SUBJECT TO PLAN. Subject to adjustment by the operation of Section 4 hereof, the maximum number of Shares with respect to which Awards may be made under the Plan is 2% of the total Shares issued in the Bank's Conversion. The Shares with respect to which Awards may be made under the Plan may be either authorized and unissued Shares or issued Shares heretofore or hereafter reacquired and held as treasury Shares. An Award shall not be considered to have been made under the Plan with respect to Restricted Stock which is forfeited and new Awards may be granted under the Plan with respect to the number of Shares as to which such forfeiture has occurred. Any Award made pursuant to this Plan, which Award is subject to the requirements of Office of Thrift Supervision Regulations, shall vest in five equal annual installments with the first installment vesting on the one-year anniversary of the date of grant, except in the event of death, disability or a change in control as defined in Section 5 of this Plan. In the event Office of Thrift Supervision Regulations are amended (the "Amended Regulations") to permit shorter vesting periods, any Award made pursuant to this Plan, which Award is subject to the requirements of such Amended Regulations, may vest, at the sole discretion of the Committee, in accordance with such Amended Regulations. The Corporation's obligation to deliver Shares with respect to an Award shall, if the Committee so requests, be conditioned upon the receipt of a representation as to the investment intention of the Participant to whom such Shares are to be delivered, in such form as the Committee shall determine to be necessary or advisable to comply with the provisions of the Securities Act of 1933 or any other Federal, state or local securities legislation or regulation. It may be provided that any representation requirement shall become inoperative upon a registration of the Shares or other action eliminating the necessity of such representation under such Securities Act or other securities legislation. The Corporation shall not be required to deliver any Shares under the Plan prior to (i) the admission of such shares to listing on any stock exchange on which Shares may then be listed, and (ii) the completion of such registration or other qualification of such Shares under any state or Federal law, rule or regulation, as the Committee shall determine to be necessary or advisable. 9. EMPLOYEE RIGHTS UNDER THE PLAN. No director, director emeritus, advisory director, officer or employee shall have a right to be selected as a Participant nor, having been so selected, to be selected again as a Participant and no director, officer, employee or other person shall have any claim or right to be granted an Award under the Plan or under any other incentive or similar plan of the Corporation or any Affiliate. Neither the Plan nor any action taken thereunder shall be construed as giving any officer or employee any right to be retained in the employ of the Corporation, the Bank or any Affiliate. 10. WITHHOLDING TAX. Upon the termination of the Restricted Period with respect to any shares of Restricted Stock (or at any such earlier time, if any, that an election is made by the Participant under Section 83(b) of the Code, or any successor provision thereto, to include the value of such shares in taxable income), the Corporation shall have the right to require the Participant or other person receiving such shares to pay the Corporation the amount of any taxes which the Corporation is required to withhold with respect to such shares; or, in lieu thereof, to retain or sell without notice, a sufficient number of shares held by it to cover the amount required to be withheld. The Corporation shall have the right to deduct from all dividends paid with respect to shares of Restricted Stock the amount of any taxes which the Corporation is required to withhold with respect to such dividend payments. No discretion or choice shall be conferred upon any Participant with respect to the form, timing or method of any such tax withholding. 11. AMENDMENT OR TERMINATION. The Board of Directors of the Corporation may amend, suspend or terminate the Plan or any portion thereof at any time; provided, however, that no such amendment shall be made without approval of the stockholders of the Corporation which shall (i) materially increase the aggregate number of Shares with respect to which Awards may be made under the Plan (except pursuant to Section 4), (ii) materially increase the benefits accruing to Participants or (iii) materially change the requirements as to eligibility for participation in the Plan, provided, however, that no such amendment, suspension or termination shall impair the rights of any Participant, without his consent, in any Award theretofore made pursuant to the Plan. Notwithstanding anything in this Plan to the contrary, to the extent that the Plan provides for formula awards, as defined in Rule 16b-3(c)(2)(ii) under the Securities Exchange Act of 1934, as amended, such provisions may not be amended more than once every six months, other than to comport with changes in the Code, ERISA or the rules thereunder. 12. TERM OF PLAN. The Plan shall become effective upon its ratification by the stockholders of the Corporation. It shall continue in effect for a term of ten years unless sooner terminated under Section 11 hereof. EX-10.1(B) 3 HMN FINANCIAL, INC. 1995 STOCK OPTION AND INCENTIVE PLAN AS AMENDED JULY 29, 1998 1. PLAN PURPOSE. The purpose of the Plan is to promote the long-term interests of the Corporation and its stockholders by providing a means for attracting and retaining directors, officers and employees of the Corporation and its Affiliates. It is intended that designated Options granted pursuant to the provisions of this Plan to persons employed by the Corporation or its Affiliates will qualify as Incentive Stock Options. Options granted to persons who are not employees will be Non-Qualified Stock Options. 2. DEFINITIONS. The following definitions are applicable to the Plan: "Affiliate" - means any "parent corporation" or "subsidiary corporation" of the Corporation, as such terms are defined in Section 424(e) and (f), respectively, of the Code. "Award" - means the grant of an Incentive Stock Option, a Non-Qualified Stock Option, a Stock Appreciation Right or a Limited Stock Appreciation Right, or any combination thereof, as provided in the Plan. "Bank" - means Home Federal Savings Bank and any predecessor or successor entity. "Cause" - means personal dishonesty, willful misconduct, any breach of fiduciary duty involving personal profit, intentional failure to perform stated duties, or the willful violation of any law, rule, regulation (other than traffic violations or similar offenses) or a final cease and desist order which results in a loss to the Bank or any Affiliate. "Code" - means the Internal Revenue Code of 1986, as amended. "Committee" - means the Committee referred to in Section 3 hereof. "Continuous Service" - means the absence of any interruption or termination of service as a director, director emeritus, advisory director, officer or employee of the Corporation or an Affiliate, except that when used with respect to any Options or Rights which at the time of exercise are intended to be Incentive Stock Options, continuous service means the absence of any interruption or termination of service as an employee of the Corporation or an Affiliate. Service shall not be considered interrupted in the case of sick leave, military leave or any other leave of absence approved by the Corporation or in the case of transfers between payroll locations of the Corporation or between the Corporation, its parent, its subsidiaries or its successor. With respect to any director emeritus or advisory director, continuous service shall mean availability to perform such functions as may be required of the Bank's directors emeriti or advisory directors, as the case may be. "Corporation" - means HMN Financial, Inc., a Delaware corporation. "Disinterested Person" - means any member of the Board of Directors of the Corporation who is not being and within the prior year has not been granted any awards related to the Shares under this Plan or any other plan of the Corporation or any of its Affiliates except for awards which (i) are calculated in accordance with a formula as contemplated in paragraph (c)(2)(ii) of Rule 16b-3 ("Rule 16b-3") under the Securities Exchange Act of 1934; (ii) result from participation in an ongoing securities acquisition plan meeting the conditions of paragraph (d)(2) of Rule 16b-3; or (iii) arise from an election by a director to receive all or part of his board fees in securities. No recipient of a stock award granted pursuant to Section 20 hereof shall be deemed not to be a Disinterested Person solely by reason of such grant. "Employee" - means any person, including an officer or director, who is employed by the Corporation or any Affiliate. "ERISA" - means the Employee Retirement Income Security Act of 1974, as amended. "Exercise Price" - means (i) in the case of an Option, the price per Share at which the Shares subject to such Option may be purchased upon exercise of such Option and (ii) in the case of a Right, the price per Share (other than the Market Value per Share on the date of exercise and the Offer Price per Share as defined in Section 10 hereof) which, upon grant, the Committee determines shall be utilized in calculating the aggregate value which a Participant shall be entitled to receive pursuant to Sections 9, 10 or 11 hereof upon exercise of such Right. "Incentive Stock Option" - means an option to purchase Shares granted by the Committee pursuant to Section 6 hereof which is subject to the limitations and restrictions of Section 8 hereof and is intended to qualify under Section 422 of the Code. "Limited Stock Appreciation Right" - means a stock appreciation right with respect to Shares granted by the Committee pursuant to Sections 6 and 10 hereof. "Market Value" - means the average of the high and low quoted sales price on the date in question (or, if there is no reported sale on such date, on the last preceding date on which any reported sale occurred) of a Share on the Composite Tape for the New York Stock Exchange Listed Stocks, or, if on such date the Shares are not quoted on the Composite Tape, on the New York Stock Exchange, or, if the Shares are not listed or admitted to trading on such Exchange, on the principal United States securities exchange registered under the Securities Exchange Act of 1934 on which the Shares are listed or admitted to trading, or, if the Shares are not listed or admitted to trading on any such exchange, the mean between the closing high bid and low asked quotations with respect to a Share on such date on the National Association of Securities Dealers, Inc., Automated Quotations System, or any similar system then in use, or, if no such quotations are available, the fair market value on such date of a Share as the Committee shall determine. "Non-Qualified Stock Option" - means an option to purchase Shares granted by the Committee pursuant to Section 6 hereof, which option is not intended to qualify under Section 422(b) of the Code. "Option" - means an Incentive Stock Option or a Non-Qualified Stock Option. "Participant" - means any director, officer or employee of the Corporation or any Affiliate who is selected by the Committee to receive an Award and any director, director emeritus or advisory director of the Corporation who is granted an Award pursuant to Section 20 hereof. "Plan" - means the 1995 Stock Option and Incentive Plan of the Corporation. "Related" - means (i) in the case of a Right, a Right which is granted in connection with, and to the extent exercisable, in whole or in part, in lieu of, an Option or another Right and (ii) in the case of an Option, an Option with respect to which and to the extent a Right is exercisable, in whole or in part, in lieu thereof has been granted. "Right" - means a Limited Stock Appreciation Right or a Stock Appreciation Right. "Shares" - means the shares of comrnon stock of the Corporation. "Senior Officer" - means the Corporation's president, principal financial officer, or principal accounting officer, any vice president of the Corporation in charge of a principal business unit, division or function (such as sales, administration or finance), any other officer who performs a policy-making function, or any other person who performs similar policy-making functions for the Corporation. Officers of the Corporation's Affiliates shall be deemed Senior Officers of the Corporation if they perform such policy-making functions for the Corporation. "Stock Appreciation Right" - means a stock appreciation right with respect to Shares granted by the Committee pursuant to Sections 6 and 9 hereof. "Ten Percent Beneficial Owner" - means the beneficial owner of more than ten percent of any class of the Corporation's equity securities registered pursuant to Section 11 of the Securities Exchange Act of 1934. 3. ADMINISTRATION. The Plan shall be administered by a Committee consisting of three or more members, each of whom shall be a Disinterested Person and each of whom shall be an "outside director" as set forth in Section 162(m) of the Code and defined in the regulations promulgated thereunder; provided, however, that with respect to awards made to any member of the Board of Directors of the corporation who is not a full-time employee of the corporation, the Plan shall be administered by the Board of Directors of the corporation. The members of the Committee shall be appointed by the Board of Directors of the corporation. The Committee or the Board of Directors, as the case may be, shall have sole and complete authority and discretion to (i) select Participants and grant Awards; (ii) determine the number of Shares to be subject to types of Awards generally as well as to individual Awards granted under the Plan; (iii) determine the terms and conditions upon which Awards shall be granted under the Plan; (iv) describe the form and terms of instruments evidencing such grants; and (v) establish from time to time regulations for the administration of the Plan, interpret the Plan and make all determinations deemed necessary or advisable for the administration of the Plan. A majority of the Committee or the Board of Directors, as the case may be, shall constitute a quorum and the acts of a majority of the members present at any meeting at which a quorum is present, or acts approved in writing by a majority of the Committee or Board of Directors without a meeting shall be acts of the Committee or Board of Directors. 4. PARTICIPATION IN COMMITTEE AWARDS. The Committee may select from time to time Participants in the Plan from those directors, officers, employees and other participants (other than Disinterested Persons), of the Corporation or its Affiliates who, in the opinion of the Committee, have the capacity for contributing to the successful performance of the Corporation or its Affiliates. 5. SHARES SUBJECT TO PLAN. Subject to adjustment by the operation of Section 11 hereof, the maximum number of Shares with respect to which Awards may be made under the Plan is 10% of the total Shares issued in the Bank's conversion to the capital stock form. The Shares with respect to which Awards may be made under the Plan may be either authorized and unissued shares or issued shares heretofore or hereafter reacquired and held as treasury shares. Shares which are subject to Related Rights and Related Options shall be counted only once in determining whether the maximum number of Shares with respect to which Awards may be granted under the Plan has been exceeded. An Award shall not be considered to have been made under the Plan with respect to any Option or Right which terminates and new Awards may be granted under the Plan with respect to the number of Shares as to which such termination has occurred. Any Award made pursuant to this Plan, which Award is subject to the requirements of Office of Thrift Supervision Regulations, shall vest in five equal annual installments with the first installment vesting on the one-year anniversary of the date of grant, except in the event of death, disability or a change in control as defined in Section 13 of this Plan. In the event Office of Thrift Supervision Regulations are amended (the "Amended Regulations") to permit shorter vesting periods, any Award made pursuant to this Plan, which Award is subject to the requirements of such Amended Regulations, may vest, at the sole discretion of the Committee, in accordance with such Amended Regulations. 6. GENERAL TERMS AND CONDITIONS OF OPTIONS AND RIGHTS. The Committee shall have full and complete authority and discretion, except as expressly limited by the Plan, to grant Options and/or Rights and to provide the terms and conditions (which need not be identical among Participants) thereof. In particular, the Committee shall prescribe the following terms and conditions: (i) the Exercise Price of any Option or Right, which shall not be less than the Market Value per Share at the date of grant of such Option or Right, (ii) the number of Shares subject to, and the expiration date of, any Option or Right, which expiration date shall not exceed ten years from the date of grant, (iii) the manner, time and rate (cumulative or otherwise) of exercise of such Option or Right, and (iv) the restrictions, if any, to be placed upon such Option or Right or upon Shares which may be issued upon exercise of such Option or Right. The Committee may, as a condition of granting any Option or Right, require that a Participant agree not to thereafter exercise one or more Options or Rights previously granted to such Participant. Notwithstanding the foregoing, no individual shall be granted Awards with respect to more than 50% of the shares reserved for issuance under the Plan in any calendar year. 7. EXERCISE OF OPTIONS OR RIGHTS. (a) Except as provided herein, an Option or Right granted under the Plan shall be exercisable during the lifetime of the Participant to whom such Option or Right was granted only by such Participant and, except as provided in paragraphs (c) and (d) of this Section 7, no such Option or Right may be exercised unless at the time such Participant exercises such Option or Right, such Participant has maintained Continuous Service since the date of grant of such Option or Right. Cash settlements of Rights may be made only in accordance with any applicable restrictions pursuant to Rule 16b-3(e) under the Securities Exchange Act of 1934 or any similar or successor provision. (b) To exercise an Option or Right under the Plan, the Participant to whom such Option or Right was granted shall give written notice to the Corporation in form satisfactory to the Committee (and, if partial exercises have been permitted by the Committee, by specifying the number of Shares with respect to which such Participant elects to exercise such Option or Right) together with full payment of the Exercise Price, if any and to the extent required. The date of exercise shall be the date on which such notice is received by the Corporation. Payment, if any is required, shall be made either (i) in cash (including check, bank draft or money order) or (ii) if permitted by the Committee, by delivering (A) Shares already owned by the Participant and having a fair market value equal to the applicable exercise price, such fair market value to be determined in such appropriate manner as may be provided by the Committee or as may be required in order to comply with or to conform to requirements of any applicable laws or regulations, or (B) a combination of cash and such Shares. (c) Except as provided in Section 14, hereof, if a Participant to whom an Option or Right was granted shall cease to maintain Continuous Service for any reason (including normal or early retirement, but excluding disability, death and termination of employment by the Corporation or any Affiliate for cause), such Participant may, but only within the period of three months immediately succeeding such cessation of Continuous Service and in no event after the expiration date of such Option or Right, exercise such Option or Right to the extent that such Participant was entitled to exercise such Option or Right at the date of such cessation, provided, however, that such right of exercise after cessation of Continuous Service shall not be available to a Participant if the Committee otherwise determines and so provides in the applicable instrument or instruments evidencing the grant of such Option or Right. Notwithstanding the foregoing, if a Participant to whom an Option or Right was granted shall cease to maintain Continuous Service due to a disability and such Participant has served the Corporation or the Bank for at least ten years, such Option or Right granted to such Participant shall become immediately exercisable, and the Participant may exercise such Option or Right, but only during the shorter of the following periods (A) the two-year period immediately succeeding such cessation of Continuous Service, or (B) the period remaining until the expiration date of such Option or Right. If the Continuous Service of a Participant to whom an Option or Right was granted by the Corporation is terminated for Cause, all rights under any Option or Right of such Participant shall expire immediately upon the giving to the Participant of notice of such termination. (d) In the event of the death of a Participant while in the Continuous Service of the Corporation or an Affiliate or within the two-year period referred to in paragraph (c) of this Section 7, the person to whom any Option or Right held by the Participant at the time of his death is transferred by will or the laws of descent and distribution, or in the case of an Award other than an Incentive Stock Option, pursuant to a qualified domestic relations order, as defined in the Code or Title 1 of ERISA or the rules thereunder may, but only to the extent such Participant was entitled to exercise such Option or Right immediately prior to his death, exercise such Option or Right at any time within a period of one year succeeding the date of death of such Participant, but in no event later than ten years from the date of grant of such Option or Right. Following the death of any Participant to whom an Option was granted under the Plan, irrespective of whether any Related Right shall have theretofore been granted to the Participant or whether the person entitled to exercise such Related Right desires to do so, the Committee may, as an alternative means of settlement of such Option, elect to pay to the person to whom such Option is transferred by will or by the laws of descent and distribution, or in the case of an Option other than an Incentive Stock Option, pursuant to a qualified domestic relations order, as defined in the Code or Title I of ERISA or the rules thereunder, the amount by which the Market Value per Share on the date of exercise of such Option shall exceed the Exercise Price of such Option, multiplied by the number of Shares with respect to which such Option is properly exercised. Any such settlement of an Option shall be considered an exercise of such Option for all purposes of the Plan. 8. INCENTIVE STOCK OPTIONS. Incentive Stock Options may be granted only to Participants who are Employees. Any provision of the Plan to the contrary notwithstanding, (i) no Incentive Stock Option shall be granted more than ten years from the date the Plan is adopted by the Board of Directors of the Corporation and no Incentive Stock Option shall be exercisable more than ten years from the date such Incentive Stock Option is granted, (ii) the Exercise Price of any Incentive Stock Option shall not be less than the Market Value per Share on the date such Incentive Stock Option is granted, (iii) any Incentive Stock Option shall not be transferable by the Participant to whom such Incentive Stock Option is granted other than by will or the laws of descent and distribution, and shall be exercisable during such Participant's lifetime only by such Participant, (iv) no Incentive Stock Option shall be granted to any individual who, at the time such Incentive Stock Option is granted, owns stock possessing more than ten percent of the total combined voting power of all classes of stock of the Corporation or any Affiliate unless the Exercise Price of such Incentive Stock Option is at least 110 percent of the Market Value per Share at the date of grant and such Incentive Stock Option is not exercisable after the expiration of five years from the date such Incentive Stock Option is granted, and (v) the aggregate Market Value (determined as of the time any Incentive Stock Option is granted) of the Shares with respect to which Incentive Stock Options are exercisable for the first time by a Participant in any calendar year shall not exceed $100,000. 9. STOCK APPRECIATION RIGHTS. A Stock Appreciation Right shall, upon its exercise, entitle the Participant to whom such Stock Appreciation Right was granted to receive a number of Shares or cash or combination thereof, as the Committee in its discretion shall determine, the aggregate value of which (i.e., the sum of the amount of cash and/or Market Value of such Shares on date of exercise) shall equal (as nearly as possible, it being understood that the Corporation shall not issue any fractional shares) the amount by which the Market Value per Share on the date of such exercise shall exceed the Exercise Price of such Stock Appreciation Right, multiplied by the number of Shares with respect of which such Stock Appreciation Right shall have been exercised. A Stock Appreciation Right may be Related to an Option or may be granted independently of any Option as the Committee shall from time to time in each case determine. At the time of grant of an Option the Committee shall determine whether and to what extent a Related Stock Appreciation Right shall be granted with respect thereto, provided, however, and notwithstanding any other provision of the Plan, that if the Related Option is an Incentive Stock Option, the Related Stock Appreciation Right shall satisfy all the restrictions and limitations of Section 8 hereof as if such Related Stock Appreciation Right were an Incentive Stock Option and as if other rights which are Related to Incentive Stock Options were Incentive Stock Options. In the case of a Related Option, such Related Option shall cease to be exercisable to the extent of the Shares with respect to which the Related Stock Appreciation Right was exercised. Upon the exercise or termination of a Related Option, any Related Stock Appreciation Right shall terminate to the extent of the Shares with respect to which the Related Option was exercised or terminated. Notwithstanding the foregoing, no Stock Appreciation Right shall be exercisable by a director, Senior Officer or Ten Percent Beneficial Owner of the Corporation within six months of the date of its grant. 10. LIMITED STOCK APPRECIATION RIGHTS. At the time of grant of an Option or Stock Appreciation Right to any Participant, the Committee shall have full and complete authority and discretion to also grant to such Participant a Limited Stock Appreciation Right which is Related to such Option or Stock Appreciation Right, provided, however and notwithstanding any other provision of the Plan, that if the Related Option is an Incentive Stock Option, the Related Limited Stock Appreciation Right shall satisfy all the restrictions and limitations of Section 8 hereof as if such Related Limited Stock Appreciation Right were an Incentive Stock Option and as if all other Rights which are Related to Incentive Stock Options were Incentive Stock Options. Subject to vesting, a Limited Stock Appreciation Right shall be exercisable only during the period beginning on the first day following the date of expiration of any "offer" (as such term is hereinafter defined) and ending on the 45th day following such date, provided, however, that no Limited Stock Appreciation Right shall be exercisable by a director, Senior Officer or Ten Percent Beneficial Owner within six months of the date of its grant. A Limited Stock Appreciation Right shall, upon its exercise, entitle the Participant to whom such Limited Stock Appreciation Right was granted to receive an amount of cash equal to the amount by which the "Offer Price per Share" (as such term is hereinafter defined) or the Market Value on the date of such exercise, as shall have been provided by the Committee in its discretion at the time of grant, shall exceed the Exercise Price of such Limited Stock Appreciation Right, multiplied by the number of Shares with respect to which such Limited Stock Appreciation Right shall have been exercised. Upon the exercise of a Limited Stock Appreciation Right, any Related Option and/or Related Stock Appreciation Right shall cease to be exercisable to the extent of the Shares with respect to which such Limited Stock Appreciation Right was exercised. Upon the exercise or termination of a Related Option or Related Stock Appreciation Right, any Related Limited Stock Appreciation Right shall terminate to the extent of the Shares with respect to which such Related Option or Related Stock Appreciation Right was exercised or terminated. For the purposes of this Section 10, the term "Offer" shall mean any tender offer or exchange offer for Shares other than one made by the Corporation, provided that the corporation, person or other entity making the offer acquires pursuant to such offer either (i) 25% of the Shares outstanding immediately prior to the commencement of such offer or (ii) a number of Shares which, together with all other Shares acquired in any tender offer or exchange offer (other than one made by the Corporation) which expired within 60 days of the expiration date of the offer in question, equals 25% of the Shares outstanding immediately prior to the commencement of the offer in question. The term "Offer Price per Share" as used in this Section 10 shall mean the highest price per Share paid in any Offer which Offer is in effect any time during the period beginning on the 60th day prior to the date on which a Limited Stock Appreciation Right is exercised and ending on the date on which such Limited Stock Appreciation Right is exercised. Any securities or property which are part or all of the consideration paid for Shares in the Offer shall be valued in determining the Offer Price per Share at the higher of (A) the valuation placed on such securities or property by the corporation, person or other entity making such Offer or (B) the valuation placed on such securities or property by the Committee. 11. ADJUSTMENTS UPON CHANGES IN CAPITALIZATION. In the event of any change in the outstanding Shares subsequent to the effective date of the Plan by reason of any reorganization, recapitalization, stock split, stock dividend, combination or exchange of shares, merger, consolidation or any change in the corporate structure or Shares of the Corporation, the maximum aggregate number and class of shares as to which Awards may be granted under the Plan and the number and class of shares with respect to which Awards theretofore have been granted under the Plan shall be appropriately adjusted by the Committee, whose determination shall be conclusive. 12. EFFECT OF MERGER. In the event of any merger, consolidation or combinationof the Corporation (other than a merger, consolidation or combination in which the Corporation is the continuing entity and which does not result in the outstanding Shares being converted into or exchanged for different securities, cash or other property, or any combination thereof) pursuant to a plan or agreement the terms of which are binding upon all stockholders of the Corporation (except to the extent that dissenting stockholders may be entitled, under statutory provisions or provisions contained in the certificate of incorporation, to receive the appraised or fair value of their holdings), any Participant to whom an Option or Right has been granted at least six months prior to such event shall have the right (subject to the provisions of the Plan and any limitation applicable to such Option or Right), thereafter and during the term of each such Option or Right, to receive upon exercise of any such Option or Right an amount equal to the excess of the fair market value on the date of such exercise of the securities, cash or other property, or combination thereof, receivable upon such merger, consolidation or combination in respect of a Share over the Exercise Price of such Right or Option, multiplied by the number of Shares with respect to which such Option or Right shall have been exercised. Such amount may be payable fully in cash, fully in one or more of the kind or kinds of property payable in such merger, consolidation or combination, or partly in cash and partly in one or more of such kinder kinds of property, all in the discretion of the Committee. 13. EFFECT OF CHANGE IN CONTROL. Each of the events specified in the following clauses (i) through (iii) of this Section 13 shall be deemed a "change of control": (i) any third person, including a group, as defined in Section 13(d)(3) of the Securities Exchange Act of 1934, shall become the beneficial owner of shares of the Corporation with respect to which 25% or more of the total number of votes may be cast for the election of the Board of Directors of the Corporation, (ii) as a result of, or in connection with, any cash tender offer, exchange offer, merger or other business combination, sale of assets or contested election, or combination of the foregoing, the persons who were directors of the Corporation shall cease to constitute a majority of the Board of Directors of the Corporation, or (iii) the shareholders of the Corporation shall approve an agreement providing either for a transaction in which the Corporation will cease to be an independent publicly owned entity or for a sale or other disposition of all or substantially all the assets of the Corporation. If a tender offer or exchange offer for Shares (other than such an offer by the Corporation) is commenced, or if the event specified in clause (iii) above shall occur, unless the Committee shall have otherwise provided in the instrument evidencing the grant of an Option or Stock Appreciation Right, all Options and Stock Appreciation Rights theretofore granted and not fully exercisable shall become exercisable in full upon the happening of such event and shall remain so exercisable for a period of sixty days following such date, after which they shall revert to being exercisable in accordance with their terms, provided, however, that no Option or Stock Appreciation Right shall be exercisable by a director, Senior Officer or Ten Percent Beneficial Owner of the Corporation within six months of the date of grant of such Option or Stock Appreciation Right and no Option or Stock Appreciation Right which has previously been exercised or otherwise terminated shall become exercisable. 14. ASSIGNMENTS AND TRANSFERS. No Award nor any right or interest of a Participant under the Plan in any instrument evidencing any Award under the Plan may be assigned, encumbered or transferred except, in the event of the death of a Participant, by will or the laws of descent and distribution or in the case of Awards other than Incentive Stock Options pursuant to a qualified domestic relations order, as defined in the Code or Title I of ERISA or the rules thereunder. 15. EMPLOYEE RIGHTS UNDER THE PLAN. No director, officer or employee shall have a right to be selected as a Participant nor, having been so selected, to be selected again as a Participant and no director, officer, employee or other person shall have any claim or right to be granted an Award under the Plan or under any other incentive or similar plan of the Corporation or any Affiliate. Neither the Plan nor any action taken thereunder shall be construed as giving any employee any right to be retained in the employ of the Corporation or any Affiliate. 16. DELIVERY AND REGISTRATION OF STOCK. The Corporation's obligation to deliver Shares with respect to an Award shall, if the Committee so requests, be conditioned upon the receipt of a representation as to the investment intention of the Participant to whom such Shares are to be delivered, in such form as the Committee shall determine to be necessary or advisable to comply with the provisions of the Securities Act of 1933 or any other Federal, state or local securities legislation or regulation. It may be provided that any representation requirement shall become inoperative upon a registration of the Shares or other action eliminating the necessity of such representation under such Securities Act or other securities legislation. The Corporation shall not be required to deliver any Shares under the Plan prior to (i) the admission of such shares to listing on any stock exchange on which Shares may then be listed, and (ii) the completion of such registration or other qualification of such Shares under any state or Federal law, rule or regulation, as the Committee shall determine to be necessary or advisable. This Plan is intended to comply with Rule 16b-3 under the Securities Exchange Act of 1934. Any provision of the Plan which is inconsistent with said Rule shall, to the extent of such inconsistency, be inoperative and shall not affect the validity of the remaining provisions of the Plan. 17. WITHHOLDING TAX. The Corporation shall have the right to deduct from all amounts paid in cash with respect to the exercise of a Right under the Plan any taxes required by law to be withheld with respect to such cash payments. Where a Participant or other person is entitled to receive Shares pursuant to the exercise of an Option or Right pursuant to the Plan, the Corporation shall have the right to require the Participant or such other person to pay the Corporation the amount of any taxes which the Corporation is required to withhold with respect to such Shares. No discretion or choice shall be conferred upon any Participant, or other Person entitled to receive Shares, with respect to the form, timing or method of any such tax withholding. 18. AMENDMENT OR TERMINATION. The Board of Directors of the Corporation may amend, suspend or terminate the Plan or any portion thereof at any time, but (except as provided in Section 11 hereof) no amendment shall be made without approval of the stockholders of the Corporation which shall (i) increase the aggregate number of Shares with respect to which Awards may be made under the Plan (except pursuant to Section 11), (ii) materially increase the benefits accruing to Participants, (iii) materially change the requirements as to eligibility for participation in the Plan or (iv) change the class of persons eligible to participate in the Plan, provided, however, that no such amendment, suspension or termination shall impair the rights of any Participant, without his consent, in any Award theretofore made pursuant to the Plan. Notwithstanding anything else in this Plan to the contrary, to the extent that the Plan provides for formula awards, as defined in Rule 16b-3(c)(2) (ii) under the Securities Exchange Act of 1934, such provisions may not be amended more than once every six months, other than to comport with changes in the Code, ERISA or the rules thereunder. 19. EFFECTIVE DATE AND TERM OF PLAN. The Plan shall become effective upon its ratification by stockholders of the Corporation. It shall continue in effect for a term of ten years unless sooner terminated under Section 18 hereof. EX-11 4 HMN Financial, Inc. Computation of Earnings Per Common Share (Unaudited) Three Months Nine Months Computation of Earnings Ended Sept 30, Ended Sept 30, Per Common Share: 1998 1997 1998 1997 ----------------------- ---------------------- Weighted average number of common shares outstanding used in basic earnings per common share calculation 4,625,803 5,533,211 5,038,496 5,532,155 Net dilutive effect of: Options 0 348,039 358,514 293,476 Restricted stock awards 0 74,009 54,344 79,007 --------- --------- --------- --------- Weighted average number of shares outstanding adjusted for effect of dilutive securities 4,625,803 5,955,259 5,451,354 5,904,637 ========= ========= ========= ========= Income available to common shareholders $(434,240) 1,524,111 2,013,145 4,330,812 Basic earnings per common share $ (0.09) 0.28 0.40 0.78 Diluted earnings per common share $ (0.09) 0.26 0.37 0.73 The earnings per share calculations reflected above are presented as if the split had been completed at the beginning of each period presented for the weighted average number of shares outstanding for each period. EX-27 5
9 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED BALANCE SHEETS AT SEPTEMBER 30, 1998 AND DECEMBER 31, 1997 AND THE CONSOLIDATED STATEMENTS OF INCOME FOR THE THREE MONTH AND NINE MONTH ENDED SEPTEMBER 30, 1998 AND 1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 9-MOS DEC-31-1998 JAN-01-1998 SEP-30-1998 7,476 0 0 0 193,642 0 0 473,353 (2,966) 706,269 446,333 20,279 7,165 164,400 0 0 91 68,002 706,269 26,346 9,705 793 36,844 17,039 24,203 12,641 235 12,406 9,933 3,226 2,013 0 0 2,013 .40 .37 7.18 404 309 0 83 2,748 (19) 2 2,966 787 0 2,179
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