-----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, WPaw7Ss/v3HwQQiCjUY31pFZE0cPPmJHp8eiGFzq3sqtRXt+GB8n1Zvk7satIzQ0 i0AfGqtAE7yM/54bTm9E9A== 0000921183-99-000010.txt : 19990817 0000921183-99-000010.hdr.sgml : 19990817 ACCESSION NUMBER: 0000921183-99-000010 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19990630 FILED AS OF DATE: 19990816 FILER: COMPANY DATA: COMPANY CONFORMED NAME: HMN FINANCIAL INC CENTRAL INDEX KEY: 0000921183 STANDARD INDUSTRIAL CLASSIFICATION: SAVINGS INSTITUTION, FEDERALLY CHARTERED [6035] IRS NUMBER: 411777397 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-24100 FILM NUMBER: 99690129 BUSINESS ADDRESS: STREET 1: 101 N BROADWAY CITY: SPRING VALLEY STATE: MN ZIP: 55975-1223 BUSINESS PHONE: 5073461100 10-Q 1 FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------------------------------------------- FORM 10-Q /X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 1999 OR / / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _________ to _________ Commission File Number 0-24100 HMN FINANCIAL, INC. ------------------------------------------------------------------- (Exact name of Registrant as specified in its Charter) Delaware 41-1777397 ----------------------------- -------------------------- - -- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 101 North Broadway, Spring Valley, Minnesota 55975-0231 -------------------------------------------------- ------------ (Address of principal executive offices) (ZIP Code) Registrant's telephone number, including area code: (507) 346-1100 ---------------- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes /X/ No / / Indicate the number of shares outstanding of each of the issuer's classes of common stock as of the latest practicable date. Class Outstanding at August 5, 1999 ------------------------------------ ------------------------------ Common stock, $0.01 par value 5,011,703 1 HMN FINANCIAL, INC. CONTENTS PART I - FINANCIAL INFORMATION Page ------ Item 1: Financial Statements (unaudited) Consolidated Balance Sheets at June 30, 1999 and December 31, 1998 3 Consolidated Statements of Income for the Three Months Ended and Six Months Ended June 30, 1999 and 1998 4 Consolidated Statements of Comprehensive Income for the Three Months and Six Months Ended June 30, 1999 and 1998 5 Consolidated Statement of Stockholders' Equity for the Six Month Period Ended June 30, 1999 5 Consolidated Statements of Cash Flows for the Six Months Ended June 30, 1999 and 1998 6-7 Notes to Consolidated Financial Statements 8 Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations 16 Item 3: Quantitative and Qualitative Disclosures about Market Risk Discussion included in Item 2 under Market Risk 20 PART II - OTHER INFORMATION Item 1: Legal Proceedings 27 Item 2: Changes in Securities 27 Item 3: Defaults Upon Senior Securities 27 Item 4: Submission of Matters to a Vote of Security Holders 27 Item 5: Other Information 28 Item 6: Exhibits and Reports on Form 8-K and Form 11-K 28 Signatures 29 2 PART I - FINANCIAL STATEMENTS HMN FINANCIAL, INC. AND SUBSIDIARIES Consolidated Balance Sheets (unaudited)
ASSETS June 30, December 31, 1999 1998 ------------- ------------- Cash and cash equivalents $ 10,543,341 20,960,957 Securities available for sale: Mortgage-backed and related securities (amortized cost $111,702,277 and $144,320,926) 110,453,963 143,146,165 Other marketable securities (amortized cost $75,034,116 and $38,657,193) 72,886,769 38,478,623 ------------ ------------- 183,340,732 181,624,788 ------------ ------------- Loans held for sale 6,721,778 13,094,528 Loans receivable, net 446,669,533 447,455,052 Accrued interest receivable 3,819,962 3,952,763 Federal Home Loan Bank stock, at cost 9,837,900 9,837,900 Mortgage servicing rights, net 1,056,509 1,005,693 Real estate, net 10,625 10,602 Premises and equipment, net 8,602,163 8,382,136 Investment in limited partnerships 2,792,773 2,437,246 Goodwill 4,251,015 4,341,033 Core deposit intangible 1,143,023 1,259,245 Prepaid expenses and other assets 914,333 295,829 Deferred income taxes 270,274 0 ------------ ------------ Total assets $ 679,973,961 694,657,772 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY Deposits $ 416,192,060 433,868,907 Federal Home Loan Bank advances 192,400,000 185,400,000 Other borrowed money 0 2,500,000 Accrued interest payable 1,287,959 1,086,013 Advance payments by borrowers for taxes and insurance 682,003 657,089 Accrued expenses and other liabilities 2,216,942 2,700,424 ------------ ------------ Total liabilities 612,778,964 626,212,433 ------------ ------------ Commitments and contingencies Stockholders' equity: Serial preferred stock: authorized 500,000 shares; issued and outstanding none 0 0 Common stock ($.01 par value): authorized 11,000,000; issued shares 9,128,662 91,287 91,287 Additional paid-in capital 59,758,134 59,739,020 Retained earnings, subject to certain restrictions 66,025,364 63,424,378 Accumulated other comprehensive loss (2,087,394) (837,838) Unearned employee stock ownership plan shares (5,608,499) (5,705,152) Unearned compensation restricted stock awards (189,344) (276,867) Treasury stock, at cost 4,058,058 and 3,835,058 shares (50,794,551) (47,989,489) ------------ ----------- Total stockholders' equity 67,194,997 68,445,339 ------------ ----------- Total liabilities and stockholders' equity $679,973,961 694,657,772 ============ ===========
See accompanying notes to consolidated financial statements. 3 HMN FINANCIAL, INC. AND SUBSIDIARIES Consolidated Statements of Income (unaudited)
Three Months Ended Six Months Ended June 30, June 30, 1999 1998 1999 1998 ----------------------- ----------------------- Interest Income: Loans receivable $8,763,487 8,797,708 17,407,061 17,440,080 Securities available for sale: Mortgage-backed and related 1,674,934 2,158,639 3,624,430 4,377,337 Other marketable 1,033,641 1,229,503 1,795,779 2,185,975 Cash equivalents 34,679 110,623 131,231 271,947 Other 153,296 149,224 304,907 271,558 ---------- ---------- ----------- ---------- Total interest income 11,660,037 12,445,697 23,263,408 24,546,897 ---------- ---------- ----------- ---------- Interest expense: Deposits 4,521,261 5,721,279 9,143,280 11,424,803 Federal Home Loan Bank advances 2,597,437 2,454,631 5,138,758 4,539,097 Other borrowed money 0 0 7,207 0 ---------- ---------- ----------- ---------- Total interest expense 7,118,698 8,175,910 14,289,245 15,963,900 ---------- ---------- ----------- ---------- Net interest income 4,541,339 4,269,787 8,974,163 8,582,997 Provision for loan losses 75,000 75,000 150,000 150,000 ---------- ---------- ----------- ---------- Net interest income after provision for loan losses 4,466,339 4,194,787 8,824,163 8,432,997 ---------- ---------- ----------- ---------- Non-interest income: Fees and service charges 280,278 257,589 495,705 459,345 Securities gains, net 23,332 737,632 162,770 1,634,079 Gain on sales of loans 584,682 351,892 1,279,674 718,136 Earnings (loss) in limited partnerships 345,527 (989,556) 362,594 (937,613) Other 98,782 161,145 218,324 274,924 ---------- ---------- ----------- ---------- Total non-interest income 1,332,601 518,702 2,519,067 2,148,871 ---------- ---------- ----------- ---------- Non-interest expense: Compensation and benefits 1,535,318 1,879,834 2,963,816 3,732,314 Occupancy 395,968 358,039 816,067 722,760 Federal deposit insurance premiums 72,608 72,608 145,216 146,439 Advertising 84,045 135,972 153,841 228,953 Data processing 176,836 164,503 361,548 338,558 Amortization of mortgage servicing rights and net valuation adjustments 151,381 237,820 316,979 276,592 Other 575,437 593,683 1,168,016 1,218,867 ---------- --------- ---------- ---------- Total non-interest expense 2,991,593 3,442,459 5,925,483 6,664,483 ---------- --------- ---------- ---------- Income before income tax expense 2,807,347 1,271,030 5,417,747 3,917,385 Income tax expense 1,091,000 487,000 2,099,400 1,470,000 ---------- --------- ---------- ---------- Net income $ 1,716,347 784,030 3,318,347 2,447,385 ========== ========= ========== ========== Basic earnings per share $ 0.39 0.16 0.74 0.47 ========== ========= ========== ========== Diluted earnings per share $ 0.37 0.14 0.71 0.43 ========== ========= ========== ==========
See accompanying notes to consolidated financial statements. 4 HMN FINANCIAL, INC. Consolidated Statements of Comprehensive Income (unaudited)
Three Months Ended June 30, 1999 1998 ------------------------ ----------------------- Net income $ 1,716,347 784,030 Other comprehensive income, net of tax: Unrealized gains (losses) on securities: Unrealized holding gains (losses) arising during period (1,254,430) 295,168 Less: reclassification adjustment for gains included in net income 18,021 452,758 ----------- ---------- Other comprehensive loss (1,272,451) (157,590) ---------- -------- Comprehensive income $ 443,896 626,440 ========== ========= Six Months Ended June 30, 1999 1998 ------------------------ ----------------------- Net income $ 3,318,347 2,447,385 Other comprehensive income, net of tax: Unrealized gains (losses) on securities: Unrealized holding gains (losses) arising during period (1,149,648) 747,516 Less: reclassification adjustment for gains included in net income 99,908 1,002,998 ----------- ---------- Other comprehensive loss (1,249,556) (255,482) ---------- --------- Comprehensive income $ 2,068,791 2,191,903 ========== =========
See accompanying notes to consolidated financial statements. HMN FINANCIAL, INC. AND SUBSIDIARIES Consolidated Statement of Stockholders' Equity For the Six Month Period Ended June 30, 1999 (unaudited)
Accumulated Additional Other Common Paid-In Retained Comprehensive Stock Capital Earnings Loss ---------------------------------------------------------- Balance, December 31, 1998 $ 91,287 59,739,020 63,424,378 (837,838) Net income 3,318,347 Treasury stock purchases Other comprehensive loss (1,249,556) Tax benefit of restricted stock awards 26,743 Employee stock options exercised (42,460) Tax benefit of exercised stock options 3,605 Amortization of restricted stock awards Dividends paid (717,361) Earned employee stock ownership plan shares 31,226 --------- ---------- ---------- --------- Balance, June 30, 1999 $ 91,287 59,758,134 66,025,364 (2,087,394) ========= ========== ========== ========= Unearned Employee Stock Unearned Ownership Compensation Total Plan Restricted Treasury Stockholders' Shares Stock Awards Stock Equity ---------------------------------------------------- Balance, December 31, 1998 $ (5,705,152) (276,867) (47,989,489) 68,445,339 Net income 3,318,347 Treasury stock purchases (2,953,437) (2,953,437) Other comprehensive loss (1,249,556) Tax benefit of restricted stock awards 26,743 Employee stock options exercised 148,375 105,915 Tax benefit of exercised stock options 3,605 Amortization of restricted stock awards 87,523 87,523 Dividends paid (717,361) Earned employee stock ownership plan shares 96,653 127,879 --------- -------- ---------- ---------- Balance, June 30, 1999 $ (5,608,499) (189,344) (50,794,551) 67,194,997 ========= ======== ========== ==========
See accompanying notes to consolidated financial statements. 5 HMN FINANCIAL, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows (unaudited)
Six Months Ended June 30, 1999 1998 ---------------------------- Cash flows from operating activities: Net income $ 3,318,347 2,447,385 Adjustments to reconcile net income to cash provided by operating activities: Provision for loan losses 150,000 150,000 Depreciation 342,174 283,577 Amortization of (discounts) premiums, net 56,106 (128,956) Amortization of deferred loan fees (425,539) (317,266) Amortization of goodwill 90,018 90,318 Amortization of core deposit intangible 116,222 143,514 Amortization of other purchase accounting adjustments 50,342 382,014 Amortization of mortgage servicing rights and net valuation adjustments 316,979 276,592 Capitalized mortgage servicing rights (327,631) (130,259) Increase (decrease) in deferred income taxes (145,499) 167,000 Securities gains, net (162,770) (1,634,079) Gain on sales of real estate 0 (21,777) Gain on sales of loans (1,279,674) (718,136) Proceeds from sale of loans held for sale 111,643,954 68,990,372 Disbursements on loans held for sale (73,129,568) (53,532,026) Principal collected on loans held for sale 1,099 0 Amortization of restricted stock awards 87,523 120,848 Amortization of unearned ESOP shares 96,653 227,716 Earned employee stock ownership shares priced above original cost 31,226 194,458 Decrease (increase) in accrued interest receivable 132,801 (516,568) Increase in accrued interest payable 201,946 20,256 Equity (earnings) loss of limited partnerships (362,594) 937,613 Decrease (increase) in other assets (618,504) 581,531 Increase (decrease) in other liabilities 219,668 (795,342) Other, net 14,976 44,179 ---------- ---------- Net cash provided by operating activities 40,418,255 17,262,964 ---------- ---------- Cash flows from investing activities: Proceeds from sales of securities available for sale 10,943,970 91,763,992 Principal collected on securities available for sale 33,335,121 16,165,151 Proceeds collected on maturity of securities available for sale 18,331,000 23,100,000 Purchases of securities available for sale (57,031,349) (136,566,747) Proceeds from sales of loans receivable 216,156 3,047,939 Purchases of mortgage servicing rights (22,443) (557,536) Purchase of interest in limited partnerships 0 (181,125) Purchase of Federal Home Loan Bank stock 0 (1,737,900) Net increase in loans receivable (39,346,322) (41,486,818) Proceeds from sale of real estate 0 152,415 Purchases of premises and equipment (562,201) (1,256,046) Decrease in due to stockholders of Marshalltown Financial Corporation (10,716) (3,495,888) ----------- ---------- Net cash used by investing activities (34,146,784) (51,052,563) ----------- ---------- Cash flows from financing activities: Decrease in deposits (17,649,118) (82,370) Purchase of treasury stock (2,953,437) (14,772,787) Increase in unearned ESOP shares 0 (1,476,000) Stock options exercised 105,915 55,237 Dividends to stockholders (717,361) (305,982) Fractional shares purchased from stock split 0 (1,716) Proceeds from Federal Home Loan Bank advances 33,100,000 92,500,000 Repayment of Federal Home Loan Bank advances(26,100,000) (42,214,284) Decrease in other borrowed money (2,500,000) 0 Decrease (increase) in advance payments by borrowers for taxes and insurance 24,914 (33,906) ----------- ----------- Net cash provided (used) by financing activities (16,689,087) 33,668,192 ----------- ----------- Decrease in cash and cash equivalents (10,417,616) (121,407) Cash and cash equivalents, beginning of period 20,960,957 9,364,635 ----------- ----------- Cash and cash equivalents, end of period $ 10,543,341 9,243,228 =========== ========== 6 Supplemental cash flow disclosures: Cash paid for interest $ 14,087,299 15,943,644 Cash paid for income taxes 2,554,000 967,000 Supplemental noncash flow disclosures: SBA certificates transferred from loans to securities available for sale 2,528,442 0 Loans securitized and transferred to securities available for sale 6,913,219 0 Loans transferred to loans held for sale 30,890,367 20,553,439 Transfer of loans to real estate 0 17,105 Securities purchased with liability due to broker 0 1,997,812 Securities sold with payment due from broker 0 3,051,977
See accompanying notes to consolidated financial statements. 7 HMN FINANCIAL, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (Unaudited) June 30, 1999 and 1998 (1) HMN FINANCIAL, INC. HMN Financial, Inc.(HMN) is a stock savings bank holding company which owns 100 percent of Home Federal Savings Bank (the Bank or Home Federal). Home Federal has a community banking philosophy and operates retail banking facilities in Minnesota and Iowa. The Bank has two wholly owned subsidiaries, Osterud Insurance Agency, Inc. (OAI) and MSL Financial Corporation (MSL), which offer financial planning products and services. As of April 30, 1999 MSL was dissolved and its assets were transferred to the Bank in exchange for the stock of MSL. HMN has two other wholly owned subsidiaries, Security Finance Corporation (SFC) and HMN Mortgage Services, Inc. (MSI). SFC invests in commercial loans and commercial real-estate loans located throughout the United States which were originated by third parties. MSI operates a mortgage banking and mortgage brokerage facility located in Brooklyn Park, Minnesota. The consolidated financial statements included herein are for HMN, SFC, MSI, the Bank and the Bank's wholly owned subsidiaries, OAI and MSL. Results of operations for MSL are included through April 30, 1999, the date of its dissolution. All significant intercompany accounts and transactions have been eliminated in consolidation. (2) BASIS OF PREPARATION The accompanying unaudited consolidated financial statements were prepared in accordance with instructions for Form 10-Q and therefore, do not include all disclosures necessary for a complete presentation of the consolidated balance sheets, consolidated statements of income, consolidated statements of comprehensive income, consolidated statements of stockholders' equity and consolidated statements of cash flows in conformity with generally accepted accounting principles. However, all adjustments consisting of only normal recurring adjustments which are, in the opinion of management, necessary for the fair presentation of the interim financial statements have been included. The statement of income for the three month and six month periods ended June 30, 1999 are not necessarily indicative of the results which may be expected for the entire year. Certain amounts in the consolidated financial statements for prior periods have been reclassified to conform with the current period presentation. (3) NEW ACCOUNTING STANDARDS In June 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES, which establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives), and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. If certain conditions are met, a derivative may be specifically designated as (a) a hedge of the exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment, (b) a hedge of the exposure to variable cash flows of a forecasted transaction, or (c) a hedge of the foreign currency exposure of a net investment in a foreign operation, an unrecognized firm commitment, an available-for-sale security, or a foreign-currency-denominated forecasted transaction. 8 The accounting for changes in the fair value of a derivative (that is, gains and losses) depends on the intended use of the derivative and the resulting designation. - - For a derivative designated as hedging the exposure to changes in the fair value of a recognized asset or liability or a firm commitment (referred to as a fair value hedge), the gain or loss is recognized in earnings in the period of change together with the offsetting loss or gain on the hedged item attributable to the risk being hedged. The effect of that accounting is to reflect in earnings the extent to which the hedge is not effective in achieving offsetting changes in fair value. - - For a derivative designated as hedging the exposure to variable cash flows of a forecasted transaction (referred to as a cash flow hedge), the effective portion of the derivative's gain or loss is initially reported as a component of other comprehensive income (outside earnings) and subsequently reclassified into earnings when the forecasted transaction affects earnings. The ineffective portion of the gain or loss is reported in earnings immediately. - - For a derivative designated as hedging the foreign currency exposure of a net investment in a foreign operation, the gain or loss is reported in other comprehensive income (outside earnings) as part of the cumulative translation adjustment. The accounting for a fair value hedge described above applies to a derivative designated or an available-for-sale security. Similarly, the accounting for a cash flow hedge described above applies to a derivative designated as a hedge of the foreign currency exposure of a foreign-currency- denominated forecasted transaction. - - For a derivative not designated as a hedging instrument, the gain or loss is recognized in earnings in the period of change. Under SFAS No. 133, an entity that elects to apply hedge accounting is required to establish at the inception of the hedge the method it will use for assessing the effectiveness of the hedging derivative and the measurement approach for determining the ineffective aspect of the hedge. Those methods must be consistent with the entity's approach to managing risk. SFAS No. 133 precludes designating a nonderivative financial instrument as a hedge of an asset, liability, unrecognized firm commitment, or forecasted transaction except that a nonderivative instrument denominated in a foreign currency may be designated as a hedge of the foreign currency exposure of an unrecognized firm commitment denominated in a foreign currency or a net investment in a foreign operation. Originally SFAS No. 133 was effective for all fiscal quarters of fiscal years beginning after June 15, 1999. Initial application should be as of the beginning of an entity's fiscal quarter; on that date, hedging relationships must be designated anew and documented pursuant to the provisions of SFAS No. 133. In June of 1999 the Financial Accounting Standards Board issued SFAS No. 137 which deferred the required adoption of SFAS No. 133 to fiscal years starting after June 15, 2000. HMN is anticipating that it will adopt SFAS No. 133 in the first quarter of 2001. HMN is currently researching the impact on its financial condition and results of operations of adopting SFAS No. 133. Effective January 1, 1999 HMN adopted FASB issued SFAS No. 134, ACCOUNTING FOR MORTGAGE-BACKED SECURITIES RETAINED AFTER THE SECURITIZATION OF MORTGAGE LOANS HELD FOR SALE BY A MORTGAGE BANKING ENTERPRISE, which amended SFAS No. 65 to require that after the securitization of mortgage loans held for sale, an entity engaged in mortgage banking activities classify the resulting mortgage- backed securities or other retained interests based on its ability and intent to sell or hold those investments. The adoption of SFAS No. 134 in the first quarter of 1999 did not have a material impact on HMN's financial condition or the results of its operations. (4) COMPREHENSIVE INCOME Comprehensive income is defined as the change in equity during a period from transactions and other events from nonowner sources. Comprehensive income is the total of net income and other comprehensive income, which for HMN is comprised entirely of unrealized gains and losses on securities available for sale. 9 The gross unrealized holding losses for the second quarter of 1999 were $2,040,000 the income tax benefit would have been $786,000 and therefore, the net loss was $1,254,000. The gross reclassification adjustment for the second quarter of 1999 was $29,000, the income tax expense would have been $11,000 and therefore, the net reclassification adjustment was $18,000. The gross unrealized holding gains for the second quarter of 1998 were $482,000, the income tax expense would have been $187,000 and therefore, the net gain was $295,000. The gross reclassification adjustment for the second quarter of 1998 was $738,000, the income tax expense would have been $285,000 and therefore, the net reclassification adjustment was $453,000. The gross unrealized holding losses for the six month period ended June 30, 1999 were $1,880,000, the income tax benefit would have been $730,000 and therefore, the net loss was $1,150,000. The gross reclassification adjustment for the first six months of 1999 was $163,000, the income tax expense would have been $63,000 and therefore, the net gain was $100,000. The gross unrealized holding gains for the first six months of 1998 were $1,162,000, the income tax expense would have been $415,000 and therefore, the net gain was $748,000. The gross reclassification adjustment for the first six months of 1998 was $1,634,000, the income tax expense would have been $631,000 and therefore, the net reclassification adjustment was $1,003,000. (5) CASH DIVIDEND On July 20, 1999 HMN's Board of Directors announced a cash dividend of $0.08 per share, payable on September 10, 1999 to stockholders of record on August 25, 1999. (6) INVESTMENT IN MORTGAGE SERVICING RIGHTS A summary of mortgage servicing activity is as follows:
- -------------------------------------------------------------- 1999 1998 -------------- -------------- Mortgage servicing rights Balance, beginning of year $ 1,117,193 845,517 Originations 327,631 127,879 Purchases 22,443 468,998 Amortization (347,558) (105,767) --------- --------- Balance, June 30, 1,119,709 1,336,627 --------- --------- Valuation reserve Balance, beginning of year (111,500) (64,512) Additions 0 (165,583) Reductions 48,300 32,000 --------- --------- Balance, June 30, (63,200) (198,095) --------- --------- Mortgage servicing rights, net $ 1,056,509 1,138,532 ========= ========= Fair value of mortgage servicing rights $ 1,192,509 1,162,532 ========= ========= - ------------------------------------------------------------
10 (7) INVESTMENT IN LIMITED PARTNERSHIPS Investments in limited partnerships were as follows:
- ------------------------------------------------------------- Primary partnership activity June 30, December 31, 1999 1998 ------------ ------------ Mortgage servicing rights $ 2,006,928 1,622,519 Common stock of financial institutions 430,283 415,189 Low to moderate income housing 355,562 399,538 ------------ ------------ $ 2,792,773 2,437,246 ============ ============ - -------------------------------------------------------------
During the second quarter of 1999 HMN's proportionate revenue from a mortgage servicing partnership (which included the reduction of previously established impairment reserves of $381,671) was $323,237, its proportionate share of gains from the common stock investments in financial institutions was $28,790 and it recognized $6,500 of losses on the low income housing partnerships. During 1999 HMN anticipates receiving low income housing credits totaling $80,000 of which $20,000 were credited to current income tax benefits in the second quarter of 1999. During the second quarter of 1998, HMN's proportionate losses from the mortgage servicing partnership was $1,112,747, its proportionate share of gains from common stock investments in financial institutions was $123,191 and it did not recognize any revenue or loss from the low income housing partnerships. During the six month period ended June 30, 1999 HMN's proportionate revenue from a mortgage servicing partnership (which included the reduction of previously established impairment reserves of $497,043) was $384,409, its proportionate share of gains from the common stock investments in financial institutions was $15,094 and it recognized $36,909 of losses on the low income housing partnerships. During 1999 HMN anticipates receiving low income housing credits totaling $80,000 of which $40,000 were credited to current income tax benefits in the six month period ended June 30, 1999. During the six month period ended June 30, 1998, HMN's proportionate revenue from the mortgage servicing partnership was $1,060,836, its proportionate share of gains from common stock investments in financial institutions was $123,223 and it did not recognize any revenue or loss from the low income housing partnerships. (8) EARNINGS PER SHARE The following table reconciles the weighted average shares outstanding and the income available to common shareholders used for basic and diluted EPS:
Three months ended Six Months ended June 30, June 30, 1999 1998 1999 1998 --------------------- ---------------------- Weighted average number of common shares outstanding used in basic earnings per common share calculation 4,442,471 5,051,205 4,465,679 5,248,262 Net dilutive effect of: Options 167,858 379,759 177,041 391,398 Restricted stock awards 20,019 54,197 23,267 57,773 --------- --------- --------- --------- Weighted average number of shares outstanding adjusted for effect of dilutive securities 4,630,348 5,485,161 4,665,987 5,697,433 ========= ========= ========= ========= Income available to common shareholders $ 1,716,347 784,030 3,318,347 2,447,385 Basic earnings per common share $ 0.39 0.16 0.74 0.47 Diluted earnings per common share $ 0.37 0.14 0.71 0.43
11 (9) REGULATORY CAPITAL The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on HMN's financial condition. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulations to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the following table) of Tangible, Tier I (Core), and Risk-based capital (as defined in the regulations) to adjusted total assets and risk-weighted assets (as defined). Management believes, as of June 30, 1999, that the Bank meets all capital adequacy requirements to which it is subject. Management believes that based upon the Bank's capital calculations at June 30, 1999 and other conditions consistent with the Prompt Corrective Actions Provisions of the OTS regulations, the Bank would be categorized as well capitalized. On June 30, 1999 the Bank's tangible assets and adjusted total assets were $657,048,000 and its risk-weighted assets were $346,906,000. The following table presents the Bank's capital amounts and ratios at June 30, 1999 for actual capital, required capital and excess capital, including ratios in order to qualify as being well capitalized under the Prompt Corrective Actions regulations.
Required to be Adequately Actual Capitalized ------------------ -------------------- Percent of Percent of (IN THOUSANDS) Amount Assets Amount Assets -------- ----------- --------- ----------- Bank stockholder's equity $48,088 Plus: Net unrealized loss on certain securities available for sale 1,685 Less: Goodwill and other intangibles 5,394 Excess mortgage servicing rights 283 ------- Tier I or core capital 44,096 ------- Tier I capital to adjusted total assets 6.71% $ 26,282 4.00% Tier I capital to risk- weighted assets 12.71% $ 13,876 4.00% Less: Equity investments & other assets required to be deducted 22 Plus: Allowable allowance for loan losses 3,185 ------- Risk-based capital $47,259 $ 27,752 ======= Risk-based capital to risk- weighted assets 13.62% 8.00% To Be Well Capitalized Under Prompt Corrective Actions Excess Capital Provisions --------------------- ------------------------ Percent of Percent of (IN THOUSANDS) Amount Assets Amount Assets ---------- ---------- ----------- ----------- Bank stockholder's equity $ Plus: Net unrealized loss on certain securities available for sale Less: Goodwill and other intangibles Excess mortgage servicing rights Tier I or core capital Tier I capital to adjusted total assets $ 17,814 2.71% $ 32,852 5.00% Tier I capital to risk- weighted assets $ 30,220 8.71% $ 20,814 6.00% Less: Equity investments & other assets required to be deducted Plus: Allowable allowance for loan losses Risk-based capital $ 19,507 $ 34,691 Risk-based capital to risk- weighted assets 5.62% 10.00% Based upon the Bank's adjusted total assets for the purpose of the tangible and core capital ratios and risk-weighted assets for the purpose of the risk-based capital ratio
The tangible capital of the Bank was in excess of the minimum 2% required at June 30, 1999, but is not reflected in the table above. 12 (10) BUSINESS SEGMENTS HMN's wholly owned subsidiaries, Home Federal Savings Bank and Mortgage Services, Inc., have been identified as reportable operating segments in accordance with the provisions of SFAS 131. MSI was deemed to be a segment because it is a separate corporation which operates independently from the Bank and it is not regulated by the Office of Thrift Supervision. MSI has been segmented further into Mortgage Servicing Rights and Mortgage Banking activities. The mortgage servicing segment owns servicing rights on loans which have either been sold to FNMA or securitized into mortgage backed instruments which were issued by FNMA. MSI receives a servicing fee which is based upon the outstanding balance of the loan being serviced and pays a subservicer a monthly fee to service the loan. MSI's mortgage banking activity includes an origination function and it also purchases loans from other loan originators. All loans acquired either by origination or by purchase are intended to be resold in the secondary loan market. Security Finance Corporation and HMN, the holding company, did not meet the quantitative thresholds for determining reportable segments and therefore are included in the "Other" category. HMN evaluates performance and allocates resources based on the segment's net income or loss, return on average assets and return on average equity. The segments follow generally accepted accounting principles as described in the summary of significant accounting policies. Each corporation is managed separately with its own president, who reports directly to HMN's chief operating decision maker and board of directors. 13 The following table sets forth certain information about the reconciliations of reported profit or loss and assets for each of HMN's reportable segments.
HMN Mortgage Services, Inc. ------------------------------- Home Federal Mortgage Mortgage (Dollars in thousands) Savings Bank Servicing Rights Banking - ------------------------------------------------------------------------- At or for the three months ended June 30, 1999: Interest income - external customers $ 11,363 0 95 Non-interest income - external customers 645 233 17 Earnings (loss) on limited partnerships 317 0 0 Intersegment interest income 18 0 0 Intersegment non- interest income 85 0 0 Interest expense 7,118 0 84 Amortization of mortgage servicing rights and net valuation adjustments 61 87 0 Other non-interest expense 2,483 0 300 Income tax expense (benefit)1,057 (25) 11 Net income (loss) 1,633 (39) 17 Total assets 661,088 231 6,938 Net interest margin 2.67 % NM NM Return on average assets 0.99 % (57.97)% 1.15% Return on average realized common equity 13.03 % (268.16)% 5.32% At or for the three months ended June 30, 1998: Interest income - external customers $ 11,963 0 60 Non-interest income - external customers 171 114 190 Earnings (loss) on limited partnerships (712) 0 0 Intersegment interest income 22 0 0 Intersegment non-interest income 76 0 0 Interest expense 8,176 0 57 Amortization of mortgage servicing rights and net valuation adjustments 7 231 0 Other non-interest expense 2,761 0 295 Income tax expense (benefit) 275 (42) (43) Net income (loss) 226 (75) (59) Total assets 701,501 985 5,829 Net interest margin 2.27 % NM NM Return on average assets 0.13 % (28.19)% (5.58)% Return on average realized common equity 1.85 % (79.53)% (16.02)% Total Reportable Consolidated (DOLLARS IN THOUSANDS) Segments Other Eliminations Total ------------------------------------------------------------------------------ At or for the three months ended June 30, 1999: Interest income - external customers $ 11,458 202 0 11,660 Non-interest income - external customers 985 1 0 986 Earnings (loss) on limited partnerships 317 29 0 346 Intersegment interest income 18 115 (133) 0 Intersegment non- interest income 85 1,629 (1,714) 0 Interest expense 7,202 49 (133) 7,118 Amortization of mortgage servicing rights and net valuation adjustments 148 0 0 148 Other non-interest expense 2,783 145 (85) 2,843 Income tax expense (benefit) 1,043 48 0 1,091 Net income (loss) 1,611 1,734 (1,629) 1,716 Total assets 668,177 69,999 (58,202) 679,974 Net interest margin NM NM NM 2.76% Return on average assets NM NM NM 1.01% Return on average realized common equity NM NM NM 9.83% At or for the three months ended June 30, 1998: Interest income - external customers $ 12,023 423 0 12,446 Non-interest income - external customers 475 756 0 1,231 Earnings (loss) on limited partnerships (712) 0 0 (712) Intersegment interest income 22 140 (162) 0 Intersegment non- interest income 76 133 (209) 0 Interest expense 8,233 105 (162) 8,176 Amortization of mortgage servicing rights and net valuation adjustments 238 0 0 238 Other non-interest expense 3,056 225 (76) 3,205 Income tax expense (benefit) 190 297 0 487 Net income (loss) 92 825 (133) 784 Total assets 708,315 80,420 (63,555) 725,180 Net interest margin NM NM NM 2.47% Return on average assets NM NM NM 0.44% Return on average realized common equity NM NM NM 4.03%
NM - Not meaningful 14
HMN Mortgage Services, Inc. ------------------------------- Home Federal Mortgage Mortgage (DOLLARS IN THOUSANDS) Savings Bank Servicing Rights Banking - ------------------------------------------------------------------------- At or for the six months ended June 30, 1999: Interest income - external customers $ 22,689 0 172 Non-interest income - external customers 1,461 55 595 Earnings (loss) on limited partnerships 348 0 0 Intersegment interest income 20 0 0 Intersegment non- interest income 165 0 0 Interest expense 14,282 0 162 Amortization of mortgage servicing rights and net valuation adjustments 118 199 0 Other non-interest expense 4,917 0 582 Income tax expense (benefit) 2,044 (56) 8 Net income (loss) 3,172 (88) 15 Total assets 661,008 231 6,938 Net interest margin 2.65 % NM NM Return on average assets 0.96 % (57.88)% 0.51% Return on average realized common equity 12.91 % (160.37)% 1.47% At or for the six months ended June 30, 1998: Interest income - external customers $ 23,674 0 108 Non-interest income - external customers 789 193 397 Earnings (loss) on limited partnerships (658) 0 0 Intersegment interest income 30 0 0 Intersegment non- interest income 153 0 0 Interest expense 15,964 0 109 Amortization of mortgage servicing rights and net valuation adjustments 12 265 0 Other non-interest expense 5,607 0 567 Income tax expense (benefit) 1,001 (28) (66) Net income (loss) 1,254 (44) (105) Total assets 701,501 985 5,829 Net interest margin 2.35 % NM NM Return on average assets 0.37 % (9.24)% (5.57)% Return on average realized common equity 4.93 % (28.25)% (17.02)% NM - Not meaningful Total Reportable Consolidated (DOLLARS IN THOUSANDS) Segments Other Eliminations Total ------------------------------------------------------------------------------ At or for the six months ended June 30, 1999: Interest income - external customers $ 22,861 402 0 23,263 Non-interest income - external customers 2,111 44 0 2,155 Earnings (loss) on limited partnerships 348 15 0 363 Intersegment interest income 20 223 (243) 0 Intersegment non-interest income 165 3,135 (3,300) 0 Interest expense 14,444 88 (243) 14,289 Amortization of mortgage servicing rights and net valuation adjustments 317 0 0 317 Other non-interest expense 5,499 274 (165) 5,608 Income tax expense (benefit) 1,996 103 0 2,099 Net income (loss) 3,099 3,354 (3,135) 3,318 Total assets 668,177 69,999 (58,202) 679,974 Net interest margin NM NM NM 2.74% Return on average assets NM NM NM 0.98% Return on average realized common equity NM NM NM 9.57% At or for the six months ended June 30, 1998: Interest income - external customers $ 23,782 765 0 24,547 Non-interest income - external customers 1,379 1,428 0 2,807 Earnings (loss) on limited partnerships (658) 0 0 (658) Intersegment interest income 30 255 (285) 0 Intersegment non- interest income 153 1,194 (1,347) 0 Interest expense 16,073 176 (285) 15,964 Amortization of mortgage servicing rights and net valuation adjustments 277 0 0 277 Other non-interest expense 6,174 367 (153) 6,388 Income tax expense (benefit) 907 563 0 1,470 Net income (loss) 1,105 2,536 (1,194) 2,447 Total assets 708,315 80,420 (63,555) 725,180 Net interest margin NM NM NM 2.53% Return on average assets NM NM NM 0.69% Return on average realized common equity NM NM NM 6.07% NM - Not meaningful
15 HMN FINANCIAL, INC. Item 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL HMN's net income is dependent primarily on its net interest income, which is the difference between interest earned on its loans and investments and the interest paid on interest-bearing liabilities. Net interest income is determined by (i) the difference between the yield earned on interest-earning assets and rates paid on interest-bearing liabilities (interest rate spread) and (ii) the relative amounts of interest-earning assets and interest-bearing liabilities. HMN's interest rate spread is affected by regulatory, economic and competitive factors that influence interest rates, loan demand and deposit flows. Net interest margin is calculated by dividing net interest income by the average interest-earning assets and is normally expressed as a percentage. Net interest income and net interest margin are affected by changes in interest rates, the volume and the mix of interest-earning assets and interest-bearing liabilities, and the level of non-performing assets. HMN's net income is also affected by the generation of non-interest income, which primarily consists of gains from the sale of securities, gains from sale of loans, service charges, fees and other income. In addition, net income is affected by the level of operating expenses, provisions made for loan losses and impairment reserve adjustments required on mortgage servicing assets. The operations of financial institutions, including the Bank, are significantly affected by prevailing economic conditions, competition and the monetary and fiscal policies of governmental agencies. Lending activities are influenced by the demand for and supply of housing, competition among lenders, the level of interest rates and the availability of funds. Deposit flows and costs of funds are influenced by prevailing market rates of interest primarily on competing investments, account maturities and the levels of personal income and savings in the market area of the Bank. NET INCOME HMN's net income for the second quarter of 1999 was $1.7 million, an increase of $932,000, or 118.9%, compared to $784,000 for the second quarter of 1998. Basic earnings per share were $0.39 for the quarter ended June 30, 1999, an increase of $0.23, or 143.8% per share, from $0.16 basic earnings per share for the same quarter of 1998. Diluted earnings per share were $0.37 for the second quarter of 1999, an increase of $0.23, or 164.3% from $0.14 diluted earnings per share for the second quarter of 1998. HMN's net income for the six month period ended June 30, 1999 was $3.3 million, an increase of $871,000, or 35.6%, compared to $2.4 million for the same period in 1998. Basic earnings per share were $0.74 for the six month period ended June 30, 1999, an increase of $0.27, or 57.5% per share, from $0.47 basic earnings per share for the same six month period of 1998. Diluted earnings per share were $0.71 for the six month period ended June 30, 1999, an increase of $0.28, or 65.1%, from $0.43 diluted earnings per share for the same six month period of 1998. NET INTEREST INCOME Net interest income for the second quarter of 1999 was $4.5 million, an increase of $272,000, or 6.4%, compared to $4.3 million for the second quarter of 1998. Interest income for the second quarter of 1999 was $11.7 million, a decrease of $786,000, or 6.3%, compared to $12.4 million for the second quarter of 1998. Interest income declined $572,000 due to a $32.2 million decrease in net average interest-earning assets from the second quarter of 1998 to the second quarter of 1999, principally due to interest-earning assets being used to fund deposit outflows and to purchase HMN's common stock under its stock repurchase program. Interest income decreased by $214,000 because the yield earned on interest-earning assets decreased from 7.21% for the quarter ended June 30, 1998 to 7.09% for the quarter ended June 30, 1999 primarily due to a decline in interest rates earned on securities and cash equivalents. Interest 16 expense was $7.1 million for the second quarter of 1999, a decrease of $1.1 million, or 12.9%, compared to $8.2 million for the same quarter of 1998. Interest expense decreased by $660,000 due to a net outflow of $46.9 million in average outstanding deposits from the second quarter of 1998, compared to the second quarter of 1999. Interest expense increased by $224,000 due to an increase of $16.6 million in the average outstanding FHLB advances from the second quarter of 1998 to the second quarter of 1999. FHLB advances were used to replace a portion of the funds lost to deposit outflows. Interest expense decreased by $621,000 primarily due to lower interest rates being paid on customer deposits and advances from the FHLB. The average interest rate paid on average interest-bearing liabilities was 4.72% during the second quarter of 1999, compared to 5.17% for the second quarter of 1998. HMN's margin was 2.76% for the second quarter of 1999, an increase of 29 basis points, or 11.7%, from 2.47% for the second quarter of 1998. Net interest income for the six month period ended June 30, 1999 was $9.0 million, an increase of $391,000, or 4.6%, compared to $8.6 million for the same six month period of 1998. Interest income for the six month period ended in 1999 was $23.3 million, a decrease of $1.3 million, or 5.2%, compared to $24.5 million for the same six month period of 1998. Interest income declined by $856,000 due to a $24.1 million decrease in net average interest-earning assets from the six month period ended in 1998 to the same period in 1999, principally due to interest-earning assets being used to fund deposit outflows and to purchase HMN's common stock under its stock repurchase program. Interest income decreased by $428,000 because the yield earned on interest- earning assets for the six month period decreased from 7.24% at June 30, 1998 to 7.11% at June 30, 1999 primarily due to a decline in interest rates earned on securities and cash equivalents. Interest expense was $14.3 million for the six month period ended June 30, 1999, a decrease of $1.7 million, or 10.5%, compared to $16.0 million for the same six month period of 1998. Interest expense decreased by $1.3 million due to a net outflow of $45.7 million in the average outstanding balance of deposits from the six months ended June 30, 1998, compared to the same six month period of 1999. Interest expense increased by $763,000 due to an increase of $28.1 million in the average outstanding FHLB advances for the six months ended June 30, 1998, compared to the same six month period of 1999. FHLB advances were used to replace a portion of the funds lost to deposit outflows. Interest expense decreased by $1.1 million primarily due to lower interest rates being paid on customer deposits and advances from the FHLB. The average interest rate paid on average interest-bearing liabilities was 4.76% during the six month period ended June 30, 1999, compared to 5.19% for the same six month period of 1998. HMN's margin was 2.74% for the six month period ended June 30, 1999, an increase of 21 basis points, or 8.3%, from 2.53% for the same six month period of 1998. PROVISION FOR LOAN LOSSES *The provision for loan losses for the second quarters ended June 30, 1999 and 1998 were both $75,000. The provision for loan losses for the six months ended June 30, 1999 and 1998 were both $150,000. The provision is the result of management's evaluation of the loan portfolio, a historically low level of non- performing loans, minimal loan charge-off experience, and its assessment of the general economic conditions in the geographic area where properties securing the loan portfolio are located such as national and regional unemployment data, single family loan delinquencies as reported separately by the Federal National Mortgage Association (FNMA) and the Federal Home Loan Bank Mortgage Corporation (FHLMC), local single family construction permits and local economic growth rates. Management's evaluation of probable losses inherent in the loan portfolio did not reveal conditions that would cause it to increase the provision for loan losses during 1999 compared to 1998. HMN will continue to monitor its allowance for losses as these conditions dictate. Future economic conditions and other unknown factors will impact the need for future provisions for loan losses. As a result, no assurances can be given that increases in the allowance for loan losses will not be required during future periods. A reconciliation of HMN's allowance for loan losses is summarized as follows: 1999 1998 ------------ -------------- Balance at January 1, $ 3,041,486 2,748,219 Provision 150,000 150,000 Charge-offs (4,676) (8,099) Recoveries 840 1,576 ----------- ------------- Balance at June 30, $ 3,187,650 2,891,696 =========== ============= * This paragraph contains a forward-looking statement(s). Refer to information regarding Forward-looking Information on page 25 of this discussion. 17 NON-INTEREST INCOME Non-interest income for the second quarter of 1999 was $1.3 million, an increase of $814,000, or 156.9%, from $519,000 for the same quarter of 1998. The increase in non-interest income was principally due to a $1.3 million increase in earnings from limited partnership interests and an increase in the gain on the sale of loans of $233,000 which were partially offset by a $714,000 decline in net gain on the sale of securities. In the second quarter of 1998, HMN recognized a charge of $1.14 million as its proportionate share of an impairment reserve established on mortgage servicing assets from its investment in a limited partnership. During the second quarter of 1999, the number of single family mortgage loan refinancings declined primarily due to an increase in the interest rates charged on mortgage loans. The decline in single family loan refinancings caused the loan prepayment assumptions used to calculate the market value of mortgage servicing assets to decline which in turn caused the market value of mortgage servicing assets to increase. The increase in the market value allowed HMN to reverse, during the second quarter of 1999, $382,000 of previously established impairment reserves. Gain on the sale of loans increased due to improved profitability on the sale of loans. During the second quarter of 1999 interest rates in general were increasing which reduced the opportunity to sell fixed rate securities at a gain. Non-interest income for the six month period ended June 30, 1999 was $2.5 million, an increase of $370,000, or 17.2%, from $2.1 million for the same six month period of 1998. The increase in non-interest income was principally due to a $1.3 million increase in earnings from limited partnerships and an increase in gain on the sale of loans of $562,000, which were partially offset by a $1.5 million decline in the net gain from the sale of securities. During the first six months of 1998, HMN recognized a charge of $1.14 million as its proportionate share of an impairment reserve established on mortgage servicing assets from its investment in a limited partnership. During the first six months of 1999, the number of single family mortgage loan refinancings declined primarily due to an increase in the interest rates charged on mortgage loans. The decline in single family loan refinancings caused the loan prepayment assumptions used to calculate the market value of mortgage servicing assets to decline which in turn caused the market value of mortgage servicing assets to increase. The increase in the market value allowed HMN to reverse, during the six month period ended June 30, 1999, $497,000 of previously established impairment reserves. Gain on the sale of loans increased by $562,000 due to improved profitability on the sale of loans. The net gain on the sale of securities for the six months ended June 30, 1999 was $163,000, a decline of $1.5 million from $1.63 million for the same six month period of 1998. During the first six months of 1999 interest rates in general were increasing which reduced the opportunity to sell fixed rate securities at a gain. NON-INTEREST EXPENSE Non-interest expense was $3.0 million for the second quarter of 1999, a decrease of $451,000, or 13.1%, from $3.4 million for the second quarter of 1998. Compensation and benefit expense decreased by $345,000, primarily due to reduced compensation and benefits paid as a result of work force reductions, commissions paid on declining loan production and a reduction in the stock allocation formula for employee stock ownership participants. Non-interest expense declined by $86,000 due to decreased amortization recorded on mortgage servicing assets and it decreased by $52,000 due to a change in HMN's advertising emphasis. Occupancy expense increased by $38,000, primarily due to the occupancy costs related to the new retail banking facility in Winona opening in December 1998. Non-interest expense was $5.9 million for the six months ended June 30, 1999, a decrease of $739,000, or 11.1%, from $6.7 million for the same period of 1998. Compensation and benefit expense decreased by $768,000, primarily due to reduced compensation and benefits paid as a result of work force reductions, commissions paid on declining loan production and a reduction in the stock allocation formula for employee stock ownership participants. HMN changed its advertising emphasis on media and was able to reduce its advertising expense by $75,000. Occupancy expense increased by $93,000 primarily due to the occupancy costs related to new retail banking facilities located in Spring Valley and Winona. The Spring Valley location opened in late February of 1998 and the Winona location opened in December of 1998 so only a portion of the occupancy costs for Spring Valley and none of the occupancy costs for Winona were included in the occupancy costs for 1998, whereas a full six months of costs were included in the six month period ended June 30, 1999. 18 INCOME TAX EXPENSE Income tax expense was $1.1 million for the second quarter of 1999, an increase of $932,000, from $784,000 for the second quarter of 1998. The increase is primarily due to an increase in taxable income between the two quarters. Income tax expense was $3.3 million for the six month period ended June 30, 1999, an increase of $871,000, from $2.4 million for the same period in 1998. The increase is primarily due to an increase in taxable income between the two six month periods. NON-PERFORMING ASSETS The following table sets forth the amounts and categories of non-performing assets in the Bank's portfolio at June 30, 1999 and December 31, 1998. June 30, December 31, (DOLLARS IN THOUSANDS) 1999 1998 ----------- -------------- Non-Accruing Loans One-to-four family real estate $ 154 317 Nonresidential real estate 0 73 Consumer 143 86 ---- ---- Total 297 476 ---- ---- Accruing loans delinquent 9 0 days or more 421 312 ---- ---- Foreclosed Assets Real estate: One-to-four family 16 18 ---- ---- Total non-performing assets $ 734 $ 806 ==== ==== Total as a percentage of total assets 0.11% 0.12% ==== ==== Total non-performing loans $ 718 $ 788 ==== ==== Total as a percentage of total loans receivable, net 0.16% 0.18% ==== ==== Total non-performing assets at June 30, 1999 were $734,000, a decrease of $72,000, from $806,000 at December 31, 1998. Non-accruing loans decreased by $179,000, primarily related to one-to-four family real estate loans being transferred to accruing loan status, nonresidential real estate being brought current on late payments, and a net increase of $57,000 in non-accruing consumer debt. DIVIDENDS During 1998 and 1999 HMN declared and paid dividends as follows: Payable Dividend Record date date per share Dividend Payout Ratio ---------------- --------------- ----------- --------------------- May 27, 1998 June 12, 1998 $0.06 21.4 % August 27, 1998 September 10, 1998 $0.06 42.9 December 1, 1998 December 15, 1998 $0.06 (66.7) February 24, 1999 March 10, 1999 $0.08 21.6 May 26, 1999 June 10, 1999 $0.08 23.5 On July 20, 1999 HMN's Board of Directors announced a cash dividend of $0.08 per share, payable on September 9, 1999 to stockholders of record on August 25, 1999. The annualized dividend payout ratio for the past four quarters was 30.3%. The dividend payout ratio is calculated by dividing dividends per share by diluted earnings per share. The declaration of dividends are subject to, among other things, HMN's financial condition and results of operations, the Bank's compliance with its regulatory capital requirements, including the fully phased-in capital requirements, tax considerations, industry standards, economic conditions, regulatory restrictions, general business practices and other factors. 19 LIQUIDITY For the six month period ended June 30, 1999, the net cash provided by operating activities was $40.4 million. HMN collected $10.9 million from the sale of securities; it collected $51.6 million in principal repayments or on the maturity of securities during the period. HMN also collected $216,000 on the sale of loans receivable during the period. It purchased $57.0 million of securities, funded a net increase in loans receivable of $39.3 million, and purchased premises and equipment of $562,000. HMN had a net deposit outflow of $17.6 million, additional net borrowing from the FHLB of $7.0 million and borrowed $2.5 million from other sources. HMN paid $3.0 million to purchase 234,500 shares of its own common stock during the first six months of 1999 and it paid $717,000 in dividends to its stockholders. *HMN has certificates of deposits with outstanding balances of $183.2 million that come due over the next 12 months. Based upon past experience management anticipates that the majority of the deposits will renew for another term. HMN believes that deposits which do not renew will be replaced with deposits from other customers, or funded with advances from the FHLB, or will be funded through the sale of securities. Management does not anticipate that it will have a liquidity problem due to maturing deposits. *HMN has $24.0 million of FHLB advances which mature over the next 12 months and $14.0 million of FHLB advances which mature in 2001 but have call features which can be exercised by the FHLB on a semiannual basis starting in August or September of 1999. If the call features are exercised HMN has the option of requesting any advance otherwise available to it pursuant to the Credit Policy of the FHLB. Since HMN has the ability to request another advance to replace the advance that is being called, management does not anticipate that it will have a liquidity problem due to advances maturing or being called by the FHLB during the next 12 month period. MARKET RISK Market risk is the risk of loss from adverse changes in market prices and rates. HMN's market risk arises primarily from interest rate risk inherent in its investing, lending and deposit taking activities. Management actively monitors and manages its interest rate risk exposure. HMN's profitability is affected by fluctuations in interest rates. A sudden and substantial increase in interest rates may adversely impact HMN's earnings to the extent that the interest rates borne by assets and liabilities do not change at the same speed, to the same extent, or on the same basis. HMN monitors how its assets will mature or reprice in comparison to how its liabilities will mature or reprice. The MATURITY OR REPRICING TABLE located in the Asset/Liability Management section of this report is used as part of the monitoring process. HMN also monitors the projected changes in net interest income that would occur if interest rates were to suddenly change up or down. The RATE SHOCK TABLE located in the Asset/Liability Management section of this report discloses HMN's projected changes in net interest income based upon immediate interest rate changes called rate shocks. *HMN utilizes a model which uses the discounted cash flows from its interest- earning assets and its interest-bearing liabilities to calculate the current market value of those assets and liabilities. The model also calculates the changes in market value of the interest-earning assets and interest-bearing liabilities due to different interest rate changes. HMN believes that over the next twelve months interest rates could conceivably fluctuate in a range of 200 basis points up or down from where the rates were at June 30, 1999. HMN does not have a trading portfolio. The following table discloses the projected changes in market value to HMN's interest-earning assets and interest-bearing liabilities based upon incremental 100 basis point changes in interest rates from interest rates in effect on June 30, 1999. * This paragraph contains a forward-looking statement(s). Refer to information regarding Forward-looking Information on page 25 of this discussion. 20
- ------------------------------------------------------------------------------ Other than trading portfolio Market Value (Dollars in thousands) Basis point change in interest rates -200 -100 0 +100 +200 - ------------------------------------------------------------------------------ Cash equivalents $ 9,549 9,542 9,534 9,526 9,518 Securities available for sale: Fixed-rate CMOs 20,389 20,470 20,248 19,820 19,344 Variable-rate CMOs 86,926 89,079 88,202 85,534 82,212 Fixed-rate available for sale mortgage-backed and related securities 2,004 1,971 1,932 1,884 1,828 Variable-rate available for sale mortgage-backed and related securities 72 70 68 67 66 Fixed-rate available for sale other marketable securities87,429 85,310 82,937 79,399 76,152 Variable-rate available for sale other marketable securities 1,662 1,660 1,658 1,655 1,653 Fixed-rate loans held for sale 6,730 6,725 6,719 6,714 6,708 Loans receivable, net: Fixed-rate real estate loans 294,525 289,787 282,121 272,977 263,662 Variable-rate real estate loans 122,861 120,971 118,251 114,694 110,486 Fixed-rate other loans 32,592 32,042 31,373 30,627 29,947 Variable-rate other loans 24,510 23,978 23,943 23,921 23,898 Mortgage servicing rights, net 343 686 1,056 1,211 1,332 Investment in limited partnerships 721 1,169 2,792 6,618 7,942 -------- ------- ------- ------ ------- Total market risk sensitive assets 690,313 683,460 670,834 654,647 634,748 -------- ------- ------- ------- ------- NOW deposits 32,054 32,028 32,001 31,975 31,948 Passbook deposits 34,892 33,434 32,093 30,855 29,710 Money market deposits 30,337 29,074 27,912 26,840 25,847 Certificate deposits 323,920 320,192 316,552 312,997 309,525 Fixed-rate Federal Home Loan Bank advances 173,721 165,257 159,858 155,310 150,921 Variable-rate Federal Home Loan Bank advances 31,070 31,045 31,019 30,994 30,968 ------- ------- ------- ------- ------- Total market risk sensitive liabilities 625,994 611,030 599,435 588,971 578,919 ------- ------- ------- ------- ------- Off-balance sheet financial instruments: Commitments to extend credit 57 56 55 53 51 ------- ------- ------- ------- ------- Net market risk $ 64,376 72,486 71,454 65,729 55,880 ======= ======= ======= ======= ======= Percentage change from current market value (9.91)% (1.44)% 0.00% (8.01)% (21.80)% ======= ======= ======= ======= =======
The preceding table was prepared utilizing the following assumptions (the "Model Assumptions") regarding prepayment and decay ratios which were determined by management based upon their review of historical prepayment speeds and future prepayment projections. Fixed rate loans were assumed to prepay at annual rates of between 8% to 45%, depending on the coupon and period to maturity. Adjustable rate mortgages ("ARMs") were assumed to prepay at annual rates of between 10% and 32%, depending on coupon and the period to maturity. Growing Equity Mortgage (GEM) loans were assumed to prepay at annual rates of between 18% and 55% depending on the coupon and the period to maturity. Mortgage-backed securities and Collateralized Mortgage Obligations (CMOs) were projected to have prepayments based upon the underlying collateral securing the instrument and the related cash flow priority of the CMO tranche owned. Certificate accounts were assumed not to be withdrawn until maturity. Passbook and money market accounts were assumed to decay at an annual rate of 20%. FHLB advances were projected to be called at the first call date where the projected interest rate on similar remaining term advances exceeded the interest rate on HMN's callable advance. 21 Certain shortcomings are inherent in the method of analysis presented in the foregoing table. The interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types of assets and liabilities may lag behind changes in market interest rates. The model assumes that the difference between the current interest rate being earned or paid compared to a treasury instrument or other interest index with a similar term to maturity (the 'Interest Spread') will remain constant over the interest changes disclosed in the table. Changes in Interest Spread could impact projected market value changes. Certain assets, such as ARMs, have features which restrict changes in interest rates on a short-term basis and over the life of the assets. The market value of the interest-bearing assets which are approaching their lifetime interest rate caps could be different from the values disclosed in the table. In the event of a change in interest rates, prepayment and early withdrawal levels may deviate significantly from those assumed in calculating the foregoing table. The ability of many borrowers to service their debt may decrease in the event of an interest rate increase. ASSET/LIABILITY MANAGEMENT *HMN's management reviews the impact that changing interest rates will have on its net interest income projected for the twelve months following June 30, 1999 to determine if its current level of interest rate risk is acceptable. The following table projects the estimated annual impact on net interest income of immediate interest rate changes called rate shocks. Rate Shock Net Interest Percentage in Basis Points Income Change --------------- ----------- ----------- +200 $ 21,595 6.68% +100 20,999 3.74% 0 20,242 0.00% -100 19,406 -4.13% -200 18,275 -9.72% The preceding table was prepared utilizing the Model Assumptions regarding prepayment and decay ratios which were determined by management based upon their review of historical prepayment speeds and future prepayment projections. Certain shortcomings are inherent in the method of analysis presented in the foregoing table. In the event of a change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed in calculating the foregoing table. The ability of many borrowers to service their debt may decrease in the event of a substantial increase in interest rates and could impact net interest income. In an attempt to manage its exposure to changes in interest rates, management closely monitors interest rate risk. The Bank has an Asset/Liability Committee consisting of executive officers which meets at least quarterly to review the interest rate risk position and projected profitability. The committee makes recommendations for adjustments to the asset liability position of the Bank to the Board of Directors of the Bank. This committee also reviews the Bank's portfolio, formulates investment strategies and oversees the timing and implementation of transactions to assure attainment of the Board's objectives in the most effective manner. In addition, the Board reviews on a quarterly basis the Bank's asset/liability position, including simulations of the effect on the Bank's capital of various interest rate scenarios. In managing its asset/liability mix, the Bank, at times, depending on the relationship between long- and short-term interest rates, market conditions and consumer preference, may place more emphasis on managing net interest margin than on better matching the interest rate sensitivity of its assets and liabilities in an effort to enhance net interest income. Management believes that the increased net interest income resulting from a mismatch in the maturity of its asset and liability portfolios can, during periods of declining or stable interest rates, provide high enough returns to justify the increased exposure to sudden and unexpected increases in interest rates. *This paragraph contains a forward-looking statement(s). Refer to information regarding Forward-looking Information on page 25 of this discussion. 22 To the extent consistent with its interest rate spread objectives, the Bank attempts to reduce its interest rate risk and has taken a number of steps to restructure its assets and liabilities. The Bank has primarily focused its fixed rate one-to-four family residential lending program on loans with contractual terms of 20 years or less. The Bank generally follows the practice of selling all of its fixed rate single family loans with contractual maturities of thirty years. At times, depending on its interest rate sensitivity, the Bank may sell fixed rate single family loans with shorter contractual maturities than thirty years in order to reduce interest rate risk and record a gain on the sale of loans. *The following table sets forth the interest rate sensitivity of HMN's assets and liabilities at June 30, 1999, using certain assumptions that are described in more detail below:
- -------------------------------------------------------------------------- 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 $ 9,543 0 0 0 Securities available for sale: Mortgage-backed and related securities 100,869 4,012 2,654 700 Other marketable securities 8,995 3,416 27,739 20,764 Loans held for sale, net 6,722 0 0 0 Loans receivable, net Fixed rate one-to- four family 27,233 24,472 75,164 48,583 Adjustable rate one-to-four family 20,851 13,508 26,334 34,992 Multi family 6,511 342 1,525 440 Fixed rate commercial real estate 3,589 2,037 6,306 3,919 Adjustable rate commercial real estate 5,884 2,102 2,759 3,368 Commercial business 4,527 1,610 4,679 2,223 Consumer loans 24,123 2,097 6,144 3,214 Federal Home Loan Bank stock 0 0 0 0 ------- ------ ------- ------- Total interest-earning assets 218,847 53,596 153,304 118,203 ------- ------ ------- ------- Non-interest checking 8,008 0 0 0 NOW accounts 24,084 0 0 0 Passbooks 3,605 3,605 10,383 6,645 Money market accounts 3,149 3,149 9,071 5,805 Certificates 118,068 65,118 103,160 28,815 Federal Home Loan Bank advances 31,000 14,000 31,000 116,400 ------- ------ ------- ------- Total interest- bearing liabilities 187,914 85,872 153,614 157,665 ------- ------ ------- ------- Interest-earning assets less interest-bearing liabilities $ 30,933 (32,276) (310) (39,462) ======= ====== ======= ======= Cumulative interest-rate sensitivity gap $ 30,933 (1,343) (1,653) (41,115) ======= ====== ======= ======= Cumulative interest-rate gap as a percentage of total assets at June 30, 1999 4.55% (0.20)% (0.24)% (6.05)% ======= ====== ======= ======= Over 5 No Stated (DOLLARS IN THOUSANDS) Years Maturity Total - -------------------------------------------------------------------------- Cash equivalents $ 0 0 9,543 Securities available for sale: Mortgage-backed and related securities 3,467 0 111,702 Other marketable securities 5,533 8,587 75,034 Loans held for sale, net 0 0 6,722 Loans receivable, net Fixed rate one-to-four family 78,181 0 253,633 Adjustable rate one-to-four family 228 0 95,913 Multi family 500 0 9,318 Fixed rate commercial real estate 6,034 0 21,885 Adjustable rate commercial real estate 0 0 14,113 Commercial business 2,957 0 15,996 Consumer loans 3,421 0 38,999 Federal Home Loan Bank stock 0 9,838 9,838 ------- ------- ------- Total interest-earning assets 100,321 18,425 662,696 ------- ------- ------- Non-interest checking 0 0 8,008 NOW accounts 0 0 24,084 Passbooks 11,816 0 36,054 Money market accounts 10,320 0 31,494 Certificates 1,392 0 316,553 Federal Home Loan Bank advances 0 0 192,400 ------- ------ ------- Total interest-bearing liabilities 23,528 0 608,593 ------- ------ ------- Interest-earning assets less interest-bearing liabilities $ 76,793 18,425 54,103 ======= ====== ======= Cumulative interest-rate sensitivity gap $ 35,678 58,103 54,103 ======= ====== ======= Cumulative interest-rate gap as a percentage of total assets at June 30, 1999 5.25 % 7.96 % 7.96 % ======= ======= ====== Schedule prepared based upon the earlier of contactural maturity or repricing date, if applicable, adjusted for scheduled repayments of principal and projected prepayments of principal based upon experience. Loans receivable are presented net of loans in process and deferred loan fees.
*This paragraph contains a forward-looking statement(s). Refer to information regarding Forward-looking Information on page 25 of this discussion. 23 The preceding table was prepared utilizing the Model Assumptions regarding prepayment and decay ratios which were determined by management based upon their review of historical prepayment speeds and future prepayment projections. Fixed rate loans were assumed to prepay at annual rates of between 8% to 45%, depending on the coupon and period to maturity. ARMs were assumed to prepay at annual rates of between 10% and 32%, depending on coupon and the period to maturity. GEM loans were assumed to prepay at annual rates of between 18% and 55% depending on the coupon and the period to maturity. Mortgage-backed securities and Collateralized Mortgage Obligations (CMOs) were projected to have prepayments based upon the underlying collateral securing the instrument and the related cash flow priority of the CMO tranche owned. Certificate accounts were assumed not to be withdrawn until maturity. Passbook and money market accounts were assumed to decay at an annual rate of 20%. FHLB advances were projected to be called at the first call date where the projected interest rate on similar remaining term advances exceeded the interest rate on HMN's callable advance. Certain shortcomings are inherent in the method of analysis presented in the foregoing table. Although certain assets and liabilities may have similar maturities and periods of repricing, they may react in different degrees to changes in market interest rates. The interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types of assets and liabilities may lag behind changes in market interest rates. Certain assets, such as adjustable- rate mortgages, have features which restrict changes in interest rates on a short-term basis and over the life of the asset. In the event of a change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed in calculating the foregoing table. The ability of many borrowers to service their debt may decrease in the event of an interest rate increase. YEAR 2000 HMN has been actively engaged in managing the Year 2000 (Y2K) project since September of 1997. HMN's management has consistently met the completion deadlines for various phases of the project that were established by the Federal Financial Institutions Examination Council (FFIEC) guidelines. HMN has an extensive business recovery plan that addresses the procedures that would be implemented in the event of certain types of disasters. A Y2K Contingency Plan (the Plan) was developed by the Y2K Committee to document how HMN would respond to the unique aspects of possible Y2K disruptions. The Plan focuses on the core business processes of HMN and the systems that support those processes in accordance with the FFIEC guidelines. *In developing the Plan HMN inventoried its computer hardware, computer software, third party vendors and its other non-computer equipment and assessed whether the items were Y2K compliant. All non-compliant hardware was replaced in either 1998 or 1999 at an aggregate cost of $102,000. The computer software inventory indicated that certain programs were not compliant. Those software programs were replaced during 1998 and 1999 at an aggregate cost of $80,000. HMN has also tested computer software to determine that the software was Y2K compliant. The assessment of non-computer equipment for Y2K compliance indicated that HMN did not have any significant issues in this area. *The majority of the Bank's loan and deposit data is supported by a third party data processing center. Other third party providers support the automated teller machines owned by the Bank and process the check clearings for the Bank's negotiable order of withdrawal accounts ('checking accounts'). The Bank is also reliant upon the Federal Home Loan Bank of Des Moines and the Federal Reserve System to properly and efficiently conduct its business. Notwithstanding the Bank's efforts, the failure of any of these third party vendors to address their Y2K issues in a timely fashion may have an adverse effect on the Bank's ability to conduct its business and/or process its customers' transactions. The Bank's Y2K Committee has worked very closely with its data processing center to ascertain that their software applications and hardware will be Y2K compliant. The Y2K Committee is also monitoring the progress that other key third party providers are making toward becoming Y2K compliant. The Y2K Committee is not aware that either the data processing center or any other key third party providers to the Bank will have issues related to Y2K that will have an adverse effect on the Bank's ability to conduct its business. *This paragraph contains a forward-looking statement(s). Refer to information regarding Forward-looking Information on page 25 of this discussion. 24 FORWARD-LOOKING INFORMATION The following paragraphs within Management's Discussion and Analysis of Financial Condition and Results of Operations contain forward-looking statements and actual results may differ materially from the expectations disclosed within this Discussion and Analysis. These forward-looking statements are subject to risks and uncertainties, including those discussed below. HMN assumes no obligations to publicly release results of any revision or updates to these forward-looking statements to reflect future events or unanticipated occurrences. PROVISION FOR LOAN LOSSES The provision for loan losses for the second quarters ended June 30, 1999 and 1998 were both $75,000. The provision for loan losses for the six months ended June 30, 1999 and 1998 were both $150,000. The provision is the result of management's evaluation of the loan portfolio, a historically low level of non-performing loans, minimal loan charge-off experience, and its assessment of the general economic conditions in the geographic area where properties securing the loan portfolio are located such as national and regional unemployment data, single family loan delinquencies as reported separately by the Federal National Mortgage Association (FNMA) and the Federal Home Loan Bank Mortgage Corporation (FHLMC), local single family construction permits and local economic growth rates. Management's evaluation of probable losses inherent in the loan portfolio did not reveal conditions that would cause it to increase the provision for loan losses during 1999 compared to 1998. HMN will continue to monitor its allowance for losses as these conditions dictate. Future economic conditions and other unknown factors will impact the need for future provisions for loan losses. As a result, no assurances can be given that increases in the allowance for loan losses will not be required during future periods. LIQUIDITY HMN has certificates of deposits with outstanding balances of $183.2 million that come due over the next 12 months. Based upon past experience management anticipates that the majority of the deposits will renew for another term. HMN believes that deposits which do not renew will be replaced with deposits from other customers, or funded with advances from the FHLB, or will be funded through the sale of securities. Management does not anticipate that it will have a liquidity problem due to maturing deposits. Competitive pricing by other institutions, the desire of a competitor to pay interest rates on deposits that are above the current rates paid by HMN, or the desire by customers to put more of their funds into nontraditional bank products such as stocks and bonds could be circumstances that would cause the maturing certificates to become a liquidity problem. HMN has $24.0 million of FHLB advances which mature over the next 12 months and $14.0 million of FHLB advances which mature in 2001 but have call features which can be exercised by the FHLB on a semiannual basis starting in August or September of 1999. If the call features are exercised HMN has the option of requesting any advance otherwise available to it pursuant to the Credit Policy of the FHLB. Since HMN has the ability to request another advance to replace the advance that is being called, management does not anticipate that it will have a liquidity problem due to advances maturing or being called by the FHLB during the next 12 month period. If circumstances exist which cause the maturing certificates of deposit to become a liquidity problem then the advances which mature and or the advances that would be called by the FHLB would also become a liquidity problem. MARKET RISK HMN utilizes a model which uses the discounted cash flows from its interest-earning assets and its interest-bearing liabilities to calculate the current market value of those assets and liabilities. The model also calculates the changes in market value of the interest-earning assets and interest-bearing liabilities due to different interest rate changes. HMN believes that over the next twelve months interest rates could conceivably fluctuate in a range of 200 basis points up or down from where the rates were at June 30, 1999. HMN does not have a trading portfolio. The following table discloses the projected changes in market value to HMN's interest-earning assets and interest-bearing liabilities based upon incremental 100 basis point 25 changes in interest rates from interest rates in effect on June 30, 1999. Interest rates could fluctuate in a range of more than 200 basis points up or down from where the rates were on June 30, 1999 due to the influence of many unforeseen factors not now known to HMN's management. Certain shortcomings are inherent in the method of analysis in the table presented in the Market Risk section. The interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types of assets and liabilities may lag behind changes in market interest rates. The model assumes that the difference between the current interest rate being earned or paid compared to a treasury instrument or other interest rate index with a similar term to maturity (the Interest Spread) will remain constant over the interest changes disclosed in the table. Changes in Interest Spread could impact projected market value changes. Certain assets, such as ARMs, have features which restrict changes in interest rates on a short-term basis and over the life of the assets. The market value of the interest-bearing assets which are approaching their life time interest rate caps could be different from the values disclosed in the table. In the event of a change in interest rates, prepayment and early withdrawal levels may deviate significantly from those assumed in calculating the foregoing table. The ability of many borrowers to service their debt may decrease in the event of an interest rate increase. ASSET/LIABILITY MANAGEMENT HMN's management reviews the impact that changing interest rates will have on its net interest income projected for the twelve months following June 30, 1999 to determine if its current level of interest rate risk is acceptable. HMN's actual net interest income caused by interest rate changes may differ from the amounts reflected in the table in the Asset/Liability section which projects the estimated impact on net interest income of immediate interest rate changes called rate shocks. The following (Maturing or Repricing) table sets forth the interest rate risk sensitivity of HMN's assets and liabilities at June 30, 1999 using certain assumptions that are described in more detail below. HMN's actual maturing and repricing results of its interest-earning assets and interest-bearing liabilities may differ from the amounts reflected in the gap table. Certain shortcomings are inherent in the method of analysis presented in each of the tables. In the event of a change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed in calculating the foregoing table. The ability of many borrowers to service their debt may decrease in the event of a substantial increase in interest rates and could impact net interest income. YEAR 2000 In developing the Plan HMN inventoried its computer hardware, computer software, third party vendors and its other non-computer equipment and assessed whether the items were Y2K compliant. All non-compliant hardware was replaced in either 1998 or 1999 at an aggregate cost of $102,000. The computer software inventory indicated that certain programs were not compliant. Those software programs were replaced during 1998 and 1999 at an aggregate cost of $80,000. HMN has also tested computer software to determine that the software was Y2K compliant. The assessment of non- computer equipment for Y2K compliance indicated that HMN did not have any significant issues in this area. The majority of the Bank's loan and deposit data is supported by a third party data processing center. Other third party providers support the automated teller machines owned by the Bank and process the check clearings for the Bank's negotiable order of withdrawal accounts ('checking accounts'). The Bank is also reliant upon the Federal Home Loan Bank of Des Moines and the Federal Reserve System to properly and efficiently conduct its business. Notwithstanding the Bank's efforts, the failure of any of these third party vendors to address their Y2K issues in a timely fashion may have an adverse effect on the Bank's ability to conduct its business and/or process its customers' transactions. The Bank's Y2K Committee has worked very closely with its data processing center to ascertain that their software applications and hardware will be Y2K compliant. The Y2K Committee is also monitoring the progress that other key third party providers are making toward becoming Y2K compliant. The Y2K Committee is not aware that either the data processing 26 center or any other key third party providers to the Bank will have issues related to Y2K that will have an adverse effect on the Bank's ability to conduct its business. While HMN has inventoried and assessed its hardware, software and other non computer equipment other unforeseen issues may come to light in the future with the above mentioned items that would cause HMN to incur additional costs in order to become Y2K compliant. While HMN has identified and assessed the Y2K risks related to each of its major third party vendors and providers, it is monitoring their activities related to becoming Y2K compliant. It is still possible that the vendors and providers may not be Y2K compliant and the Plan that HMN has developed would not have anticipated the problem. An example of this situation would be if all the telephone communication lines became inoperative because of a Y2K issue on September 9, 1999, the Bank would not be able to process its daily activity and servicing its customers would be difficult without the communication lines for any extended period of time. It would be difficult to have a contingency plan that would allow the Bank to conduct its business without using the communication lines to transmit its business activity. 27 HMN FINANCIAL, INC. PART II - OTHER INFORMATION ITEM 1. Legal Proceedings. None. ITEM 2. Changes in Securities. Not applicable ITEM 3. Defaults Upon Senior Securities. Not applicable. ITEM 4. Submission of Matters to a Vote of Security Holders. The Annual Meeting of Stockholders of the Company was held on April 27, 1999 at 10:00 a.m.. The following is a record of the votes cast in the election of directors of the Company: FOR VOTE WITHHELD ---------- -------------- Term expiring in 2000: Michael McNeil 4,677,368 94,331 Term expiring in 2001: Richard J. Ziebell 4,686,696 85,003 Term expiring in 2001: James B. Gardner 4,621,964 149,690 Timothy R. Geisler 4,681,701 89,998 Allan R. DeBoer 4,686,509 85,190 Accordingly, the individuals named above were declared to be duly elected directors of the Company for terms to expire as stated above. The following is a record of the votes cast in respect of the proposal to ratify the appointment of KPMG LLP as the Company's auditors for the fiscal year ending December 31, 1999. NUMBER PERCENTAGE OF VOTES OF VOTES ACTUALLY CAST ------------- ---------------- FOR 4,703,896 98.58% AGAINST 31,137 .65% ABSTAIN 36,666 .77% BROKER NON-VOTES -- 0% 28 Accordingly, the proposal described above was declared to be duly adopted by the stockholders of the Company. ITEM 5. Other Information. None. ITEM 6. Exhibits and Reports on Form 8-K. (a) Exhibits. See Index to Exhibits on page 30 of this report. 29 SIGNATURES Pursuant to the requirement of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. HMN FINANCIAL, INC. Registrant Date: 8/13/99 /s/ Roger P. Weise ----------------------- -------------------------------- Roger P. Weise, Chairman, President and Chief Executive Officer (Duly Authorized Officer) Date: 8/13/99 /s/ James B. Gardner ----------------------- -------------------------------- James B. Gardner, Executive Vice President (Principal Financial Officer) 30 HMN FINANCIAL, INC. INDEX TO EXHIBITS FOR FORM 10-Q Sequential Reference Page Numbering to Prior Where Attached Filing or Exhibits Are Exhibit Located Number In This Regulation S-K Attached Form 10-Q Exhibit Number Document Hereto Report - -------------- ----------------------- ------------- ------------ 3.1 Amended and Restated Articles of Incorporation *1 N/A 3.2 Amended and Restated By-laws *2 N/A 4 Form of Common Stock Certificate *3 N/A 10.1 Extension of Employment Agreement 10.1 Filed electronically for Roger P. Weise dated May 25, 1999 10.2 Extension of Employment Agreement 10.2 Filed electronically for James B. Gardner dated May 25, 1999 11 Computation of Earnings Per Common Share 11 Filed electronically 27 Financial Data Schedule 27 Filed electronically *1 Incorporated by reference to the same numbered exhibit to the Company's Quarterly Report on Form 10-Q for the period ended March 31, 1998 (File No. 0- 24100). *2 Incorporated by reference to the same numbered exhibit to the Company's Quarterly Report on Form 10-Q for the period ended September 30, 1997 (File No. 0-24100). *3 Incorporated by reference to the same numbered exhibit to the Company's Registration Statement on Form S-1 dated April 1, 1994 (File No. 33-77212). 31 EX-10 2 MEMORANDUM TO: Roger P. Weise FROM: Carol J. Thouin, Corporate Secretary DATE: May 25, 1999 RE: Notice of Extension of Employment Contract - ---------------------------------------------------------------- The Board of Directors (the 'Board') of Home Federal Savings Bank has reviewed your formal performance evaluation performed by selected members of the Board. In connection therewith and pursuant to Section 1 of your contract, on May 25, 1999, the Board determined to extend your employment contract until the May Board Meeting, 2002. HOME FEDERAL SAVINGS BANK By: /s/ M.F. Schumann --------------------------- M.F. Schumann Director EMPLOYEE ACKNOWLEDGMENT I hereby acknowledge receipt of this notice of extension of the above-referenced agreement and accept the extension of the term of such agreement. EMPLOYEE Dated: May 25, 1999 By: /s/ Roger P. Weise --------------------- ------------------------ Roger P. Weise EX-10 3 MEMORANDUM TO: James B. Gardner FROM: Carol J. Thouin, Corporate Secretary DATE: May 25, 1999 RE: Notice of Extension of Employment Contract - ---------------------------------------------------------------- The Board of Directors (the "Board") of Home Federal Savings Bank has reviewed your formal performance evaluation performed by selected members of the Board. In connection therewith and pursuant to Section 1 of your contract, on May 25, 1999, the Board determined to extend your employment contract until the May Board Meeting, 2002. HOME FEDERAL SAVINGS BANK By: /s/ M.F. Schumann --------------------------- M.F. Schumann Director EMPLOYEE ACKNOWLEDGMENT I hereby acknowledge receipt of this notice of extension of the above-referenced agreement and accept the extension of the term of such agreement. EMPLOYEE Dated: May 25, 1999 By: /s/ James B. Gardner --------------------- -------------------------- James B. Gardner EX-11 4 EXHIBIT 11 - Computation of Earnings per Common Share HMN Financial, Inc. Computation of Earnings Per Common Share (Unaudited) Three months ended Six Months ended June 30, June 30, 1999 1998 1999 1998 --------------------- ---------------------- Weighted average number of common shares outstanding used in basic earnings per common share calculation 4,442,471 5,051,205 4,465,679 5,248,262 Net dilutive effect of: Options 167,858 379,759 177,041 391,398 Restricted stock awards 20,019 54,197 23,267 57,773 --------- --------- --------- --------- Weighted average number of shares outstanding adjusted for effect of dilutive securities 4,630,348 5,485,161 4,665,987 5,697,433 ========= ========= ========= ========= Income available to common shareholders $ 1,716,347 784,030 3,318,347 2,447,385 Basic earnings per common share $ 0.39 0.16 0.74 0.47 Diluted earnings per common share $ 0.37 0.14 0.71 0.43 The earnings per share calculations reflected above are presented as if the split had been completed at the beginning of each period presented for the weighted average number of shares outstanding for each period. EX-27 5
9 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED BALANCE SHEETS AT JUNE 30, 1999 AND DECEMBER 31, 1998 AND THE CONSOLIDATED STATEMENTS OF INCOME FOR THE THREE MONTHS AND SIX MONTHS ENDED JUNE 30, 1999 AND 1998, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS 1000 6-MOS DEC-31-1999 JAN-01-1999 JUN-30-1999 2,413 8,130 0 0 183,341 0 0 446,670 3,188 679,974 416,192 24,000 4,187 168,400 0 0 91 67,104 679,974 17,407 5,552 304 23,263 9,143 14,289 8,974 150 163 5,925 5,418 0 0 0 3,318 .74 .71 2.74 297 421 0 133 3,041 (4) 1 3,188 1,284 0 1,904
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