10-K

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

ý ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [ No Fee Required]

For the fiscal year ended December 31, 2003

OR

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [No Fee Required]

For the transition period from            to             .

Commission file number 0-24100.

HMN FINANCIAL, INC.

(Exact Name of Registrant as Specified in its Charter)

Delaware	41-1777397
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
1016 Civic Center Drive Northwest PO Box 6057 Rochester, Minnesota	55901
(Address of principal executive offices)	(Zip Code)
Registrant’s telephone number, including area code:	(507) 535-1200

Securities Registered Pursuant to Section 12(b) of the Act:   None

Securities Registered Pursuant to Section 12(g) of the Act:   Common Stock, par value $.01 per share  (Title of Class)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such requirements for the past 90 days.   YES ý NO  o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best or registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ý

Indicate by checkmark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act.)   YES o NO ý

The aggregate market value of the voting stock held by non-affiliates of the registrant as of June 30, 2003 (the last business day of the registrant’s most recently completed second fiscal quarter), was approximately $64.7 million computed by reference to the average high and low prices of $19.40 on such date as reported on Nasdaq National Market.   (The exclusion from such amount of the market value of the shares owned by any person shall not be deemed an admission by the Registrant that such person is an affiliate of the Registrant.)

As of March 2, 2004, the Registrant had issued and outstanding 4,535,280 shares of the Registrant’s Common Stock.

Our Internet website is http://www.hmnf.com and you may access, free of charge, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to such reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission.

DOCUMENTS INCORPORATED BY REFERENCE

Parts of the Registrant’s Annual Report for the year ended December 31, 2003, are incorporated by reference in Parts I, II and IV of this Form 10-K. Parts of the Registrant’s Proxy Statement dated March 12, 2004, are incorporated by reference in Part III of this Form 10-K.

TABLE OF CONTENTS

PART I
Item 1.	Business
	General
	Market Area
	Lending Activities
	Origination, Purchases and Sales of Mortgage-Backed and Related Securities
	Classified Assets and Delinquencies
	Investment Activities
	Sources of Funds
	Other Information
	Service Corporations of the Bank
	Competition
	Other Corporations Owned by HMN
	Employees
	Regulation and Supervision
	Forward-looking Information
Item 2.	Properties
Item 3.	Legal Proceedings
Item 4.	Submission of Matters to a Vote of Security Holders
PART II
Item 5.	Market for the Registrant’s Common Equity and Related Stockholder Matters
Item 6.	Selected Financial Data
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 7A.	Quantitative and Qualitative Disclosure About Market Risk
Item 8.	Financial Statements and Supplementary Data
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Item 9A.	Controls and Procedures
PART III
Item 10.	Directors and Executive Officers of the Registrant
Item 11.	Executive Compensation
Item 12.	Security Ownership of Certain Beneficial Owners and Management
Item 13.	Certain Relationships and Related Transactions
Item 14.	Principal Accountant Fees and Services
PART IV
Item 15.	Exhibits, Financial Statement Schedules and Reports on Form 8-K
Signatures
Index to Exhibits

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PART I

ITEM 1.     BUSINESS

General

HMN Financial, Inc. (HMN or the Company) is a stock savings bank holding company that owns 100 percent of Home Federal Savings Bank (the Bank).  The Bank has a community banking philosophy and operates retail banking and loan production facilities in Minnesota and Iowa.  The Bank also provides highly personalized financial services to a select group of individuals and businesses through Eagle Crest Capital Bank, a division of Home Federal Savings Bank, in Edina and Rochester, Minnesota.  The Bank has two wholly owned subsidiaries, Osterud Insurance Agency, Inc. (OAI) which offers financial planning products and services and Home Federal Holding, Inc. (HFH) which is the holding company for Home Federal REIT, Inc. (HFREIT) which invests in real estate loans acquired from the Bank.  HMN has another wholly owned subsidiary, Security Finance Corporation (SFC) which acts as an intermediary for the Bank in transacting like-kind property exchanges for Bank customers.  The Bank has a 51% owned subsidiary, Home Federal Mortgage Services, LLC (HFMS), which was a mortgage banking and mortgage brokerage business located in Brooklyn Park, Minnesota.  HFMS’s brokerage and production activity stopped during the third quarter of 2002, its assets were liquidated in 2003 and it is in the process of being dissolved.  The Bank has an 80% owned subsidiary, Federal Title Services, LLC (FTS), which performs mortgage title services for Bank customers.

As a community-oriented financial institution, HMN seeks to serve the financial needs of communities in its market area.  HMN’s business involves attracting deposits from the general public and businesses and using such deposits to originate or purchase one-to-four family residential, commercial real estate, and multi-family mortgage loans in addition to consumer, construction, and commercial business loans.  HMN also invests in mortgage-backed and related securities, investment securities (consisting primarily of U.S. government agency obligations) and other permissible investments.  The executive offices of HMN are located at 1016 Civic Center Drive Northwest, Rochester, Minnesota 55901.  Its telephone number at that address is (507) 535-1200.

Market Area

The Company serves the southern Minnesota counties of Fillmore, Freeborn, Houston, Mower, Olmsted and Winona and portions of Steele, Dodge, Goodhue and Wabasha through its corporate office located in Rochester, Minnesota and its nine branch offices located in Albert Lea, Austin, LaCrescent, Rochester, Spring Valley and Winona, Minnesota. The portion of HMN’s southern Minnesota market area consisting of Rochester and the contiguous communities is composed of primarily urban and suburban communities, while the balance of the Company’s southern Minnesota market area consists primarily of rural areas and small towns.  Primary industries in the Company’s southern Minnesota market area include manufacturing, agriculture, health care, wholesale and retail trade, service industries and education. Major employers include IBM, Mayo Clinic, Hormel - a food processing company, and various other companies. The Company’s market area is also the home of Winona State University, Rochester Community and Technical College, University of Minnesota - - Rochester Center, Winona State University - Rochester Center and Austin’s Riverland Community College.

The Company serves the Iowa counties of Marshall and Tama through its branch offices located in Marshalltown and Toledo. Major industries in the area are Swift & Company - pork processors, Fisher Controls International - valve and regulator manufacturing, Lennox Industries - furnace and air conditioner manufacturing, Iowa Veterans Home - hospital care, Marshall Community School District - education, Marshall Medical & Surgical Center - hospital care and Meskwaki Casino - gaming operations.

Based upon information obtained from the U.S. Census Bureau for 2001 (the last year for which information is available), the population of the six primary counties in the Bank’s southern Minnesota market area was as follows:  Fillmore - 21,296; Freeborn - 32,300; Houston - 19,940; Mower - 38,631; Olmsted - 126,275; and Winona - 49,588. The median household income for these six counties ranged from $36,651 to $51,316.  With respect to Iowa, the population of Marshall County was 39,438 and the population of Tama County was 18,045. The median household income of these two counties ranged from $37,419 to $38,268.

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The Company also serves a diverse high net worth customer base primarily in the seven county metropolitan area of Minneapolis and St. Paul from Eagle Crest Capital Bank, a division of Home Federal Savings Bank, located in Edina, Minnesota.  The Company serves a similar group of individuals and businesses in Olmsted county from its Eagle Crest Capital Bank location in Rochester, Minnesota.

Lending Activities

General.  Historically, the Company has originated 15 and 30-year, fixed-rate mortgage loans secured by one-to-four family residences for its loan portfolio.  Over the past five years, the Company has focused on reducing interest rate risk and increasing interest income by increasing its investment in shorter term and generally higher yielding commercial real estate and commercial business loans and reducing its investment in longer term (greater than 15 year) one-to-four family real estate loans.  The Company continues to originate 15 and 30 year fixed rate mortgage loans, however, the majority of these loans are sold in the secondary mortgage market and adjustable rate mortgage loans that are fixed for an initial period of one, three or five years are placed into portfolio.  The Company also offers a competitive array of consumer loan products which includes both open lines and closed end home equity loans as well as other consumer loans. The home equity line of credit has an adjustable interest rate based upon the Wall Street Journal prime rate plus a margin. Refer to Note 4 of the Notes to Consolidated Financial Statements in the Annual Report for more information on the loan portfolio.

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The following table shows the composition of the Company’s loan portfolio by fixed and adjustable-rate loans as of December 31:

	2003				2002				2001				2000				1999
(Dollars in thousands)	Amount		Percent		Amount		Percent		Amount		Percent		Amount		Percent		Amount		Percent
Fixed-Rate Loans
Real Estate:
One-to-four family
GEM	$	13,387	1.89	%	$	17,394	3.18	%	$	30,727	6.38	%	$	47,811	9.08	%	$	51,309	10.56	%
Other	65,004		9.17		74,510		13.63		110,619		22.97		158,083		30.03		187,796		38.66
Total one-to-four family	78,391		11.06		91,904		16.81		141,346		29.35		205,894		39.11		239,105		49.22
Multi-family	6,471		0.91		6,588		1.20		7,644		1.59		7,099		1.35		7,475		1.54
GEM - multi-family	61		0.01		64		0.01		68		0.01		71		0.01		74		0.02
Commercial	52,563		7.42		37,878		6.93		29,756		6.18		27,743		5.27		27,801		5.72
Construction or development	17,215		2.43		17,234		3.15		15,542		3.22		2,126		0.40		5,011		1.03
Total fixed-rate real estate loans	154,701		21.83		153,668		28.10		194,356		40.35		242,933		46.14		279,466		57.53
Consumer loans:
Savings	494		0.07		534		0.10		594		0.12		695		0.13		733		0.15
Automobile	14,754		2.08		11,062		2.02		6,624		1.38		6,363		1.21		4,532		0.93
Home equity	18,742		2.65		21,049		3.85		26,300		5.46		27,832		5.29		16,962		3.49
Mobile home	3,665		0.52		4,534		0.83		5,456		1.13		4,921		0.94		791		0.16
Other	3,859		0.54		4,080		0.75		4,093		0.85		3,650		0.69		2,311		0.48
Total consumer loans	41,515		5.86		41,259		7.55		43,067		8.94		43,461		8.26		25,329		5.21
Commercial business loans	51,609		7.28		42,272		7.73		37,123		7.71		27,821		5.28		18,936		3.90
Total other loans	93,123		13.14		83,531		15.28		80,190		16.65		71,282		13.54		44,265		9.11
Total fixed-rate loans	247,824		34.97		237,199		43.38		274,546		57.00		314,215		59.68		323,731		66.64
Adjustable-Rate Loans
Real estate:
One-to-four family	65,924		9.30		59,662		10.91		74,102		15.38		106,994		20.32		105,569		21.73
Multi-family	25,008		3.53		9,113		1.67		6,657		1.38		4,920		0.93		724		0.15
Commercial	146,603		20.69		92,539		16.92		41,012		8.52		33,911		6.44		16,309		3.36
Construction or development	78,131		11.02		44,102		8.07		31,435		6.53		18,085		3.44		11,035		2.27
Total adjustable-rate real estate loans	315,666		44.54		205,416		37.57		153,206		31.81		163,910		31.13		133,637		27.51
Consumer (home equity and other)	64,391		9.09		55,162		10.09		36,064		7.49		27,435		5.21		22,907		4.72
Commercial business loans	80,808		11.40		48,989		8.96		17,817		3.70		20,939		3.98		5,499		1.13
Total adjustable-rate loans	460,865		65.03		309,567		56.62		207,087		43.00		212,284		40.32		162,043		33.36
Total loans	708,689		100.00	%	546,766		100.00	%	481,633		100.00	%	526,499		100.00	%	485,774		100.00	%
Less
Loans in process	11,298				6,826				4,692				2,953				2,771
Unamortized discounts	166				142				278				289				297
Net deferred loan fees	1,334				1,068				1,212				1,348				1,537
Allowance for losses on loans	6,940				4,824				3,783				3,144				3,273
Total loans receivable, net	$	688,951			$	533,906			$	471,668			$	518,765			$	477,896

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The following table illustrates the interest rate maturities of the Company’s loan portfolio at December 31, 2003. Loans which have adjustable or renegotiable interest rates are shown as maturing in the period during which the contract is due. Scheduled repayments of principal are reflected in the year in which they are scheduled to be paid.

	Real Estate
	One-to-four family				Multi-family and Commercial				Construction				Consumer				Commercial Business				Total
Due During Years Ending December 31,	Amount		Weighted Average Rate		Amount		Weighted Average Rate		Amount		Weighted Average Rate		Amount		Weighted Average Rate		Amount		Weighted Average Rate		Amount		Weighted Average Rate
2004 (1)	$	14,969	6.45	%	$	29,774	6.22	%	$	30,481	6.12	%	$	17,401	7.70	%	$	65,675	5.36	%	$	158,300	6.04	%
2005	8,356		6.09		20,048		6.90		11,624		6.32		14,710		7.10		16,789		6.21		71,527		6.59
2006	8,277		6.03		43,369		6.75		1,963		5.99		13,467		7.18		18,737		6.10		85,813		6.59
2007 through 2008	15,974		5.89		40,413		6.81		454		6.13		21,586		6.91		16,927		6.76		95,354		6.66
2009 through 2013	37,878		5.68		62,076		6.82		8,033		4.68		30,969		6.59		9,546		6.18		148,502		6.33
2014 through 2028	68,920		5.71		34,422		5.92		18,878		5.30		7,773		6.65		4,785		5.99		134,778		5.77
2029 and following	14,416		5.48		0		0.00		0		0.00		0		0.00		0		0.00		14,416		5.48
	$	168,790			$	230,102			$	71,433			$	105,906			$	132,459			$	708,690

(1)Includes demand loans, loans having no stated maturity, and overdraft loans.

The total amount of loans due after December 31, 2004 which have predetermined interest rates is $186.1 million, while the total amount of loans due after such date which have floating or adjustable interest rates is $364.2 million.

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Under the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA), the aggregate amount of loans that the Bank is permitted to make to any one borrower is generally limited to 15% of unimpaired capital and surplus (25% if the security for such loan has a “readily ascertainable” value or 30% for certain residential development loans).  At December 31, 2003, based upon the 15% limitation, the Bank’s regulatory limit for loans-to-one borrower was approximately $10.8 million. At December 31, 2003, the dollar amount of outstanding loans to three borrowers or groups of related borrowers exceeded this amount, but some of the loans included in these loan totals were exempt from the lending limit due to the “Direct Benefit and Common Enterprise Rules”. Some of the loans to one of the borrowers were secured by certificates of deposit or marketable securities held by the Bank, which provided the Bank with an expanded lending limit.  The total loans outstanding to these borrowers at December 31, 2003 were $13.8 million, $11.6 million, and $11.2 million, respectively.  The amounts outstanding, excluding those loans that were exempt from the loans to one borrower limits because of the “Direct Benefit and Common Enterprise Rules”, were $8.8 million, $7.6 million and $6.2 million, respectively.  The largest borrowing relationship is secured by various manufacturing and food processing facilities as well as equipment.  The loans relating to this borrowing relationship were performing in accordance with their terms at December 31, 2003.

All of the Bank’s lending is subject to its written underwriting standards and to loan origination procedures. Decisions on loan applications are made on the basis of detailed applications and property valuations determined by an independent appraiser. The loan applications are designed primarily to determine the borrower’s ability to repay. The more significant items on the application are verified through use of credit reports, financial statements, tax returns and/or confirmations. The Bank also offers the Home Credit Plus Program which relies on the credit score of the loan applicant instead of income, asset and employment verification procedures.  The Bank also offers low or alternative documentation underwriting procedures which conform to Federal National Mortgage Association (FNMA) underwriting guidelines.

The Bank’s Mortgage and Consumer Loan Committee is responsible for reviewing and approving all loans over the Federal Home Loan Mortgage Corporation (FHLMC)/FNMA conforming loan dollar limit (the Limit) originated by the Bank which are not sold in the secondary loan market. The Limit was $322,700 for 2003 and $300,700 for 2002.  Approval of one member of the Mortgage and Consumer Loan Committee was obtained on all loans above the Limit.

The Bank’s Commercial Loan Committee is responsible for reviewing and approving individual commercial loans or loans to borrowers with aggregate lending relationships ranging from $1.0 million to $7.5 million.  The Bank’s individual commercial loan officers have the authority to approve loans which meet the guidelines established by the commercial loan policy for loans up to $250,000, subject to specific loan officer authority limits.  The Bank’s Commercial Loan Officers Committee has the authority to approve loans which meet the commercial loan policy guidelines that are less than $1.0 million.  Individual loans of $7.5 million or more, and loans to borrowers with aggregate lending relationships that exceed that amount, must be approved by the Board of Directors or its Executive Commercial Loan Committee.

The Bank generally requires title insurance on its mortgage loans as well as fire and extended coverage casualty insurance in amounts at least equal to the principal amount of the loan or the value of improvements on the property. The Bank also requires flood insurance to protect the property securing its interest when the property is located in a flood plain.

One-to-Four Family Residential Real Estate Lending.  At December 31, 2003 the Company’s one-to-four family real estate loans, consisting of both fixed rate and adjustable rate loans, totaled $144.3 million, a decline of $7.3 million, from $151.6 million at December 31, 2002.  This decrease in the one-to-four family loans is consistent with the Company’s strategy of changing the composition of its portfolio toward commercial and consumer loans.

The Company offers conventional fixed-rate one-to-four family loans that have maximum terms of 30 years. In order to reduce interest rate risk, the Company sells the majority of fixed rate loan originations or refinances with terms to maturity of 15 years or greater that are eligible for sale in the secondary market. The

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interest rates charged on the fixed-rate loan products are set based on the FNMA delivery rates, as well as other competitive factors.   The Company also originates a limited number of fixed-rate loans with terms up to 30 years which are insured by the Federal Housing Authority (FHA), Veterans Administration (VA) and Minnesota Home Finance Administration (MHFA).

The Company also offers one-year ARMs at a margin (generally 275 to 375 basis points) over the yield on the Average Monthly One Year U.S. Treasury Constant Maturity Index for terms of up to 30 years. The ARM loans offered by the Company allow the borrower to select (subject to pricing) an initial period of one year, three years, or five years between the loan origination and the date the first interest rate change occurs.  The ARMs generally have a 200 basis point annual interest rate change cap and a lifetime cap of 600 basis points over or under the initial rate. Initial interest rates offered on the ARM loans during 2003 ranged from 100 basis points below the fully indexed loan rate to 100 basis points over that rate. All borrowers are qualified for the loan at the fully indexed rate. HMN’s originated ARMs do not permit negative amortization of principal, generally do not contain prepayment penalties and are not convertible into fixed-rate loans.

In underwriting one-to-four family residential real estate loans, the Company evaluates the borrower’s credit history; ability to make principal, interest and escrow payments; the value of the property that will secure the loan; and debt to income ratios. Properties securing one-to-four family residential real estate loans made by the Company are appraised by independent fee appraisers.  The Company originates residential mortgage loans with loan-to-value ratios up to 100% for owner-occupied homes and up to 90% for non-owner occupied homes; however, private mortgage insurance is generally required to reduce the Company’s ratio to 80% or less on most loans.  The Company generally seeks to underwrite its loans in accordance with secondary market standards.

The Company’s residential mortgage loans customarily include due-on-sale clauses giving it the right to declare the loan immediately due and payable in the event that, among other things, the borrower sells or otherwise disposes of the property subject to the mortgage.

Fixed rate loans in the Company’s portfolio include both GEM loans and conventional fixed-rate loans.  The GEM loans require payments which increase after the first year. Under the GEM loans, the monthly payments required for the first year are established based on a 30-year amortization schedule.  Depending upon the program selected, the payments may increase in the succeeding years by amounts ranging from 0% to 6.2%. Most of the GEM loans originated by the Company provide for at least four annual payment increases over the first five years of the loan. The increased payments required under GEM loans are applied to principal and have the effect of shortening the term to maturity; the GEM loans do not permit negative amortization. The Company currently offers one GEM product with a contractual maturity of approximately 15 years. The GEMs are generally priced based upon loans with similar contractual maturities. The GEMs are popular with consumers who anticipate future increases in income and who desire an amortization schedule of less than 30 years.  The low mortgage interest rates over the past several years has decreased the demand for GEM loans as consumers have opted for shorter term fixed rate loans.

Commercial Real Estate and Multi-Family Lending.   The Company originates permanent commercial real estate and multi-family loans secured by properties located primarily in its market area. It also purchases commercial real estate and multi-family loans originated by third parties on properties outside of its market area.  The commercial real estate and multi-family loan portfolio includes loans secured by motels, hotels, apartment buildings, churches, office buildings, business facilities, shopping malls, nursing homes, golf courses, warehouses and other non-residential building properties primarily located in the upper midwestern United States.

Permanent commercial real estate and multi-family loans are generally originated for a maximum term of 15 years and may have longer amortization periods with balloon maturity features. The interest rates may be fixed for the term of the loan or have adjustable features which are tied to prime or a published index. Commercial real estate and multi-family loans are generally written in amounts up to 80% of the lesser of the appraised value of the property or the purchase price and generally have a debt service coverage ratio of at least 120%. The debt service coverage is the ratio of net cash from operations before debt service payments.  The Company may

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originate construction loans secured by commercial or multi-family real estate, or may purchase participation interests in third party originated construction loans secured by commercial or multi-family real estate.

Appraisals on commercial real estate and multi-family real estate properties are performed by independent appraisers prior to the time the loan is made.  For transactions less than $250,000, the Company may use an internal valuation.  All appraisals on commercial and multi-family real estate are reviewed and approved by a commercial loan officer, credit manager, commercial department manager, or a qualified third party.  The Bank’s underwriting procedures require verification of the borrower’s credit history, income and financial statements, banking relationships and income projections for the property. All commercial real estate and multi-family loans over $1.0 million must be approved by a majority of the Commercial Loan Committee prior to closing.  The commercial loan policy generally requires personal guarantees from the proposed borrowers.  An initial on-site inspection is generally required for all collateral properties for loans with balances in excess of $250,000.  Independent annual reviews are performed for aggregate commercial lending relationships that exceed $500,000.  The reviews cover financial performance, documentation completeness and accuracy of loan risk ratings.

At December 31, 2003, the Company’s two largest commercial real estate loans totaled $10.8 million and $9.9 million.  The first loan is secured by land to be developed in Rochester, Minnesota and the second loan is secured by a golf course development in Byron, Minnesota.  Both of these loans were performing at December 31, 2003.

Multi-family and commercial real estate loans generally present a higher level of risk than loans secured by one-to-four family residences. This greater risk is due to several factors, including the concentration of principal in a limited number of loans and borrowers, the effects of general economic conditions on income producing properties and the increased difficulty of evaluating and monitoring these types of loans.  Furthermore, the repayment of loans secured by multi-family and commercial real estate is typically dependent upon the successful operation of the related real estate project. If the cash flow from the project is reduced (for example, if leases are not obtained or renewed), the borrower’s ability to repay the loan may be impaired. At December 31, 2003, $2.2 million of loans in the commercial real estate portfolio were nonperforming.  There were three nonperforming loans in this category at December 31, 2003 with the largest one being a $1.7 million loan secured by a hotel.  There can be no assurance that the amount of nonperforming loans will not increase in the future.

Construction Lending.  The Company makes construction loans to individuals for the construction of their residences and to builders for the construction of one-to-four family residences. It also makes some loans to builders for houses built on speculation.  Construction loans also include commercial real estate loans.

Almost all loans to individuals for the construction of their residences are structured as permanent loans.  Such loans are made on the same terms as residential loans, except that during the construction phase, which typically lasts up to seven months, the borrower pays interest only. Generally, the borrower also pays a construction fee at the time of origination equal to the origination fee plus other costs associated with processing the loan. Residential construction loans are underwritten pursuant to the same guidelines used for originating residential loans on existing properties.

Construction loans to builders or developers of one-to-four family residences generally carry terms of one year or less. Such loans may permit the payment of interest from loan proceeds.

Construction loans to owner occupants are generally made in amounts up to 95% of the lesser of cost or appraised value, but no more than 85% of the loan proceeds can be disbursed until the building is completed. HMN generally limits the loan-to-value ratios on loans to builders to 80%. Prior to making a commitment to fund a construction loan, the Company requires a valuation of the property, financial data, and verification of the borrower’s income. The Company obtains personal guarantees for substantially all of its construction loans to builders.  Personal financial statements of guarantors are also obtained as part of the loan underwriting process. Construction loans are generally located in the Company’s market area.

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Construction loans are obtained principally through continued business from builders and developers who have previously borrowed from the Bank, as well as referrals from existing customers and walk-in customers. The application process includes a submission to the Bank of accurate plans, specifications and costs of the project to be constructed. These items are used as a basis to determine the appraised value of the subject property to be built.

At December 31, 2003 construction real estate loans totaled $95.3 million of which one-to-four family residential loans totaled $44.6 million, multi-family residential totaled $23.3 million and commercial real estate totaled $27.4 million.

The nature of construction loans is such that they are more difficult to evaluate and monitor.  The risk of loss on a construction loan is dependent largely upon the accuracy of the initial estimate of the property’s value upon completion of the project, experience of the builder, and the estimated cost (including interest) of the project. If the estimate of value proves to be inaccurate, the Company may be confronted, at or prior to the maturity of the loan, with a project having a value which is insufficient to assure full repayment and/or the possibility of having to make substantial investments to complete and sell the project.  Because defaults in repayment may not occur during the construction period it may be difficult to identify problem loans at an early stage.  In such cases, the Company may be required to modify the terms of the loan.

Consumer Lending.The Company originates a variety of consumer loans, including home equity loans (open-end and closed-end), automobile, home improvement, mobile home, lot loans, deposit account and other loans for household and personal purposes.

Consumer loan terms vary according to the type and value of collateral, length of contract and creditworthiness of the borrower. The Company’s consumer loans are made at fixed or adjustable interest rates, with terms up to 20 years for secured loans and up to three years for unsecured loans.

The Company’s home equity loans are written so that the total commitment amount, when combined with the balance of any other outstanding mortgage liens, may not exceed 100% of the appraised value of the property.  The closed-end home equity loans are written with fixed or adjustable-rates with terms up to 15 years.  The open-end home equity lines are written with an adjustable rate with terms up to 20 years, a 10 year draw period which requires “interest only” payments and a 10 year repayment period which fully amortizes the outstanding balance.  The consumer may access the open-end home equity line either by making a withdrawal at the Bank or writing a check on the home equity line of credit account.  Open and closed-end equity loans, which are generally secured by second mortgages on the borrower’s principal residence, represented 69.1% of the consumer loan portfolio at December 31, 2003.

The underwriting standards employed by the Bank for consumer loans include a determination of the applicant’s payment history on other debts and ability to meet existing obligations and payments on the proposed loan. Although creditworthiness of the applicant is of primary consideration, the underwriting process also includes a comparison of the value of the security, if any, in relation to the proposed loan amount. Consumer loans may entail greater credit risk than do residential mortgage loans, particularly in the case of consumer loans which are unsecured or are secured by rapidly depreciable assets, such as automobiles or mobile homes. In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation. In addition, consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be affected by adverse personal circumstances. Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans. At December 31, 2003, $1.0 million of the consumer loan portfolio was non-performing. There can be no assurance that the amount of nonperforming loans will not increase in the future.

Commercial Business Lending.  In order to satisfy the demand for financial services to individuals and businesses in its market area, the Company maintains a portfolio of commercial business loans primarily to retail and manufacturing operations and professional firms.  The Company’s commercial business loans generally have terms ranging from six months to five years and may have either fixed or variable interest rates.  The Company’s

10

commercial business loans generally include personal guarantees and are usually, but not always, secured by business assets such as inventory, equipment, leasehold interests in equipment, fixtures, real estate and accounts receivable. The underwriting process for commercial business loans includes consideration of the borrower’s financial statements, tax returns, projections of future business operations and inspection of the subject collateral, if any. The Company has also purchased participation interests in commercial business loans from third party originators. These loans generally have underlying collateral of inventory or equipment and repayment periods of less than ten years.

Unlike residential mortgage loans, which generally are made on the basis of the borrower’s ability to make repayment from his or her income, and which are secured by real property whose value tends to be more easily ascertainable, commercial business loans are of higher risk and typically are made on the basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business.  As a result, the availability of funds for the repayment of commercial business loans may be substantially dependent on the success of the business itself. Furthermore, the collateral securing the loans may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business.  At December 31, 2003, $186,000 of loans in the commercial business loan portfolio were non-performing. There can be no assurance that the amount of nonperforming loans will not increase in the future.

Originations, Purchases and Sales of Loans and Mortgage-Backed and Related Securities

Real estate loans are generally originated by the Company’s staff of salaried and commissioned loan officers.  Loan applications are taken in all branch and loan production offices.

The Company originates both fixed and adjustable-rate loans, however, its ability to originate loans is dependent upon the relative customer demand for loans in its markets.  Demand for adjustable-rate loans is affected by the interest rate environment. The Company originated for portfolio $25.4 million of one-to-four family adjustable rate loans during 2003, an increase of $16.8 million, from $8.6 million in 2002 and 2001.  The Company also originated for portfolio $32.2 million of fixed rate one-to-four family loans during 2003, an increase of $12.4 million, from $19.8 million for 2002, compared to $13.4 million for 2001.

During the past several years, the Company has focused its portfolio loan origination efforts on commercial real estate, commercial business and consumer loans because these loans have terms to maturity and adjustable interest rate characteristics which are generally more beneficial to the Company than single family fixed-rate conventional loans.  The Company originated $297.0 million of multi-family and commercial real estate, commercial business and consumer loans (which excludes commercial real estate loans in construction or development) during the year ended December 31, 2003, an increase of $95.8 million, from originations of $201.2 million for 2002, compared to $109.6 million for 2001.

In order to supplement loan demand in the Company’s market area and geographically diversify its loan portfolio, The Company purchases real estate loans from selected sellers, with yields based upon current market rates.  The Company carefully reviews and underwrites all loans to be purchased to ensure that they meet the Company’s underwriting standards and the seller generally continues to service the purchased loans. The Company purchased $102.4 million of loans during 2003, an increase of $31.1 million, from $71.3 million during 2002, compared to $12.4 million during 2001.  The majority of the purchased one-to-four family loans have interest rates that are fixed for a one, three or five year period and then adjust annually thereafter.  In 2001, the Banks mortgage banking subsidiary, Home Federal Mortgage Services, LLC (HFMS), purchased loans available for sale from brokers and resold these loans into the secondary market.  HFMS ceased operation in 2002 which reduced subsequent purchases of loans available for sale.   The purchased commercial real estate and commercial business loans have terms and interest rates that are similar in nature to the Company’s originated commercial and business portfolio.  All purchased loans are reviewed to determine that each loan meets certain underwriting requirements. Refer to Note 4 of the Notes to Consolidated Financial Statements in the Annual Report for more information on purchased loans.

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The Company has some mortgage-backed and related securities which are held, based on investment intent, in the “available for sale” portfolio. The Company purchased $15.1 million of mortgage-backed securities during 2003, an increase of $5.0 million, from $10.1 million purchased in 2002, compared to no purchases in 2001.  The Company sold $22.3 million in mortgage-backed securities during 2003, an increase of $22.3 million, from no sales in 2002, compared to sales of $2.0 million in 2001. See — “Investment Activities.”

The following table shows the loan and mortgage-backed and related securities origination, purchase, acquisition, sale and repayment activities of the Company for the periods indicated.

LOANS HELD FOR INVESTMENT

	Year Ended December 31,
(Dollars in thousands)	2003			2002		2001
Originations by type:
Adjustable-rate:
Real-estate - one-to-four family	$	25,433		8,583		8,581
-multi-family	5,316			866		1,765
-commercial	47,647			25,768		8,947
-construction or development	50,552			63,145		49,314
Non-real estate – consumer	30,561			36,498		21,199
-commercial business	84,406			48,866		13,262
Total adjustable-rate	243,915			183,726		103,068
Fixed-rate:
Real estate-one-to-four family	32,181			19,798		13,350
-multi-family	250			0		56
-commercial	42,370			21,666		7,003
-construction or development	25,040			16,335		16,731
Non-real estate - consumer	38,640			26,589		30,756
-commercial business	47,841			40,981		26,571
Total fixed-rate	186,322			125,369		94,467
Total loans originated	430,237			309,095		197,535
Purchases:
Real estate-one-to-four family	15,277			11,819		0
- mulit-family	7,830			0		0
- commercial	43,542			23,305		2,371
-construction or development	25,365			25,049		1,715
Non-real estate – commercial business	10,396			11,105		8,360
Total loans purchased	102,410			71,278		12,446
Sales and repayments:
Real estate - commercial	18,912			162		2,398
Construction or development	431			6,381		99
Non-real estate – commercial business	4,105			162		439
Total sales	23,448			6,705		2,936
Transfers to loans held for sale	3,555			9,502		2,214
Principal repayments	322,104			243,828		221,495
Total reductions	349,107			260,035		226,645
Decrease in other items, net	(21,618		)	(55,205	)	(28,202	)
Net increase (decrease)	$	161,922		65,133		(44,866	)

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LOANS HELD FOR SALE

	Year Ended December 31,
(Dollars in thousands)	2003			2002		2001
Originations by type:
Adjustable-rate:
Real-estate – one-to-four family	$	5,302		7,477		664
- construction or development	0			268		0
Total adjustable-rate	5,302			7,745		664
Fixed-rate:
Real estate-one-to-four family	269,475			167,884		235,614
-construction or development	5,184			3,667		2,559
Total fixed-rate	274,659			171,551		238,173
Total loans originated	279,961			179,296		238,837
Purchases:
Real estate-one-to-four family	0			32,203		544,053
Total loans purchased	0			32,203		544,053
Sales and repayments:
Real estate – one-to-four family	292,163			274,602		724,219
Total sales	292,163			274,602		724,219
Transfers from loans held for investment	(3,555		)	(9,502	)	(2,214	)
Total reductions	288,608			265,100		722,005
Net increase (decrease)	$	(8,647	)	(53,601	)	60,885
MORTGAGE-BACKED AND RELATED SECURITIES
	Year Ended December 31,
(Dollars in thousands)	2003			2002		2001
Purchases:
Mortgage-backed securities:
CMOs and REMICs (1)	$	15,139		10,063		0
Total purchases	15,139			10,063		0
Sales:
Mortgage-backed securities:
CMOs and REMICs	22,268			0		2,069
Total sales	22,268			0		2,069
Principal repayments	(31,718		)	(24,397	)	(7,081	)
Net decrease	$	(38,847	)	(14,334	)	(9,150	)

(1) Collateralized Mortgage Obligations and Real Estate Mortgage Investment Conduits

Classified Assets and Delinquencies

Classification of Assets.  Federal regulations require that each savings institution classify its assets on a regular basis. In addition, in connection with examinations of savings institutions, the Office of Thrift Supervision (OTS) and the Federal Deposit Insurance Corporation (FDIC) examiners may identify problem assets and, if appropriate, require them to be classified.  There are three classifications for problem assets:  substandard, doubtful and loss.  Assets classified as substandard have one or more defined weaknesses and are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.  Assets classified as doubtful have the weaknesses of those classified as substandard, with additional characteristics that make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable, and there is a high possibility of loss. An asset classified as loss is considered uncollectible and of such little value that continuance as an asset on the balance sheet of the institution is not warranted.  Assets classified as substandard or doubtful require the institution to establish prudent general allowances for loan losses. If an asset, or portion thereof, is classified as loss, the institution must either establish specific allowances for loan losses in the amount of 100% of the portion of the asset classified as loss, or charge off such amount. If an institution does not agree with an examiner’s classification of an asset, it may appeal the determination to the OTS District Director or the

13

appropriate FDIC personnel, depending on the regulator.  On the basis of management’s review of its assets, at December 31, 2003, the Bank classified a total of $5.2 million of its loans and other assets as follows:

(Dollars in thousands)	One-to-Four Family		Commercial And Multi-family	Consumer	Commercial Business	Other Assets	Total
Substandard	$	1,291	189	831	465	348	3,124
Doubtful	0		0	89	0	0	89
Loss	0		1,674	130	151	0	1,955
Total	$	1,291	1,863	1,050	616	348	5,168

The Bank’s classified assets consist of non-performing loans and loans and other assets of concern discussed herein.  As of the date hereof, these asset classifications are materially consistent with those of the OTS and FDIC.

Delinquency Procedures. When a borrower fails to make a required payment on a loan, the Company attempts to cure the delinquency by contacting the borrower. A late notice is sent on all loans over 16 days delinquent. Additional written and verbal contacts may be made with the borrower between 30 and 60 days after the due date. If the loan is contractually delinquent 90 days, the Company sends a 30-day demand letter to the borrower and after the loan is contractually delinquent 120 days, institutes appropriate action to foreclose on the property. If foreclosed, the property is sold at a sheriff’s sale and may be purchased by the Company. Delinquent consumer loans are generally handled in a similar manner. The Company’s procedures for repossession and sale of consumer collateral are subject to various requirements under state consumer protection laws.

Real estate acquired by the Company as a result of foreclosure or by deed in lieu of foreclosure is classified as real estate in judgment for six to twelve months and thereafter as real estate owned until it is sold. When property is acquired or expected to be acquired by foreclosure or deed in lieu of foreclosure, it is recorded at the lower of cost or estimated fair value, less the estimated cost of disposition. After acquisition, all costs incurred in maintaining the property are expensed. Costs relating to the development and improvement of the property, however, are capitalized to the extent of fair value less disposition cost.

The following table sets forth the Company’s loan delinquencies by loan type, amount and percentage of type at December 31, 2003.

	Loans Delinquent For:										Total Delinquent
	60-89 Days					90 Days and Over					Loans
(Dollars in thousands)	Number	Amount		Percent of Loan Category		Number	Amount		Percent of Loan Category		Number	Amount		Percent of Loan Category
One-to-four family real estate	5	$	573	0.40	%	16	$	1,200	0.83	%	21	$	1,773	1.23	%
Nonresidential	1	648		0.33		1	300		0.15		2	948		0.48
Consumer	37	415		0.39		23	1,032		0.97		60	1,447		1.37
Commercial business	1	89		0.07		0	0		0.00		1	89		0.07
Total	44	$	1,725	0.24	%	40	$	2,532	0.36	%	84	$	4,257	0.60	%

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Investment Activities

HMN and the Bank utilize the available for sale securities portfolio in virtually all aspects of asset/liability management strategy. In making investment decisions, the Investment-Asset/Liability Committee considers, among other things, the yield and interest rate objectives, the credit risk position, and the Bank’s liquidity and projected cash flow requirements.

Securities.  Federally chartered savings institutions have the authority to invest in various types of liquid assets, including United States Treasury obligations, securities of various federal agencies, certain certificates of deposit of insured banks and savings institutions, certain bankers’ acceptances, repurchase agreements and federal funds. Subject to various restrictions, the holding company of a federally chartered savings institution may also invest its assets in commercial paper, investment grade corporate debt securities and mutual funds whose assets conform to the investments that a federally chartered savings institution is otherwise authorized to make directly.

The investment strategy of HMN and the Bank has been directed toward a mix of high-quality assets (primarily government agency obligations) with short and intermediate terms to maturity.  At December 31, 2003, the Company did not own any investment securities of a single issuer which exceeded 10% of the Company’s stockholder’s equity other than U.S. government agency obligations.

The Bank invests a portion of its liquid assets in interest-earning overnight deposits of the Federal Home Loan Bank of Des Moines (FHLB) and various money market mutual funds.  Other investments include high grade medium-term (up to three years) federal agency notes, and a variety of other types of mutual funds which invest in adjustable-rate, mortgage-backed securities, asset-backed securities, repurchase agreements and U.S. Treasury and agency obligations.  The Company invests in the same type of investment securities as the Bank and also invests in taxable and tax exempt municipal obligations and corporate equities such as preferred and common stock.  Refer to Note 3 of the Notes to Consolidated Financial Statements in the Annual Report for additional information regarding the Company’s securities portfolio.

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The following table set forth the composition of the Company’s securities portfolio, excluding mortgage-backed and related securities, at the dates indicated.

	2003							2002							2001
	Amort Cost		Adjusted To		Market Value	% of Total		Amort Cost		Adjusted To		Market Value	% of Total		Amort Cost		Adjusted To		Market Value	% of Total
Securities available for sale:
U.S. Government agency obligations	$	86,658	930		87,588	67.32	%	$	61,098	2,154		63,252	59.05	%	$	34,576	210		34,786	41.04	%
Municipal obligations	177		(7	)	170	0.13		319		(11	)	308	0.29		728		(9	)	719	0.85
Corporate debt	0		0		0	0.00		1,061		16		1,077	1.01		9,546		96		9,642	11.37
Corporate equity (1)	700		0		700	0.54		1,300		191		1,491	1.39		4,821		(91	)	4,730	5.58
Stock of federal agencies (1)	3,500		(343	)	3,157	2.43		3,504		(131	)	3,373	3.15		3,768		21		3,789	4.47
Subtotal	91,035				91,615	70.42		67,282				69,501	64.89		53,439				53,666	63.31
Federal Home Loan Bank stock	10,004				10,004	7.69		11,881				11,881	11.09		12,245				12,245	14.44
Total investment securities and Federal Home Loan Bank stock	101,039				101,619	78.11		79,163				81,382	75.98		65,684				65,911	77.75
Average remaining life of investment securities excluding Federal Home Loan Bank stock	1.8 years							2.3 years							2.8 years
Other interest earning assets:
Cash equivalents	28,497				28,497	21.89		25,729				25,729	24.02		18,864				18,864	22.25
Total	$	129,536			130,116	100.00	%	$	104,892			107,111	100.00	%	$	84,548			84,775	100.00	%
Average remaining life or term to repricing of investment securities and other interest earning assets, excluding
Federal Home Loan Bank stock	1.4 years							1.7 years							2.1 years

(1)Average life assigned to corporate equity holdings and stock of federal agencies is five years.

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The composition and maturities of the investment securities portfolio, excluding Federal Home Loan Bank stock, mortgage-backed and related securities, are indicated in the following table.

	December 31, 2003
	1 Year or Less			After 1 through 5 Years		After 5 through 10 Years		Over 10 Years		No Stated Maturity		Total Securities
(Dollars in thousands)	Amortized Cost			Amortized Cost		Amortized Cost		Amortized Cost		Amortized Cost		Amortized Cost		Adjusted To		Market Value
Securities available for sale:
U.S. government agency securities	$	24,915		61,638		0		105		0		86,658		930		87,588
Municipal obligations	0			0		177		0		0		177		(7	)	170
Corporate equity	0			0		0		0		700		700		0		700
Stock of federal agencies	0			0		0		0		3,500		3,500		(343	)	3,157
Total stock	$	24,915		61,638		177		105		4,200		91,035				91,615
Weighted average yield (1)	3.36		%	2.82	%	7.25	%	3.25	%	2.36	%	2.95	%

(1)  Yields are computed on a tax equivalent basis.

Mortgage-Backed and Related Securities.  In order to supplement loan production and achieve its asset/liability management goals, the Company invests in mortgage-backed and related securities. All of the mortgage-backed and related securities owned by the Company are issued, insured or guaranteed either directly or indirectly by a federal agency or are rated “AA” or higher.  The Company had $13.0 million of mortgage-backed and related securities classified as “available for sale” at December 31, 2003, compared to $51.9 at December 31, 2002 and $66.2 million at December 31, 2001.

The contractual maturities of the mortgage-backed and related securities portfolio without any prepayment assumptions at December 31, 2003 are as follows:

(Dollars in thousands)	5 Years or Less			5 to 10 Years		10 to 20 Years		Over 20 Years		December 31, 2003 Balance Outstanding
Securities available for sale:
Federal Home Loan Mortgage Corporation	$	0		327		0		115		442
Government National Mortgage Association	1			0		32		0		33
Collateralized Mortgage Obligations	150			0		8,035		4,389		12,574
Total	$	151		327		8,067		4,504		13,049
Weighted average yield	6.57		%	6.61	%	4.14	%	4.06	%	4.19	%

At December 31, 2003, the Company did not have any non-agency mortgage-backed or related securities in excess of 10% of its stockholders’ equity.

CMOs are securities derived by reallocating the cash flows from mortgage-backed securities or pools of mortgage loans in order to create multiple classes, or tranches, of securities with coupon rates and average lives that differ from the underlying collateral as a whole.  The terms to maturity of any particular tranche is dependent upon the prepayment speed of the underlying collateral as well as the structure of the particular CMO.  Although a significant proportion of the Company’s CMOs are in tranches which have been structured (through the use of cash flow priority and “support” tranches) to give somewhat more predictable cash flows, the cash flow and hence the value of CMOs is subject to change.

At December 31, 2003, the Company had $84,000 invested in CMOs which have floating interest rates that change either monthly or quarterly, compared to $43.6 million at December 31, 2002 and $54.6 million at December 31, 2001.

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Mortgage-backed and related securities can serve as collateral for borrowings and, through sales and repayments, as a source of liquidity.  In addition, mortgage-backed and related securities available for sale can be sold to respond to changes in economic conditions.

Sources of Funds

General.  The Bank’s primary sources of funds are retail and brokered deposits, payments of loan principal, interest earned on loans and securities, repayments and maturities of securities, borrowings and other funds provided from operations.

Deposits.  The Bank offers a variety of deposit accounts having a wide range of interest rates and terms.  The Bank’s deposits consist of passbook, negotiable order of withdrawal (NOW), money market, non-interest bearing checking and certificate accounts (including individual retirement accounts) to retail and commercial business customers.  The Bank relies primarily on competitive pricing policies and customer service to attract and retain these deposits.

The variety of deposit accounts offered by the Bank has allowed it to be competitive in obtaining funds and to respond with flexibility to changes in consumer demand.  As customers have become more interest rate conscious, the Bank has become more susceptible to short-term fluctuations in deposit flows.  The Bank manages the pricing of its deposits in keeping with its asset/liability management, profitability and growth objectives.  Based on its experience, the Bank believes that its passbook, NOW, and money market accounts are relatively stable sources of deposits.  However, the ability of the Bank to attract and maintain certificate deposits, and the rates paid on these deposits, has been and will continue to be significantly affected by market conditions.

The following table sets forth the savings flows at the Bank during the periods indicated.

	Year Ended December 31,
(Dollars in thousands)	2003			2002		2001
Opening balance	$	432,951		421,843		421,691
Deposits	2,498,532			1,444,532		1,075,211
Withdrawals	(2,388,783		)	(1,442,495	)	(1,091,668	)
Interest credited	8,988			9,071		16,609
Ending balance	551,688			432,951		421,843
Net increase	$	118,737		11,108		152
Percent increase	27.43		%	2.63	%	0.04	%

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The following table sets forth the dollar amount of savings deposits in the various types of deposit programs offered by the Bank as of December 31:

	2003				2002				2001
(Dollars in thousands)	Amount		Percent of Total		Amount		Percent of Total		Amount		Percent of Total
Transactions and Savings Deposits(1):
Non-interest checking	$	37,629	6.82	%	$	28,173	6.51	%	$	18,148	4.30	%
NOW Accounts – 0.39%(2)	61,271		11.11		43,509		10.03		40,225		9.54
Passbook Accounts – 0.20%(3)	35,883		6.50		41,033		9.48		32,738		7.76
Money Market Accounts – 1.23%(4)	91,315		16.57		49,510		11.44		45,002		10.67
Total Non-Certificates	$	226,098	41.00	%	$	162,225	37.46	%	$	136,113	32.27	%
Certificates:
0.00 -  0.99%	$	1,525	0.28	%	$	481	0.11	%	$	0	0.00	%
1.00 -  1.99%	$	55,629	10.08	%	$	22,522	5.20	%	$	2,785	0.66	%
2.00 -  2.99%	103,450		18.75		72,161		16.67		34,924		8.28
3.00 -  3.99%	71,691		12.99		75,445		17.43		64,330		15.25
4.00 -  4.99%	76,315		13.83		74,818		17.28		64,097		15.19
5.00 -  5.99%	16,621		3.01		23,719		5.48		35,909		8.51
6.00 -  6.99%	246		0.04		1,468		0.35		70,282		16.66
7.00 -  7.99%	113		0.02		112		0.02		13,403		3.18
Total Certificates	325,590		59.00		270,726		62.54		285,730		67.73
Total Deposits	$	551,688	100.00	%	$	432,951	100.00	%	$	421,843	100.00	%

(1)Reflects rates paid on transaction and savings deposits at December 31, 2003.

(2)The rate on NOW accounts for 2002 was 0.30% and 2001 was 0.64%.

(3)The rate on Passbook Accounts for 2002 was 0.35% and 2001 was 0.75%.

(4)The rate on Money Market Accounts for 2002 was 1.16% and 2001 was 1.89%.

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The following table shows rate and maturity information for the Bank’s certificates of deposit as of December 31, 2003.

(Dollars in thousands)
Certificate accounts maturing in quarter ending:	0.00- 0.99%			1.00- 1.99%		2.00- 2.99%		3.00- 3.99%		4.00- 4.99%		5.00- 5.99%		6.00- 6.99%		7.00- 7.99%		Total		Percent of Total
March 31, 2004	596			16,523		20,354		263		6,485		4,161		194		0		48,576		14.92
June 30, 2004	380			9,743		19,380		464		8,736		10,033		42		0		48,778		14.98
September 30, 2004	85			7,969		13,678		9,653		10,851		920		0		0		43,156		13.25
December 31, 2004	164			15,305		1,438		8,926		665		230		6		0		26,734		8.21
March 31, 2005	49			2,030		188		3,161		10,678		285		0		0		16,391		5.03
June 30, 2005	31			1,472		2,021		2,520		16,958		150		0		13		23,165		7.11
September 30, 2005	51			1,247		881		18,718		626		116		0		100		21,739		6.69
December 31, 2005	39			1,286		928		5,001		337		70		0		0		7,661		2.35
March 31, 2006	8			16		1,881		2,435		312		125		0		0		4,777		1.47
June 30, 2006	7			16		2,039		161		685		360		0		0		3,268		1.00
September 30, 2006	14			6		2,605		231		254		7		4		0		3,121		0.97
December 31, 2006	16			13		29,829		919		1,366		0		0		0		32,143		9.87
Thereafter	85			3		8,228		19,239		18,362		164		0		0		46,081		14.15
Total	$	1,525		55,629		103,450		71,691		76,315		16,621		246		113		325,590		100.00	%
Percent of total	0.47		%	17.09	%	31.77	%	22.02	%	23.44	%	5.10	%	0.08	%	0.03	%	100.00	%

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The following table indicates the amount of the Bank’s certificates of deposit and other deposits by time remaining until maturity as of December 31, 2003.

	Maturity
(Dollars in thousands)	3 Months or Less			Over 3 to 6 Months	Over 6 to 12 Months	Over 12 months	Total
Certificates of deposit less than $100,000	$	35,683		42,442	53,700	80,537	212,362
Certificates of deposit of $100,000 or more	10,443			5,274	15,187	75,894	106,798
Public funds less than $100,000	50			50	0	0	100
Public funds of $100,000 or more(1)	2,400			1,012	1,003	1,915	6,330
Total certificates of deposit	$		48,576	48,778	69,890	158,346	325,590
Passbook of $100,000 or more	$		3,898	0	0	0	3,898
Accounts of $100,000 or more	$	16,741		6,286	16,190	77,809	117,026

(1)Deposits from governmental and other public entities.

For additional information regarding the composition of the Bank’s deposits, see Note 13 of the Notes to Consolidated Financial Statements in the Annual Report.  For additional information on certificate maturities and the impact on the Company’s liquidity see Liquidity starting on page 18 of the Annual Report.

Borrowings.  The Bank’s other available sources of funds include advances from the FHLB and other borrowings.  As a member of the FHLB, the Bank is required to own capital stock in the FHLB and is authorized to apply for advances.  Each FHLB credit program has its own interest rate, which may be fixed or variable, and range of maturities.  The FHLB may prescribe the acceptable uses for these advances, as well as limitations on the size of the advances and repayment provisions.  Consistent with its asset/liability management strategy, the Bank has utilized FHLB advances from time to time to extend the term to maturity of its liabilities.  The Bank has also used FHLB borrowings to fund loan demand and other investment opportunities and to offset deposit outflows.  At December 31, 2003, the Bank had $203.9 million of FHLB advances outstanding.  On such date, the Bank had a collateral pledge arrangement with the FHLB of Des Moines pursuant to which the Bank may borrow up to an additional $9.7 million for liquidity purposes.  Refer to Note 14 of the Notes to Consolidated Financial Statements in the Annual Report for more information on FHLB advances.

At December 31, 2002, HMN had an undrawn $2.5 million revolving line of credit with a bank.  The credit line matured on November 15, 2003 and was renewed in the first quarter of 2004 with a rate of prime minus 75 basis points.

Service Corporations of the Bank

As a federally chartered savings bank, the Bank is permitted by OTS regulations to invest up to 2% of its assets in the stock of, or loans to, service corporation subsidiaries, and may invest an additional 1% of its assets in service corporations where such additional funds are used for inner-city or community development purposes.  In addition to investments in service corporations, federal institutions are permitted to invest an unlimited amount in operating subsidiaries engaged solely in activities in which a federal savings bank may engage directly.

OAI is a Minnesota corporation that was organized in 1983 and operated as an insurance agency until 1986 when its assets were sold.  OAI remained inactive until 1993 when it began offering credit life insurance, annuity and mutual fund products to the Bank’s customers and others.

The Bank owns a 51% interest in HFMS, a Delaware limited liability company, that was formed in 2001 to operate a mortgage banking and mortgage brokerage business in Brooklyn Park, Minnesota.  HFMS’s

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brokerage and production activity stopped in the third quarter of 2002.  The company’s assets were liquidated in 2003 and it is in the process of being dissolved.

HFH is a wholly owned Delaware corporation that was formed in 2002, and has its principal office in Grand Cayman Islands.  HFH is the holding company for HFREIT which invests in real estate loans acquired from the Bank.

The Bank owns an 80% interest in Federal Title Services, LLC (FTS), a Minnesota limited liability company formed in 2003.  FTS operates a mortgage title services business located in Minnetonka, Minnesota.

Competition

The Bank faces strong competition both in originating real estate, commercial and consumer loans and in attracting deposits.  Competition in originating loans comes primarily from mortgage bankers, commercial banks, credit unions and other savings institutions, which have offices in the Bank’s market area and those that operate through Internet banking operations throughout the continental United States.  The Bank competes for loans principally on the basis of the interest rates and loan fees it charges, the types of loans it originates and the quality of services it provides to borrowers.

Competition for deposits is principally from money market and mutual funds, securities firms, commercial banks, credit unions and other savings institutions located in the same communities and those that operate through Internet banking operations throughout the continental United States.  The ability of the Bank to attract and retain deposits depends on its ability to provide an investment opportunity that satisfies the requirements of investors as to rate of return, liquidity, risk, convenience and other factors.  The Bank competes for these deposits by offering a variety of deposit accounts at competitive rates, convenient business hours and a customer oriented staff.

Other Corporations Owned by HMN

HMN has one other wholly owned subsidiary, Security Finance Corporation (SFC).  SFC acts as an intermediary for the Bank in transacting like kind property exchanges for Bank customers.

Employees

At December 31, 2003, the Company had a total of 223 employees including part-time employees.  None of the employees of the Company or its subsidiaries are represented by any collective bargaining unit.  Management considers its employee relations to be good.

Regulation and Supervision

The banking industry is highly regulated, as a savings and loan holding company, HMN is subject to regulation by the OTS.  The Bank, a federally-chartered savings association, is subject to extensive regulation and examination by the OTS, which is the Bank’s primary federal regulator.  The FDIC also has some authority to regulate the Bank.  Subsidiaries of HMN and the Bank may also be subject to state regulation and/or licensing in connection with certain insurance or mortgage banking activities.  HMN and the Bank are subject to numerous laws and regulations.  These laws and regulations impose restrictions on activities, set minimum capital

22

requirements, impose lending and deposit restrictions and establish other restrictions.  References in this section to applicable statutes and regulations are brief and incomplete summaries only.  You should consult the statutes and regulations for a full understanding of the details of their operation.

Holding Company Regulation

An entity that owns a savings association is a savings and loan holding company (SLHC).  If a holding company owns more than one savings association, it is a multiple SLHC; if it owns only one savings association, it is a unitary SLHC.  HMN is a unitary SLHC.  The Home Owners Loan Act (HOLA) historically limited multiple SLHCs and their non-association subsidiaries to financial activities and services and to activities authorized for bank holding companies, but unitary SLHCs, in the past, were not subject to restrictions on the activities that could be conducted by holding companies or their affiliates.

In November of 1999 the Gramm-Leach-Bliley Act (GLB Act) was signed into law.  The GLB Act made significant changes to laws regulating the financial services industry.  Changes included:  (1) a new framework under in which bank holding companies can own securities firms, insurance companies and other financial companies; (2) prohibitions on new unitary SLHCs from engaging in non-financial activities or affiliating with non-financial entities; (3) new consumer protections associated with the transfer and use of non-public personal information by financial institutions; and (4) modifications to the Federal Home Loan Bank System.  Unitary SLHCs, such as HMN, that were in existence or had an application filed with the OTS on or before May 4, 1999, are not subject to the new restrictions on unitary SLHCs.  As a result, the GLB Act did not affect HMN’s ability to control non-financial firms or engage in non-financial activities.

Acquisitions by Savings and Loan Holding Companies.  Acquisition of a savings association or a savings and loan holding company is generally subject to OTS approval and the public must have an opportunity to comment on the proposed acquisition.  Without prior approval from the OTS, HMN may not acquire, directly or indirectly, more than 5% of the voting stock of a savings association.

Examination and Reporting.  Under HOLA and OTS regulations HMN, as a SLHC, must file periodic reports with the OTS.  In addition, HMN must comply with OTS record keeping requirements.  HMN is subject to holding company examination by the OTS.  The OTS may take enforcement action if the activities of a SLHC constitute a serious risk to the financial safety, soundness or stability of a subsidiary savings association.

Affiliate Transactions.  The Bank, as a holding company subsidiary that is a depository institution, is subject to both qualitative and quantitative limitations on transactions with HMN and HMN’s other subsidiaries.  See “Transactions with Affiliates and Insiders”.

Capital Adequacy.  HMN is not currently subject to regulatory capital requirements, the Bank is subject to various capital requirements.  See “Capital Requirements”.

Bank Regulation

As a federally-chartered savings association, the Bank is subject to regulation and supervision by the OTS.  Federal law authorizes the Bank as a federal savings association, to conduct, subject to various conditions and limitations, business activities that include:  accepting deposits and paying interest on them; making and buying loans secured by residential and other real estate; making a limited amount of consumer loans; making a limited amount of commercial loans; investing in corporate obligations, government debt securities, and other securities; and offering various banking, trust, securities and insurance agency services to its customers.

OTS regulations place limits on the Bank’s lending and investment powers.  Savings associations are expected to conduct lending activities in a prudent, safe and sound manner.  OTS regulations set aggregate limits on certain types of loans including commercial, commercial  real estate, and consumer loans.  OTS regulations also establish limits on loans to a single borrower.  As of December 31, 2003, the Bank’s loan limit to one borrower was approximately $10.8 million.  A federal savings association generally may not invest in

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noninvestment-grade debt securities.  A federal savings association may establish subsidiaries to conduct any activity the association is authorized to conduct and may establish service corporation subsidiaries for limited preapproved activities.

Qualified Thrift Lender Test.  Savings associations, including the Bank, must be qualified thrift lenders (QTL).  A savings association generally satisfies the QTL requirement if at least 65% of a specified asset base consists of things such as loans to small businesses and loans to purchase or improve domestic residential real estate.  Savings associations may qualify as QTLs in other ways.  Savings associations that do not qualify as QTLs are subject to significant restrictions on their operations.  If the Bank fails to meet QTL requirements the Bank and HMN would face certain limitations, including limits on HMN’s ability to control non-financial firms.  As of December 31, 2003, the Bank met the QTL test.

OTS Assessments.  HOLA authorizes the OTS to charge assessments to recover the costs of examining savings associations and their affiliates.  The assessment is done semi-annually.  The OTS bases the assessment on three factors:  1) asset size; 2) condition; and 3) complexity of the institution.  The Bank’s OTS assessment for the year ended December 31, 2003, was approximately $149,000.

Transactions with Affiliates and Insiders.  Banks and savings associations are subject to affiliate and insider transaction restrictions.  The restrictions prohibit or limit a savings association from extending credit to, or entering into certain transactions with affiliates, principal stockholders, directors and executive officers of the savings association and its affiliates.  The term “affiliate” generally includes a holding company, such as HMN, and any company under common control with the savings association.  Federal law limits transactions between the Bank and any one affiliate to 10% of the Bank’s capital and surplus and with all affiliates in the aggregate to 20%.In addition, the federal law governing unitary savings and loan holding companies prohibits the Bank from making any loan to any affiliate whose activity is not permitted for a subsidiary of a bank holding company.  This law also prohibits the Bank from making any equity investment in any affiliate that is not its subsidiary. The Bank is currently in compliance with these requirements.

Dividend Restrictions.  Federal law limits the ability of a depository institution, such as the Bank, to pay dividends or make other capital distributions.  The Bank, as a subsidiary of a savings and loan holding company, must file a notice with the OTS before the proposed declaration of a dividend or approval of a proposed capital distribution by its board of directors and must obtain prior approval from the OTS if it fails to meet certain regulatory conditions. No dividends were declared or distributed by the Bank in 2003.

Deposit Insurance

The FDIC insures the deposits of the Bank.  The FDIC administers two separate deposit insurance funds, the Bank Insurance Fund (BIF) and the Savings Association Insurance Fund (SAIF).  The BIF is a deposit insurance fund for commercial banks and some state-chartered savings associations.  The SAIF is a deposit insurance fund for most savings associations.The Bank is a member of the SAIF.

The FDIC has established a risk-based system for setting deposit insurance assessments.  Under the risk-based assessment system, an institution’s insurance assessments vary according to the level of capital the institution holds and the degree to which it is the subject of supervisory concern.  In addition, regardless of the potential risk to the insurance fund, federal law requires the FDIC to establish assessment rates that will maintain each insurance fund’s ratio of reserves to insured deposits at $1.25 per $100.  Both funds currently exceed this reserve ratio.  During 2003, the assessment rate for both SAIF and BIF deposits ranged from zero to 0.27% of covered deposits.  The Bank qualified for the lowest rate on SAIF deposits in 2003 and thus paid $0 in 2003.  It is possible that the reserve ratio will fall below 1.25% and accordingly, it is possible the Bank will have to pay deposit insurance assessments in 2004 or subsequent years.

In addition to deposit insurance assessments, the FDIC is authorized to collect assessments against insured deposits to be paid to the Financing Corporation (FICO) to service FICO debt incurred in the 1980s.  The FICO assessment rate is adjusted quarterly. In 2003 the Bank paid an assessment of approximately $72,000.

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Capital Requirements

The federal bank regulatory agencies, including the OTS, have a risk-based capital framework in place.  The regulators use a combination of risk based guidelines and leverage ratios to evaluate capital adequacy.

The following table sets forth the current regulatory requirement for capital ratios for savings associations as compared with the Bank’s capital ratios at December 31, 2003:

	Core or Tier 1 Capital to Adjusted Total Assets		Tangible Capital to Assets		Core or Tier 1 Capital to Risk- Weighted Assets		Total Capital to Risk-Weighted Assets
Regulatory Minimum	3.00	%(1)	1.50	%	4.00	%	8.00	%
The Bank’s Actual	8.03	%	8.03	%	10.19	%	11.06	%

(1)  Most savings associations are required to maintain a leverage ratio of 4.00% or more.

Capital Categories and Prompt Corrective Action

The Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) created a statutory framework that increased the importance of meeting applicable capital requirements.  FDICIA established five capital categories:  (1) well-capitalized; (2) adequately capitalized; (3) undercapitalized; (4) significantly undercapitalized; and (5) critically undercapitalized.  The activities in which a depository institution may engage and regulatory responsibilities of federal bank regulatory agencies vary depending upon whether an institution is well-capitalized, adequately capitalized or under capitalized.  Under capitalized institutions are subject to various restrictions such as limitations on dividends and growth.  A depository institution’s category depends upon where its capital levels are in relation to relevant capital measures, which include a risk-based capital measure and certain other factors.  The federal banking agencies (including the OTS) adopted regulations that implement this statutory framework.  Under these regulations, an institution is generally treated as well-capitalized if its ratio of total capital to risk-weighted assets is 10.00% or more, its ratio of core capital to risk-weighted assets is 6.00% or more, its ratio of core capital to adjusted total assets (leverage ratio) is 5.00% or more, and it is not subject to any federal supervisory order or directive to meet a specific capital level.  In order to be adequately capitalized, an institution must have a total risk-based capital ratio of not less than 8.00%, a Tier 1 risk-based capital ratio of not less than 4.00%, and a leverage ratio of not less than 4.00%.  Any institution that is neither well capitalized nor adequately capitalized will be considered undercapitalized.  The Bank currently is considered well capitalized.

Other Regulations and Examination Authority

The FDIC has adopted regulations to protect the deposit insurance funds and depositors, including regulations governing the deposit insurance of various forms of accounts.  Federal regulation of depository institutions is intended for the protection of depositors (and the BIF and the SAIF), and not for the protection of stockholders or other creditors.  In addition, federal law requires that in any liquidation or other resolution of any FDIC-insured depository institution, claims for administrative expenses of the receiver and for deposits in U.S. branches (including claims of the FDIC as subrogee of the insured institution) shall have priority over the claims of general unsecured creditors.

The OTS may sanction any OTS-regulated bank that does not operate in accordance with OTS regulations, policies and directives.  The FDIC has additional authority to terminate insurance of accounts, after notice and hearing, upon a finding that the insured institution is or has engaged in any unsafe or unsound practice that has not been corrected, is operating in an unsafe or unsound condition, or has violated any applicable law, regulation, rule, or order of or condition imposed by the FDIC.

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Federal Home Loan Bank (FHLB) System

The Bank is a member of the FHLB of Des Moines (FHLB), which is one of the 12 regional Federal Home Loan Banks (FHB), that administers the home financing credit function of savings associations.  Each FHB serves as a reserve or central bank for its members within its assigned region.  It is funded primarily from proceeds derived from the sale of consolidated obligations of the FHB System.  It makes loans or advances to members in accordance with policies and procedures established by the board of directors of the FHB.  These policies and procedures are subject to the regulation and oversight of the Federal Housing Financing Board.  All advances from the FHLB are required to be fully secured by sufficient collateral as determined by the FHB.  Long-term advances are required to be used for residential home financing and small business and agricultural loans.

As a member, the Bank is required to purchase and maintain stock in the FHLB of Des Moines.  As of December 31, 2003, the Bank had $10.0 million in FHLB stock, which was in compliance with this requirement.  The Bank receives dividends on its FHLB stock and over the past five calendar years dividends have averaged approximately 4.6%.

Federal Reserve Regulation

Under Federal Reserve Board regulations, the Bank is required to maintain reserves against transaction accounts (primarily interest-bearing and noninterest-bearing checking accounts).  Because reserves must generally be maintained in cash or in noninterest-bearing accounts, the effect of the reserve requirements is to increase an institution’s cost of funds.  These regulations generally require that the Bank maintain reserves against net transaction accounts.  The reserve levels are subject to adjustment by the Federal Reserve Board.  A savings association, like other depository institutions maintaining reservable accounts, may, under certain conditions, borrow from the Federal Reserve Bank discount window.

Numerous other regulations promulgated by the Federal Reserve Board or the OTS affect the business operations of the Bank.  These include regulations relating to privacy, equal credit access, electronic fund transfers, collection of checks, lending and savings disclosures, and availability of funds.

Community Reinvestment Act

The Community Reinvestment Act (CRA) requires financial institutions regulated by the federal financial supervisory agencies to ascertain and help meet the credit needs of their delineated communities, including low-to moderate-income neighborhoods within those communities, while maintaining safe and sound banking practices.  The regulatory agency assigns one of four possible ratings to an institution’s CRA performance and is required to make public an institution’s rating and written evaluation.  The four possible ratings of meeting community credit needs are outstanding, satisfactory, needs improvement and substantial noncompliance.  Under regulations that apply to all CRA performance evaluations after July 1, 1997, many factors play a role in assessing a financial institution’s CRA performance.  The institution’s regulator must consider its financial capacity and size, legal impediments, local economic conditions and demographics, including the competitive environment in which it operates.  The evaluation does not rely on absolute standards, and the institutions are not required to perform specific activities or to provide specific amounts or types of credit.  The Bank maintains a CRA statement for public viewing, as well as an annual CRA highlights document.  These documents describe the Bank’s credit programs and services, community outreach activities, public comments and other efforts to meet community credit needs.  The Bank’s last CRA exam was November 11, 2001 and the Bank received a “Satisfactory” rating.

Bank Secrecy Act

The Bank Secrecy Act requires financial institutions to keep records and file reports that are determined to have a high degree of usefulness in criminal, tax and regulatory matters, and to implement counter-money laundering programs and compliance procedures.  It was amended by the USA Patriot Act.  See “USA Patriot Act of 2001” below.

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USA Patriot Act of 2001

Enacted in response to the terrorist attacks in New York, Pennsylvania and Washington, D.C. on September 11, 2001, the USA Patriot Act of 2001 (the Patriot Act) is intended to strengthen U.S. law enforcement’s and the intelligence communities’ ability to work cohesively to combat terrorism on a variety of fronts. The Patriot Act contains anti-money laundering and financial transparency law modifications and requires various regulation including: due diligence requirements for financial institutions that administer, maintain or manage private bank accounts or correspondent accounts for non-U.S. persons; standards for verifying customer identification at the time of account opening; rules to promote cooperation among financial institutions, regulators, and law enforcement entities in identifying parties that may be involved in terrorism or money laundering; filing of reports with the Treasury Department’s Financial Crimes Enforcement Network for certain transactions in currency;  and filing of suspicious activity reports by financial institutions if they believe a customer may be violating U.S. laws and regulations. The impact on Bank operations from the Patriot Act will ultimately depend on the types of customers served by the Bank.

Forward-looking Information

This Form 10-K and other reports issued by the Company, including other reports filed with the Securities and Exchange Commission, may contain “forward-looking” statements that deal with future results, plans or performance. In addition, the Company’s management may make such statements orally to the media, or to securities analysts, investors or others.  Forward-looking statements deal with matters that do not relate strictly to historical facts. The Company’s future results may differ materially from historical performance and forward-looking statements about the Company’s expected financial results or other plans are subject to a number of risks and uncertainties. These include, but are not limited to, possible legislative changes and adverse economic, business and competitive developments such as shrinking interest margins; deposit outflows; reduced demand for financial services and loan and lease products; changes in accounting policies and guidelines, or monetary and fiscal policies of the federal government; changes in credit and other risks posed by the Company’s loan and investment portfolios; technological, computer-related or operational difficulties; adverse changes in securities markets; results of litigation or other significant uncertainties.

ITEM 2.   PROPERTIES

The Company leases the corporate office at 1016 Civic Center Drive NW, Rochester, Minnesota and owned the buildings and land for 9 of its 11 full service branches. The remaining two full service branches are leased, as well as the Eagle Crest Capital Bank location at 5201 Eden Avenue, Suite 170, Edina, Minnesota and the title company office located at 13911 Ridgedale Drive, Suite 450, Minnetonka, Minnesota.  The Bank uses all properties except for the title company office, which is used by Federal Title Services, LLC. All the properties are located in Minnesota, except for two full service branches located in Iowa.

ITEM 3.  LEGAL PROCEEDINGS

From time to time, the Bank and HMN are involved as plaintiff or defendant in various legal proceedings arising in the normal course of its business. While the ultimate outcome of these various legal proceedings cannot be predicted with certainty, it is the opinion of management that the resolution of these legal actions should not have a material effect on HMN’s consolidated financial condition or results of operations.

ITEM 4.   SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

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PART II

ITEM 5.   MARKET FOR THE REGISTRANT’S COMMON EQUITY AND RELATED SECURITY HOLDER MATTERS

The information on pages 19, 38, 48 and the back cover page of the Annual Report to Security Holders for the year ended December 31, 2003 is incorporated herein by reference.

ITEM 6.   SELECTED FINANCIAL DATA

The information on page 5 of the Annual Report to Security Holders for the year ended December 31, 2003 is incorporated herein by reference.

ITEM 7.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The information on pages 6 through 21 of the Annual Report to Security Holders for the year ended December 31, 2003 is incorporated herein by reference.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

The information on pages 20 and 21 of the Annual Report to Security Holders for the year ended December 31, 2003 is incorporated herein by reference.

ITEM 8.   FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The information on pages 22 through 48 of the Annual Report to Security Holders for the year ended December 31, 2003 is incorporated herein by reference.

ITEM 9.   CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

ITEM 9A.   CONTROLS AND PROCEDURES

Evaluation of disclosure controls and procedures.  An evaluation was carried out under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this annual report.  Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms.

Changes in internal controls. No change in the Company’s internal control over financial reporting was identified in connection with the evaluation required by Rule 13a-15(d) of the Exchange Act that occurred during

28

the period covered by this report and that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART III

ITEM 10.   DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The information required by this Item is incorporated by reference from the information under the captions “Director Nominees,” “Directors Continuing in Office After Annual Meeting,” “Director Emeritus,” “Board of Directors’ Meetings and Committees” (excluding any information not related to the audit committee) and “Section 16(a) Beneficial Ownership Reporting Compliance” in our definitive proxy statement for the Annual Meeting of Stockholders to be held on April 27, 2004.

HMN has adopted a Code of Ethics that applies to our principal executive officer, principal financial officer, principal accounting officer, controller and other persons performing similar functions.  We have posted the Code of Ethics on our website located at www.hmnf.com.  We intend to post on our website any amendment to, or waiver from, a provision of our Code of Ethics that applies to our principal executive officer, principal financial and accounting officer, controller and other persons performing similar functions within five business days following the date of such amendment or waiver.

Executive Officers of the Registrant Who Are Not Directors

Officers are elected annually by the Board of Directors of HMN and the Bank.  The business experience of each executive officer of both HMN and the Bank who is not also a director of HMN is set forth below.

Dwain C. Jorgensen.  Mr. Jorgensen, age 55, is Senior Vice President Operations of HMN and the Bank.  Mr. Jorgensen has held such positions since 1998.  From 1989 to 1998, he served as Vice President, Controller and Chief Accounting Officer of HMN and the Bank. From 1983 to 1989, Mr. Jorgensen was an Assistant Vice President and Operations Officer with the Bank.

Jon J. Eberle.  Mr. Eberle, age 38, is Chief Financial Officer, Senior Vice President and Treasurer of HMN and the Bank.  Mr. Eberle was appointed to these positions in 2003.  Prior to that he had served as a Vice President since 2000 and as the Controller since 1998.  From 1994 to 1998, he served as the Director of Internal Audit for HMN and the Bank.

ITEM 11.   EXECUTIVE COMPENSATION

The information required by this Item is incorporated by reference from the information under the captions “Executive Compensation” (excluding information under caption “Compensation Committee Report on Executive Compensation” and “Stockholder Return Performance Presentation”), “Compensation Committee Interlocks and Insider Participation” and “Director Cash Compensation” in our definitive proxy statement for the Annual Meeting of Stockholders to be held on April 27, 2004.

ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information required by this Item is incorporated by reference from the information under the captions “Security Ownership of Management and Certain Beneficial Owners” in our definitive proxy statement for the Annual Meeting of Stockholders to be held on April 27, 2004.

The following table provides information as of December 31, 2003 for compensation plans under which equity securities may be issued.

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Plan Category	(a) Number of Securities to be issued upon exercise of outstanding options, warrants and rights	(b) Weighted-average exercise price of outstanding options, warrants and rights		(c) Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)) (1)
Equity compensation plans approved by shareholders	374,718	$	13.85	213,434
Equity compensation plans not approved by shareholders	0	0		0
Total	374,718	$	13.85	213,434

(1)Includes securities available for future issuance under stockholder approved compensation plans other than upon the exercise of an option, warrant or right, as follows: 9,397 shares under the Company’s Amended and Restated Stock Option and Incentive Plan dated July 29, 1998 and 187,590 shares under the Company’s 2001 Omnibus Stock Plan.

ITEM 13.   CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information required by this Item is incorporated by reference from the information under the captions “Certain Transactions” in our definitive proxy statement for the Annual Meeting of Stockholders to be held on April 27, 2004.

ITEM 14.   PRINCIPAL ACCOUNTANT FEES AND SERVICES

The information required by this Item is incorporated by reference from the information under the captions “Audit Fees, Audit-Related Fees, Tax Fees and All Other Fees” in our definitive proxy statement for the Annual Meeting of Stockholders to be held on April 27, 2004.

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PART IV

ITEM 15.   EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(a)  Financial Statements, Financial Statement Schedules and Exhibits

1.  Financial Statements

The following information appearing in the Registrant’s Annual Report to Security Holders for the year ended December 31, 2003, is incorporated by reference in this Form 10-K Annual Report as Exhibit 13.

Annual Report Section	Pages in 2003 Annual Report
Five Year Consolidated Financial Highlights	5
Consolidated Balance Sheets —
December 31, 2003 and 2002	22
Consolidated Statements of Income —
Each of the Years in the Three-Year Period Ended December 31, 2003	23
Consolidated Statements of Comprehensive Income —
Each of the Years in the Three-Year Period Ended December 31, 2003	23
Consolidated Statement of Stockholders’
Equity — Each of the Years in the Three-Year Period Ended December 31, 2003	24
Consolidated Statements of Cash Flows —	25
Each of the Years in the Three-Year Period Ended December 31, 2003
Notes to Consolidated Financial Statements	26-44
Independent Auditors’ Report	45
Selected Quarterly Financial Data	46-47
Other Financial Data	48
Common Stock Price Information	48

2.  Financial Statement Schedules

All financial statement schedules have been omitted as information is not required under the related instructions, is not applicable or has been included in the Notes to Consolidated Financial Statements.

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3.             Exhibits

Regulation S-K Exhibit Number	Document	Reference to Prior Filing or Exhibit Number Attached Hereto	Sequential Page Numbering Where Attached Exhibits Are Located in This Form 10-K Report
2	Agreement and Plan of Merger dated July 1, 1997	1*	Not applicable
3.1	Amended and Restated Certificate of Incorporation	2*	Not applicable
3.2	Amended and Restated By-laws	Exhibit 3.2	Filed electronically
4	Form of Common Stock Certificate	3*	Not applicable
10.1†	Change in Control Agreement for Mr. McNeil dated as of March 1, 2004	Exhibit 10.1	Filed electronically
10.2†	Employment Agreement for Mr. McNeil dated as of November 1, 2000	6*	Not applicable
10.3†	Form of Change in Control Agreement for Executive Officers	Exhibit 10.3	Filed electronically
10.4†	Separation Agreement for Mr. Johnson dated as of March 17, 2003	8*	Not applicable
10.5†	Directors Deferred Compensation Plan	4*	Not applicable
10.6†	Amended and Restated HMN Financial, Inc. Recognition and Retention Plan dated July 29, 1998	5*	Not applicable
10.7†	Amended and Restated HMN Financial, Inc. Stock Option and Incentive Plan dated July 29, 1998	5*	Not applicable
10.8†	HMN Financial, Inc. 2001 Omnibus Stock Plan	7*	Not applicable
13	Portions of Annual Report to security holders incorporated by reference	Exhibit 13	Filed electronically
21	Subsidiaries of Registrant	Exhibit 21	Filed electronically
23	Consent of KPMG LLP dated March 12, 2004	Exhibit 23	Filed electronically
31.1	Rule 13a-14(a)/15d-14(a) Certifications of Chief Executive Officer	Exhibit 31.1	Filed electronically
31.2	Rule 13a-14(a)/15d-14(a) Certifications of Chief Financial Officer	Exhibit 31.2	Filed electronically
32.1	Section 1350 Certifications of Chief Executive Officer	Exhibit 32.1	Filed electronically
32.2	Section 1350 Certifications of Chief Financial Officer	Exhibit 32.2	Filed electronically

† Management contract of compensatory arrangement.

1*Incorporated by reference to the same numbered exhibit to the Company’s Current Report on Form 8-K dated July 1, 1997, filed on July 10, 1997.

2*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).

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).

4* Incorporated by reference to the same numbered exhibit to the Company’s Annual Report on Form 10-K for the period ended December 31, 1994 (File No. 0-24100).

5* Incorporated by reference to the same numbered exhibit to the Company’s Quarterly Report on Form 10-Q for the period ended September 30, 1998 (File No. 0-24100).

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6*Incorporated by reference to the same numbered exhibit to the Company’s Annual Report on Form 10-K for the period ended December 31, 2000 (File No. 0-24100).

7*Incorporated by reference to Exhibit B to the Company’s Proxy Statement for its Annual Meeting of Stockholders held on April 24, 2001 (File no. 0-24100).

8*Incorporated by reference to Exhibit B to the Company’s Annual Report on Form 10-K for the period ended December 31, 2002 (File No. 0-24100).

(b) Reports on Form 8-K:

(1)  On October 23, 2003, HMN reported its financial results for its third fiscal quarter ended September 30, 2003.

(2)  On January 22, 2004, HMN reported its financial results for its fourth fiscal quarter and year-ended December 31, 2003.

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	HMN FINANCIAL, INC.
Date:   March 12, 2004	By:	/s/ Michael McNeil
	Michael McNeil, President
	(Duly Authorized Representative)

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

By:	/s/ Timothy R. Geisler	By:	/s/ Jon J. Eberle
	Timothy R. Geisler, Chairman		Jon J. Eberle, Sr. Vice President, CFO and Treasurer
Date:	March 12, 2004		(Principal Financial and Accounting Officer)
		Date:	March 12, 2004

By:	/s/ Michael McNeil
	Michael McNeil, President
	(Principal Executive Officer)
Date:	March 12, 2004
By:	/s/ Allan R. DeBoer	By:	/s/Duane D. Benson
	Allan R. DeBoer, Director		Duane D. Benson, Director
Date:	March 12, 2004	Date:	March 12, 2004
By:	/s/ Roger P. Weise	By:	/s/ Susan K. Kolling
	Roger P. Weise, Director		Susan K. Kolling, Director
Date:	March 12, 2004	Date:	March 12, 2004
By:	/s/ Mahlon C. Schneider	By:	/s/ Michael J. Fogarty
	Mahlon C. Schneider, Director		Michael J. Fogarty, Director
Date:	March 12, 2004	Date:	March 12, 2004

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INDEX TO EXHIBITS

Regulation S-K Exhibit Number	Document	Sequential Page Numbering Where Attached Exhibits Are Located in This Form 10-K Report
Exhibit 3.2	Amended and Restated By-Laws	Filed electronically
Exhibit 10.1	Change in Control Agreement for Mr. McNeil dated March 1, 2004	Filed electronically
Exhibit 10.3	Form of Change in Control Agreement for incorporated by reference Executive Officers	Filed electronically
Exhibit 13	Portions of Annual Report to security holders incorporated by reference	Filed electronically
Exhibit 21	Subsidiaries of Registrant	Filed electronically
Exhibit 23	Consent of KPMG, LLP dated March 12, 2004	Filed electronically
Exhibit 31.1	Rule 13a-14(a)/15d-14(a) Certifications of Chief Executive Officer	Filed electronically
Exhibit 31.2	Rule 13a-14(a)/15d-14(a) Certifications of Chief Financial Officer	Filed electronically
Exhibit 32.1	Section 1350 Certifications of Chief Executive Officer	Filed electronically
Exhibit 32.2	Section 1350 Certifications of Chief Financial Officer	Filed electronically

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EX-3.2

Exhibit 3.2

HMN FINANCIAL, INC.

BY-LAWS

ARTICLE I

STOCKHOLDERS

Section 1.Annual Meeting.

An annual meeting of the stockholders, for the election of directors to succeed those whose terms expire and for the transaction of such other business as may properly come before the meeting, shall be held at such place, on such date, and at such time as the Board of Directors shall fix each year, which date shall be within thirteen (13) months subsequent to the later of the date of incorporation or the last annual meeting of stockholders.

Section 2.Special Meetings.

Subject to the rights of the holders of any class or series of preferred stock of the Corporation, special meetings of stockholders of the Corporation may be called only by the Board of Directors pursuant to a resolution adopted by a majority of the total number of directors which the Corporation would have if there were no vacancies on the Board of Directors (hereinafter the “Whole Board”).

Section 3.Notice of Meetings.

Written notice of the place, date, and time of all meetings of the stockholders shall be given, not less than ten (10) nor more than sixty (60) days before the date on which the meeting is to be held, to each stockholder entitled to vote at such meeting, except as otherwise provided herein or required by law (meaning, here and hereinafter, as required from time to time by the Delaware General Corporation Law or the Certificate of Incorporation of the Corporation).

When a meeting is adjourned to another place, date or time, written notice need not be given of the adjourned meeting if the place, date and time thereof are announced at the meeting at which the adjournment is taken; provided, however, that if the date of any adjourned meeting is more than thirty (30) days after the date for which the meeting was originally noticed, or if a new record date is fixed for the adjourned meeting, written notice of the place, date and time of the adjourned meeting shall be given in conformity herewith.  At any adjourned meeting, any business may be transacted which might have been transacted at the original meeting.

Section 4.Quorum.

At any meeting of the stockholders, the holders of a majority of all of the shares of the stock entitled to vote at the meeting, present in person or by proxy, shall constitute a quorum for all purposes, unless or except to the extent that the presence of a larger number may be required by law.  Where a separate vote by a class or classes is required, a majority of the shares of such class or classes, present in person or represented by proxy, shall constitute a quorum entitled to take action with respect to that vote on that matter.

If a quorum shall fail to attend any meeting, the chairman of the meeting or the holders of a majority of the shares of stock entitled to vote who are present, in person or by proxy, may adjourn the meeting to another place, date or time.

If a notice of any adjourned special meeting of stockholders is sent to all stockholders entitled to vote thereat, stating that it will be held with those present constituting a quorum, then except as otherwise required by law, those present at such adjourned meeting shall constitute a quorum and all matters shall be determined by a majority of the votes cast at such meeting.

Section 5.Organization.

Such person as the Board of Directors may have designated or, in the absence of such a person, the President of the Corporation or, in his or her absence, such person as may be chosen by the holders of a majority of the shares entitled to vote who are present, in person or by proxy, shall call to order any meeting of the stockholders and act as chairman of the meeting.  In the absence of the Secretary of the Corporation, the secretary of the meeting shall be such person as the chairman appoints.

Section 6.Conduct of Business.

(a)The chairman of any meeting of stockholders shall determine the order of business and the procedure at the meeting, including such regulation of the manner of voting and the conduct of discussion as seem to him or her in order.

(b)At any annual meeting of the stockholders, only such business shall be conducted as shall have been brought before the meeting (i) by or at the direction of the Board of Directors or (ii) by any stockholder of the Corporation who is entitled to vote with respect thereto and who complies with the notice procedures set forth in this Section 6(b).  For business to be properly brought before an annual meeting by a stockholder, the business must relate to a proper subject matter for stockholder action and the stockholder must have given timely notice thereof in writing to the Secretary of the Corporation.  To be timely, a stockholder’s notice must be delivered or mailed to and received at the principal executive offices of the Corporation not less than ninety (90) days prior to the date of the annual meeting; provided, however, that in the event that less than one hundred (100) days’ notice or prior public disclosure of the date of the meeting is given or made to stockholders, notice by the stockholder to be timely must be received not later than the close of business on the 10th day following the day on which such notice of the date of the annual meeting was mailed or such public disclosure was made, whichever occurs first.  In no event shall the public announcement of an adjournment of an annual meeting commence a new time period for the giving of a stockholder’s notice.  A stockholder’s notice to the Secretary shall set forth as to each matter such stockholder proposes to bring before the annual meeting (i) a brief description of the business desired to be brought before the annual meeting and the reasons for conducting such business at the annual meeting, (ii) the name and address, as they appear on the Corporation’s books, of the stockholder who proposed such business, (iii) the class and number of shares of the Corporation’s capital stock that are beneficially owned by such stockholder, (iv) a description of all arrangements or understandings between such stockholder and any other person or persons (including their names) in connection with the proposal of such business by such stockholder and any material interest of such business, and (v) a representation that such stockholder intends to appear in person or by proxy at the annual meeting to bring such business before the meeting.  Notwithstanding anything in

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these Bylaws to the contrary, no business shall be brought before or conducted at an annual meeting except in accordance with the provisions of this Section 6(b).  The officer of the Corporation or other person presiding over the annual meeting shall, if the facts so warrant, determine and declare to the meeting that business was not properly brought before the meeting in accordance with the provisions of this Section 6(b) and, if he should so determine, he shall so declare to the meeting and any such business so determined to be not properly brought before the meeting shall not be transacted.  At any special meeting of the stockholders, only such business shall be conducted as shall have been brought before the meeting by or at the direction of the Board of Directors.

(c)Only persons who are nominated in accordance with the procedures set forth in these By-laws shall be eligible for election as directors.  Nominations of persons for election to the Board of Directors of the Corporation may be made at a meeting of stockholders at which directors are to be elected only (i) by or at the direction of the Board of Directors or (ii) by any stockholder of the Corporation entitled to vote for the election of directors at the meeting who complies with the notice procedures set forth in this Section 6(c).  Such nominations, other than those made by or at the direction of the Board of Directors, shall be made by timely notice in writing to the Secretary of the Corporation.  To be timely, a stockholder’s notice shall be delivered or mailed to and received at the principal executive offices of the Corporation not less than ninety (90) days prior to the date of the meeting; provided, however, that in the event that less than one hundred (100) days’ notice or prior public disclosure of the date of the meeting is given or made to stockholders, notice by the stockholder to be timely must be so received not later than the close of business on the 10th day following the day on which such notice of the date of the meeting was mailed or such public disclosure was made, whichever occurs first.  In no event shall the public announcement of an adjournment of an annual meeting commence a new time period for the giving of a stockholder’s notice.  Such stockholder’s notice shall set forth (i) as to each person whom such stockholder proposes to nominate for election or reelection as a director, all information relating to such person that is required to be disclosed in solicitations of proxies for election of directors, or is otherwise required, in each case pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended (including such person’s written consent to being named in the proxy statement as a nominee and to serving as a director if elected); and (ii) as to the stockholder giving the notice: (x) the name and address, as they appear on the Corporation’s books, of such stockholder and (y) the class and number of shares of the Corporation’s capital stock that are beneficially owned by such stockholder.  At the request of the Board of Directors, any person nominated by the Board of Directors for election as a director shall furnish to the Secretary of the Corporation that information required to be set forth in a stockholder’s notice of nomination which pertains to the nominee.  No person shall be eligible for election as a director of the Corporation unless nominated in accordance with the provisions of this Section 6(c).  The officer of the Corporation or other person presiding at the meeting shall, if the facts so warrant, determine that a nomination was not made in accordance with such provisions and, if he or she should so determine, he or she shall so declare to the meeting and the defective nomination shall be disregarded.

Section 7.Proxies and Voting.

At any meeting of the stockholders, every stockholder entitled to vote may vote in person or by proxy authorized by an instrument in writing (or as otherwise permitted under applicable law) by the stockholder or his duly authorized attorney-in-fact filed in accordance with the

3

procedure established for the meeting.  Proxies solicited on behalf of the management shall be voted as directed by the stockholder or in the absence of such direction, as determined by a majority of the Board of Directors.  No proxy shall be valid after eleven months from the date of its execution except for a proxy coupled with an interest under Delaware law.

Each stockholder shall have one (1) vote for every share of stock entitled to vote which is registered in his or her name on the record date for the meeting, except as otherwise provided herein or in the Certificate of Incorporation of the Corporation or as required by law.

All voting, including on the election of directors but excepting where otherwise required by law, may be by a voice vote; provided, however, that upon demand therefore by a stockholder entitled to vote or his or her proxy, a written vote shall be taken.  Every written vote shall be taken by ballot, each of which shall state the name of the stockholder or proxy voting and such other information as may be required under the procedure established for the meeting.  Every vote taken by ballot shall be counted by a properly appointed inspector or inspectors of election.

All elections shall be determined by a plurality of the votes cast, and except as otherwise required by law or as provided in the Certificate of Incorporation, all other matters shall be determined by a majority of the votes cast.

Section 8.Stock List.

The officer who has charge of the stock transfer books of the Corporation shall prepare and make, in the time and manner required by applicable law, a list of stockholders entitled to vote and shall make such list available for such purposes, at such places, at such times and to such persons as required by applicable law.  The stock transfer books shall be the only evidence as to the identity of the stockholders entitled to examine the stock transfer books or to vote in person or by proxy at any meeting of stockholders.

Section 9.Consent of Stockholders in Lieu of Meeting.

Subject to the rights of the holders of any class or series of preferred stock of the Corporation, any action required or permitted to be taken by the stockholders of the Corporation must be effected at a duly called annual or special meeting of stockholders of the Corporation and may not be effected by any consent in writing by such stockholders.

Section 10.Inspectors of Election.

The Board of Directors shall, in advance of any meeting of stockholders, appoint one or more persons as inspectors of election, to act at the meeting or any adjournment thereof and make a written report thereof, in accordance with applicable law.  In the event the Board of Directors fails to appoint an inspector of election, the chairman presiding at the meeting shall appoint one or more persons as inspectors of election.

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ARTICLE II
BOARD OF DIRECTORS

Section 1.General Powers, Number, Term of Office and Qualifications.

The business and affairs of the Corporation shall be managed by or under the direction of the Board of Directors.  The Board of Directors shall annually elect a Chairman of the Board and a President from among its members and shall designate, when present, either the Chairman of the Board or the President to preside at its meetings.

The directors, other than those who may be elected by the holders of any class or series of preferred stock, shall be divided into three classes, as nearly equal in number as reasonably possible, with the term of office of the first class to expire at the first annual meeting of stockholders, the term of office of the second class to expire at the annual meeting of stockholders one year thereafter, and the term of office of the third class to expire at the annual meeting of stockholders two years thereafter, with each director to hold office until his or her successor shall have been duly elected and qualified.  At each annual meeting of stockholders, commencing with the first annual meeting, directors elected to succeed those directors whose terms expire shall be elected for a term of office to expire at the third succeeding annual meeting of stockholders after their election, with each director to hold office until his or her successor shall have been duly elected and qualified.

Directors shall, in order to qualify as such, have their primary domicile in a county in which Home Federal Savings Bank, a wholly owned subsidiary of the corporation, has a full service branch; provided, however, the Board of Directors may waive this requirement by resolution approved by a majority of the Whole Board so long as a majority of the directors currently on the Board of Directors have their primary domicile in a county in which Home Federal Savings Bank has a full service branch.

Section 2.Vacancies and Newly Created Directorships.

Subject to the rights of the holders of any class or series of preferred stock then outstanding, newly created directorships resulting from any increase in the authorized number of directors or any vacancies in the Board of Directors resulting from death, resignation, retirement, disqualification, removal from office or other cause may be filled only by a majority vote of the directors then in office, though less than a quorum, and directors so chosen shall hold office for a term expiring at the annual meeting of stockholders at which the term of office of the class to which they have been elected expires, and until such director’s successor shall have been duly elected and qualified.  No decrease in the number of authorized directors constituting the Board shall shorten the term of any incumbent director.

Section 3.Regular Meetings.

Regular meetings of the Board of Directors shall be held at such place or places, on such date or dates, and at such time or times as shall have been established by the Board of Directors and publicized among all directors.  A notice of each regular meeting shall not be required.

Section 4.Special Meetings.

Special meetings of the Board of Directors may be called by one-third (1/3) of the directors then in office (rounded up to the nearest whole number) or by the Chairman of the Board or the President and shall be held at such place, on such date, and at such time as they or he or she shall fix.  Notice of the place, date, and time of each such special meeting shall be given to each director by whom it is not waived by mailing written notice not less than five (5)

5

days before the meeting or by telegraphing or telexing or by facsimile transmission of the same not less than twenty-four (24) hours before the meeting.  Unless otherwise indicated in the notice thereof, any and all business may be transacted at a special meeting.

Section 5.Quorum.

At any meeting of the Board of Directors, a majority of the authorized number of directors then constituting the Board shall constitute a quorum for all purposes.  If a quorum shall fail to attend any meeting, a majority of those present may adjourn the meeting to another place, date, or time, without further notice or waiver thereof.

Section 6.Participation in Meetings By Conference Telephone.

Members of the Board of Directors, or of any committee thereof, may participate in a meeting of such Board or committee by means of conference telephone or similar communications equipment by means of which all persons participating in the meeting can hear each other and such participation shall constitute presence in person at such meeting.

Section 7.Conduct of Business.

At any meeting of the Board of Directors, business shall be transacted in such order and manner as the Board may from time to time determine, and all matters shall be determined by the vote of a majority of the directors present, except as otherwise provided herein or required by law.  Action may be taken by the Board of Directors without a meeting if all members thereof consent thereto in writing, and the writing or writings are filed with the minutes of proceedings of the Board of Directors.

Section 8.Powers.

The Board of Directors may, except as otherwise required by law, exercise all such powers and do all such acts and things as may be exercised or done by the Corporation, including, without limiting the generality of the foregoing, the unqualified power:

(1)To declare dividends from time to time in accordance with law;

(2)To purchase or otherwise acquire any property, rights or privileges on such terms as it shall determine;

(3)To authorize the creation, making and issuance, in such form as it may determine, of written obligations of every kind, negotiable or nonnegotiable, secured or unsecured, and to do all things necessary in connection therewith;

(4)To remove any officer of the Corporation with or without cause, and from time to time to devolve the powers and duties of any officer upon any other person for the time being;

(5)To confer upon any officer of the Corporation the power to appoint, remove and suspend subordinate officers, employees and agents;

6

(6)To adopt from time to time such stock, option, stock purchase, bonus or other compensation plans for directors, officers, employees and agents of the Corporation and its subsidiaries as it may determine;

(7)To adopt from time to time such insurance, retirement, and other benefit plans for directors, officers, employees and agents of the Corporation and its subsidiaries as it may determine; and,

(8)To adopt from time to time regulations, not inconsistent with these Bylaws, for the management of the Corporation’s business and affairs.

Section 9.Compensation of Directors.

Directors, as such, may receive, pursuant to resolution of the Board of Directors, fixed fees and other compensation for their services as directors, including, without limitation, their services as members of committees of the Board of Directors.

ARTICLE III
COMMITTEES

Section 1.Committees of the Board of Directors.

The Board of Directors, by a vote of a majority of the Board of Directors, may from time to time designate committees of the Board, with such lawfully delegable powers and duties as it thereby confers, to serve at the pleasure of the Board and shall, for those committees and any others provided for herein, elect a director or directors to serve as the member or members, designating, if it desires, other directors as alternate members who may replace any absent or disqualified member at any meeting of the committee.  Any committee so designated may exercise the power and authority of the Board of Directors to declare a dividend, to authorize the issuance of stock or to adopt a certificate of ownership and merger pursuant to Section 253 of the Delaware General Corporation Law if the resolution which designated the committee or a supplemental resolution of the Board of Directors shall so provide.  In the absence or disqualification of any member of any committee and any alternate member in his or her place, the member or members of the committee present at the meeting and not disqualified from voting, whether or not he or she or they constitute a quorum, may by unanimous vote appoint another member of the Board of Directors to act at the meeting in the place of the absent or disqualified member.

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Section 2.Conduct of Business.

Each committee may determine the procedural rules for meeting and conducting its business and shall act in accordance therewith, except as otherwise provided herein or required by law.  Adequate provision shall be made for notice to members of all meetings; one-third (1/3) of the members shall constitute a quorum unless the committee shall consist of one (1) or two (2) members, in which event one (1) member shall constitute a quorum; and all matters shall be determined by a majority vote of the members present.  Action may be taken by any committee without a meeting if all members thereof consent thereto in writing, and the writing or writings are filed with the minutes of the proceedings of such committee.

ARTICLE IV
OFFICERS

Section 1.Generally.

(a)The Board of Directors as soon as may be practicable after the annual meeting of stockholders shall choose a Chairman of the Board, a President, one or more Vice Presidents, a Secretary and a Chief Financial Officer and from time to time may choose such other officers as it may deem proper.  The Chairman of the Board shall be chosen from among the directors.  Any number of offices may be held by the same person.

(b)The term of office of all officers shall be until the next annual election of officers and until their respective successors are chosen, but any officer may be removed from office at any time by the affirmative vote of a majority of the authorized number of directors then constituting the Board of Directors.

(c)All officers chosen by the Board of Directors shall each have such powers and duties as generally pertain to their respective offices, subject to the specific provisions of this Article IV.  Such officers shall also have such powers and duties as from time to time may be conferred by the Board of Directors or by any committee thereof.

Section 2.Chairman of the Board of Directors.

The Chairman of the Board of Directors of the Corporation shall preside at all meetings of the Corporation and the Executive Committee meetings of the Board of Directors.  He may sign account books, deeds, mortgages, bonds, contracts or other instruments which the Board of Directors has authorized to be executed, except where otherwise provided by other resolutions of the Board of Directors or by these By-laws or Certificate of Incorporation of the Corporation.

Section 3.President.

The President shall be the chief executive officer and, subject to the control of the Board of Directors, shall have general power over the management and oversight of the administration and operation of the Corporation’s business and general supervisory power and authority over its policies and affairs.  He shall see that all orders and resolutions of the Board of Directors and of any committee thereof are carried into effect.  Each meeting of the stockholders and of the Board

8

of Directors shall be presided over by such officer as has been designated by the Board of Directors or, in his absence, by such officer or other person as is chosen at the meeting.  The Secretary or, in his absence, the General Counsel of the Corporation or such officer as has been designated by the Board of Directors or, in his absence, such officer or other person as is chosen by the person presiding, shall act as secretary of each such meeting.

Section 4.Vice President.

The Vice President or Vice Presidents shall perform the duties of the President in his absence or during his disability to act.  In addition, the Vice Presidents shall perform the duties and exercise the powers usually incident to their respective offices and/or such other duties and powers as may be properly assigned to them from time to time by the Board of Directors, the Chairman of the Board or the President.

Section 5.Secretary.

The Secretary or an Assistant Secretary shall issue notices of meetings, shall keep their minutes, shall have charge of the seal and the corporate books, shall perform such other duties and exercise such other powers as are usually incident to such offices and/or such other duties and powers as are properly assigned thereto by the Board of Directors, the Chairman of the Board or the President.

Section 6.Chief Financial Officer.

The Chief Financial Officer shall have charge of all monies and securities of the Corporation, other than monies and securities of any division of the Corporation which has a treasurer or financial officer appointed by the Board of Directors, and shall keep regular books of account.  The funds of the Corporation shall be deposited in the name of the Corporation by the Chief Financial Officer with such banks or trust companies as the Board of Directors from time to time shall designate.  He shall sign or countersign such instruments as require his signature, shall perform all such duties and have all such powers as are usually incident to such office and/or such other duties and powers as are properly assigned to him by the Board of Directors, the Chairman of the Board or the President, and may be required to give bond for the faithful performance of his duties in such sum and with such surety as may be required by the Board of Directors.

Section 7.Assistant Secretaries and Other Officers.

The Board of Directors may appoint one or more assistant secretaries and one or more assistants to the Chief Financial Officer, or one appointee to both such positions, which officers shall have such powers and shall perform such duties as are provided in these By-laws or as may be assigned to them by the Board of Directors, the Chairman of the Board or the President.

Section 8.Action with Respect to Securities of Other Corporations.

Unless otherwise directed by the Board of Directors, the President or any officer of the Corporation authorized by the President shall have power to vote and otherwise act on behalf of the Corporation, in person or by proxy, at any meeting of stockholders of or with respect to any action of stockholders of any other corporation in which this Corporation may hold securities and

9

otherwise to exercise any and all rights and powers which this Corporation may possess by reason of its ownership of securities in such other Corporation.

ARTICLE V
STOCK

Section 1.Certificates of Stock.

Each stockholder shall be entitled to a certificate signed by, or in the name of the Corporation by, the President or a Vice President, and by the Secretary or an Assistant Secretary, or the Treasurer or an Assistant Treasurer, certifying the number of shares owned by him or her. Any or all of the signatures on the certificate may be by facsimile.

Section 2.Transfers of Stock.

Transfers of stock shall be made only upon the transfer books of the Corporation kept at an office of the Corporation or by transfer agents designated to transfer shares of the stock of the Corporation.  Except where a certificate is issued in accordance with Section 4 of Article V of these Bylaws, an outstanding certificate for the number of shares involved shall be surrendered for cancellation before a new certificate is issued therefore.

Section 3.Record Date.

In order that the Corporation may determine the stockholders entitled to notice of or to vote at any meeting of stockholders, or to receive payment of any dividend or other distribution or allotment of any rights or to exercise any rights in respect of any change, conversion or exchange of stock or for the purpose of any other lawful action, the Board of Directors may fix a record date, which record date shall not precede the date on which the resolution fixing the record date is adopted and which record date shall not be more than sixty (60) nor less than ten (10) days before the date of any meeting of stockholders, nor more than sixty (60) days prior to the time for such other action as hereinbefore described; provided, however, that if no record date is fixed by the Board of Directors, the record date for determining stockholders entitled to notice of or to vote at a meeting of stockholders shall be at the close of business on the day next preceding the day on which notice is given or, if notice is waived, at the close of business on the day next preceding the day on which the meeting is held, and, for determining stockholders entitled to receive payment of any dividend or other distribution or allotment of rights or to exercise any rights of change, conversion or exchange of stock or for any other purpose, the record date shall be at the close of business on the day on which the Board of Directors adopts a resolution relating thereto.

A determination of stockholders of record entitled to notice of or to vote at a meeting of stockholders shall apply to any adjournment of the meeting; provided, however, that the Board of Directors may fix a new record date for the adjourned meeting.

Section 4.Lost, Stolen or Destroyed Certificates.

In the event of the loss, theft or destruction of any certificate of stock, another may be issued in its place pursuant to such regulations as the Board of Directors may establish

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concerning proof of such loss, theft or destruction and concerning the giving of a satisfactory bond or bonds of indemnity.

Section 5.Regulations.

The issue, transfer, conversion and registration of certificates of stock shall be governed by such other regulations as the Board of Directors may establish.

ARTICLE VI
NOTICES

Section 1.Notices.

Except as otherwise specifically provided herein or required by law, all notices required to be given to any stockholder, director, officer, employee or agent shall be in writing and may in every instance be effectively given by hand delivery to the recipient thereof, by depositing such notice in the mail, postage paid, or by sending such notice by prepaid telegram or mailgram.  Any such notice shall be addressed to such stockholder, director, officer, employee or agent at his or her last known address as the same appears on the books of the Corporation.  The time when such notice is received, if hand delivered, or dispatched, if delivered through the mail or by telegram or mailgram, shall be the time of the giving of the notice.

Section 2.Waivers.

A written waiver of any notice, signed by a stockholder, director, officer, employee or agent, whether before or after the time of the event for which notice is to be given, shall be deemed equivalent to the notice required to be given to such stockholder, director, officer, employee or agent.  Neither the business nor the purpose of any meeting need be specified in such a waiver.

ARTICLE VII
MISCELLANEOUS

Section 1.Facsimile Signatures.

In addition to the provisions for use of facsimile signatures elsewhere specifically authorized in these By-laws, facsimile signatures of any officer or officers of the Corporation may be used whenever and as authorized by the Board of Directors or a committee thereof.

Section 2.Corporate Seal.

The Board of Directors may provide a suitable seal, containing the name of the Corporation, which seal shall be in the charge of the Secretary.  If and when so directed by the Board of Directors or a committee thereof, duplicates of the seal may be kept and used by the Treasurer or by an Assistant Secretary or Assistant Treasurer.

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Section 3.Reliance Upon Books, Reports and Records.

Each director, each member of any committee designated by the Board of Directors, and each officer of the Corporation shall, in the performance of his or her duties, be fully protected in relying in good faith upon the books of account or other records of the Corporation and upon such information, opinions, reports or statements presented to the Corporation by any of its officers or employees, or committees of the Board of Directors so designated, or by any other person as to matters which such director or committee member reasonably believes are within such other person’s professional or expert competence and who has been selected with reasonable care by or on behalf of the Corporation.

Section 4.Fiscal Year.

The fiscal year of the Corporation shall be as fixed by the Board of Directors.

Section 5.Time Periods.

In applying any provision of these By-laws which requires that an act be done or not be done a specified number of days prior to an event or that an act be done during a period of a specified number of days prior to an event, calendar days shall be used, the day of the doing of the act shall be excluded and the day of the event shall be included.

ARTICLE VIII
AMENDMENTS

The By-laws of the Corporation may be adopted, amended or repealed as provided in Article Seventh of the Certificate of Incorporation of the Corporation.

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EX-10.1

Exhibit 10.1

CHANGE-IN-CONTROL AGREEMENT

AGREEMENT entered into as of March 1, 2004 by and between Home Federal Savings Bank, a federally chartered savings bank (the “Bank”) and a wholly owned subsidiary of HMN Financial, Inc., a Delaware corporation (the “Company”), and Michael McNeil (the “Executive”).

WITNESSETH:

WHEREAS, the Executive is a key member of the management of the Company and the Bank and has heretofore devoted substantial skill and effort to the affairs of the Company and the Bank; and

WHEREAS, it is desirable and in the best interests of the Bank and the Company and its shareholders to continue to obtain the benefits of the Executive’s services and attention to the affairs of the Company and the Bank; and

WHEREAS, it is desirable and in the best interests of the Bank and the Company and its shareholders to provide inducement for the Executive (A) to remain in the service of the Company and the Bank in the event of any proposed or anticipated change in control of the Company and (B) to remain in the service of the Company and the Bank in order to facilitate an orderly transition in the event of a change in control of the Company; and

WHEREAS, it is desirable and in the best interests of the Bank and the Company and its shareholders that the Executive be in a position to make judgments and advise the Company with respect to proposed changes in control of the Company or the Bank; and

WHEREAS, the Executive desires to be protected in the event of certain changes in control of the Company or the Bank; and

WHEREAS, Executive and the Bank are currently party to a Change-in-Control Agreement dated November 1, 2000 (the “Prior Agreement”); and

WHEREAS, Executive and the Bank desire to terminate the Prior Agreement and to enter into this Agreement to conform the renewal period of this Agreement with that of the Executive’s Employment Agreement with the Company;  and

WHEREAS, for the reasons set forth above, the Bank and the Executive desire to enter into this Agreement.

NOW, THEREFORE, in consideration of the foregoing and the mutual covenants and agreements contained herein, the Bank and the Executive agree as follows:

1.Employment.  The Executive has previously executed an Employment Agreement (the “Employment Agreement”) which governs the terms of the Executive’s employment, unless an Event shall be deemed to have occurred as contemplated by Section 2.

2.Events.  No amounts or benefits shall be payable or provided for pursuant to this Agreement unless an Event shall occur during the Term of this Agreement.

(a)For purposes of this Agreement, an “Event” shall be deemed to have occurred if any of the following occur:

(i)Any “person” (as defined in Sections 13(d) and 14(d) of the Securities Exchange Act of 1934, as amended, or any successor statute thereto (the “Exchange Act”)) acquires or becomes a “beneficial owner” (as defined in Rule 13d-3 or any successor rule under the Exchange Act), directly or indirectly, of securities of the Company or the Bank representing 35% or more of the combined voting power of the then outstanding securities entitled to vote generally in the election of directors (“Voting Securities”), provided, however, that the following shall not constitute an Event pursuant to this Section 2(a)(i):

(A)any acquisition of beneficial ownership by the Company, the Bank or a subsidiary of the Company or the Bank;

(B)any acquisition or beneficial ownership by any employee benefit plan (or related trust) sponsored or maintained by the Company, the Bank or one or more of their subsidiaries;

(C)any acquisition or beneficial ownership by any corporation (including without limitation an acquisition in a transaction of the nature described in Section 2(a)(iii)) with respect to which, immediately following such acquisition, more than 65%, respectively, of (x) the combined voting power of the Company’s or the Bank’s then outstanding Voting Securities and (y) the Company’s or the Bank’s then outstanding common stock (the “Common Stock”) is then beneficially owned, directly or indirectly, by all or substantially all of the persons who beneficially owned Voting Securities and Common Stock, respectively, of the Company or the Bank immediately prior to such acquisition in substantially the same proportions as their ownership of such Voting Securities and Common Stock, as the case may be, immediately prior to such acquisition;

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(D)any acquisition of Voting Securities or Common Stock directly from the Company or the Bank;

(ii)Continuing Directors shall not constitute a majority of the members of the Board of Directors of the Company.  For purposes of this Section 2(a)(ii), “Continuing Directors” shall mean:  (A) individuals who, on the date hereof, are directors of the Company, (B) individuals elected as directors of the Company subsequent to the date hereof for whose election proxies shall have been solicited by the Board of Directors of the Company or (C) any individual elected or appointed by the Board of Directors of the Company to fill vacancies on the Board of Directors of the Company caused by death or resignation (but not by removal) or to fill newly-created directorships, provided that a “Continuing Director” shall not include an individual whose initial assumption of office occurs as a result of an actual or threatened election contest with respect to the threatened election or removal of directors (or other actual or threatened solicitation of proxies or consents) by or on behalf of any person other than the Board of Directors of the Company;

(iii)Consummation of a reorganization, merger or consolidation of the Company or the Bank or a statutory exchange of outstanding Voting Securities of the Company or the Bank, unless immediately following such reorganization, merger, consolidation or exchange, all or substantially all of the persons who were the beneficial owners, respectively, of Voting Securities and Common Stock immediately prior to such reorganization, merger, consolidation or exchange beneficially own, directly or indirectly, more than 65% of, respectively, (x) the combined voting power of the then outstanding voting securities entitled to vote generally in the election of directors and (y) the then outstanding shares of common stock of the corporation resulting from such reorganization, merger, consolidation or exchange in substantially the same proportions as their ownership, immediately prior to such reorganization, merger, consolidation or exchange, of the Voting Securities and Common Stock, as the case may be;

(iv)(x) Approval by the shareholders of the Company of a complete liquidation or dissolution of the Company or the Bank or (y)  approval by the shareholders of the Company of the sale or other disposition of all or substantially all of the assets of the Company or the Bank (in one or a series of transactions), other than to a corporation with respect to which, immediately following such sale or other disposition, more than 65% of, respectively, (1) the combined voting power of the then outstanding voting securities of such

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corporation entitled to vote generally in the election of directors and (2) the then outstanding shares of common stock of such corporation is then beneficially owned, directly or indirectly, by all or substantially all of the persons who were the beneficial owners, respectively, of the Voting Securities and Common Stock immediately prior to such sale or other disposition in substantially the same proportions as their ownership, immediately prior to such sale or other disposition, of the Voting Securities and Common Stock, as the case may be;

(v)The Company or the Bank enters into a letter of intent, an agreement in principle or a definitive agreement relating to an Event described in Section 2(a)(i), 2(a)(ii), 2(a)(iii) or 2(a)(iv) hereof that ultimately results in such an Event, or a tender or exchange offer or proxy contest is commenced which ultimately results in an Event described in Section 2(a)(i) or 2(a)(ii) hereof; or

(vi)There shall be an involuntary termination or Constructive Involuntary Termination of employment of the Executive, and the Executive reasonably demonstrates that such event (x) was requested by a party other than the Board of Directors of the Company or the Bank that had previously taken other steps reasonably calculated to result in an Event described in Section 2(a)(i), 2(a)(ii), 2(a)(iii) or 2(a)(iv) hereof and which ultimately results in an Event described in Section 2(a)(i), 2(a)(ii), 2(a)(iii) or 2(a)(iv) hereof, or (y) otherwise arose in connection with or in anticipation of an Event described in Section 2(a)(i), 2(a)(ii), 2(a)(iii) or 2(a)(iv) hereof that ultimately occurs.

Notwithstanding anything stated in this Section 2(a), an Event shall not be deemed to occur with respect to the Executive if (x) the acquisition or beneficial ownership of the 35% or greater interest referred to in Section 2(a)(i) is by the Executive or by a group, acting in concert, that includes the Executive or (y) a majority of the then combined voting power of the then outstanding voting securities (or voting equity interests) of the surviving corporation or of any corporation (or other entity) acquiring all or substantially all of the assets of the Company or the Bank shall, immediately after a reorganization, merger, consolidation, exchange or disposition of assets referred to in Section 2(a)(iii) or 2(a)(iv), be beneficially owned, directly or indirectly, by the Executive or by a group, acting in concert, that includes the Executive.

(b)For purposes of this Agreement, a “subsidiary” of the Company or the Bank shall mean any entity of which securities or other ownership interests having general voting power to elect a majority of the board of directors or other persons performing similar functions are at the time directly or indirectly owned by the Company or the Bank.

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3.Payments and Benefits.  If any Event shall occur during the Term of this Agreement, then the Executive shall be entitled to receive from the Company, the Bank or either of their successors (which term as used herein shall include any person acquiring all or substantially all of the assets of the Company or the Bank) a cash payment and other benefits on the following basis (unless the Executive’s employment by the Company is terminated voluntarily or involuntarily prior to the occurrence of the earliest Event to occur (the “First Event”), in which case the Executive shall be entitled to no payment or benefits under this Section 3):

(a)If at the time of, or at any time after, the occurrence of the First Event and prior to the end of the Transition Period (as defined in Section 4(d)), the employment of the Executive with the Company or the Bank is voluntarily or involuntarily terminated for any reason (unless such termination is a voluntary termination by the Executive other than a Constructive Involuntary Termination or is on account of the death or Disability of the Executive or is a termination by the Company or the Bank for Cause), the Executive (or the Executive’s legal representative, as the case may be),

(i)shall be entitled to receive from the Company, the Bank or either of their successors, upon such termination of employment with the Company, the Bank or either of their successors, a cash payment in an amount equal to 2.99 times the average annual base salary payable by the Bank and included in the gross income for Federal Income Tax purposes of the Executive during the shorter of the period consisting of the five most recently completed taxable years of the Executive ending before the First Event (other than an Event described in Section 2(a)(v) or 2(a)(vi) unless the Executive is terminated prior to the occurrence of an Event described in Section 2(a)(i), 2(a)(ii), 2(a)(iii) or 2(a)(iv)) or that portion of such period during which the Executive was employed by the Company or the Bank (for which purpose compensation for a partial year shall be annualized, in accordance with temporary or final regulations promulgated under Section 280G(d) of the Internal Revenue Code of 1986, as amended (the “Code”), or any successor provision thereto, before determining average annual compensation for the period, such average annual compensation to be determined in accordance with temporary or final regulations promulgated under Section 280G(d) of the Code or any successor provision thereto and such payment to be made to the Executive by the Company, the Bank or either of their successors in a lump sum at the time of such termination of employment; and

(ii)shall be entitled for two years after the termination of the Executive’s employment with the Company or the Bank to participate in any health, disability and life insurance plan or program in which the Executive was entitled to participate immediately prior to the First Event as if he were an

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employee of the Company or the Bank during such two-year period (except, with respect to health insurance coverage, for those portions remaining during such two-year period that duplicate health insurance coverage that is in place for the Executive under any other policy provided at the expense of another employer); provided however, that in the event that the Executive’s participation in any such health, disability or life insurance plan or program of the Company or the Bank is barred, the Company or the Bank, at its sole cost and expense, shall arrange to provide the Executive with benefits substantially similar to those which the Executive would be entitled to receive under such plan or program if he were not barred from participation.

(b)The payments provided for in this Section 3 shall be in addition to any salary or other remuneration otherwise payable to the Executive on account of employment by the Company, the Bank or one or more of either of their subsidiaries or successors (including any amounts received prior to such termination of employment for personal services rendered after the occurrence of the First Event) but shall be reduced by any severance pay which the Executive receives from the Bank, its subsidiaries or its successor under any other policy or agreement of the Bank or its subsidiaries in the event of involuntary termination of Executive’s employment.

(c)In the event that at any time from the date of the First Event until the end of the Transition Period,

(i)the Executive shall not be given substantially equivalent or greater title, duties, responsibilities and authority, in each case as compared with the Executive’s status immediately prior to the First Event, other than for Cause or on account of Disability;

(ii)the Executive’s annual base salary shall be reduced from the Executive’s annual base salary in effect immediately prior to the First Event;

(iii)the Company or the Bank shall fail to provide the Executive with benefits under either of their pension, profit sharing, retirement, life insurance, medical, health and accident, disability, bonus and incentive plans and other employee benefit plans and arrangements that in the aggregate for all such plans and arrangements are at least as favorable to the Executive as those benefits covering the Executive immediately prior to the First Event or shall fail to provide the Executive with at least the number of paid vacation days to which the Executive was entitled immediately prior to the First Event;

(iv)the Bank shall have failed to obtain assumption of this Agreement by any successor as contemplated by Section 5(b) hereof;

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(v)the Company or the Bank shall require the Executive to relocate to any place other than a location within thirty-five miles of the location at which the Executive performed his primary duties immediately prior to the First Event or, if the Executive performed such duties at the Company’s principal executive offices, the Company shall relocate its principal executive offices to any location other than a location within thirty-five miles of the location of the principal executive offices immediately prior to the First Event; or

a termination of employment with the Company or the Bank by the Executive thereafter shall constitute a Constructive Involuntary Termination.

(d)Notwithstanding any provision to the contrary contained herein except the last sentence of this Section 3(d), if the lump sum cash payment due and the other benefits to which the Executive shall become entitled under Section 3(a) hereof, either alone or together with other payments in the nature of compensation to the Executive which are contingent on a change in the ownership or effective control of the Company or the Bank or in the ownership of a substantial portion of the assets of the Company or the Bank or otherwise, would constitute a “parachute payment” as defined in Section 280G of the Code or any successor provision thereto, such lump sum payment and/or such other benefits and payments shall be reduced (but not below zero) to the largest aggregate amount as will result in no portion thereof being subject to the excise tax imposed under Section 4999 of the Code (or any successor provision thereto) or being non-deductible to the Company or the Bank for federal income tax purposes pursuant to Section 280G of the Code (or any successor provision thereto).  The Company or the Bank in good faith shall determine the amount of any reduction to be made pursuant to this Section 3(d) and shall select from among the foregoing benefits and payments those which shall be reduced.  No modification of, or successor provision to, Section 280G or Section 4999 subsequent to the date of this Agreement shall, however, reduce the benefits to which the Executive would be entitled under this Agreement in the absence of this Section 3(d) to a greater extent than they would have been reduced if Section 280G and Section 4999 had not been modified or superseded subsequent to the date of this Agreement, notwithstanding anything to the contrary provided in the first sentence of this Section 3(d).

(e)The Executive shall not be required to mitigate the amount of any payment or other benefit provided for in Section 3 by seeking other employment or otherwise, nor (except as specifically provided in Section 3(a)(ii) or 3(b)) shall the amount of any payment or other benefit provided for in Section 3 be reduced by any compensation earned by the Executive as the result of employment by another employer after termination, or otherwise.

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(f)The obligations of the Company and the Bank under this Section 3 shall survive the termination of this Agreement.

4.Definition of Certain Additional Terms.

(a)As used herein, other than in Section 2(a) hereof, the term “person” shall mean an individual, partnership, corporation, estate, trust or other entity.

(b)As used herein, the term “Cause” shall mean, and be limited to:

(i)an act or acts of dishonesty undertaken by Executive and intended to result in substantial gain or personal enrichment of Executive at the expense of the Company or the Bank;

(ii)unlawful conduct or gross misconduct that is willful and deliberate on Executive’s part and that, in either event, is injurious to the Company or the Bank; or

(iii)the conviction of Executive of a felony.

(iv)failure of Executive to perform his duties and responsibilities under the Employment Agreement or to satisfy his obligations as an officer or employee of the Company or the Bank, which failure has not been cured by Executive within 30 days after written notice thereof to Executive from the Company or the Bank, as applicable; or

(v)material breach of any terms and conditions of the Employment Agreement by Executive not caused by the Company or the Bank, which breach has not been cured by Executive within ten days after written notice thereof to Executive from the Company or the Bank.

(c)As used herein, the term “Disability” shall mean the inability of Executive to perform on a full-time basis the duties and responsibilities of his employment with the Company or the Bank by reason of his illness or other physical or mental impairment or condition, if such inability continues for an uninterrupted period of 180 days or more during any 360-day period.  A period of inability shall be “uninterrupted” unless and until Executive returns to full-time work for a continuous period of at least 30 days.

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(d)As used herein, the term “Transition Period” shall mean the one year period commencing on the date of the earliest to occur of an Event described in Section 2(a)(i), 2(a)(ii), 2(a)(iii) or 2(a)(iv) hereof (the “Commencement Date”) and ending one year after the Commencement Date.

5.Successors and Assigns.

(a)This Agreement shall be binding upon and inure to the benefit of the successors, legal representatives and assigns of the parties hereto; provided, however, that the Executive shall not have any right to assign, pledge or otherwise dispose of or transfer any interest in this Agreement or any payments hereunder, whether directly or indirectly or in whole or in part, without the written consent of the Company or the Bank or either of their successors.

(b)The Company and the Bank will require any successor (whether direct or indirect, by purchase of a majority of the outstanding voting stock of the Company or the Bank or all or substantially all of the assets of the Company or the Bank, or by merger, consolidation or otherwise), by agreement in form and substance satisfactory to the Executive, to assume expressly and agree to perform this Agreement in the same manner and to the same extent that the Company and the Bank would be required to perform it if no such succession had taken place.  Failure of the Company or the Bank, as applicable, to obtain such agreement prior to the effectiveness of any such succession (other than in the case of a merger or consolidation) shall be a breach of this Agreement and shall entitle the Executive to compensation from the Bank in the same amount and on the same terms as the Executive would be entitled hereunder if the Executive terminated his employment on account of a Constructive Involuntary Termination, except that for purposes of implementing the foregoing, the date on which any such succession becomes effective shall be deemed the date of termination.  As used in this Agreement, “Company” shall mean the Company as hereinbefore defined and any successor to its business and/or assets as aforesaid which is required to execute and deliver the agreement provided for in this Section 5(b) or which otherwise becomes bound by all the terms and provisions of this Agreement by operation of law and “Bank” shall mean the Bank as hereinbefore defined and any successor to its business and/or assets as aforesaid which is required to execute and deliver the agreement provided for in this Section 5(b) or which otherwise becomes bound by all the terms and provisions of this Agreement by operation of law.

6.Governing Law.  This Agreement shall be construed in accordance with the laws of the State of Minnesota.

7.Notices.  All notices, requests and demands given to or made pursuant hereto shall be in writing and shall be delivered or mailed to any such party at its address which:

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(a)In the case of the Company or the Bank shall be:

HMN Financial, Inc.
Attention:  Chairman of the Board
1016 Civic Center Drive NW
Rochester, Minnesota  55901

(b)In the case of the Executive shall be:

Michael McNeil
1951 Waterford Place Southwest
Rochester, MN 55902

Either party may, by notice hereunder, designate a changed address.  Any notice, if mailed properly addressed, postage prepaid, registered or certified mail, shall be deemed to have been given on the registered date or that date stamped on the certified mail receipt.

8.Severability; Severance.  In the event that any portion of this Agreement is held to be invalid or unenforceable for any reason, it is hereby agreed that such invalidity or unenforceability shall not affect the other portions of this Agreement and that the remaining covenants, terms and conditions or portions hereof shall remain in full force and effect, and any court of competent jurisdiction may so modify the objectionable provision as to make it valid, reasonable and enforceable.  In the event that any benefits to the Executive provided in this Agreement are held to be unavailable to the Executive as a matter of law, the Executive shall be entitled to severance benefits from the Bank, in the event of an involuntary termination or Constructive Involuntary Termination of employment of the Executive (other than a termination on account of the death or Disability of the Executive or a termination for Cause) during the term of this Agreement occurring at the time of or following the occurrence of an Event, at least as favorable to the Executive (when taken together with the benefits under this Agreement that are actually received by the Executive) as the most advantageous benefits made available by the Employer to employees of comparable position and seniority to the Executive during the five-year period prior to the First Event.

9.Term.  This Agreement shall commence on the date of this Agreement and shall terminate, and the Term of this Agreement shall end, on the later of (A) March 31, 2005,  provided that such period shall be extended automatically for one year and from year to year thereafter until notice of termination is given by the Company or the Executive to the other party hereto at least 30 days prior to March 31, 2005 or the expiration of the one-year extension period then in effect, as the case may be, or (B) if the Commencement Date occurs on or prior to March 31, 2005 (or prior to the end of the extension year then in effect as provided for in clause (A) hereof), one year after the Commencement Date.

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10.Termination of Prior Agreement.  This Agreement supercedes the Prior Agreement which is hereby terminated and neither party shall have any rights or obligations pursuant to the terms of the Prior Agreement.

IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the day and year first above written.

HOME FEDERAL SAVINGS BANK
By
	Its
Executive

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EX-10.3

Exhibit 10.3

CHANGE-IN-CONTROL AGREEMENT

AGREEMENT entered into as of March 1, 2004 by and between Home Federal Savings Bank, a federally chartered savings bank (the “Bank”) and a wholly owned subsidiary of HMN Financial, Inc., a Delaware corporation (the “Company”), and                                         (the “Executive”).

WITNESSETH:

WHEREAS, the Executive is a key member of the management of the Company and the Bank and has heretofore devoted substantial skill and effort to the affairs of the Company and the Bank; and

WHEREAS, it is desirable and in the best interests of the Bank and the Company and its shareholders to continue to obtain the benefits of the Executive’s services and attention to the affairs of the Company and the Bank; and

WHEREAS, it is desirable and in the best interests of the Bank and the Company and its shareholders to provide inducement for the Executive (A) to remain in the service of the Company and the Bank in the event of any proposed or anticipated change in control of the Company and (B) to remain in the service of the Company and the Bank in order to facilitate an orderly transition in the event of a change in control of the Company; and

WHEREAS, it is desirable and in the best interests of the Bank and the Company and its shareholders that the Executive be in a position to make judgments and advise the Company with respect to proposed changes in control of the Company or the Bank; and

WHEREAS, the Executive desires to be protected in the event of certain changes in control of the Company or the Bank; and

WHEREAS, Executive and the Bank desire to terminate the prior agreement between Executive and the Bank and to enter into this Agreement to conform the renewal period of this Agreement with that of other similar agreements regarding payments upon a change in control between certain other employees and the Company;  and

WHEREAS, for the reasons set forth above, the Bank and the Executive desire to enter into this Agreement.

NOW, THEREFORE, in consideration of the foregoing and the mutual covenants and agreements contained herein, the Bank and the Executive agree as follows:

1.Employment.  This Agreement does not govern the terms of the Executive’s employment, unless an Event shall be deemed to have occurred as contemplated by Section 2.

2.Events.  No amounts or benefits shall be payable or provided for pursuant to this Agreement unless an Event shall occur during the Term of this Agreement.

(a)For purposes of this Agreement, an “Event” shall be deemed to have occurred if any of the following occur:

(i)Any “person” (as defined in Sections 13(d) and 14(d) of the Securities Exchange Act of 1934, as amended, or any successor statute thereto (the “Exchange Act”)) acquires or becomes a “beneficial owner” (as defined in Rule 13d-3 or any successor rule under the Exchange Act), directly or indirectly, of securities of the Company or the Bank representing 35% or more of the combined voting power of the then outstanding securities entitled to vote generally in the election of directors (“Voting Securities”), provided, however, that the following shall not constitute an Event pursuant to this Section 2(a)(i):

(A)any acquisition of beneficial ownership by the Company, the Bank or a subsidiary of the Company or the Bank;

(B)any acquisition or beneficial ownership by any employee benefit plan (or related trust) sponsored or maintained by the Company, the Bank or one or more of their subsidiaries;

(C)any acquisition or beneficial ownership by any corporation (including without limitation an acquisition in a transaction of the nature described in Section 2(a)(iii)) with respect to which, immediately following such acquisition, more than 65%, respectively, of (x) the combined voting power of the Company’s or the Bank’s then outstanding Voting Securities and (y) the Company’s or the Bank’s then outstanding common stock (the “Common Stock”) is then beneficially owned, directly or indirectly, by all or substantially all of the persons who beneficially owned Voting Securities and Common Stock, respectively, of the Company or the Bank immediately prior to such acquisition in substantially the same proportions as their ownership of such Voting Securities and Common Stock, as the case may be, immediately prior to such acquisition;

(D)any acquisition of Voting Securities or Common Stock directly from the Company or the Bank;

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(ii)Continuing Directors shall not constitute a majority of the members of the Board of Directors of the Company.  For purposes of this Section 2(a)(ii), “Continuing Directors” shall mean:  (A) individuals who, on the date hereof, are directors of the Company, (B) individuals elected as directors of the Company subsequent to the date hereof for whose election proxies shall have been solicited by the Board of Directors of the Company or (C) any individual elected or appointed by the Board of Directors of the Company to fill vacancies on the Board of Directors of the Company caused by death or resignation (but not by removal) or to fill newly-created directorships, provided that a “Continuing Director” shall not include an individual whose initial assumption of office occurs as a result of an actual or threatened election contest with respect to the threatened election or removal of directors (or other actual or threatened solicitation of proxies or consents) by or on behalf of any person other than the Board of Directors of the Company;

(iii)Consummation of a reorganization, merger or consolidation of the Company or the Bank or a statutory exchange of outstanding Voting Securities of the Company or the Bank, unless immediately following such reorganization, merger, consolidation or exchange, all or substantially all of the persons who were the beneficial owners, respectively, of Voting Securities and Common Stock immediately prior to such reorganization, merger, consolidation or exchange beneficially own, directly or indirectly, more than 65% of, respectively, (x) the combined voting power of the then outstanding voting securities entitled to vote generally in the election of directors and (y) the then outstanding shares of common stock of the corporation resulting from such reorganization, merger, consolidation or exchange in substantially the same proportions as their ownership, immediately prior to such reorganization, merger, consolidation or exchange, of the Voting Securities and Common Stock, as the case may be;

(iv)(x) Approval by the shareholders of the Company of a complete liquidation or dissolution of the Company or the Bank or (y)  approval by the shareholders of the Company of the sale or other disposition of all or substantially all of the assets of the Company or the Bank (in one or a series of transactions), other than to a corporation with respect to which, immediately following such sale or other disposition, more than 65% of, respectively, (1) the combined voting power of the then outstanding voting securities of such corporation entitled to vote generally in the election of directors and (2) the then outstanding shares of common stock of such corporation is then beneficially owned, directly or indirectly, by all or substantially all of the

3

persons who were the beneficial owners, respectively, of the Voting Securities and Common Stock immediately prior to such sale or other disposition in substantially the same proportions as their ownership, immediately prior to such sale or other disposition, of the Voting Securities and Common Stock, as the case may be;

(v)The Company or the Bank enters into a letter of intent, an agreement in principle or a definitive agreement relating to an Event described in Section 2(a)(i), 2(a)(ii), 2(a)(iii) or 2(a)(iv) hereof that ultimately results in such an Event, or a tender or exchange offer or proxy contest is commenced which ultimately results in an Event described in Section 2(a)(i) or 2(a)(ii) hereof; or

(vi)There shall be an involuntary termination or Constructive Involuntary Termination of employment of the Executive, and the Executive reasonably demonstrates that such event (x) was requested by a party other than the Board of Directors of the Company or the Bank that had previously taken other steps reasonably calculated to result in an Event described in Section 2(a)(i), 2(a)(ii), 2(a)(iii) or 2(a)(iv) hereof and which ultimately results in an Event described in Section 2(a)(i), 2(a)(ii), 2(a)(iii) or 2(a)(iv) hereof, or (y) otherwise arose in connection with or in anticipation of an Event described in Section 2(a)(i), 2(a)(ii), 2(a)(iii) or 2(a)(iv) hereof that ultimately occurs.

Notwithstanding anything stated in this Section 2(a), an Event shall not be deemed to occur with respect to the Executive if (x) the acquisition or beneficial ownership of the 35% or greater interest referred to in Section 2(a)(i) is by the Executive or by a group, acting in concert, that includes the Executive or (y) a majority of the then combined voting power of the then outstanding voting securities (or voting equity interests) of the surviving corporation or of any corporation (or other entity) acquiring all or substantially all of the assets of the Company or the Bank shall, immediately after a reorganization, merger, consolidation, exchange or disposition of assets referred to in Section 2(a)(iii) or 2(a)(iv), be beneficially owned, directly or indirectly, by the Executive or by a group, acting in concert, that includes the Executive.

(b)For purposes of this Agreement, a “subsidiary” of the Company or the Bank shall mean any entity of which securities or other ownership interests having general voting power to elect a majority of the board of directors or other persons performing similar functions are at the time directly or indirectly owned by the Company or the Bank.

3.Payments and Benefits.  If any Event shall occur during the Term of this Agreement, then the Executive shall be entitled to receive from the Company, the Bank or

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either of their successors (which term as used herein shall include any person acquiring all or substantially all of the assets of the Company or the Bank) a cash payment and other benefits on the following basis (unless the Executive’s employment by the Company is terminated voluntarily or involuntarily prior to the occurrence of the earliest Event to occur (the “First Event”), in which case the Executive shall be entitled to no payment or benefits under this Section 3):

(a)If at the time of, or at any time after, the occurrence of the First Event and prior to the end of the Transition Period (as defined in Section 4(d)), the employment of the Executive with the Company or the Bank is voluntarily or involuntarily terminated for any reason (unless such termination is a voluntary termination by the Executive other than a Constructive Involuntary Termination or is on account of the death or Disability of the Executive or is a termination by the Company or the Bank for Cause), the Executive (or the Executive’s legal representative, as the case may be),

(i)shall be entitled to receive from the Company, the Bank or either of their successors, upon such termination of employment with the Company, the Bank or either of their successors, a cash payment in an amount equal to 2.0 times the average annual base salary payable by the Bank and included in the gross income for Federal Income Tax purposes of the Executive during the shorter of the period consisting of the five most recently completed taxable years of the Executive ending before the First Event (other than an Event described in Section 2(a)(v) or 2(a)(vi) unless the Executive is terminated prior to the occurrence of an Event described in Section 2(a)(i), 2(a)(ii), 2(a)(iii) or 2(a)(iv)) or that portion of such period during which the Executive was employed by the Company or the Bank (for which purpose compensation for a partial year shall be annualized, in accordance with temporary or final regulations promulgated under Section 280G(d) of the Internal Revenue Code of 1986, as amended (the “Code”), or any successor provision thereto, before determining average annual compensation for the period, such average annual compensation to be determined in accordance with temporary or final regulations promulgated under Section 280G(d) of the Code or any successor provision thereto and such payment to be made to the Executive by the Company, the Bank or either of their successors in a lump sum at the time of such termination of employment; and

(ii)shall be entitled for one year after the termination of the Executive’s employment with the Company or the Bank to participate in any health, disability and life insurance plan or program in which the Executive was entitled to participate immediately prior to the First Event as if he were an employee of the Company or the Bank during such one-year period (except, with respect to health insurance coverage, for those portions remaining during such one-year period that duplicate health insurance coverage that is in place for the

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Executive under any other policy provided at the expense of another employer); provided however, that in the event that the Executive’s participation in any such health, disability or life insurance plan or program of the Company or the Bank is barred, the Company or the Bank, at its sole cost and expense, shall arrange to provide the Executive with benefits substantially similar to those which the Executive would be entitled to receive under such plan or program if he were not barred from participation.

(b)The payments provided for in this Section 3 shall be in addition to any salary or other remuneration otherwise payable to the Executive on account of employment by the Company, the Bank or one or more of either of their subsidiaries or successors (including any amounts received prior to such termination of employment for personal services rendered after the occurrence of the First Event) but shall be reduced by any severance pay which the Executive receives from the Bank, its subsidiaries or its successor under any other policy or agreement of the Bank or its subsidiaries in the event of involuntary termination of Executive’s employment.

(c)In the event that at any time from the date of the First Event until the end of the Transition Period,

(i)the Executive shall not be given substantially equivalent or greater title, duties, responsibilities and authority, in each case as compared with the Executive’s status immediately prior to the First Event, other than for Cause or on account of Disability;

(ii)the Executive’s annual base salary shall be reduced from the Executive’s annual base salary in effect immediately prior to the First Event;

(iii)the Company or the Bank shall fail to provide the Executive with benefits under either of their pension, profit sharing, retirement, life insurance, medical, health and accident, disability, bonus and incentive plans and other employee benefit plans and arrangements that in the aggregate for all such plans and arrangements are at least as favorable to the Executive as those benefits covering the Executive immediately prior to the First Event or shall fail to provide the Executive with at least the number of paid vacation days to which the Executive was entitled immediately prior to the First Event;

(iv)the Bank shall have failed to obtain assumption of this Agreement by any successor as contemplated by Section 5(b) hereof;

(v)the Company or the Bank shall require the Executive to relocate to any place other than a location within thirty-five miles of the location at which

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the Executive performed his primary duties immediately prior to the First Event or, if the Executive performed such duties at the Company’s principal executive offices, the Company shall relocate its principal executive offices to any location other than a location within thirty-five miles of the location of the principal executive offices immediately prior to the First Event; or

a termination of employment with the Company or the Bank by the Executive thereafter shall constitute a Constructive Involuntary Termination.

(d)Notwithstanding any provision to the contrary contained herein except the last sentence of this Section 3(d), if the lump sum cash payment due and the other benefits to which the Executive shall become entitled under Section 3(a) hereof, either alone or together with other payments in the nature of compensation to the Executive which are contingent on a change in the ownership or effective control of the Company or the Bank or in the ownership of a substantial portion of the assets of the Company or the Bank or otherwise, would constitute a “parachute payment” as defined in Section 280G of the Code or any successor provision thereto, such lump sum payment and/or such other benefits and payments shall be reduced (but not below zero) to the largest aggregate amount as will result in no portion thereof being subject to the excise tax imposed under Section 4999 of the Code (or any successor provision thereto) or being non-deductible to the Company or the Bank for federal income tax purposes pursuant to Section 280G of the Code (or any successor provision thereto).  The Company or the Bank in good faith shall determine the amount of any reduction to be made pursuant to this Section 3(d) and shall select from among the foregoing benefits and payments those which shall be reduced.  No modification of, or successor provision to, Section 280G or Section 4999 subsequent to the date of this Agreement shall, however, reduce the benefits to which the Executive would be entitled under this Agreement in the absence of this Section 3(d) to a greater extent than they would have been reduced if Section 280G and Section 4999 had not been modified or superseded subsequent to the date of this Agreement, notwithstanding anything to the contrary provided in the first sentence of this Section 3(d).

(e)The Executive shall not be required to mitigate the amount of any payment or other benefit provided for in Section 3 by seeking other employment or otherwise, nor (except as specifically provided in Section 3(a)(ii) or 3(b)) shall the amount of any payment or other benefit provided for in Section 3 be reduced by any compensation earned by the Executive as the result of employment by another employer after termination, or otherwise.

(f)The obligations of the Company and the Bank under this Section 3 shall survive the termination of this Agreement.

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4.Definition of Certain Additional Terms.

(a)As used herein, other than in Section 2(a) hereof, the term “person” shall mean an individual, partnership, corporation, estate, trust or other entity.

(b)As used herein, the term “Cause” shall mean, and be limited to:

(i)an act or acts of dishonesty undertaken by Executive and intended to result in substantial gain or personal enrichment of Executive at the expense of the Company or the Bank;

(ii)unlawful conduct or gross misconduct that is willful and deliberate on Executive’s part and that, in either event, is injurious to the Company or the Bank; or

(iii)the conviction of Executive of a felony.

(iv)failure of Executive to perform his duties and responsibilities under the Employment Agreement or to satisfy his obligations as an officer or employee of the Company or the Bank, which failure has not been cured by Executive within 30 days after written notice thereof to Executive from the Company or the Bank, as applicable; or

(v)material breach of any terms and conditions of the Employment Agreement by Executive not caused by the Company or the Bank, which breach has not been cured by Executive within ten days after written notice thereof to Executive from the Company or the Bank.

(c)As used herein, the term “Disability” shall mean the inability of Executive to perform on a full-time basis the duties and responsibilities of his employment with the Company or the Bank by reason of his illness or other physical or mental impairment or condition, if such inability continues for an uninterrupted period of 180 days or more during any 360-day period.  A period of inability shall be “uninterrupted” unless and until Executive returns to full-time work for a continuous period of at least 30 days.

(d)As used herein, the term “Transition Period” shall mean the one year period commencing on the date of the earliest to occur of an Event described in Section 

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2(a)(i), 2(a)(ii), 2(a)(iii) or 2(a)(iv) hereof (the “Commencement Date”) and ending one year after the Commencement Date.

5.Successors and Assigns.

(a)This Agreement shall be binding upon and inure to the benefit of the successors, legal representatives and assigns of the parties hereto; provided, however, that the Executive shall not have any right to assign, pledge or otherwise dispose of or transfer any interest in this Agreement or any payments hereunder, whether directly or indirectly or in whole or in part, without the written consent of the Company or the Bank or either of their successors.

(b)The Company and the Bank will require any successor (whether direct or indirect, by purchase of a majority of the outstanding voting stock of the Company or the Bank or all or substantially all of the assets of the Company or the Bank, or by merger, consolidation or otherwise), by agreement in form and substance satisfactory to the Executive, to assume expressly and agree to perform this Agreement in the same manner and to the same extent that the Company and the Bank would be required to perform it if no such succession had taken place.  Failure of the Company or the Bank, as applicable, to obtain such agreement prior to the effectiveness of any such succession (other than in the case of a merger or consolidation) shall be a breach of this Agreement and shall entitle the Executive to compensation from the Bank in the same amount and on the same terms as the Executive would be entitled hereunder if the Executive terminated his employment on account of a Constructive Involuntary Termination, except that for purposes of implementing the foregoing, the date on which any such succession becomes effective shall be deemed the date of termination.  As used in this Agreement, “Company” shall mean the Company as hereinbefore defined and any successor to its business and/or assets as aforesaid which is required to execute and deliver the agreement provided for in this Section 5(b) or which otherwise becomes bound by all the terms and provisions of this Agreement by operation of law and “Bank” shall mean the Bank as hereinbefore defined and any successor to its business and/or assets as aforesaid which is required to execute and deliver the agreement provided for in this Section 5(b) or which otherwise becomes bound by all the terms and provisions of this Agreement by operation of law.

6.Governing Law.  This Agreement shall be construed in accordance with the laws of the State of Minnesota.

7.Notices.  All notices, requests and demands given to or made pursuant hereto shall be in writing and shall be delivered or mailed to any such party at its address which:

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(a)In the case of the Company or the Bank shall be:

HMN Financial, Inc.
Attention:  Chairman of the Board
1016 Civic Center Drive NW
Rochester, Minnesota  55901

(b)In the case of the Executive shall be:

Either party may, by notice hereunder, designate a changed address.  Any notice, if mailed properly addressed, postage prepaid, registered or certified mail, shall be deemed to have been given on the registered date or that date stamped on the certified mail receipt.

8.Severability; Severance.  In the event that any portion of this Agreement is held to be invalid or unenforceable for any reason, it is hereby agreed that such invalidity or unenforceability shall not affect the other portions of this Agreement and that the remaining covenants, terms and conditions or portions hereof shall remain in full force and effect, and any court of competent jurisdiction may so modify the objectionable provision as to make it valid, reasonable and enforceable.  In the event that any benefits to the Executive provided in this Agreement are held to be unavailable to the Executive as a matter of law, the Executive shall be entitled to severance benefits from the Bank, in the event of an involuntary termination or Constructive Involuntary Termination of employment of the Executive (other than a termination on account of the death or Disability of the Executive or a termination for Cause) during the term of this Agreement occurring at the time of or following the occurrence of an Event, at least as favorable to the Executive (when taken together with the benefits under this Agreement that are actually received by the Executive) as the most advantageous benefits made available by the Employer to employees of comparable position and seniority to the Executive during the five-year period prior to the First Event.

9.Term.  This Agreement shall commence on the date of this Agreement and shall terminate, and the Term of this Agreement shall end, on the later of (A) March 31, 2005,  provided that such period shall be extended automatically for one year and from year to year thereafter until notice of termination is given by the Company or the Executive to the other party hereto at least 30 days prior to March 31, 2005 or the expiration of the one-year extension period then in effect, as the case may be, or (B) if the Commencement Date occurs on or prior to March 31, 2005 (or prior to the end of the extension year then in effect as provided for in clause (A) hereof), one year after the Commencement Date.

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10.Termination of Prior Agreement.  This Agreement supercedes any prior agreement, other than stock option agreements, regarding payments by the Bank to Executive upon a change-in-control of the Company or the Bank and any such agreement is hereby terminated and neither party shall have any rights or obligations pursuant to the terms of any such agreement.

IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the day and year first above written.

HOME FEDERAL SAVINGS BANK
By
	Its
Executive

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EX-13

Exhibit 13

FIVE - YEAR CONSOLIDATED FINANCIAL HIGHLIGHTS

Selected Operations Data:

	Year Ended December 31,
(Dollars in thousands, except per share data)	2003			2002		2001		2000		1999
Total interest income	$	44,937		42,868		51,468		52,917		47,104
Total interest expense	20,289			21,295		30,444		33,001		28,911
Net interest income	24,648			21,573		21,024		19,916		18,193
Provision for loan losses	2,610			2,376		1,150		180		240
Net interest income after provision for loan losses	22,038			19,197		19,874		19,736		17,953
Fees and service charges	2,304			1,723		1,563		1,297		848
Mortgage servicing fees	998			715		470		341		335
Securities gains (losses), net	1,275			422		(671	)	(23	)	122
Gain on sales of loans	5,240			3,077		2,934		1,216		1,932
Earnings (losses) in limited partnerships	(243		)	(659	)	(1,311	)	(121	)	550
Other non-interest income	681			597		599		613		506
Total non-interest income	10,255			5,875		3,584		3,323		4,293
Other non-interest expense	19,653			17,849		15,749		12,559		11,895
Total non-interest expense	19,653			17,849		15,749		12,559		11,895
Income tax expense	4,038			2,099		2,634		3,798		3,960
Income before minority interest	8,602			5,124		5,075		6,702		6,391
Minority interest	(3		)	(142	)	(383	)	0		0
Net income	$	8,605		5,266		5,458		6,702		6,391
Per common share and common share equivalents:
Basic	$	2.26		1.40		1.45		1.75		1.47
Diluted	2.16			1.32		1.37		1.69		1.41

Selected Financial Condition Data:

	December 31,
(Dollars in thousands, except per share data)	2003			2002		2001		2000		1999
Total assets	$	866,436		737,523		721,114		716,016		699,186
Securities available for sale	104,664			121,397		119,895		139,206		173,477
Loans held for sale	6,543			15,127		68,018		7,861		4,083
Loans receivable, net	688,951			533,906		471,668		518,765		447,896
Deposits	551,688			432,951		421,843		421,691		400,382
Federal Home Loan Bank advances	203,900			218,300		217,800		221,900		229,400
Stockholders’ equity	80,931			76,065		72,161		66,626		64,561
Book value per share	17.93			17.28		16.41		15.17		13.57
Tangible book value per share	16.23			15.68		15.39		14.09		12.48
Number of full service offices	12			13		12		11		10
Number of mortgage origination offices	6			2		1		1		1
Key Ratios(1)
Stockholders’ equity to total assets at year end	9.34		%	10.31	%	10.01	%	9.31	%	9.23	%
Average stockholders’ equity to average assets	10.15			10.66		9.91		9.56		10.13
Return on stockholders’ equity (ratio of net income to average equity)	10.85			6.94		7.57		9.81		9.18
Return on assets (ratio of net income to average assets)	1.10			0.74		0.75		0.94		0.93
Dividend payout ratio	39.58			57.63		39.71		27.22		24.11

(1)     Average balances were calculated based upon amortized cost without the market value impact of SFAS No. 115.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

This Annual Report, other reports filed with the Securities and Exchange Commission, and HMN’s proxy statement may contain “forward-looking” statements that deal with future results, plans or performance. In addition, the Company’s management may make such statements orally to the media, or to securities analysts, investors or others. Forward-looking statements deal with matters that do not relate strictly to historical facts. The Company’s future results may differ materially from historical performance and forward-looking statements about the Company’s expected financial results or other plans are subject to a number of risks and uncertainties. These include but are not limited to possible legislative changes and adverse economic, business and competitive developments such as shrinking interest margins; deposit outflows; reduced demand for financial services and loan products; changes in accounting policies and guidelines, or monetary and fiscal policies of the federal government; changes in credit and other risks posed by the Company’s loan and investment portfolios; technological, computer-related or operational difficulties; adverse changes in securities markets; results of litigation or other significant uncertainties.

OVERVIEW

HMN Financial, Inc. (HMN or the Company) is the stock savings bank holding company for Home Federal Savings Bank (the Bank) which operates community retail banking facilities and loan production offices in southern Minnesota and Iowa. Eagle Crest Capital Bank, a division of Home Federal Savings Bank, provides private banking services to a diverse group of high net worth customers from offices in Edina and Rochester Minnesota. The earnings of the Company are primarily dependant on the Bank’s net interest income, which is the difference between interest earned on its loans and investments, and the interest paid on interest-bearing liabilities such as deposits and Federal Home Loan Bank (FHLB) advances. The difference between the average rate of interest earned on assets and the average rate paid on liabilities is the “interest rate spread”. Net interest income is produced when interest-earning assets equal or exceed interest-bearing liabilities and there is a positive interest rate spread. The Company’s interest rate spread has been enhanced by the increased level of commercial loans placed in portfolio and the increased amount of lower rate deposit products such as checking and money market accounts. Net interest income and net interest rate spread 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. The Company’s net income is also affected by the generation of non-interest income, which consists primarily of gains or losses from the sale of securities, gains from the sale of loans, and the generation of fees and service charges on deposit accounts. The Company’s non-interest income has been enhanced by increased fees and service charges on deposit accounts. The Bank incurs expenses in addition to interest expense in the form of salaries and benefits, occupancy expenses, provisions for loan losses and amortization and valuation adjustments on mortgage servicing assets.

The earnings of financial institutions, such as the Bank, are significantly affected by prevailing economic and competitive conditions, particularly changes in interest rates, government monetary and fiscal policies, and regulations of various regulatory authorities. Lending activities are influenced by the demand for and supply of single family and commercial properties, competition among lenders, the level of interest rates and the availability of funds. Due to an anticipated increase in mortgage interest rates, we expect mortgage activity to slow in 2004. Deposit flows and costs of deposits are influenced by prevailing market rates of interest on competing investments, account maturities and the levels of personal income and savings.

Critical Accounting Policies

Critical accounting policies are those policies that the Company’s management believes are the most important to understanding the Company’s financial condition and operating results. The Company has identified the following three policies as being critical because they require difficult, subjective, and/or complex judgments that are inherently uncertain. Therefore, actual financial results could differ significantly depending upon the estimates used.

Allowance for Loan Losses and Related Provision

The allowance for loan losses is based on periodic analysis of the loan portfolio. In this analysis, management considers factors including, but not limited to, specific occurrences of loan impairment, changes in the size of the portfolios, national and regional economic conditions, such as unemployment data, loan portfolio composition, loan delinquencies, local construction permits, development plans, local economic growth rates, historical experience and observations made by the Company’s ongoing internal audit and regulatory exam processes. The allowance for loan losses is established for known problem loans, as well as for loans which are not currently known to require specific allowances. Loans are charged off to the extent they are deemed to be uncollectible. The Company has established separate processes to determine the adequacy of the loan loss allowance for its homogeneous and non-homogeneous loan portfolios. The determination of the allowance for the nonhomogeneous commercial, commercial real estate, and multi-family loan portfolios involves assigning standardized risk ratings and loss factors that are periodically reviewed. The loss factors are estimated using a combination of the Company’s own loss experience and external industry data and are assigned to all loans without identified credit weaknesses. The Company also performs an individual analysis of impairment on each non-performing loan that is based on the expected cash flows or the value of the assets collateralizing the loans. The determination of the allowance on the homogeneous single-family and consumer loan portfolios is calculated on a pooled basis with individual determination of the allowance of all non-performing loans.

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The adequacy of the allowance for loan losses is dependent upon management’s estimates of variables affecting valuation, appraisals of collateral, evaluations of performance and status, and the amounts and timing of future cash flows expected to be received on impaired loans. Such estimates, appraisals, evaluations and cash flows may be subject to frequent adjustments due to changing economic prospects of borrowers or properties. The estimates are reviewed periodically and adjustments, if any, are recorded in the provision for loan losses in the periods in which the adjustments become known. The allowance is allocated to individual loan categories based upon the relative risk characteristics of the loan portfolios and the actual loss experience. The Company increases its allowance for loan losses by charging the provision for loan losses against income. The methodology for establishing the allowance for loan losses takes into consideration probable losses that have been identified in connection with specific loans as well as losses in the loan portfolio for which specific reserves are not required. Although management believes that the allowance for loan losses is maintained at an adequate amount to provide for probable loan losses inherent in the portfolio as of the balance sheet dates, future adjustments to the provision for loan losses may be necessary if conditions differ substantially from those in the assumptions used to determine the allowance for loan losses.

Mortgage Servicing Rights

The Company recognizes as an asset the rights to service mortgage loans for others, which are referred to as mortgage servicing rights (MSRs). MSRs are capitalized at the relative fair value of the servicing rights on the date the mortgage loan is sold and are carried at the lower of the capitalized amount, net of accumulated amortization, or fair value. MSRs are capitalized and amortized in proportion to, and over the period of, estimated net servicing income. Each quarter the Company evaluates its MSRs for impairment in accordance with Statement of Financial Accounting Standard (SFAS) No. 140.  Loan type and interest rate are the predominant risk characteristics of the underlying loans used to stratify the MSRs for purposes of measuring impairment. If temporary impairment exists, a valuation allowance is established for any excess of amortized cost over the current fair value through a charge to income. If the Company later determines that all or a portion of the temporary impairment no longer exists, a reduction of the valuation allowance is recorded as an increase to income.  The valuation of the MSRs is based on various assumptions including the estimated prepayment speeds and default rates of the stratified portfolio. Changes in the mix of loans, interest rates, prepayment speeds, or default rates from the estimates used in the valuation of the mortgage servicing rights may have a material effect on the amortization and valuation of MSRs. Although management believes that the assumptions used and the values determined are reasonable, future adjustments may be necessary if economic conditions differ substantially from the economic conditions in the assumptions used to determine the value of the MSRs. The Company does not formally hedge its MSRs because they are hedged naturally by the Company’s origination volume. Generally, as interest rates rise the origination volume declines and the value of MSRs increases and as interest rates decline the origination volume increases and the value of MSRs decreases.

Income Taxes

Deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. These calculations are based on many complex factors including estimates of the timing of reversals of temporary differences, the interpretation of federal and state income tax laws, and a determination of the differences between the tax and the financial reporting basis of assets and liabilities. Actual results could differ significantly from the estimates and interpretations used in determining the current and deferred income tax liabilities.

Results of Operations

Net income was $8.6 million for the year ended December 31, 2003, compared to $5.3 million for the year ended December 31, 2002. Basic earnings per share were $2.26 for the year ended December 31, 2003, compared to $1.40 for the year ended December 31, 2002. Diluted earnings per common share for the year ended December 31, 2003 were $2.16, compared to $1.32 for the year ended December 31, 2002. Return on average assets was 1.10% and 0.74% and return on average equity was 10.85% and 6.94% for the years ended December 31, 2003 and 2002, respectively.

Net Interest Income

In comparing the year ended December 31, 2003 to the year ended December 31, 2002, net interest income increased by $3.1 million to $24.6 million from $21.5 million in 2002. Interest income was $44.9 million for the year ended December 31, 2003, an increase of $2.0 million, from $42.9 million for the same period in 2002. Interest income increased primarily because of an increase in interest-earning assets and because of a higher concentration of commercial and consumer loans in portfolio. The commercial and consumer loan portfolios increased by $148 million between the periods.  During 2003, the Company’s commercial and consumer loan portfolios continued to increase and the

3

percentage of loans in these portfolios represented 61.7% of the Company’s outstanding loans at December 31, 2003, compared to 58.2% at December 31, 2002. The increase in interest-earning assets offsets the decrease in the interest rates earned on the assets between the periods. Interest expense was $20.3 million for the year ended December 31, 2003, a decrease of $1.0 million, from the $21.3 million for the same period in 2002. Interest expense declined primarily because of a decrease in the rates paid on deposits and Federal Home Loan Bank advances and because of a $45 million increase in the outstanding average balance of checking and money market accounts between the periods, which generally have lower interest rates than other deposit accounts.

The following table presents the total dollar amount of interest income from average interest-earning assets and the resultant yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and rates. Non-accruing loans have been included in the table as loans carrying a zero yield.

	Year Ended December 31,
	2003						2002						2001
(Dollars in thousands)	Average Outstanding Balance		Interest Earned/ Paid		Yield/ Rate		Average Outstanding Balance		Interest Earned/ Paid		Yield/ Rate		Average Outstanding Balance		Interest Earned/ Paid		Yield/ Rate
Interest-earning assets:
Securities available for sale:
Mortgage-backed and related securities	$	21,885	272		1.24	%	$	63,022	1,704		2.70	%	$	71,230	3,867		5.43	%
Other marketable securities(1)	74,487		2,387		3.20		60,973		2,420		3.97		38,106		2,248		5.90
Loans held for sale	12,899		748		5.80		22,485		1,587		7.06		54,009		3,764		6.97
Loans receivable, net(2)	602,653		41,052		6.81		479,158		36,426		7.60		503,063		40,806		8.11
Federal Home Loan Bank stock	11,464		349		3.04		12,086		349		2.89		12,245		537		4.38
Other, including cash equivalents	20,503		129		0.63		37,831		382		1.01		16,715		246		1.47
Total interest-earning assets	$	743,891	44,937		6.04		$	675,555	42,868		6.35		$	695,368	51,468		7.40
Interest-bearing liabilities:
Noninterest checking	$	28,964	0		0.00	%	$	19,095	0		0.00	%	$	13,055	0		0.00	%
NOW accounts	46,277		120		0.26		39,625		226		0.57		33,457		380		1.13
Passbooks	38,201		91		0.24		35,847		241		0.67		32,707		455		1.39
Money market accounts	73,800		878		1.19		47,593		796		1.67		39,924		1,271		3.18
Certificate accounts	286,238		9,185		3.21		270,482		9,686		3.58		299,336		16,472		5.50
Federal Home Loan Bank advances	221,503		10,015		4.52		215,623		10,346		4.80		221,891		11,866		5.35
Other interest-bearing liabilities	2,556		0		0.00		1,544		0		0.00		1,220		0		0.00
Total interest-bearing liabilities	$	697,539	20,289		2.91		$	629,809	21,295		3.39		$	641,590	30,444		4.75
Net interest income			24,648						21,573						21,024
Net interest rate spread					3.13	%					2.96	%					2.65	%
Net earning assets	$	46,352					$	45,746					$	53,778
Net interest margin					3.31	%					3.19	%					3.02	%
Average interest-earning assets to average interest-bearing liabilities			106.65	%					107.26	%					108.38	%

(1)Tax exempt income was not significant; therefore, the yield was not presented on a tax equivalent basis. The tax-exempt income was $837,343 for 2003, $315,093 for 2002 and $70,702 for 2001.

(2)Calculated net of deferred loan fees, loan discounts, loans in process and loss reserve.

4

Net interest margin increased to 3.31% in 2003 compared to 3.19% for 2002 primarily because of the increased focus on commercial and consumer loans and the increase in the outstanding average balance of checking and money market accounts. Average net earning assets were $46.4 million in 2003 compared to $45.7 million for 2002. The Company has actively purchased its common stock in the open market and has paid quarterly dividends to its stockholders, both of which reduce net interest earning assets. During 2003 and 2002 HMN paid $1.4 million and $1.5 million to purchase its common stock in the open market and paid dividends to stockholders of $2.9 million and $2.6 million, respectively. The increase in net interest earning assets in 2003 is primarily the result of net income exceeding stock repurchases, dividends on common stock, and fixed asset additions.

The following schedule presents the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities. It quantifies the changes in interest income and interest expense related to changes in the average outstanding balances (volume) and those changes caused by fluctuating interest rates. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in volume (i.e., changes in volume multiplied by old rate) and (ii) changes in rate (i.e., changes in rate multiplied by old volume).

	Year Ended December 31,
	2003 vs. 2002								2002 vs. 2001
(Dollars in thousands)	Increase (Decrease) Due to					Total Increase (Decrease)			Increase (Decrease) Due to					Total Increase (Decrease)
	Volume(1)			Rate(1)					Volume(1)			Rate(1)
Interest-earning assets:
Securities available for sale:
Mortgage-backed and related securities	$	(784	)	(648	)	(1,432		)	$	(404	)	(1,759	)	(2,163		)
Other marketable securities	591			(620	)	(29		)	1,634			(1,462	)	172
Loans held for sale	(592		)	(247	)	(839		)	(2,224		)	47		(2,177		)
Loans receivable, net	10,084			(5,457	)	4,627			(1,887		)	(2,494	)	(4,381		)
Federal Home Loan Bank stock	(18		)	24		6			(7		)	(180	)	(187		)
Other, including cash equivalents	(136		)	(128	)	(264		)	390			(254	)	136
Total interest-earning assets	$	9,145		(7,076	)	2,069			$	(2,498	)	(6,102	)	(8,600		)
Interest-bearing liabilities:
NOW accounts	$	88		(194	)	(106		)	$	79		(233	)	(154		)
Passbooks	17			(168	)	(151		)	48			(261	)	(213		)
Money market accounts	702			(622	)	80			277			(752	)	(475		)
Certificates	585			(1,084	)	(499		)	(1,468		)	(5,319	)	(6,787		)
Federal Home Loan Bank advances	287			(617	)	(330		)	(328		)	(1,192	)	(1,520		)
Total interest-bearing liabilities	$	1,679		(2,685	)	(1,006		)	$	(1,392	)	(7,757	)	(9,149		)
Net interest income						$	24,648							$	21,573

(1)For purposes of this table, changes attributable to both rate and volume which cannot be segregated, have been allocated proportionately to the change due to volume and the change due to rate.

5

The following table sets forth the weighted average yields on the Company’s interest-earning assets, the weighted average interest rates on interest-bearing liabilities and the interest rate spread between the weighted average yields and rates as of the date indicated. Non-accruing loans have been included in the table as loans carrying a zero yield.

At December 31, 2003

Weighted average yield on:
Securities available for sale:
Mortgage-backed and related securities	3.52	%
Other marketable securities	2.86
Loans held for sale	5.56
Loans receivable, net	6.41
Federal Home Loan Bank stock	3.00
Other interest-earning assets	0.66
Combined weighted average yield on interest-earning assets	5.82
Weighted average rate on:
NOW accounts	0.39	%
Passbooks	0.20
Money market accounts	1.23
Certificates	3.11
Federal Home Loan Bank advances	4.33
Other interest bearing liabilities	0.02
Combined weighted average rate on interest-bearing liabilities	2.63
Interest rate spread	3.19

Provision For Loan Losses

The provision for loan losses is recorded to bring the allowance for loan losses to a level deemed appropriate by management based on factors disclosed in the critical accounting policy previously discussed. The provision for loan losses for the year ended December 31, 2003 was $2.6 million compared to $2.4 million for the year ended December 31, 2002. The provision increased primarily because of the additional $33 million in growth experienced in the commercial and consumer loan portfolios in 2003. Commercial and consumer loans generally require a larger provision due to the greater inherent credit risk of these loans. The provision also increased because of increases in specific consumer loan reserves and increased instances of personal bankruptcies which resulted in an increase in non-accruing loans of $1.2 million between the periods. The Company incurred $494,000 of net loan charge-offs in 2003 compared to $1.3 million of net loan charge-offs in 2002.

Non-Interest Income

Non-interest income was $10.3 million for the year ended December 31, 2003, an increase of $4.4 million, from $5.9 million for the same period in 2002. The following table presents the components of non-interest income:

								Percentage
	Year Ended December 31,							Increase (Decrease)
(Dollars in thousands)	2003			2002		2001		2003/2002		2002/2001
Fees and service charges	$	2,304		1,723		1,563		33.7	%	10.2	%
Mortgage servicing fees	998			715		470		39.6		52.1
Securities gains (losses), net	1,275			422		(671	)	202.1		162.9
Gain on sales of loans	5,240			3,077		2,934		70.3		4.9
Losses in limited partnerships	(243		)	(659	)	(1,311	)	63.1		49.7
Other non-interest income	$	681		597		599		14.1		(0.3	)
Total non-interest income	$	10,255		5,875		3,584		74.6		63.9

6

Fees and service charges earned for the year ended December 31, 2003 increased by $581,000 from those earned in 2002, primarily due to the increased fees generated from an overdraft protection program that was implemented in the second quarter of 2003. The Company also increased the charges for some services and developed more retail and commercial checking account relationships during 2003, which created more fee income opportunities. The Company will continue to focus on deposit growth in checking and money market accounts to increase fee income opportunities and decrease its cost of funds.

Mortgage servicing fees increased by $283,000 for the year ended December 31, 2003. The increase was due to the increased number of single-family loans that were serviced for others. The lower mortgage interest rates in 2003 resulted in increased loan originations and the majority of these loans were sold on the secondary mortgage market with the servicing rights retained.

Gains on the sale of securities increased by $853,000 for the year ended December 31, 2003 as investments were sold to fund a portion of the consumer and commercial loan growth that was experienced. The ability to realize gains on the sale of securities is dependent on the type of securities in the securities portfolio and on changes in the general interest rate environment. The Company was able to recognize gains on both its debt and equity security portfolios in the declining interest rate conditions that existed during 2003.

Gains on the sale of single-family loans increased by $2.2 million for the year ended December 31, 2003. Low mortgage rates during 2003 resulted in higher single-family loan originations than in 2002 as consumers took advantage of the low interest rates to purchase a home or refinance their existing home mortgage. The majority of the fixed rate single-family loans originated were sold in the secondary mortgage market in order to reduce interest rate risk, increase non-interest income, and provide funding for the commercial and consumer loan growth.  The Company expects mortgage interest rates to trend higher in 2004, which will result in lower single-family loan originations and less gain on sales of loans.

Losses from limited partnerships decreased by $416,000 for the year ended December 31, 2003 primarily because of lower losses on an investment in a limited partnership that invested in mortgage servicing rights. Generally, as interest rates rise the value of fixed rate mortgage servicing rights increases and as interest rates fall the value of mortgage servicing rights declines due to changes in the anticipated cash flows caused by prepayments on the loans being serviced. During 2003 and 2002, declines in interest rates on single-family mortgages caused the Company to recognize losses on its investment in the mortgage servicing limited partnership. This partnership was dissolved in the second quarter of 2003. For more information on investments in limited partnerships refer to Notes 1 and 9 of the Notes to Consolidated Financial Statements.

Other non-interest income consists primarily of fees and commissions earned on the sale of financial planning and insurance products and the gains and losses from the sale of assets.  For the year ended December 31, 2003, other non-interest income was $681,000, compared to $597,000 for 2002. The change in other non-interest income is principally due to increases in the gains recognized on the sale of assets as the Company sold three former branch locations in 2003.

Non-Interest Expense

Non-interest expense for the year ended December 31, 2003 was $19.7 million, compared to $17.8 million for the year ended in 2002. The following table presents the components of non-interest expense:

	Year Ended December 31,				Percentage Increase (Decrease)
(Dollars in thousands)	2003		2002	2001	2003/2002		2002/2001
Compensation and benefits	$	8,676	8,013	7,915	8.3	%	1.2	%
Occupancy	3,424		3,110	2,239	10.1		38.9
Federal deposit insurance premiums	72		74	80	(2.7	)	(7.5	)
Advertising	393		522	426	(24.7	)	22.5
Data processing	1,109		1,107	964	0.2		14.8
Amortization of mortgage servicing rights, net of valuation adjustments and servicing costs	1,982		1,166	758	70.0		53.8
Other	3,997		3,857	3,367	3.6		14.6
Total non-interest expense	$	19,653	17,849	15,749	10.1		13.3

7

Non-interest expense increased by $1.8 million in 2003 primarily because of an increase of $816,000 in the amortization of mortgage servicing rights which was caused by the large number of loan prepayments during the year. Because of the low interest rates in 2003, many loans that were being serviced by the Bank were refinanced.  When a serviced loan was paid off, the remaining value of the right to service that loan was recorded as additional amortization expense in the month in which the loan was repaid. Compensation and benefits expense increased by $663,000 primarily because of an increase in the number of employees, annual payroll cost increases, and costs related to a separation agreement with a former executive officer. Occupancy expense increased by $314,000 due to the increased costs associated with operating and maintaining additional facilities in 2003, including loan production offices opened in Byron, Stewartville, and St. Cloud, Minnesota, as well as West Des Moines, Iowa.

Income Taxes

The Company considers the calculation of current and deferred income taxes to be a critical accounting policy that is subject to significant estimates.  Actual results could differ significantly from the estimates and interpretations used in determining the current and deferred income tax liabilities. During 2003 and 2002 the Company recorded income tax expense of $4.0 million and $2.1 million, respectively. The change in income tax expense is the result of changes in taxable income and an increase in the Company’s effective tax rate between the years. The increased effective tax rate was caused primarily by lower state tax deductions as a percentage of income in 2003 when compared to 2002. Refer to Note 16 of the Notes to Consolidated Financial Statements for additional information relating to income taxes.

COMPARISON OF 2002 WITH 2001

Net income for the year ended December 31, 2002 was $5.3 million, compared to $5.5 million for 2001. Basic earnings per share were $1.40 for the year ended December 31, 2002, compared to $1.45 for 2001. Diluted earnings per share were $1.32 for the year ended December 31, 2002, compared to $1.37 for 2001. Return on average assets was 0.74% and 0.75% and return on average equity was 6.94% and 7.57% for 2002 and 2001, respectively.

In comparing the year ended December 31, 2002 to the year ended December 31, 2001, net interest income increased by $549,000 primarily because interest rates declined to a greater degree on FHLB advances and deposits than on interest earning assets. The provision for loan losses increased $1.2 million due to certain loans that deteriorated in 2002 and were charged off. The provision also increased because of increases in the commercial and consumer loan portfolios which generally require a larger provision due to the greater inherent credit risk of these loans. Non-interest income increased by $2.3 million primarily due to increased gains recognized on the sale of securities and lower losses from a limited partnership that invests in mortgage servicing rights. Non-interest expense increased by $2.1 million primarily due to increased occupancy, other operating costs and amortization expense on mortgage servicing rights.

Net interest income for the year ended December 31, 2002 was $21.6 million, an increase of $549,000, from $21.0 million during 2001. Interest income was $42.9 million for the year ended December 31, 2002, a decrease of $8.6 million, from $51.5 million for the same period in 2001. Interest income declined by $3.7 million due to a reduction in interest rates on investments and $2.4 million due to a reduction in interest rates on loans. During 2001 and 2002 the Federal Reserve decreased the Federal Funds interest rate twelve times and interest rates on treasury instruments with maturities of two years and longer generally decreased. The Wall Street Journal prime rate decreased from 9.50% at the beginning of 2001 to 4.75% at the end of 2001 and decreased another 50 basis points in the fourth quarter of 2002.  These decreases resulted in a lower rate environment in 2002 when compared to 2001. As a result, loans with rates that were indexed to prime, such as commercial loans and consumer lines of credit, earned less interest income and funds generated from fixed rate loans that prepaid during the year were reinvested in loans at lower rates.  Interest income decreased by $2.5 million due to a decrease in the average outstanding interest earning assets. Interest expense was $21.3 million for the year ended December 31, 2002, a decrease of $9.1 million, from the $30.4 million for 2001. Interest expense declined by $6.6 million due to a decrease in the general interest rates paid on deposits and by $1.2 million due to decreased rates paid on FHLB advances. Interest expense also decreased by $1.4 million due to a decline in the average outstanding balance of deposits and Federal Home Loan Bank advances.

Net interest margin was 3.19% and 3.02% and average net earning assets were $47.3 million and $55.0 million for the years ended December 31, 2002 and 2001, respectively.

The provision for loan losses for 2002 was $2.4 million, compared to $1.2 million for 2001. The provision for loan losses increased due to the deterioration of certain loans that were charged off during 2002 and due to the $115 million in growth that was experienced in the commercial and consumer loan portfolios which generally require a larger provision due to the greater inherent credit risk of these loans. The provision also increased because of increases in specific loan reserves, as well as a slowing economy which resulted in an increase in non-accruing loans of $1.1 million. HMN incurred $1.4 million of loan charge-offs during 2002 and it recovered $34,000 of loans previously charged-off. HMN incurred $516,000 of loan charge-offs during 2001 and it recovered $6,000 of loans previously charged-off.

Non-interest income was $5.9 million for 2002, compared to $3.6 million for 2001. Fees and service charges earned for the year ended December 31, 2002 increased by

8

$160,000 from fees and service charges earned in 2001, primarily due to increased fees and service charges on an increased number of deposit accounts.

Mortgage servicing fees increased by $245,000 and $129,000 for the years ended December 31, 2002 and December 31, 2001, respectively. The increases were primarily due to the increased number of single-family loans that were serviced for others. The lower mortgage interest rates in 2002 and 2001 resulted in increased loan originations and loan sales at the Bank and the servicing rights on all of these loans were retained.

The ability to realize gains on the sale of securities is dependent on the type of securities in the securities portfolio and upon changes in the general interest rate environment. Interest rates in general were declining in 2002 and the opportunity to sell investments at a gain was present. Consequently, the Company recognized $422,000 in gains on the sale of securities for the year ended December 31, 2002, an increase of $1.1 million over 2001’s net losses. The increase in securities gains is primarily because the Bank recognized impairment losses of $1.0 million on its securities portfolio in 2001. These losses resulted in a net loss on the sale of securities of $671,000 for 2001.

In order to reduce its interest rate risk and increase its other non-interest income, the Bank, which originates all of its 1-4 family loans at its retail facilities, sold many of its originated or refinanced fixed rate 1-4 family loans in 2002 and 2001. The mortgage banking business operated by Home Federal Mortgage Services, LLC (HFMS) also sold the majority of their mortgage origination and loan brokerage activity. The origination and brokerage activity at HFMS decreased by $604.4 million in 2002 from 2001 production levels as the operations were being phased down throughout the first half of the year and production stopped completely in the third quarter of 2002. The lower interest rate environment in 2002 caused loan originations at the Bank to increase by $40.1 million. For the year ended December 31, 2002, HMN recognized $3.1 million of net gain on the sale of $274.6 million of primarily single-family mortgage loans. The Bank accounted for $2.9 million of the net gain on sale on $184.6 million of loans sold. HFMS accounted for $262,000 of the net gain on sale on $90.0 million of loans sold. For the year ended December 31, 2001, HMN recognized $2.9 million of net gain on the sale of $724.2 million of primarily single-family mortgage loans. The Bank accounted for $2.1 million of the net gain on sale on $136.2 million of loans sold and HFMS accounted for $842,000 of the net gain on sale on $588.1 million of loans sold. During 2002 and 2001 HFMS brokered $26.9 million and $349.6 million of loans, respectively, from correspondent lenders at lower profit margins than its other brokerage and origination activity. The significant increase in loan volume from these correspondents during 2001 and carrying over into 2002 resulted in the Company incurring pair off fees because loans were not delivered into their forward sales commitments on a timely basis. The pair off fees resulted in a lower gain on sale of loans for HFMS as a percentage of loans sold. The lower profit margins coupled with the additional costs relating to processing the increased loan volume resulted in HFMS generating losses for 2002 and 2001.

For the years ended December 31, 2002 and 2001, HMN recognized net losses of $659,000 and $1.3 million, respectively, from its limited partnership investments. A major portion of HMN’s investment in limited partnerships resided in a partnership that owned mortgage servicing rights. Generally, as interest rates rise the value of fixed rate mortgage servicing rights increases and as interest rates fall the value of mortgage servicing rights declines due to changes in the anticipated cash flows caused by prepayments on the loans being serviced. During 2002 and 2001 significant declines in interest rates on single-family mortgages caused HMN to recognize losses on its investment in the mortgage servicing limited partnership.

Non-interest expenses increased by $2.1 million from 2001 to 2002 primarily due to an $870,000 increase in occupancy expense caused by the three additional facilities maintained during 2002 and a full year of expenses associated with facility changes that occurred in 2001. Amortization of mortgage servicing rights increased by $407,000 because of increased amortization on loans that prepaid during the year and because the number of loans being serviced increased. Because of the lower interest rates in 2002 many loans that were being serviced by the Bank were refinanced.  When a serviced loan was paid off, the remaining value of the right to service that loan was recorded as additional amortization expense in the month in which the loan was repaid. Compensation and benefits expense increased by $99,000 in 2002, despite the decrease in compensation expense at the mortgage banking operation, as the Bank hired more employees to staff the additional retail facilities that were opened during the year. Data processing expenses increased by $143,000 due to the increased number of customers and the costs of various services offered to customers. Other expenses increased by $490,000 primarily due to $175,000 in valuation reserves recorded on other assets and increased expenses related to additional facilities and increased loan activity. Other expenses decreased by $180,000 due to decreased goodwill amortization relating to the adoption of Statement of Financial Accounting Standards (SFAS) No. 142. See Notes 1 and 11 of the Notes to Consolidated Financial Statements for additional information relating to goodwill amortization.

During 2002 and 2001 HMN recorded income tax expense of $2.1 million and $2.6 million, respectively. The change in income tax expense between the years is primarily the result of changes in taxable income between the years and state tax planning implemented during 2002.

9

Financial Condition

Loans Receivable, Net

The following table sets forth the information on the Company’s loan portfolio in dollar amounts and in percentages (before deductions for loans in process, deferred fees and discounts and allowances for losses) as of the dates indicated.

	December 31,
	2003				2002				2001				2000				1999
(Dollars in thousands)	Amount		Percent		Amount		Percent		Amount		Percent		Amount		Percent		Amount		Percent
Real Estate Loans:
One-to-four family	$	144,315	20.37	%	$	151,566	27.72	%	$	215,448	44.73	%	$	312,888	59.43	%	$	344,674	70.95	%
Multi-family	31,540		4.45		15,766		2.88		14,369		2.98		12,090		2.30		8,489		1.75
Commercial	199,124		28.10		130,417		23.85		70,768		14.69		61,654		11.71		43,894		9.04
Construction or development	95,346		13.45		61,336		11.22		46,977		9.75		20,211		3.84		16,046		3.30
Total real estate	470,325		66.37		359,085		65.67		347,562		72.15		406,843		77.28		413,103		85.04
Other Loans:
Consumer Loans:
Automobile	14,754		2.08		11,062		2.02		6,624		1.38		6,363		1.21		4,532		0.94
Home equity line	54,193		7.64		52,106		9.53		35,714		7.42		26,907		5.11		22,437		4.62
Home equity	18,974		2.68		23,760		4.35		26,440		5.49		28,144		5.35		17,349		3.57
Mobile home	3,665		0.52		4,534		0.83		5,456		1.13		4,921		0.93		791		0.16
Other	14,319		2.02		4,959		0.91		4,897		1.02		4,561		0.87		3,127		0.64
Total consumer loans	105,905		14.94		96,421		17.64		79,131		16.44		70,896		13.47		48,236		9.93
Commercial business loans	132,459		18.69		91,260		16.69		54,940		11.41		48,760		9.25		24,435		5.03
Total other loans	238,364		33.63		187,681		34.33		134,071		27.85		119,656		22.72		72,671		14.96
Total loans	708,689		100.00	%	546,766		100.00	%	481,633		100.00	%	526,499		100.00	%	485,774		100.00	%
Less:
Loans in process	11,298				6,826				4,692				2,953				2,771
Unamortized discounts	166				142				278				289				297
Net deferred loan fees	1,334				1,068				1,212				1,348				1,537
Allowance for losses	6,940				4,824				3,783				3,144				3,273
Total loans receivable, net	$	688,951			$	533,906			$	471,668			$	518,765			$	477,896

The Company continues to reduce interest rate risk and increase interest income by increasing its investment in shorter term and generally higher yielding commercial real estate and commercial business loans and reducing its investment in longer term one-to-four family real estate loans. The Company intends to continue to increase the size of its commercial real estate, commercial business and consumer loan portfolios while maintaining the level of one-to-four family loans held in portfolio.

The one-to-four family real estate loans were $144.3 million at December 31, 2003, a decrease of $7.3 million, compared to $151.6 million at December 31, 2002. During 2003 loan prepayments on single-family loans increased as a result of the low interest rate environment and many loans that were in the loan portfolio at December 31, 2002 were refinanced and sold in the secondary mortgage market.  Some of these loans were replaced in the portfolio with shorter term (10 year) fixed rate and adjustable rate loans during 2003. The

10

increased prepayments and the related loan sales were the principal cause of the decline in the one-to-four family loan portfolio during 2003.

Commercial real estate loans were $199.1 million at December 31, 2003, an increase of $68.7 million, compared to $130.4 million at December 31, 2002. Commercial business loans were $132.5 million at December 31, 2003, an increase of $41.2 million, compared to $91.3 million at December 31, 2002. The Company’s continued emphasis on commercial real estate and commercial business loans resulted in the origination or purchase of commercial real estate loans totaling $133.6 million in 2003 and $70.7 million in 2002. Commercial business loans originated or purchased were $142.6 million in 2003 compared to $101.0 million in 2002. The increased production and the Company’s continued focus in this area were the principal reasons for the increase in commercial real estate and commercial business loans in 2003.

Home equity line loans were $54.2 million at December 31, 2003, compared to $52.1 million at December 31, 2002. The open-end home equity lines are written with an adjustable rate with a term of 20 years, a 10 year draw period which requires “interest only” payments and a 10 year repayment period which fully amortizes the outstanding balance.  Closed-end home equity loans are written with fixed or adjustable-rates with terms up to 15 years. Home equity loans were $19.0 million at December 31, 2003, compared to $23.8 million at December 31, 2002.  Due to the general decline in interest rates during 2003 and 2002, many borrowers consolidated their debt and paid off open and closed home equity loans when refinancing their first mortgage. The increased debt consolidation into first mortgages was the principal reason for the slight decline in the combined home equity and home equity line loan portfolios in 2003.

Allowances for Loan Losses

The determination of the allowance for loan losses and the related provision is a critical accounting policy of the Company that is subject to significant estimates, as previously discussed. The current level of the allowance for loan losses is a result of management’s assessment of the risks within the portfolio based on the information obtained through the credit evaluation process. The Company utilizes a risk-rating system on non-homogenous commercial real estate and commercial business loans that includes regular credit reviews to identify and quantify the risk in the commercial portfolio. Management conducts quarterly reviews of the loan portfolio and evaluates the need to establish general allowances on the basis of these reviews.

Management continues to actively monitor asset quality and to charge off loans against the allowance for loan losses when appropriate. Although management believes it uses the best information available to make determinations with respect to the allowance for loan losses, future adjustments may be necessary if economic conditions differ substantially from the economic conditions in the assumptions used to determine the size of the allowance for losses.

The allowance for loan losses was $6.9 million, or 0.98%, of gross loans at December 31, 2003, compared to $4.8 million, or 0.88%, of gross loans at December 31, 2002. The following table reflects the activity in the allowance for loan losses and selected statistics:

	December 31,
(Dollars in thousands)	2003			2002		2001		2000		1999
Balance at the beginning of year	$	4,824		3,783		3,144		3,273		3,041
Provision for losses	2,610			2,376		1,150		180		240
Charge-offs:
One-to-four family	(69		)	(44	)	0		0		(1	)
Consumer	(226		)	(310	)	(170	)	(59	)	(9	)
Commercial business and real estate	(255		)	(1,015	)	(347	)	(253	)	0
Recoveries	56			34		6		3		2
Net charge-offs	(494		)	(1,335	)	(511	)	(309	)	(8	)
Balance at end of year	$	6,940		4,824		3,783		3,144		3,273
Year end allowance for loan losses as a percent of year end gross loan balance	0.98		%	0.88	%	0.79	%	0.60	%	0.69	%
Ratio of net loan charge-offs to average loans outstanding	0.09			0.26		0.10		0.06		0.00
Allowance for loan losses as a percentage of total assets at year end	0.80			0.65		0.52		0.44		0.47

11

The following table reflects the allocation of the allowance for loan losses:

	December 31,
	2003				2002				2001				2000				1999
(Dollars in thousands)	Allocated allowance as of % of loan category		Percent of loans in each category in total loans		Allocated allowance as a% of loan category		Percent of loans in each category to total loans		Allocated allowance as a% of loan category		Percent of loans in each category to total loans		Allocated allowance as a% of loan category		Percent of loans in each category to total loans		Allocated allowance as a% of loan category		Percent of loans in each category to total loans
Real estate loans:
One-to-four family	0.12	%	20.36	%	0.06	%	27.72	%	0.10	%	44.73	%	0.10	%	59.43	%	0.15	%	70.95	%
Multi-family	1.34		4.45		1.30		2.88		1.41		2.98		0.92		2.30		1.57		1.75
Commercial real estate	1.42		28.10		1.55		23.88		1.28		14.69		1.30		11.71		1.21		9.04
Construction or development	0.92		13.45		0.97		11.22		1.19		9.75		2.02		3.84		1.44		3.30
Consumer	0.98		14.95		0.56		17.63		0.71		16.44		0.58		13.47		1.40		9.93
Commercial business	1.20		18.69		1.48		16.67		2.44		11.41		2.72		9.25		1.19		5.03
Total	0.98	%	100.00	%	0.88	%	100.00	%	0.79	%	100.00	%	0.60	%	100.00	%	0.67	%	100.00	%

The allocation of the allowance for loan losses decreased in 2003 for commercial, construction or development, and commercial business loans primarily because management’s overall assessment of the risk of the individual loans in these categories improved between the years. The allocated percentage for the consumer loans increased in 2003 primarily because of increases in non-performing consumer loans between the periods.

Allowance for Real Estate Losses

Real estate properties acquired or expected to be acquired through loan foreclosures are initially recorded at the lower of the related loan balance, less any specific allowance for loss, or fair value less estimated selling costs. Valuations are periodically performed by management and an allowance for losses is established if the carrying value of a property exceeds its fair value less estimated selling costs. There was limited activity in the allowance for real estate losses during 2003 and 2002 and the balance of the allowance for real estate losses was zero at December 31, 2003 and December 31, 2002.

Non-performing Assets

Loans are reviewed at least quarterly and any loan whose collectibility is doubtful is placed on non-accrual status. Loans are placed on non-accrual status when either principal or interest is 90 days or more past due, unless, in the judgment of management, the loan is well collateralized and in the process of collection. Interest accrued and unpaid at the time a loan is placed on non-accrual status is charged against interest income. Subsequent payments are either applied to the outstanding principal balance or recorded as interest income, depending on the assessment of the ultimate collectibility of the loan. Restructured loans include the Bank’s troubled debt restructurings which involved forgiving a portion of interest or principal on any loans or making loans at a rate materially less than the market rate. Foreclosed and repossessed assets include assets acquired in settlement of loans.

Non-performing assets is comprised of non-accrual loans, restructured loans, impaired securities, delinquent accounts receivable, real estate acquired through foreclosure, and repossessed assets and totaled $5.0 million at December 31, 2003, compared to $4.9 million at December 31, 2002.  The $128,000 increase in non-performing assets in 2003 relates primarily to a net increase of $1.2 million in non-accruing loans due primarily to an increase in non-performing single-family loans of $482,000 and non-performing consumer loans of $555,000. The increase in non-performing loans was almost completely offset by decreases of $655,000 in non-performing other assets caused by the sale of a non-performing investment, and a decrease of $399,000 in foreclosed and repossessed assets between the years.

The following table sets forth the amounts and categories of non-performing assets in the Company’s portfolio.

12

	December 31,
(Dollars in thousands)	2003			2002		2001		2000		1999
Non-accruing loans:
Real estate:
One-to-four family	$	1,177		695		771		775		165
Commercial real estate	2,162			1,719		187		0		0
Consumer	1,050			495		311		142		177
Commercial business	186			427		890		95		0
Total	4,575			3,336		2,159		1,012		342
Accruing loans delinquent 90 days or more:
One-to-four family	114			171		24		405		476
Other assets	211			866		1,390		0		0
Foreclosed and repossessed assets:
Real estate:
One-to-four family	73			300		0		195		0
Commercial real estate	0			127		0		0		0
Consumer	62			107		155		0		0
Commercial business	0			0		33		0		0
Total	135			534		188		195		0
Total non-performing assets	$	5,035		4,907		3,761		1,612		818
Total as a percentage of total assets	0.58		%	0.67	%	0.52	%	0.23	%	0.12	%
Total non-performing loans	$	4,689		3,507		2,183		1,417		818
Total as a percentage of total loans receivable, net	0.68		%	0.66	%	0.46	%	0.27	%	0.17	%
Allowance for loan losses to non-performing loans	147.99		%	134.60	%	173.29	%	221.87	%	400.29	%

For the year ended December 31, 2003, gross interest income which would have been recorded had the non-accruing loans been current in accordance with their original terms amounted to $458,473. The amounts that were included in interest income on a cash basis for such loans during 2003 were $163,044.

In addition to the non-performing assets set forth in the table above, as of December 31, 2003 there were no loans with known information about the possible credit problems of the borrowers or the cash flows of the secured properties that have caused management to have concerns as to the ability of the borrowers to comply with present loan repayment terms which may result in the future inclusion of such items in the non-performing asset categories. Management has considered the Bank’s non-performing and “of concern” assets in establishing its allowance for loan losses.

Mortgage Servicing Rights

The capitalization and valuation of mortgage servicing rights (MSR’s) is a critical accounting policy of the Company that is subject to significant estimates. MSR’s are valued quarterly by an unrelated third party specializing in the valuation of servicing rights and are reviewed by the Company’s management. The assumptions used to value the MSR’s are based on loan types, note rates, default rates, and prepayment speeds, among other assumptions. Changes in the mix of loans, interest rates, default rates, or prepayment speeds may have a material effect on the amortization and valuation of MSR’s. Although management believes that the assumptions used and the values determined are reasonable based upon current circumstances, adjustments may be necessary if future economic conditions differ substantially from the economic conditions in the assumptions used to determine the value of the MSR’s. Refer to Notes 1 and 7 of the Notes to Consolidated Financial Statements for additional information relating to MSR’s.

13

Contractual Obligations and Commercial Commitments

The Company has certain obligations and commitments to make future payments under contracts. At December 31, 2003, the aggregate contractual obligations (excluding bank deposits) and commercial commitments are as follows:

	Payments Due by Period
(Dollars in thousands)	Total		Less than 1 Year	1-3 Years	4-5 Years	After 5 Years
Contractual Obligations:
Total borrowings	$	203,900	33,000	10,000	60,000	100,900
Annual rental commitments under non-cancelable operating leases	1,472		499	858	115	0
	$	205,372	33,499	10,858	60,115	100,900
	Amount of Commitment-Expiration by Period
Other Commercial Commitments:
Commercial lines of credit	$	25,612	18,058	7,448	91	15
Commitments to lend	101,090		29,572	53,843	2,617	15,058
Standby letters of credit	2,028		813	1,215	0	0
	$	128,730	48,443	62,506	2,708	15,073

Regulatory Capital Requirements

As a result of the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA), banking and thrift regulators are required to take prompt regulatory action against institutions which are undercapitalized. FDICIA requires banking and thrift regulators to categorize institutions as “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” or “critically undercapitalized”. A savings institution will be deemed to be well capitalized if it: (i) has a total risk-based capital ratio of 10% or greater, (ii) has a Tier 1 (core) risk-based capital ratio of 6% or greater, (iii) has a leverage (core) ratio of 5% or greater, and (iv) is not subject to any order or written directive by the Office of Thrift Supervision (OTS) to meet and maintain a specific capital level for any capital measure. Management believes that, as of December 31, 2003, the Bank met all of the capital requirements to which it was subject and is well capitalized based on the regulatory definition described above. Refer to Note 20 of the Notes to Consolidated Financial Statements for a table which reflects the Bank’s capital compared to its capital requirements.

Liquidity and Capital Resources

The Company manages its liquidity position to ensure that the funding needs of borrowers and depositors are met timely and in the most cost effective manner. Asset liquidity is the ability to convert assets to cash through the maturity or sale of the asset. Liability liquidity is the ability of the Bank to attract retail or brokered deposits or to borrow funds from third parties such as the FHLB.

The primary investing activities are the origination of loans and the purchase of securities. Principal and interest payments on loans and securities along with the proceeds from the sale of loans held for sale are the primary sources of cash for the Company. Additional cash can be obtained by selling securities from the available for sale portfolio or by selling loans. Loans could also be securitized and used as collateral for additional borrowings with the FHLB to generate additional cash.

The primary financing activity is the attraction of retail and brokered deposits. The Bank has the ability to borrow additional funds from the FHLB by pledging additional securities or loans. Refer to Note 14 of the Notes to Consolidated Financial Statements for more information on additional advances that could be drawn upon based on existing collateral levels with the FHLB. Information on outstanding advance maturities and related early call features is also included in Note 14.

The Company anticipates that its liquidity requirements for 2004 will be similar to the cash flows it experienced in 2003 with the following exceptions: net increase in loans receivable is anticipated to be $125 million; net decrease in customer escrows is anticipated to be $21 million; the funds provided from deposits and/or FHLB advances are anticipated to be $86 million; and the funds provided by security sales and/or principal collections on securities are anticipated to be $34 million.

The Company’s most liquid assets are cash and cash equivalents, which consist of short-term highly liquid investments with original maturities of less than three months that are readily convertible to known amounts of cash and interest-bearing deposits. The level of these assets is dependent on the operating, financing, and investing activities during any given period.

14

Cash and cash equivalents at December 31, 2003 were $30.5 million, an increase of $2.8 million, compared to $27.7 million at December 31, 2002. Net cash provided by operating activities during 2003 was $24.1 million. The Company conducted the following major investing activities during 2003: proceeds from the sale of securities available for sale were $50.4 million, principal received on payments and maturities of securities available for sale was $40.9 million, purchases of securities available for sale were $76.4 million, and net loans receivable increased by $161.5 million. HMN spent $1.0 million for the purchase of equipment and updating its premises, and received $1.2 million from the sale of real estate and old branch facilities. Net cash used by investing activities during 2003 was $144.6 million. HMN conducted the following major financing activities during 2003: purchase of treasury stock of $1.4 million, received $1.4 million from the exercise of HMN common stock options, paid $2.9 million in dividends to HMN stockholders, proceeds from FHLB advances totaled $161.0 million, repayments of FHLB advances totaled $175.4 million, and increase in deposits were $118.8 million. Net cash provided by financing activities was $123.3 million.

The Company has certificates of deposit with outstanding balances of $167.2 million that mature during 2004. Based upon past experience, management anticipates that the majority of the deposits will renew for another term. The Company believes that deposits which do not renew will be replaced with deposits from a combination of other customers or brokers. FHLB advances or the sale of securities could also be used to replace unanticipated outflows of deposits. Management does not anticipate that it will have a liquidity problem due to maturing deposits.

The Company has $33.0 million of FHLB advances that mature in 2004 and it has $100.9 million of FHLB advances with maturities beyond 2004 that have call features that may be exercised by the FHLB during 2004. If the call features are exercised, the Company has the option of requesting any advance otherwise available to it pursuant to the credit policy of the FHLB. Since the Company has the ability to request another advance to replace the advance that is being called, management does not anticipate that it will have a liquidity problem due to advances being called by the FHLB during 2004.

The credit policy of the FHLB may change such that the current collateral pledged to secure the advances is no longer acceptable or the formulas for determining the excess pledged collateral may change. If this were to happen the Bank may not have additional collateral to pledge to secure the existing advances which could cause the FHLB advances to become a liquidity problem during 2004.

On February 24, 2004, HMN’s Board of Directors authorized the extension of the stock repurchase program to August 26, 2005. The plan authorizes HMN to repurchase up to 350,000 shares of its common stock in the open market.

Dividends

The declaration of dividends are subject to, among other things, the Company’s financial condition and results of operations, the Bank’s compliance with its regulatory capital requirements, tax considerations, industry standards, economic conditions, regulatory restrictions, general business practices and other factors. Refer to Note 19 of the Notes to Consolidated Financial Statements for information on regulatory limitations on dividends from the Bank to the Company and additional information on dividends. The payment of dividends is dependant upon the Company having adequate cash or other assets that can be converted to cash to pay dividends to its stockholders. The Company does not anticipate a liquidity problem in 2004 relating to the payment of dividends.

Merger and Acquisitions

From time to time management reviews the possibility of acquiring or merging with different companies that would complement the business conducted by the Company. The Company’s Board of Directors has adopted the policy of not disclosing to the public its intent to acquire or merge until a formal definitive agreement has been signed by all parties involved with the transaction, except as otherwise required by law.

Impact of Inflation and Changing Prices

The impact of inflation is reflected in the increased cost of operations. Unlike most industrial companies, nearly all of the assets and liabilities of the Company are monetary in nature. As a result, interest rates have a greater impact on the Company’s performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.

New Accounting Pronouncement

The Financial Accounting Standards Board (FASB) issued a revised Interpretation No. 46, Consolidation of Variable Interest Entities (FIN 46) that addresses consolidation by business enterprises of variable interest entities that have certain characteristics. It requires a business enterprise that has a controlling interest in a variable interest entity (as defined by FIN 46) to include the assets, liabilities, and results of the activities of the variable interest entity in the consolidated financial statements of the business enterprise. The impact of adopting FIN 46 on the Company’s financial condition and results of operation will not be material.

15

Market Risk

Market risk is the risk of loss from adverse changes in market prices and rates. The Company’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.

The Company’s profitability is affected by fluctuations in interest rates. A sudden and substantial change in interest rates may adversely impact the Company’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. The Company monitors the projected changes in net interest income that occur if interest rates were to suddenly change up or down. The Rate Shock Table located in the Asset/Liability Management section of this report discloses the Company’s projected changes in net interest income based upon immediate interest rate changes called rate shocks.

The Company 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 under different interest rate changes.

The management of the Company believes that over the next twelve months interest rates could conceivably fluctuate in a range of 200 basis points up or 100 basis points down from where the rates were at December 31, 2003. The following table discloses the projected changes in market value to the Company’s interest-earning assets and interest-bearing liabilities based upon incremental 100 basis point changes in interest rates from interest rates in effect on December 31, 2003.

Other than trading portfolio (Dollars in thousands) Basis point change in interest rates	Market Value
	-100			0		+100		+200
Total market risk sensitive assets	$	884,037		868,534		851,556		835,089
Total market risk sensitive liabilities	(803,381		)	(790,192	)	(779,336	)	(772,416	)
Off-balance sheet financial instruments	858			0		(252	)	(569	)
Net market risk	$	81,514		78,342		71,968		62,104
Percentage change from current market value	4.05		%	0.00	%	(8.14	)%	(20.73	)%

The preceding table was prepared utilizing the following assumptions (the Model Assumptions) regarding prepayment and decay ratios which were determined by management based upon their review of historical prepayment speeds and future prepayment projections. Fixed rate loans were assumed to prepay at annual rates of between 7% and 48%, depending on the note rate and the period to maturity. Adjustable rate mortgages (ARMs) were assumed to prepay at annual rates of between 11% and 17%, depending on the note rate and the period to maturity. Growing Equity Mortgage (GEM) loans were assumed to prepay at annual rates of between 7% and 20% depending on the note rate 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%. Non-interest checking and NOW accounts were assumed to decay at an annual rate of 19%. Commercial NOW and MMDA accounts were assumed to decay at an annual rate of 40%. 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 the callable advance. Refer to Note 14 of the Notes to Consolidated Financial Statements for more information on call provisions of the FHLB advances.

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 that are approaching their lifetime interest rate caps could be different from the values calculated 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 a substantial sustained interest rate increase.

16

Asset/Liability Management

The Company’s management reviews the impact that changing interest rates will have on its net interest income projected for the twelve months following December 31, 2003 to determine if its current level of interest rate risk is acceptable. The following table projects the estimated impact on net interest income of immediate interest rate changes called rate shocks.

Rate Shock in Basis Points	Net Interest Income	Percentage Change
+200	31,972,000	13.12	%
+100	30,929,000	9.43	%
0	28,263,000	0.00	%
-100	25,672,000	(9.17	)%

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 prepared by third parties.

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 Company has an Asset/Liability Committee which meets frequently to discuss changes made to the interest rate risk position and projected profitability. The Committee makes adjustments to the asset/liability position of the Bank which are reviewed by 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 Bank’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.

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 that are saleable to third parties and only places fixed rate loans that meet certain risk characteristics into its loan portfolio. The Bank does place into portfolio adjustable rate single-family loans that reprice over a one-year, three year or five-year period. The Bank’s commercial loan production has primarily been in adjustable rate loans and the fixed rate commercial loans placed in portfolio have been shorter-term loans, usually with maturities of five years or less, in order to lower the Company’s interest rate risk exposure.

17

CONSOLIDATED BALANCE SHEETS

December 31, 2003 and 2002	2003			2002
ASSETS
Cash and cash equivalents	$	30,496,823		27,729,007
Securities available for sale:
Mortgage-backed and related securities (amortized cost $13,707,005 and $51,677,294)	13,048,718			51,895,832
Other marketable securities (amortized cost $91,035,285 and $67,282,379)	91,615,047			69,501,417
	104,663,765			121,397,249
Loans held for sale	6,542,824			15,126,509
Loans receivable, net	688,951,119			533,905,652
Accrued interest receivable	3,462,221			3,050,636
Real estate, net	73,271			426,691
Federal Home Loan Bank stock, at cost	10,004,400			11,880,500
Mortgage servicing rights, net	3,447,843			2,691,031
Premises and equipment, net	12,110,151			12,875,816
Investment in limited partnerships	617,042			862,666
Goodwill	3,800,938			3,800,938
Core deposit intangible	447,474			561,331
Prepaid expenses and other assets	1,818,156			3,214,792
Total assets	$	866,436,027		737,522,818
LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits	$	551,687,995		432,951,462
Federal Home Loan Bank advances	203,900,000			218,300,000
Accrued interest payable	766,837			849,427
Customer escrows	22,457,671			707,213
Accrued expenses and other liabilities	6,952,600			7,614,406
Deferred tax liabilities	26,300			1,456,600
Total liabilities	785,791,403			661,879,108
Commitments and contingencies
Minority interest	(286,433		)	(420,846	)
Stockholders’ equity:
Serial preferred stock: ($.01 par value)
Authorized 500,000 shares; issued and outstanding none	0			0
Common stock ($.01 par value):
Authorized 11,000,000; issued shares 9,128,662	91,287			91,287
Additional paid-in capital	57,863,726			58,885,279
Retained earnings, subject to certain restrictions	85,364,657			79,660,481
Accumulated other comprehensive income (loss)	(50,725		)	1,575,577
Unearned employee stock ownership plan shares	(4,738,084		)	(4,931,385	)
Treasury stock, at cost 4,616,010 and 4,722,856 shares	(57,599,804		)	(59,216,683	)
Total stockholders’ equity	80,931,057			76,064,556
Total liabilities and stockholders’ equity	$	866,436,027		737,522,818

See accompanying notes to consolidated financial statements.

18

CONSOLIDATED STATEMENTS OF INCOME

Years ended December 31, 2003, 2002 and 2001	2003			2002		2001
Interest income:
Loans receivable	$	41,800,039		38,011,750		44,569,397
Securities available for sale:
Mortgage-backed and related	272,253			1,704,248		3,867,079
Other marketable	2,386,590			2,420,317		2,248,383
Cash equivalents	128,948			382,021		246,449
Other	349,150			349,214		536,619
Total interest income	44,936,980			42,867,550		51,467,927
Interest expense:
Deposits	10,274,188			10,949,802		18,578,348
Federal Home Loan Bank advances and other borrowed money	10,014,865			10,345,102		11,865,682
Total interest expense	20,289,053			21,294,904		30,444,030
Net interest income	24,647,927			21,572,646		21,023,897
Provision for loan losses	2,610,000			2,376,000		1,150,000
Net interest income after provision for loan losses	22,037,927			19,196,646		19,873,897
Non-interest income:
Fees and service charges	2,304,090			1,723,117		1,563,031
Mortgage servicing fees	998,200			715,074		470,081
Securities gains (losses), net	1,274,537			422,346		(670,958	)
Gain on sales of loans	5,240,442			3,077,294		2,934,317
Losses in limited partnerships	(243,305		)	(659,378	)	(1,311,568	)
Other	681,518			596,117		598,625
Total non-interest income	10,255,482			5,874,570		3,583,528
Non-interest expense:
Compensation and benefits	8,675,596			8,012,953		7,914,452
Occupancy	3,423,745			3,109,548		2,239,152
Federal deposit insurance premiums	72,524			74,108		79,714
Advertising	392,833			521,898		426,357
Data processing	1,109,098			1,107,248		963,958
Amortization of mortgage servicing rights, net of valuation adjustments and servicing costs	1,982,337			1,165,762		758,352
Other	3,997,243			3,857,117		3,366,698
Total noninterest expense	19,653,376			17,848,634		15,748,683
Income before income tax expense	12,640,033			7,222,582		7,708,742
Income tax expense	4,037,800			2,099,200		2,634,385
Income before minority interest	8,602,233			5,123,382		5,074,357
Minority interest	(3,014		)	(142,274	)	(383,259	)
Net income	$	8,605,247		5,265,656		5,457,616
Basic earnings per share	$	2.26		1.40		1.45
Diluted earnings per share	$	2.16		1.32		1.37

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

Net income	$	8,605,247		5,265,656		5,457,616
Other comprehensive income, net of tax:
Unrealized gains (losses) on hedging valuation	0			(35,795	)	35,795
Less: minority interest in hedging valuation	0			(21,950	)	21,950
Net unrealized gains (losses) on hedging valuation	0			(13,845	)	13,845
Unrealized gains on securities:
Unrealized holding gains (losses) arising during period	(801,965		)	1,494,824		1,988,754
Less: reclassification adjustment for gains (losses) included in net income	824,337			273,146		(402,150	)
Net unrealized gains (losses) on securities	(1,626,302		)	1,221,678		2,390,904
Other comprehensive income (loss)	(1,626,302		)	1,207,833		2,404,749
Comprehensive income	$	6,978,945		6,473,489		7,862,365

See accompanying notes to consolidated financial statements.

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CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

	Common Stock		Additional Paid-In Capital		Retained Earnings		Accumulated Other Comprehensive Income (Loss)		Unearned Employee Stock Ownership Plan Shares		Unearned Compensation Restricted Stock Awards		Treasury Stock		Total Stockholders’ Equity
Balance, December 31, 2000	$	91,287	59,584,176		73,380,588		(2,037,005	)	(5,318,067	)	(9,800	)	(59,065,531	)	66,625,648
Net income					5,457,616										5,457,616
Other comprehensive income							2,404,749								2,404,749
Treasury stock purchases													(1,584,152	)	(1,584,152	)
Employee stock options exercised			(712,140	)									1,358,339		646,199
Tax benefits of exercised stock options			191,695												191,695
Tax benefit of restricted stock awards			2,479												2,479
Amortization of restricted stock awards											2,450				2,450
Earned employee stock ownership plan shares			102,572						193,321						295,893
Dividends paid					(1,881,226	)									(1,881,226	)
Balance, December 31, 2001	$	91,287	59,168,782		76,956,978		367,744		(5,124,746	)	(7,350	)	(59,291,344	)	72,161,351
Net income					5,265,656										5,265,656
Other comprehensive income							1,207,833								1,207,833
Treasury stock purchases													(1,496,111	)	(1,496,111	)
Employee stock options exercised			(699,641	)									1,570,772		871,131
Tax benefits of exercised stock options			272,534												272,534
Amortization of restricted stock awards											7,350				7,350
Earned employee stock ownership plan shares			143,604						193,361						336,965
Dividends paid					(2,562,153	)									(2,562,153	)
Balance, December 31, 2002	$	91,287	58,885,279		79,660,481		1,575,577		(4,931,385	)	0		(59,216,683	)	76,064,556
Net income					8,605,247										8,605,247
Other comprehensive loss							(1,626,302	)							(1,626,302	)
Treasury stock purchases													(1,384,560	)	(1,384,560	)
Employee stock options exercised			(1,578,979	)									3,001,439		1,422,460
Tax benefits of exercised stock options			376,969												376,969
Earned employee stock ownership plan shares			180,457						193,301						373,758
Dividends paid					(2,901,071	)									(2,901,071	)
Balance, December 31, 2003	$	91,287	57,863,726		85,364,657		(50,725	)	(4,738,084	)	0		(57,599,804	)	80,931,057

See accompanying notes to consolidated financial statements.

20

CONSOLIDATED STATEMENTS OF CASH FLOWS

Years ended December 31, 2003, 2002 and 2001	2003			2002		2001
Cash flows from operating activities:
Net income	$	8,605,247		5,265,656		5,457,616
Adjustments to reconcile net income to cash provided (used) by operating activities:
Provision for loan losses	2,610,000			2,376,000		1,150,000
Depreciation	1,549,997			1,460,636		1,037,897
Amortization of premiums, net	652,344			501,945		107,719
Amortization of deferred loan fees	(690,176		)	(672,993	)	(513,671	)
Amortization of goodwill	0			0		180,036
Amortization of core deposit intangible	113,857			124,178		108,854
Amortization of mortgage servicing rights, net of valuation adjustments and servicing costs	1,982,337			1,165,762		758,352
Capitalized mortgage servicing rights	(2,522,231		)	(1,956,845	)	(1,458,321	)
Deferred income taxes	(540,900		)	(158,700	)	(821,600	)
Securities losses (gains), net	(1,274,537		)	(422,346	)	670,958
(Gain) loss on sale of premises	(185,630		)	85,434		0
Loss (gain) on sales of real estate	115,710			(1,254	)	(17,293	)
Gain on sales of loans	(5,240,442		)	(3,077,294	)	(2,934,317	)
Proceeds from sales of loans held for sale	297,862,680			283,485,340		753,564,329
Disbursements on loans held for sale	(280,633,930		)	(221,645,865	)	(809,722,094	)
Principal collected on loans held for sale	11,521			120,621		179,020
Amortization of restricted stock awards	0			7,350		2,450
Amortization of unearned ESOP Shares	193,301			193,361		193,321
Earned employee stock ownership shares priced above original cost	180,457			143,604		102,572
Decrease (increase) in accrued interest receivable	(411,585		)	458,192		802,919
Decrease in accrued interest payable	(82,590		)	(168,029	)	(558,065	)
Equity losses of limited partnerships	243,305			659,378		1,311,568
Equity losses of minority interest	(3,014		)	(142,274	)	(383,259	)
Decrease (increase) in other assets	680,227			126,663		(1,937,860	)
Increase in other liabilities	663,785			629,031		2,890,551
Other, net	178,627			366,903		(60,665	)
Net cash provided (used) by operating activities	24,058,360			68,924,454		(49,888,983	)
Cash flows from investing activities:
Proceeds from sales of securities available for sale	50,372,919			18,036,553		19,135,721
Principal collected on securities available for sale	30,938,152			25,481,396		24,062,724
Proceeds collected on maturity of securities available for sale	10,000,000			19,900,000		13,695,000
Purchases of securities available for sale	(76,410,791		)	(63,173,006	)	(34,461,933	)
Proceeds from sales of loans receivable	0			0		12,156
Purchase of Federal Home Loan Bank stock	(768,900		)	0		0
Redemption of Federal Home Loan Bank stock	2,645,000			364,500		0
Net decrease (increase) in loans receivable	(161,455,973		)	(69,313,264	)	44,264,172
Proceeds from sale of mortgage servicing rights	0			33,032		0
Proceeds from sale of premises and equipment	416,354			655,465		0
Proceeds from sale of real estate	740,194			151,453		316,797
Purchases of premises and equipment	(1,046,235		)	(4,281,615	)	(2,438,943	)
Net cash (used) provided by investing activities	(144,569,280		)	(72,145,486	)	64,585,694
Cash flows from financing activities:
Increase in deposits	118,784,449			10,925,976		334,938
Purchase of treasury stock	(1,384,560		)	(1,496,111	)	(1,584,152	)
Stock options exercised	1,422,460			871,131		646,199
Dividends to stockholders	(2,901,071		)	(2,562,153	)	(1,881,226	)
Proceeds from Federal Home Loan Bank advances	161,000,000			10,000,000		267,700,000
Repayment of Federal Home Loan Bank advances	(175,400,000		)	(9,500,000	)	(271,800,000	)
Minority interest in subsidiaries	7,000			0		125,000
Increase (decrease) in customer escrows	21,750,458			(308,357	)	365,222
Net cash provided (used) by financing activities	123,278,736			7,930,486		(6,094,019	)
Increase in cash and cash equivalents	2,767,816			4,709,454		8,602,692
Cash and cash equivalents, beginning of year	27,729,007			23,019,553		14,416,861
Cash and cash equivalents, end of year	$	30,496,823		27,729,007		23,019,553
Supplemental cash flow disclosures:
Cash paid for interest	$	20,371,643		21,462,933		31,002,095
Cash paid for income taxes	2,141,000			1,952,500		3,713,121
Supplemental noncash flow disclosures:
Loans transferred to loans held for sale	3,741,477			4,669,139		2,172,128
Transfer of loans to real estate	769,584			628,233		86,123
Transfer of real estate to loans	47,802			0		0

See accompanying notes to consolidated financial statements.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2003, 2002 and 2001

NOTE 1  Description of the Business and Summary of Significant Accounting Policies

HMN Financial, Inc. (HMN or the Company) is a stock savings bank holding company that owns 100 percent of Home Federal Savings Bank (the Bank). The Bank 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) which offers financial planning products and services and Home Federal Holding, Inc. (HFH) which is the holding company for Home Federal REIT, Inc. (HFREIT) which invests in real estate loans acquired from the Bank. HMN has another wholly owned subsidiary, Security Finance Corporation (SFC) which acts as an intermediary for the Bank in transacting like kind property exchanges for Bank customers. The Bank has a 51% owned subsidiary, Home Federal Mortgage Services, LLC (HFMS), which was a mortgage banking and mortgage brokerage business located in Brooklyn Park, Minnesota. HFMS’s brokerage and production activity stopped during the third quarter of 2002 and the company is in the process of being dissolved. The Bank has an 80% owned subsidiary, Federal Title Services, LLC (FTS), which performs mortgage title services for Bank customers.

The consolidated financial statements included herein are for HMN, SFC, the Bank and the Bank’s consolidated entities, OIA, HFH, HFREIT, HFMS, and FTS. All significant intercompany accounts and transactions have been eliminated in consolidation.

Use of Estimates   In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. Actual results could differ from those estimates.

Estimates that are particularly susceptible to change relate to the determination of the allowance for loan losses and the valuation of mortgage servicing rights.

Management believes that the allowance for loan losses is adequate to cover probable losses inherent in the portfolio at the date of the balance sheet. While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the allowance for loan losses. Such agencies may require additions to the allowance based on their judgment about information available to them at the time of their examination.

Mortgage servicing rights are stratified by loan type and note rate and are valued quarterly using prepayment and default rate assumptions. While management believes that the assumptions used and the values determined are reasonable, future adjustments may be necessary if economic conditions differ substantially from the economic conditions in the assumptions used to determine the value of the mortgage servicing rights.

Cash and Cash Equivalents   The Company considers highly liquid investments with original maturities of three months or less to be cash equivalents.

Securities   Securities are accounted for according to their purpose and holding period. The Company classifies its debt and equity securities in one of three categories:

Trading Securities  Securities held principally for resale in the near term are classified as trading securities and are recorded at their fair values. Unrealized gains and losses on trading securities are included in other income.

Securities Held to Maturity  Securities that the Company has the positive intent and ability to hold to maturity are reported at cost and adjusted for premiums and discounts that are recognized in interest income using the interest method over the period to maturity. Unrealized losses on securities held to maturity reflecting a decline in value judged to be other than temporary are charged to income.

Securities Available for Sale  Securities available for sale consist of securities not classified as trading securities or as securities held to maturity. They include securities that management intends to use as part of its asset/liability strategy or that may be sold in response to changes in interest rate, changes in prepayment risk, or similar factors. Unrealized gains and losses, net of income taxes, are reported as a separate component of stockholders’ equity until realized. Gains and losses on the sale of securities available for sale are determined using the specific identification method and recognized on the trade date. Premiums and discounts are recognized in interest income using the interest method over the period to maturity. Unrealized losses on securities available for sale reflecting a decline in value judged to be other than temporary are charged to income.

Loans Held for Sale   Mortgage loans originated or purchased which are intended for sale in the secondary market are carried at the lower of cost or estimated market value in the aggregate. Net fees and costs associated with acquiring and/or originating loans held for sale are deferred and included in the basis of the loan in determining the gain or loss on the sale of the loans. Gains are recognized on the settlement date. Net unrealized losses are recognized through a valuation allowance by charges to income.

Loans Receivable, Net   Loans receivable, net are considered long-term investments and, accordingly, are carried at amortized cost. Loan origination fees received, net of certain loan origination costs, are deferred as an adjustment to the carrying value of the related loans, and are amortized into income using the interest method over the estimated life of the loans.

Premiums and discounts on loans are amortized into interest income using the interest method over the period to contractual maturity, adjusted for estimated prepayments.

The allowance for loan losses is maintained at an amount considered adequate by management to provide for probable losses inherent in the loan portfolio as of the balance sheet dates. The allowance for loan losses is based on periodic analysis of the loan portfolio by management. In this analysis, management considers factors including, but not limited to, specific occurrences which include loan impairment, changes in the size of the portfolios, general economic conditions, loan portfolio composition and historical experience.  In connection with the determination of the allowance for loan losses, management obtains independent

22

appraisals for significant properties.  The allowance for loan losses is established for known problem loans as well as for loans which are not currently known to require specific allowances. Loans are charged off to the extent they are deemed to be uncollectible. The adequacy of the allowance for loan losses is dependent upon management’s estimates of variables affecting valuation, appraisals of collateral, evaluations of performance and status, and the amounts and timing of future cash flows expected to be received on impaired loans. Such estimates, appraisals, evaluations and cash flows may be subject to frequent adjustments due to changing economic prospects of borrowers or properties. The estimates are reviewed periodically and adjustments, if any, are recorded in the provision for loan losses in the periods in which the adjustments become known.

Interest income is recognized on an accrual basis except when collectibility is in doubt. When loans are placed on a non-accrual basis, generally when the loan is 90 days past due, previously accrued but unpaid interest is reversed from income. Interest is subsequently recognized as income to the extent cash is received when, in management’s judgment, principal is collectible.

All impaired loans are valued at the present value of expected future cash flows discounted at the loan’s initial effective interest rate. The fair value of the collateral of an impaired collateral-dependent loan or an observable market price, if one exists, may be used as an alternative to discounting. If the value of the impaired loan is less than the recorded investment in the loan, impairment will be recognized through the allowance for loan losses. A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement.  Impaired loans include all loans which are delinquent as to principal and interest for 120 days or greater and all loans that are restructured in a troubled debt restructuring involving a modification of terms. All portfolio loans are reviewed for impairment on an individual basis.

Mortgage Servicing Rights   Mortgage servicing rights are capitalized and amortized in proportion to, and over the period of, estimated net servicing income. HMN evaluates quarterly its capitalized mortgage servicing rights for impairment. Loan type and note rate are predominant risk characteristics of the underlying loans used to stratify capitalized mortgage servicing rights for purposes of measuring impairment. Any impairment is recognized through a valuation allowance.

Real Estate, Net   Real estate acquired through loan foreclosures are initially recorded at the lower of the related loan balance, less any specific allowance for loss, or fair value less estimated selling costs. Valuations are periodically performed by management and an allowance for losses is established if the carrying value of a property exceeds its fair value less estimated selling costs.

Premises and Equipment   Land is carried at cost. Office buildings, improvements, furniture and equipment are carried at cost less accumulated depreciation.

Depreciation is computed on a straight-line basis over estimated useful lives of 5 to 40 years for office buildings and improvements and 3 to 10 years for furniture and equipment.

Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of   HMN reviews long-lived assets and certain identifiable intangibles for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.

Investment in Limited Partnerships   HMN has investments in limited partnerships which invest in mortgage servicing assets, the common stock of other financial institutions and low to moderate income housing projects which generate tax credits for HMN. HMN accounts for the earnings or losses from the limited partnerships on the equity method.

Intangible Assets   Goodwill resulting from acquisitions is not amortized but is tested for impairment annually in accordance with the requirements of SFAS No. 142, Goodwill and Other Intangible Assets. Deposit base intangibles are amortized on an accelerated basis as the deposits run off. HMN reviews the recoverability of the carrying value of these assets annually or whenever an event occurs indicating that they may be impaired.

Stock-Based Compensation   Effective January 1, 1996, HMN adopted SFAS No. 123, Accounting for Stock-Based Compensation. It elected to continue using the accounting methods prescribed by Accounting Principles Board (APB) Opinion No. 25 and related interpretations which measure compensation cost using the intrinsic value method.  See Note 17 for additional information relating to stock based compensation. Had compensation cost for HMN’s stock-based plan been determined in accordance with the fair value method recommended by SFAS No. 123, HMN’s net income and earnings per share would have been adjusted to the pro forma amounts indicated below:

	2003		2002	2001
Net income:
As reported	$	8,605,247	5,265,656	5,457,616
Deduct: Total stock-based employee compensation expense (benefit) determined under fair value based method for all awards, net of related tax effects	44,935		42,960	(6,805	)
Pro forma	$	8,560,312	5,222,696	5,464,421
Earnings per common share:
As reported:
Basic	$	2.26	1.40	1.45
Diluted	2.16		1.32	1.37
Pro forma:
Basic	2.25		1.39	1.45
Diluted	2.15		1.31	1.37

Income Taxes   Deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

23

Earnings per Share   Basic earnings per share (EPS) excludes dilution and is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that shared in the earnings of the entity. See Note 18 for disclosure of EPS calculations.

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 of unrealized gains and losses on securities available for sale and unrealized gains and losses on hedging valuations qualifying for cash flow hedge accounting treatment pursuant to SFAS No. 133.

Segment Information   The amount of each segment item reported is the measure reported to the chief operating decision maker for purposes of making decisions about allocating resources to the segment and assessing its performance. Adjustments and eliminations made in preparing an enterprise’s general-purpose financial statements and allocations of revenues, expenses and gains or losses are included in determining reported segment profit or loss if they are included in the measure of the segment’s profit or loss that is used by the chief operating decision maker. Similarly, only those assets that are included in the measure of the segment’s assets that are used by the chief operating decision maker are reported for that segment.

New Accounting Standards   In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities. This Statement amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities. This Statement is effective prospectively for contracts entered into or modified after June 30, 2003, except for those provisions of the Statement that relate to Statement 133 Implementation Issues that have been effective for fiscal quarters that began prior to June 15, 2003, which should continue to be applied in accordance with their respective effective dates. The impact of adopting SFAS No. 149 on HMN’s financial condition and results of operations was not material.

In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. This Statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). Many of those instruments were previously classified as equity. This Statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003, however, the effective date has been delayed under certain conditions. The impact of adopting SFAS No. 150 on HMN’s financial condition and results of operations was not material.

In December 2003, the FASB issued a revised SFAS No. 132, Employers’ Disclosures about Pensions and Other Postretirement Benefits. This Statement revises employers’ disclosures about pension plans and other postretirement benefit plans. It requires additional disclosures to those in the original Statement 132 about the assets, obligations, cash flow, and net periodic benefit cost of defined benefit pension plans and other defined benefit postretirement plans. This Statement is effective for financial statements with fiscal years ending after December 15, 2003. The impact of adopting SFAS was not material. See Note 17 for the related employee benefits disclosure.

In December 2003, the FASB issued a revised Interpretation No. 46, Consolidation of Variable Interest Entities (FIN 46). FIN 46 addresses consolidation by business enterprises of variable interest entities that have certain characteristics. It requires a business enterprise that has a controlling interest in a variable interest entity (as defined by FIN 46) to include the assets, liabilities, and results of the activities of the variable interest entity in the consolidated financial statements of the business enterprise. FIN 46 applies to a public entity that is not a small business issuer no later than the end of the first reporting period that ends after March 15, 2004. The impact of adopting FIN 46 on HMN’s financial condition and results of operations will not be material.

Derivative Financial Instruments   HMN uses derivative financial instruments in order to manage the interest rate risk on residential loans held for sale and its commitments to extend credit for residential loans. HMN also uses interest rate swaps to manage interest rate risk. Derivative financial instruments include commitments to extend credit and forward mortgage loan sales commitments. See Note 22 for additional information concerning these derivative financial instruments.

Reclassifications   Certain amounts in the consolidated financial statements for prior years have been reclassified to conform with the current year presentation.

NOTE 2  Other Comprehensive Income

There was no hedging valuation for the year ended December 31, 2003. The gross unrealized holding losses on securities for the year ended December 31, 2003 was $1,241,000, the income tax benefit would have been $439,000 and therefore, the net loss was $802,000. The gross reclassification adjustment for the year ended December 31, 2003 was $1,274,000, the income tax expense would have been $450,000 and therefore, the net reclassification adjustment was $824,000. The gross unrealized losses in hedging valuation for the year ended December 31, 2002 was $45,000, the income tax benefit would have been $9,000 and therefore, the net loss was $36,000. The gross minority interest in hedging valuation for the year ended December 31, 2002 was $22,000. The gross unrealized holding gains on securities for the year ended December 31, 2002 was $2,283,000, the income tax expense would have been $788,000 and therefore, the net gain was $1,495,000. The gross reclassification adjustment in the year ended December 31, 2002 was $422,000, the income tax expense would have been $149,000 and therefore, the net reclassification adjustment was $273,000.

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NOTE 3  Securities Available for Sale

A summary of securities available for sale at December 31, 2003 and 2002 is as follows:

	Amortized cost		Gross unrealized gains	Gross unrealized losses	Fair value
December 31, 2003:
Mortgage-backed securities:
FHLMC	$	421,818	19,938	0	441,756
GNMA	31,715		1,621	3	33,333
Collateralized mortgage obligations:
FHLMC	4,697,157		1,618	266,403	4,432,372
FNMA	8,556,315		14,262	429,320	8,141,257
	13,707,005		37,439	695,726	13,048,718
Other marketable securities:
U.S. Government and agency obligations	86,658,130		929,527	0	87,587,657
Corporate debt	177,155		0	6,765	170,390
Corporate equity	4,200,000		0	343,000	3,857,000
	91,035,285		929,527	349,765	91,615,047
	$	104,742,290	966,966	1,045,491	104,663,765
December 31, 2002:
Mortgage-backed securities:
FHLMC	$	1,507,799	84,778	0	1,592,577
FNMA	140,791		2,859	0	143,650
GNMA	53,582		2,399	0	55,981
Collateralized mortgage obligations:
FHLMC	18,707,714		181,933	1,277	18,888,370
FNMA	19,048,094		84,734	134,270	18,998,558
Other	12,219,314		112,263	114,881	12,216,696
	51,677,294		468,966	250,428	51,895,832
Other marketable securities:
U.S. Government and agency obligations	61,417,086		2,168,825	25,928	63,559,983
Corporate debt	1,061,140		16,548	0	1,077,688
Corporate equity	4,804,153		199,593	140,000	4,863,746
	67,282,379		2,384,966	165,928	69,501,417
	$	118,959,673	2,853,932	416,356	121,397,249

Proceeds from securities available for sale which were sold during 2003 were $50,372,919, resulting in gross gains of $1,353,885 and gross losses of $79,348. Proceeds from securities available for sale which were sold during 2002 were $18,036,553, resulting in gross gains of $456,946 and gross losses of $34,600. Proceeds from securities available for sale which were sold during 2001 were $19,135,721, resulting in gross gains of $349,563 and gross losses of $521. The Company also recognized losses of $1,020,000 resulting from other than temporary impairments of securities in 2001.

The following table indicates amortized cost and estimated fair value of securities available for sale at December 31, 2003 based upon contractual maturity adjusted for scheduled repayments of principal and projected prepayments of principal based upon current economic conditions and interest rates. Actual maturities may differ from the maturities in the following table because obligors may have the right to call or prepay obligations with or without call or prepayment penalties:

	Amortized cost		Fair value
Due less than one year	$	20,409,718	20,570,137
Due after one year through five years	78,312,100		78,468,608
Due after five years through ten years	1,464,103		1,414,191
Due after ten years	356,369		353,829
No stated maturity	4,200,000		3,857,000
Total	$	104,742,290	104,663,765

The allocation of mortgage-backed securities and collateralized mortgage obligations in the table above is based upon the anticipated future cash flow of the securities using estimated mortgage prepayment speeds.

25

The following table shows the gross unrealized losses and fair values for the securities available for sale portfolio aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2003.

	Less than twelve months				Twelve months or more			Total
(Dollars in thousands)	Fair Value		Unrealized Losses		Fair Value	Unrealized Losses		Fair Value	Unrealized Losses
Mortgage backed securities:
Collateralized mortgage obligations	$	12,338	(695	)	0	0		12,338	(695	)
Other marketable securities:
Corporate debt	0		0		170	(7	)	170	(7	)
Corporate equity	0		0		3,157	(343	)	3,157	(343	)
Total temporarily impaired securities	$	12,338	(695	)	3,327	(350	)	15,665	(1,045	)

NOTE 4  Loans Receivable, Net

A summary of loans receivable at December 31 is as follows:

	2003			2002
Residential real estate loans:
1-4 family conventional	$	187,821,158		174,232,528
1-4 family FHA	692,690			306,815
1-4 family VA	382,107			128,911
	188,895,955			174,668,254
5 or more family	54,877,999			29,903,411
	243,773,954			204,571,665
Commercial real estate:
Lodging	39,464,818			37,188,951
Retail/office	54,770,096			40,648,853
Nursing home/health care	5,545,180			2,250,556
Land developments	53,374,516			22,587,781
Golf courses	26,938,649			11,282,148
Restaurant, bar, café	3,400,084			3,279,726
Gaming	0			1,204,980
Warehouse	7,577,813			6,203,530
Manufacturing	5,950,639			5,806,968
Other	29,529,814			24,201,130
	226,551,609			154,654,623
Other loans:
Autos	14,754,042			11,061,725
Home equity line	54,192,801			52,105,686
Home equity	18,973,890			23,760,135
Consumer – secured	12,030,495			2,700,204
Commercial business	132,459,066			91,119,446
Savings	494,227			533,695
Mobile home	3,665,206			4,534,353
Consumer – unsecured	1,794,226			1,724,858
Total other loans	238,363,953			187,540,102
Total loans	708,689,516			546,766,390
Less:
Unamortized discounts	166,364			142,439
Net deferred loan fees	1,334,284			1,068,297
Allowance for losses	6,939,602			4,824,217
Loans in process	11,298,147			6,825,785
	$	688,951,119		533,905,652
Weighted average contractual interest rate	6.20		%	6.97	%
Commitments to originate, fund or purchase loans	$	69,547,706		80,999,893
Commitments to deliver loans to secondary market	7,077,725			61,711,741
Loans serviced for others	483,620,394			337,490,407

Included in total commitments to originate or purchase loans are fixed rate loans aggregating $20,037,650 and $44,943,293 as of December 31, 2003 and 2002, respectively. The interest rates on these commitments ranged from 4.75% to 8.50% at December 31, 2003 and from 4.75% to 7.88% at December 31, 2002.

At December 31, 2003 and 2002, loans on nonaccrual status totaled $4,574,950 and $3,336,046, respectively. Had the loans performed in accordance with their original terms throughout 2003, HMN would have recorded gross interest income of $458,473 for these loans. Interest income of $163,044 has been recorded on these loans for the year ended December 31, 2003.

At December 31, 2003 and 2002 there were no loans included in loans receivable, net, with terms that had been modified in a troubled debt restructuring.

There were no material commitments to lend additional funds to customers whose loans were classified as restructured or nonaccrual at December 31, 2003.

At December 31, 2003, 2002 and 2001, the recorded investment in loans that are considered to be impaired was $4,689,162, $3,507,418 and $2,183,483 for which the related allowance for credit losses was $1,045,495, $904,840 and $637,233, respectively. The average investment in impaired loans during 2003, 2002 and 2001 was $4,801,109, $3,005,743 and $1,385,071, respectively. For the years ended December 31, 2003, 2002, and 2001, HMN recognized interest income on impaired loans of $163,044, $551,542 and $125,040, respectively. All of the interest income that was recognized for impaired loans was recognized using the cash basis method of income recognition.

The aggregate amounts of loans to executive officers and directors of HMN was $1,038,119, $8,861,210 and $1,324,983, at December 31, 2003, 2002 and 2001, respectively. During 2003 repayments on loans to executive officers and directors were $7,891,091, new loans to executive officers and directors totaled $490,500, and sales of executive officer and director loans totaled $422,500. During 2002 repayments on loans to executive officers and directors aggregated $871,573, loans originated aggregated $8,897,300, and loans removed from the executive officer and director listing due to a change in status of the officer or director were $5,000. All loans were made in the ordinary course of business on normal credit terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated parties.

At December 31, 2003, 2002 and 2001, HMN was servicing real estate loans for others with aggregate unpaid principal balances of approximately $483,620,394, $337,490,407 and $234,911,618, respectively.

26

HMN originates residential, commercial real estate and other loans primarily in southern Minnesota and Iowa. HMN has also purchased loans from a third party broker located in the southeastern United States. At December 31, 2003 and 2002, HMN owned single family and multi-family residential loans located in the following states:

	2003				2002
	Amount		Percent of Total		Amount		Percent of Total
Alabama	$	2,084,425	0.9	%	$	3,967,366	1.9	%
Arizona	1,559,579		0.6		0		0.0
Colorado	1,794,321		0.7		416,455		0.2
Florida	5,206,942		2.2		4,277,451		2.1
Georgia	7,338,911		3.0		16,004,376		7.8
Illinois	3,914,175		1.6		5,753,548		2.8
Iowa	16,106,426		6.6		13,819,533		6.8
Massachusetts	2,647,058		1.1		2,217,054		1.1
Minnesota	178,051,169		73.0		135,894,338		66.4
North Carolina	3,243,818		1.3		6,099,133		3.0
South Carolina	4,335,467		1.8		4,040,068		2.0
Texas	5,826,905		2.4		0		0.0
Wisconsin	4,977,308		2.0		3,324,013		1.6
Other states	6,687,450		2.8		8,758,330		4.3
Total	$	243,773,954	100.0	%	$	204,571,665	100.0	%

Amounts under one million dollars are included in “Other states”.

At December 31, 2003 and 2002, HMN owned commercial real estate loans located in the following states:

	2003					2002
	Amount			Percent of Total		Amount			Percent of Total
Alabama		$	0	0.0	%		$	3,216,316	2.1	%
Arizona		12,967,520		5.7			12,099,641		7.8
Colorado		3,255,512		1.4			1,719,175		1.1
Connecticut		2,481,462		1.1			0		0.0
Iowa		14,390,247		6.4			8,237,520		5.3
Minnesota		168,828,643		74.5			121,301,043		78.5
Missouri		4,447,653		2.0			0		0.0
Montana		2,186,326		1.0			2,260,264		1.5
Nebraska		947,905		0.4			969,127		0.6
Oregon		0		0.0			1,204,980		0.8
South Dakota		8,499,929		3.8			0		0.0
Texas		3,459,878		1.5			3,583,300		2.3
Utah		1,848,385		0.8			0		0.0
Wisconsin		3,238,149		1.4			63,257		0.0
Total		$	226,551,609	100.0	%		$	154,654,623	100.0	%

NOTE 5  Allowance for Loan Losses

The allowance for loan losses is summarized as follows:

Balance, December 31, 2000	$	3,143,746
Provision for losses	1,150,000
Charge-offs	(516,337		)
Recoveries	5,703
Balance, December 31, 2001	3,783,112
Provision for losses	2,376,000
Charge-offs	(1,369,241		)
Recoveries	34,346
Balance, December 31, 2002	4,824,217
Provision for losses	2,610,000
Charge-offs	(550,580		)
Recoveries	55,965
Balance, December 31, 2003	$	6,939,602

NOTE 6  Accrued Interest Receivable

Accrued interest receivable at December 31 is summarized as follows:

	2003		2002
Securities available for sale	$	609,913	388,705
Loans receivable	2,852,308		2,661,931
	$	3,462,221	3,050,636

NOTE 7  Investment in Mortgage Servicing Rights

A summary of mortgage servicing activity is as follows:

	2003			2002
Mortgage servicing rights
Balance, beginning of year	$	2,701,031		1,922,736
Originations	2,522,231			1,956,845
Sales	0			(41,532	)
Amortization	(1,775,419		)	(1,137,018	)
Balance, end of year	3,447,843			2,701,031
Valuation reserve
Balance, beginning of year	(10,000		)	(19,100	)
Additions	(800,000		)	(213,000	)
Reductions	810,000			222,100
Balance, end of year	0			(10,000	)
Mortgage servicing rights, net	$	3,447,843		2,691,031

Mortgage servicing costs, which include professional services related to valuing mortgage servicing rights and guarantee fees on securitized mortgage loans, were $216,917 and $29,344, respectively, in 2003 and 2002.

All of the loans being serviced were single family loans serviced for FNMA under the mortgage-backed security program or the individual loan sale program. The following is a summary of the risk characteristics of the loans being serviced at December 31, 2003:

	Loan Principal Balance		Weighted Average Interest Rate		Weighted Average Remaining Term	Number of Loans
Original term 30 year fixed rate	$	184,135,459	5.99	%	347	1,675
Original term 15 year fixed rate	245,332,910		5.39		168	2,915
Seven year balloon	121,796		5.75		61	1
Adjustable rate	9,772,175		4.95		344	84

NOTE 8  Real Estate

A summary of real estate at December 31 is as follows:

	2003		2002
In-substance foreclosures	$	73,271	127,000
Real estate in judgment subject to redemption	0		89,691
Real estate acquired through foreclosure	0		210,000
	73,271		426,691
Allowance for losses	0		0
	$	73,271	426,691

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NOTE 9  Investment in Limited Partnerships

Investments in limited partnerships at December 31 were as follows:

Primary partnership activity	2003		2002
Mortgage servicing rights	$	0	349,577
Common stock of financial institutions	421,671		289,398
Low to moderate income housing	195,371		223,691
	$	617,042	862,666

During 2003 HMN’s proportionate loss from the mortgage servicing partnership was $349,577, its proportionate share of gains from the common stock investments in financial institutions was $132,273 and its proportionate loss on low income housing was $26,000.  During 2003 HMN received low income housing credits totaling $84,000 which were credited to current income tax benefits.

During 2002 HMN’s proportionate loss from the mortgage servicing partnership was $642,364, its proportionate share of gains from the common stock investments in financial institutions was $23,442 and its proportionate loss on low income housing was $40,456.  During 2002 HMN received low income housing credits totaling $84,000 which were credited to current income tax benefits.

During 2003, the limited partnership that invested in mortgage servicing rights was dissolved and HMN requested the general partner of the limited partnership that invests in the common stock of financial institutions to liquidate its investment in that partnership effective December 31, 2003.

NOTE 10  Intangible Assets

The gross carrying amount of intangible assets and the associated accumulated amortization at December 31, 2003 and December 31, 2002 are presented in the table below. Amortization expense for intangible assets was $1,889,276 and $1,261,196 for the years ended December 31, 2003 and December 31, 2002, respectively.

	Gross Carrying Amount		Accumulated Amortization		Valuation Adjustment		Unamortized Intangible Assets
December 31, 2003
Amortized intangible assets:
Mortgage servicing rights	$	4,308,468	(860,625	)	0		3,447,843
Core deposit intangible	1,567,000		(1,119,526	)	0		447,474
Total	$	5,875,468	(1,980,151	)	0		3,895,317
December 31, 2002
Amortized intangible assets:
Mortgage servicing rights	$	4,370,652	(1,669,621	)	(10,000	)	2,691,031
Core deposit intangible	1,567,000		(1,005,669	)	0		561,331
Total	$	5,937,652	(2,675,290	)	(10,000	)	3,252,362

The following table indicates the estimated future amortization expense for amortized intangible assets:

	Mortgage Servicing Rights		Core Deposit Intangible	Total
Year ended December 31,
2004	$	1,020,432	113,857	1,134,289
2005	680,700		113,857	794,557
2006	497,096		113,857	610,953
2007	361,742		105,903	467,645
2008	243,444		0	243,444

Projections of amortization are based on existing asset balances and the existing interest rate environment as of December 31, 2003. HMN’s actual experiences may be significantly different depending upon changes in mortgage interest rates and other market conditions.

28

NOTE 11  “Adjusted” Earnings SFAS No. 142 Transitional Disclosure

Effective January 1, 2002, the amortization of goodwill was discontinued. The table below reconciles reported earnings for 2003, 2002 and 2001 to “adjusted” earnings, which excludes goodwill amortization.

	Year			Year		Year ended December 31, 2001
	Ended December 31, 2003			Ended December 31, 2002		Reported Earnings		Goodwill Amortization	Adjusted Earnings
Income before income tax expense	$	12,640,033		7,222,582		7,708,742		180,036	7,888,778
Income tax expense	4,037,800			2,099,200		2,634,385		0	2,634,385
Income before minority interest	8,602,233			5,123,382		5,074,357		180,036	5,254,393
Minority interest	(3,014		)	(142,274	)	(383,259	)	0	(383,259	)
Net income	$	8,605,247		5,265,656		5,457,616		180,036	5,637,652
Earnings per common share	$	2.26		1.40		1.45		0.05	1.50
Diluted earnings per common share	$	2.16		1.32		1.37		0.05	1.42

NOTE 12  Premises and Equipment

A summary of premises and equipment at December 31 is as follows:

	2003		2002
Land	$	1,338,943	1,399,741
Office buildings and improvements	9,376,782		9,712,405
Furniture and equipment	9,875,743		9,325,853
	20,591,468		20,437,999
Less accumulated depreciation	8,481,317		7,562,183
	$	12,110,151	12,875,816

NOTE 13  Deposits

Deposits and their weighted average interest rates at December 31 are summarized as follows:

	2003						2002
	Weighted average rate		Amount		Percent of total		Weighted average rate		Amount		Percent of total
Noninterest checking	0.00	%	$	37,629,054	6.8	%	0.00	%	$	28,173,034	6.5	%
NOW accounts	0.39		61,270,853		11.1		0.30		43,508,898		10.1
Savings accounts	0.20		35,882,917		6.5		0.35		41,032,871		9.5
Money market accounts	1.23		91,314,858		16.6		1.16		49,510,654		11.4
			226,097,682		41.0				162,225,457		37.5
Certificates:
1-1.99%			57,153,099		10.4				23,002,684		5.3
2-2.99%			103,449,915		18.8				72,161,515		16.7
3-3.99%			71,691,188		13.0				75,444,893		17.4
4-4.99%			76,315,958		13.8				74,817,691		17.3
5-5.99%			16,621,295		3.0				23,719,214		5.5
6-6.99%			246,042		0.0				1,468,058		0.3
7-7.99%			112,816		0.0				111,950		0.0
Total certificates	3.11		325,590,313		59.0		3.42		270,726,005		62.5
Total deposits	2.09		$	551,687,995	100.0	%	2.34		$	432,951,462	100.0	%

At December 31, 2003 and 2002 HMN had $117,733,801 and $61,353,755, respectively, of deposit accounts with balances at $100,000 or more. At December 31, 2003 and 2002, HMN had $66,003,390 and $11,203,358 of certificate accounts, respectively, that were acquired through a broker.

29

Certificates had the following maturities at December 31:

	2003				2002
Remaining term to maturity	Amount (in thousands)		Weighted average rate		Amount (in thousands)		Weighted average rate
1-6 months	$	97,354	2.81	%	$	87,070	2.70	%
7-12 months	69,890		2.73		27,310		2.92
13-36 months	112,265		3.19		136,382		3.88
Over 36 months	46,081		3.61		19,964		4.10
	$	325,590	3.03		$	270,726	3.42

At December 31, 2003 mortgage loans and mortgage-backed and related securities with an amortized cost of approximately $56,976,000 were pledged as collateral for certain deposits and $650,000 of letters of credit from the Federal Home Loan Bank (FHLB) were pledged as additional collateral on Bank deposits.

Interest expense on deposits is summarized as follows for the years ended December 31:

	2003		2002	2001
NOW	$	211,736	181,073	315,149
Savings Accounts	90,421		241,397	454,628
Money Market	437,645		589,406	897,875
Certificates	9,534,386		9,937,926	16,910,696
	$	10,274,188	10,949,802	18,578,348

NOTE 14  Federal Home Loan Bank Advances

Fixed and variable rate Federal Home Loan Bank advances consisted of the following at December 31, 2003 and 2002:

	2003				2002
Year of Maturity	Amount		Rate		Amount		Rate
2003					$	64,400,000	3.20	%
2004	$	33,000,000	5.01	%	33,000,000		5.01
2005	10,000,000		2.69		10,000,000		2.69
2007	40,000,000		2.91		0		0.00
2008	20,000,000		3.83		90,000,000		5.40
2010	10,000,000		6.48		10,000,000		6.48
2011	10,900,000		4.81		10,900,000		4.81
2013	80,000,000		4.75		0		0.00
	203,900,000		4.33		218,300,000		4.59
Lines of Credit	0		0.00		0		0.00
	$	203,900,000	4.33		$	218,300,000	4.59

Many of the advances listed above have call provisions which allow the FHLB to request that the advance be paid back or refinanced at the rates then being offered by the FHLB. As of December 31, 2003, HMN had advances from the FHLB with the following call features:

Year of Maturity	Callable Quarterly in Year 2004		Callable Quarterly in Year 2005
2004	$	15,000,000	0
2008	10,000,000		0
2010	0		10,000,000
2011	10,900,000		0
2013	80,000,000		0
	$	115,900,000	10,000,000

At December 31, 2003 the advances from the FHLB were collateralized by the Bank’s FHLB stock and mortgage loans with unamortized principal balances of $313.4 million. The Bank has the ability to draw additional borrowings of $9.7 million based upon the mortgage loans that are currently pledged subject to a requirement to purchase FHLB stock.

NOTE 15  Other Borrowed Money

HMN had a $2,500,000 revolving line of credit established with a bank that was not drawn at December 31, 2002. The line of credit expired on November 15, 2003 and was renewed in the first quarter of 2004.

30

NOTE 16  Income Taxes

Income tax expense (benefit) for the years ended December 31 is as follows:

	2003			2002		2001
Current:
Federal	$	4,080,500		2,223,300		2,773,200
State	498,200			34,600		682,785
Total current	4,578,700			2,257,900		3,455,985
Deferred:
Federal	(506,200		)	1,400		(638,000	)
State	(34,700		)	(160,100	)	(183,600	)
Total deferred	(540,900		)	(158,700	)	(821,600	)
	$	4,037,800		2,099,200		2,634,385

The reasons for the difference between “expected” income tax expense utilizing the federal corporate tax rate of 34% and the actual income tax expense are as follows:

	2003			2002		2001
Federal expected income tax expense	$	4,297,600		2,455,700		2,621,000
Items affecting federal income tax:
Dividend received deduction	(26,100		)	(145,200	)	(108,200	)
Non deductible portion of minority interest loss	0			72,800		130,300
State income taxes, net of federal income tax benefit	249,700			21,700		329,500
Reduction of tax rate due to employee stock ownership plan dividends	(160,500		)	(149,100	)	(313,000	)
Low income housing credits	(84,000		)	(84,000	)	(84,000	)
Tax exempt interest	(284,600		)	(107,000	)	(24,200	)
Other, net	45,700			34,300		82,985
	$	4,037,800		2,099,200		2,634,385

The tax effects of temporary differences that give rise to the deferred tax assets and deferred tax liabilities are as follows at December 31:

	2003			2002
Deferred tax assets:
Allowances for loan and real estate losses	$	2,453,000		1,705,300
Investment in limited partnership	0			164,500
Discounts on assets and liabilities acquired from Marshalltown Financial Corporation	400			900
Deferred compensation and pension costs	181,500			176,100
Impairment losses on securities available for sale	0			157,900
Net unrealized loss on market value adjustments to securities available for sale	27,800			0
Mark to market on forward sales commitments	0			85,500
Total gross deferred tax assets	2,662,700			2,290,200
Valuation allowance	0			0
Net deferred tax assets	2,662,700			2,290,200
Deferred tax liabilities:
Tax bad debt reserve over base year	0			213,500
Premium on assets acquired from Marshalltown Financial Corporation	158,100			199,200
Net unrealized gain on market value adjustments to securities available for sale	0			861,600
FHLB stock	0			285,000
Deferred loan fees and costs	458,600			400,500
Premises and equipment basis difference	852,800			809,800
Originated mortgage servicing rights	1,218,700			954,700
Other	800			22,500
Total gross deferred tax liabilities	2,689,000			3,746,800
Net deferred tax liabilities	$	(26,300	)	(1,456,600	)

Retained earnings at December 31, 2003 included approximately $8,800,000 for which no provision for income taxes was made. This amount represents allocations of income to bad debt deductions for tax purposes. Reduction of amounts so allocated for purposes other than absorbing losses will create income for tax purposes, which will be subject to the then-current corporate income tax rate. The Company has, in its judgment, made reasonable assumptions relating to the realization of deferred tax assets. Based upon these assumptions, the Company has determined that no valuation allowance is required with respect to the deferred tax assets.

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NOTE 17  Employee Benefits

Prior to 2002, all eligible full-time employees of the Bank were included in a noncontributory retirement plan sponsored by the Financial Institutions Retirement Fund (FIRF). Effective September 1, 2002 the Bank froze the accrual of benefits for existing participants and no new enrollments are permitted into the plan. The actuarial present value of accumulated plan benefits and net assets available for benefits relating to the Bank’s employees is not available at December 31, 2003 because such information is not accumulated for each participating institution. As of June 30, 2003, the FIRF valuation report reflected that the Bank was obligated to make a contribution for the plan year ending June 30, 2003 totaling $36,014. The contribution was $20,575 in 2002 and no contribution was required in 2001 because the retirement plan benefits had been reduced and the plan was fully funded.

HMN has a qualified, tax-exempt savings plan with a deferred feature qualifying under Section 401(k) of the Internal Revenue Code (the 401(k) Plan). All employees who have attained 18 years of age are eligible to participate in the Plan. Participants are permitted to make contributions to the 401(k) Plan equal to the lesser of 50% of the participant’s annual salary or the maximum allowed by law, which was $12,000 for 2003. HMN matches 25% of each participant’s contributions up to a maximum of 8% of the participant’s annual salary. Employee contributions above 8% are not matched by HMN. Participant contributions and earnings are fully and immediately vested. HMN’s contributions made prior to January 1, 2002 are vested on a five year cliff basis and contributions made after December 31, 2001 are vested on a three year cliff basis. HMN’s matching contributions to the 401(k) plan are expensed when made and they totaled  $113,843, $76,005 and $71,200 in 2003, 2002 and 2001, respectively.

HMN adopted an Employee Stock Ownership Plan (the ESOP) which met the requirements of Section(e)(7) of the Internal Revenue Code and Section 407(d)(6) of the Employee Retirement Income Security Act of 1974, as amended (ERISA) and, as such the ESOP was empowered to borrow in order to finance purchases of the common stock of HMN. The ESOP borrowed $6,085,770 from HMN to purchase 912,866 shares of common stock in the initial public offering of HMN. As a result of a merger with Marshalltown Financial Corporation (MFC), the ESOP borrowed $1,476,000 to purchase 76,933 shares of HMN common stock to provide the employees from MFC with an ESOP benefit. The ESOP debt requires quarterly payments of principal plus interest at 7.52%. HMN has committed to make quarterly contributions to the ESOP necessary to repay the loan including interest. HMN contributed $525,224 for each of the years 2003, 2002 and 2001.

As the debt is repaid, ESOP shares that were pledged as collateral for the debt are committed to be released from collateral and allocated to active employees based on the proportion of debt service paid in the year. HMN accounts for its ESOP in accordance with Statement of Position 93-6, Employers’ Accounting for Employee Stock Ownership Plans. Accordingly, the shares pledged as collateral are reported as unearned ESOP shares in stockholders’ equity. As shares are determined to be ratably released from collateral, HMN reports compensation expense equal to the current market price of the shares, and the shares become outstanding for earnings per share computations. ESOP compensation benefit expense was $472,108, $418,700 and $365,921 respectively, for 2003, 2002 and 2001.

All employees of the Bank are eligible to participate in the ESOP after they attain age 21 and complete one year of service during which they worked at least 1,000 hours. A summary of the ESOP share allocation is as follows for the years ended:

	2003			2002		2001
Shares allocated to participants beginning of the year	$	245,031		233,697		246,710
Shares allocated to participants	24,317			24,317		24,317
Shares purchased with dividends from allocated shares	10,638			8,485		7,884
Shares distributed to participants	(4,398		)	(21,468	)	(45,214	)
Shares allocated to participants end of year	275,588			245,031		233,697
Unreleased shares beginning of the year	620,430			644,747		669,064
Shares released during year	(24,317		)	(24,317	)	(24,317	)
Unreleased shares end of year	596,113			620,430		644,747
Total ESOP shares end of year	$	871,701		865,461		878,444
Fair value of unreleased shares at December 31	$	14,479,585		10,435,633		9,987,131

In June of 1995, HMN as part of a Recognition and Retention Plan (RRP) awarded 126,729 shares of restricted common stock to its officers and directors. The shares vested over a five year period and were issued from treasury stock. In April 1997, 3,000 shares of restricted common stock were awarded to a director. Those shares vested over a five year period beginning in 1998. Compensation and benefit expense related to the restricted stock was $0, $7,350 and $2,450, respectively for 2003, 2002 and 2001.

In June 1995, HMN adopted the 1995 Stock Option and Incentive Plan (the SOP). During 1995, options exercisable for 821,569 shares of HMN common stock were granted to certain officers and directors at an exercise price of $9.211 per share. In December 1996, options exercisable for 1,500 shares of common stock were granted to certain officers at an exercise price of $12.089. In April 1997, options for 18,000 shares of common stock were granted to a director at an exercise price of $13.007. In April 1999, options for 80,000 shares of common stock were granted to an officer and directors at an exercise price of $11.50. In April 2000, options for 30,000 shares were granted to directors at an exercise price of $11.25. In April of 2002, options for 15,000 shares were granted to a director at an exercise price of $16.25. All options issued under this plan vest over a five year period and expire 10 years from the grant date.

In March 2001, HMN adopted the HMN Financial, Inc. 2001 Omnibus Stock Plan (2001 Plan). The purpose of the 2001 Plan was to promote the interests of HMN and its stockholders by providing key personnel with an opportunity to acquire a proprietary interest in HMN and reward them for achieving a high level of corporate performance and thereby develop a stronger incentive to put forth maximum effort for the success and growth of HMN. The total number of shares of HMN common stock available for distribution under the 2001 Plan in either restricted stock or stock options was

32

400,000 subject to adjustment for future stock splits, stock dividends and similar changes to the capitalization of HMN. In April 2002, HMN awarded 212,410 options at $16.13 per share which vest starting in April of 2008 through 2012.

The fair value of the options granted under the SOP were $1.85, $2.59, $4.11, $6.08, $5.55 and $4.49 for 2002, 2000, 1999, 1998, 1997, and 1995, respectively, and $1.43 for 2002 under the 2001 Plan. A summary of stock option activities under both plans are detailed as follows:

	Options available for grant		Options outstanding		Weighted average exercise price
1995 Stock Option and Incentive Plan
December 31, 1998	111,799		727,246		$	9.308
Exercised			(49,516	)	9.211
Forfeited	6,848		(6,848	)	9.211
Granted April 27, 1999	(80,000	)	80,000		11.500
December 31, 1999	38,647		750,882		9.549
Exercised			(91,742	)	9.211
Forfeited	750		(750	)	12.089
Granted May 23, 2000	(30,000	)	30,000		11.250
December 31, 2000	9,397		688,390		9.665
Exercised			(171,271	)	9.211
Forfeited	15,000		(15,000	)	11.500
December 31, 2001	24,397		502,119		9.765
Exercised			(109,871	)	9.211
Granted April 23, 2002	(15,000	)	15,000		16.250
December 31, 2002	9,397		407,248		10.154
Exercised			(228,493	)	9.211
December 31, 2003	9,397		178,755		11.358
2001 Omnibus Stock Plan
December 31, 2001	400,000
Granted April 16, 2002	(212,410	)	212,410		16.130
December 31, 2002	187,590		212,410		16.130
Forfeited	16,447		(16,447	)	16.130
December 31, 2003	204,037		195,963		16.130
Total both plans	213,434		374,718		13.854

The following table summarizes information about stock options outstanding at December 31, 2003:

Options Outstanding				Options Exercisable
Exercise price		Number outstanding	Weighted average remaining contractual life in years	Number	Price
$	9.211	50,755	1.4	50,755	$	9.211
13.007		18,000	3.3	18,000	13.007
11.500		65,000	5.3	52,000	11.500
11.250		30,000	6.4	18,000	11.250
16.250		15,000	8.4	3,000	16.250
16.130		195,963	8.3	0	16.130
		374,718		141,755

HMN uses the intrinsic value method as described in APB Opinion No. 25 and related interpretations to account for its stock incentive plans. Accordingly, no compensation cost has been recognized for the option plans. Proceeds from stock options exercised are credited to common stock and additional paid-in capital. There are no charges or credits to expense with respect to the granting or exercise of options since the options were issued at fair value on the respective grant dates. Had compensation cost for HMN’s stock-based plan been determined in accordance with the fair value method recommended by SFAS No. 123, HMN’s net income and earnings per share would have been adjusted to the pro forma amounts indicated below:

	2003		2002	2001
Net income:
As reported	$	8,605,247	5,265,656	5,457,616
Deduct: total stock-based employee compensation expense (benefit) determined under fair value based method for all awards, net of related tax effects	44,935		42,960	(6,805	)
Pro forma	$	8,560,312	5,222,696	5,464,421
Earnings per common share:
As reported:
Basic	$	2.26	1.40	1.45
Diluted	2.16		1.32	1.37
Pro forma:
Basic	2.25		1.39	1.45
Diluted	2.15		1.31	1.37

The preceding disclosed pro forma effects of applying SFAS No. 123 to compensation costs may not be representative of the effects on reported pro forma net income for future years.

The fair value for each option grant is estimated on the date of the grant using the Option Designer Model. The model incorporated the following assumptions for each year of grant:

	2002		2000		1999		1998		1997
Risk-free interest rate	5.20	%	6.49	%	5.59	%	6.80	%	6.21	%
Expected life	9 years		9 years		9 years		10 years		10 years
Expected volatility	13.00	%	15.60	%	30.00	%	18.00	%	18.00	%
Expected dividends	4.5	%	3.0	%	2.1	%	None		None

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NOTE 18  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:

	Year Ended December 31,
	2003		2002	2001
Weighted average number of common shares outstanding used in basic earnings per common share calculation	3,812,213		3,767,216	3,761,115
Net dilutive effect of:
Options	169,171		217,576	212,854
Restricted stock awards	0		36	509
Weighted average number of shares outstanding adjusted for effect of dilutive securities	3,981,384		3,984,828	3,974,478
Income available to common shareholders	$	8,605,247	5,265,656	5,457,616
Basic earnings per common share	$	2.26	1.40	1.45
Diluted earnings per common share	$	2.16	1.32	1.37

NOTE 19  Stockholders’ Equity

HMN repurchased 86,600 shares of its common stock in the open market during 2003, 92,300 shares during 2002 and 105,200 shares during 2001 for $1,384,560, $1,496,111 and $1,584,152, respectively. The shares were placed in treasury stock.

HMN declared and paid dividends as follows:

Record date	Payable date	Dividend per share		Dividend Payout Ratio
February 22, 2001	March 8, 2001	$	0.12	29.27	%
May 24, 2001	June 11, 2001	$	0.12	30.00	%
August 28, 2001	September 11, 2001	$	0.14	43.75	%
November 23, 2001	December 12, 2001	$	0.14	28.00	%
February 21, 2002	March 7, 2002	$	0.14	100.00	%
May 23, 2002	June 10, 2002	$	0.18	36.00	%
August 27, 2002	September 10, 2002	$	0.18	56.25	%
November 22, 2002	December 11, 2002	$	0.18	81.82	%
February 21, 2003	March 7, 2003	$	0.18	64.29	%
May 22, 2003	June 9, 2003	$	0.18	50.00	%
August 28, 2003	September 11, 2003	$	0.20	38.46	%
November 28, 2003	December 17, 2003	$	0.20	26.32	%

On January 28, 2004 HMN declared a cash dividend of $0.20 per share payable on March 8, 2004, to stockholders of record on February 20, 2004. The annualized dividend payout ratios for 2003, 2002 and 2001 were 39.58%, 57.63% and 31.90%, respectively.

HMN’s certificate of incorporation authorizes the issuance of up to 500,000 shares of preferred stock, but to date no shares have been issued.

In order to grant a priority to eligible accountholders in the event of future liquidation, the Bank, at the time of conversion established a liquidation account equal to its regulatory capital as of September 30, 1993. In the event of future liquidation of the Bank, an eligible accountholder who continues to maintain their deposit account shall be entitled to receive a distribution from the liquidation account. The total amount of the liquidation account will be decreased as the balance of eligible accountholders are reduced subsequent to the conversion, based on an annual determination of such balance.

The Bank may not declare or pay a cash dividend to HMN without filing a capital distribution application with the OTS if the total amount of the dividends for the year exceeds the Bank’s net income for the year plus the Bank’s retained net income for the preceding two years. Additional limitations on dividends declared or paid on, or repurchases of, the Bank’s capital stock are tied to the Bank’s level of compliance with its regulatory capital requirements.

NOTE 20  Federal Home Loan Bank Investment and Regulatory Capital Requirements

The Bank, as a member of the Federal Home Loan Bank System, is required to hold a specified number of shares of capital stock, which is carried at cost, in the Federal Home Loan Bank of Des Moines. The Bank has met the requirements as of December 31, 2003.

The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on HMN’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

Quantitative measures established by regulations to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the following table) of Tier I or Core capital, and Risk-based capital (as defined in the regulations) to total assets (as defined). Management believes, as of December 31, 2003, that the Bank meets all capital adequacy requirements to which it is subject.

Management believes that based upon the Bank’s capital calculations at December 31, 2003 and other conditions consistent with the Prompt Corrective Actions Provisions of the OTS regulations, the Bank would be categorized as well capitalized.

34

At December 31, 2003 the Bank’s capital amounts and ratios are also presented for actual capital, required capital, and excess capital, including amounts and ratios in order to qualify as being well capitalized under the Prompt Corrective Actions regulations:

	Actual				Required to be Adequately Capitalized				Excess Capital				To Be Well Capitalized Under Prompt Corrective Actions Provisions
(in thousands)	Amount		Percent of Assets (1)		Amount		Percent of Assets (1)		Amount		Percent of Assets (1)		Amount		Percent of Assets (1)
Bank stockholder’s equity	$	73,279
Less:
Goodwill and other intangibles	4,249
Tier I or core capital	69,030
Tier I capital to adjusted total assets			8.03	%	$	34,366	4.00	%	$	34,664	4.03	%	$	42,957	5.00	%
Tier I capital to risk-weighted assets			10.19	%	$	27,088	4.00	%	$	41,942	6.19	%	$	40,633	6.00	%
Plus:
Allowable allowance for loan losses	5,901
Risk-based capital	$	74,931			$	54,177			$	20,754			$	67,721
Risk-based capital to risk-weighted assets			11.06	%			8.00	%			3.06	%			10.00	%

(1)   Based upon the Bank’s adjusted total assets for the purpose of the Tier I or core capital ratios and risk-weighted assets for the purpose of the risk-based capital ratio.

NOTE 21  Financial Instruments with Off-Balance Sheet Risk

HMN is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the balance sheet. The contract amounts of these instruments reflect the extent of involvement by HMN.

HMN’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit is represented by the contract amount of these commitments. HMN uses the same credit policies in making commitments as it does for on-balance sheet instruments.

	Contract amount
(in thousands)	2003		2002
Financial instruments whose contract amount represents credit risk:
Commitments to extend credit	$	238,291	215,285
Commitment of counter party to purchase loans	7,078		61,712

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since a portion of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on the loan type and on management’s credit evaluation of the borrower. Collateral consists primarily of residential and commercial real estate and personal property.

Commitments of a counter party to purchase loans represents commitments to sell loans to FNMA and are entered into in the normal course of business by the Bank.

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NOTE 22  Derivative Instruments and Hedging Activities

HMN originates and purchases single family residential loans for sale into the secondary market and enters into commitments to sell or securitize those loans in order to mitigate the interest rate risk associated with holding the loans until they are sold. HMN adopted SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, in the first quarter of 2001. At the beginning of the second quarter of 2001, certain commitments to sell loans held for sale were designated as a cash flow hedge of a forecasted transaction and were accounted for in accordance with SFAS No. 133 with no ineffectiveness recognized in the income statement. In the second quarter of 2002 cash flow hedge accounting was discontinued because HMN ceased delivering loans under a mortgage backed security program. The mortgage banking operations in the Brooklyn Park location were eliminated in 2002 and some of the activity was moved to other branches within HMN.

HMN has commitments outstanding to extend credit to future borrowers that had not closed prior to the end of the quarter, which is referred to as its mortgage pipeline. As commitments to originate loans enter the mortgage pipeline, HMN generally enters into commitments to sell the loans into the secondary market. The commitments to originate and sell loans are derivatives that are recorded at market value. As a result of marking these derivatives to market for the period ended December 31, 2003, HMN recorded a decrease in other assets of $689,313, a decrease in other liabilities of $690,504, and a net gain on the sale of loans of $1,191.

The current commitments to sell loans held for sale are derivatives that do not qualify for hedge accounting. As a result, these derivatives are marked to market. The loans held for sale that are not hedged are recorded at the lower of cost or market. As a result of marking these loans, HMN recorded an increase in loans held for sale of $15,219, a decrease in other liabilities of $243,246, and a net gain on the sale of loans of $258,465.

NOTE 23  Fair Value of Financial Instruments

SFAS No. 107, Disclosures about Fair Values of Financial Instruments, requires disclosure of estimated fair values of HMN’s financial instruments, including assets, liabilities and off-balance sheet items for which it is practicable to estimate fair value. The fair value estimates are made as of December 31, 2003 and 2002 based upon relevant market information, if available, and upon the characteristics of the financial instruments themselves. Because no market exists for a significant portion of HMN’s financial instruments, fair value estimates are based upon judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. The estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

Fair value estimates are based only on existing financial instruments without attempting to estimate the value of anticipated future business or the value of assets and liabilities that are not considered financial instruments. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on the fair value estimates and have not been considered in any of the estimates.

The estimated fair value of HMN’s financial instruments are shown below. Following the table, there is an explanation of the methods and assumptions used to estimate the fair value of each class of financial instruments.

	December 31,
	2003						2002
(in thousands)	Carrying amount			Estimated fair value		Contract amount	Carrying amount		Estimated fair value		Contract amount
Financial assets:
Cash and cash equivalents	$	30,497		30,497			27,729		27,729
Securities available for sale	104,664			104,664			121,397		121,397
Loans held for sale	6,543			6,560			15,127		15,127
Loans receivable, net	688,951			695,454			533,906		558,625
Federal Home Loan Bank stock	10,004			10,004			11,881		11,881
Accrued interest receivable	3,462			3,462			3,051		3,051
Financial liabilities:
Deposits	551,688			554,936			432,951		437,490
Federal Home Loan Bank advances	203,900			213,256			218,300		222,109
Accrued interest payable	767			767			849		849
Off-balance sheet financial instruments:
Commitments to extend credit	16			16		238,291	706		706		215,285
Commitments to sell loans	(14		)	(14	)	7,078	(947	)	(947	)	61,712

36

Cash and Cash Equivalents  The carrying amount of cash and cash equivalents approximates their fair value.

Securities Available for Sale  The fair values of securities were based upon quoted market prices.

Loans Held for Sale  The fair values of loans held for sale were based upon quoted market prices for loans with similar interest rates and terms to maturity.

Loans Receivable  The fair values of loans receivable were estimated for groups of loans with similar characteristics. The fair value of the loan portfolio, with the exception of the adjustable rate portfolio, was calculated by discounting the scheduled cash flows through the estimated maturity using anticipated prepayment speeds and using discount rates that reflect the credit and interest rate risk inherent in each loan portfolio. The fair value of the adjustable loan portfolio was estimated by grouping the loans with similar characteristics and comparing the characteristics of each group to the prices quoted for similar types of loans in the secondary market.

Federal Home Loan Bank Stock  The carrying amount of FHLB stock approximates its fair value.

Accrued Interest Receivable  The carrying amount of accrued interest receivable approximates its fair value since it is short-term in nature and does not present unanticipated credit concerns.

Deposits  Under SFAS No. 107, the fair value of deposits with no stated maturity such as checking, savings and money market accounts, is equal to the amount payable on demand. The fair value of certificates of deposit is based on the discounted value of contractual cash flows using as discount rates the rates that were offered by HMN as of December 31, 2003 and 2002 for deposits with maturities similar to the remaining maturities of the existing certificates of deposit.

The fair value estimate for deposits does not include the benefit that results from the low cost funding provided by HMN’s existing deposits and long-term customer relationships compared to the cost of obtaining different sources of funding. This benefit is commonly referred to as the core deposit intangible.

Federal Home Loan Bank Advances  The fair values of advances with fixed maturities are estimated based on discounted cash flow analysis using as discount rates the interest rates charged by the FHLB at December 31, 2003 and 2002 for borrowings of similar remaining maturities.

Accrued Interest Payable  The carrying amount of accrued interest payable approximates its fair value since it is short-term in nature.

Commitments to Extend Credit  The fair values of commitments to extend credit for 2003 and 2002 are estimated using the fees normally charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counter parties.

Commitments to Sell Loans  The fair values of commitments to sell loans for 2003 and 2002 are estimated using the quoted market prices for loans with similar interest rates and terms to maturity.

NOTE 24  Commitments and Contingencies

The Bank entered into two guaranty agreements with third parties in order for Home Federal Mortgage Services, LLC (HFMS) to secure loan purchase agreements. Under the agreements, the Bank guaranteed to satisfy and discharge all obligations of HFMS arising from transactions entered into between HFMS and the third parties if HFMS failed to fulfill its obligations. The agreements are in effect until the obligations of HFMS are fully satisfied and the Bank’s guaranty is limited to a combined maximum of $3 million. No liability has been recorded in the consolidated financial statements of HMN for these guarantees and HMN is not aware of any outstanding obligations of HFMS to either of the third parties with whom a guarantee exists. HFMS ceased doing business with both third parties in 2002. There is the possibility that the Bank would be required to purchase loans that were previously sold to the third parties by HFMS prior to 2002 if the loans did not meet the requirements in the loan purchase agreements. If this were to occur, the proceeds from the subsequent sale of these loans would enable the Bank to recover a portion of the amounts paid under the guaranty.

The Bank issued standby letters of credit which guarantee the performance of customers to third parties. The standby letters of credit outstanding at December 31, 2003 expire over the next two years and totaled approximately $2.5 million at December 31, 2003 and $1.2 million at December 31, 2002. The letters of credit were collateralized primarily with commercial real estate mortgages. Since the conditions under which the Bank is required to fund the standby letters of credit may not materialize, the cash requirements are expected to be less than the total outstanding commitments.

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NOTE 25  HMN Financial, Inc. Financial Information (Parent Company Only)

The following are the condensed financial statements for the parent company only as of December 31, 2003 and 2002 and for the years ended December 31, 2003, 2002 and 2001.

	2003			2002		2001
Condensed Balance Sheets
Assets:
Cash and cash equivalents	$	5,929,858		447,420
Securities available for sale	0			1,490,500
Loans receivable from subsidiaries	0			4,700,000
Loans receivable, net	110,000			1,601,383
Investment in subsidiaries	73,337,245			66,479,330
Investment in limited partnerships	421,671			289,398
Accrued interest receivable	5,620			21,168
Prepaid expenses and other assets	1,318,313			1,270,981
Deferred tax asset	33,600			0
Total assets	$	81,156,307		76,300,180
Liabilities and Stockholders’ Equity
Accrued expenses and other liabilities	$	225,250		198,724
Deferred tax liability	0			36,900
Total liabilities	225,250			235,624
Serial preferred stock	0			0
Common stock	91,287			91,287
Additional paid-in capital	57,863,726			58,885,279
Retained earnings	85,364,657			79,660,481
Net unrealized loss (gain) on securities available for sale	(50,725		)	1,575,577
Unearned employee stock option plan shares	(4,738,084		)	(4,931,385	)
Treasury stock, at cost, 4,616,010 and 4,722,856 shares	(57,599,804		)	(59,216,683	)
Total stockholders’ equity	80,931,057			76,064,556
Total liabilities and stockholders’ equity	$	81,156,307		76,300,180
Condensed Statements of Income
Interest income	$	193,334		365,202		651,478
Interest expense	0			0		(14,557	)
Securities gains (losses), net	301,006			118,238		(130,344	)
Equity earnings of subsidiaries	8,361,418			5,095,784		5,282,142
Equity earnings (losses) of limited partnerships	132,273			23,441		(19,568	)
Other income	0			15,514		0
Compensation and benefits	(42,100		)	(44,250	)	(48,601	)
Occupancy	(6,005		)	(6,000	)	(6,324	)
Advertising	(2,500		)	0		0
Data processing	(1,200		)	(1,200	)	(2,722	)
Mortgage servicing	(8,009		)	(1,459	)	0
Other	(481,770		)	(523,314	)	(458,788	)
Income before income tax expense	8,446,447			5,041,956		5,252,716
Income tax benefit	(158,800		)	(223,700	)	(204,900	)
Net income	$	8,605,247		5,265,656		5,457,616

38

	2003			2002		2001
Condensed Statements of Cash Flows
Cash flows from operating activities:
Net income	$	8,605,247		5,265,656		5,457,616
Adjustments to reconcile net income to cash provided by operating activities:
Equity earnings of subsidiaries	(8,361,418		)	(5,095,784	)	(5,282,142	)
Equity (earnings) losses in limited partnership	(132,273		)	(23,441	)	19,568
Amortization of premiums, net	0			31,028		0
Securities (gains) losses, net	(301,006		)	(118,238	)	130,344
Deferred income taxes	(3,200		)	257,600		(171,800	)
Earned employee stock ownership shares priced above original cost	180,457			143,604		102,572
Decrease in restricted stock awards	0			7,350		2,450
Decrease in unearned ESOP shares	193,301			193,361		193,321
Decrease in accrued interest receivable	15,548			98,659		88,983
Increase in accrued expenses and other liabilities	26,526			199,219		41,073
Decrease (increase) in other assets	330,037			(944,817	)	51,583
Other, net	0			1		0
Net cash provided by operating activities	553,219			14,198		633,568
Cash flows from investing activities:
Proceeds from sales of securities available for sale	1,601,007			6,296,788		3,634,968
Purchases of securities available for sale	0			0		(2,688,600	)
Decrease (increase) in loans receivable, net	1,491,383			(1,601,383	)	0
Decrease of investments in subsidiaries	0			0		1,096,972
Net decrease (increase) in loans receivable from subsidiaries	4,700,000			(3,985,118	)	3,745,510
Net cash provided by investing activities	7,792,390			710,287		5,788,850
Cash flows from financing activities:
Purchase of treasury stock	(1,384,560		)	(1,496,111	)	(1,584,152	)
Stock options exercised	1,422,460			871,131		646,199
Dividends to stockholders	(2,901,071		)	(2,562,153	)	(1,881,226	)
Decrease in other borrowed money	0			0		(750,000	)
Net cash used by financing activities	(2,863,171		)	(3,187,133	)	(3,569,179	)
Increase (decrease) in cash and cash equivalents	5,482,438			(2,462,648	)	2,853,239
Cash and cash equivalents, beginning of year	447,420			2,910,068		56,829
Cash and cash equivalents, end of year	$	5,929,858		447,420		2,910,068

39

NOTE 26  Business Segments

The Bank has been identified as a reportable operating segment in accordance with the provisions of SFAS No. 131.  SFC and HMN, the holding company, did not meet the quantitative thresholds for a reportable segment and therefore are not included in the “Other” category. Prior to 2003, Home Federal Mortgage Services, (HFMS) was reported as a separate business segment. HFMS is in the process of being dissolved and its segmented information for earlier years has been included in the “Home Federal Savings Bank” category to conform with the current year presentation.

HMN evaluates performance and allocates resources based on the segment’s net income, return on average assets and return on average equity. Each corporation is managed separately with its own officers and board of directors.

The following table sets forth certain information about the reconciliations of reported net income and assets for each of HMN’s reportable segments.

(Dollars in thousands)	Home Federal Savings Bank			Other		Eliminations		Consolidated Total
At or for the year ended December 31, 2003:
Interest income – external customers	$	44,775		162		0		44,937
Non-interest income – external customers	10,198			301		0		10,499
Earnings (losses) on limited partnerships	(376		)	132		0		(244	)
Intersegment interest income	28			31		(59	)	0
Intersegment non-interest income	868			8,361		(9,229	)	0
Interest expense	20,348			0		(59	)	20,289
Amortization of mortgage servicing rights and net valuation adjustments and servicing costs	2,298			8		(324	)	1,982
Other non-interest expense	17,456			542		(327	)	17,671
Income tax expense (benefit)	4,200			(162	)	0		4,038
Minority interest	(3		)	0		0		(3	)
Net income	8,584			8,599		(8,578	)	8,605
Goodwill	3,801			0		0		3,801
Total assets	860,220			81,182		(74,966	)	866,436
Net interest margin	3.30		%	NM		NM		3.31	%
Return on average assets	1.08			NM		NM		1.10
Return on average realized common equity	11.88			NM		NM		10.85
At or for the year ended December 31, 2002:
Interest income – external customers	$	42,550		318		0		42,868
Non-interest income – external customers	6,401			134		0		6,535
Earnings (losses) on limited partnerships	(683		)	23		0		(660	)
Intersegment interest income	517			47		(564	)	0
Intersegment non-interest income	305			5,168		(5,473	)	0
Interest expense	21,859			0		(564	)	21,295
Amortization of mortgage servicing rights and net valuation adjustments and servicing costs	1,364			1		(199	)	1,166
Other non-interest expense	16,643			583		(543	)	16,683
Income tax expense (benefit)	2,368			(269	)	0		2,099
Minority interest	(142		)	0		0		(142	)
Net income	4,728			5,269		(4,731	)	5,266
Goodwill	3,801			0		0		3,801
Total assets	732,769			76,436		(71,682	)	737,523
Net interest margin	3.13		%	NM		NM		3.19	%
Return on average assets	0.75			NM		NM		0.74
Return on average realized common equity	8.33			NM		NM		6.94
At or for the year ended December 31, 2001:
Interest income – external customers	$	51,040		428		0		51,468
Non-interest income – external customers	4,573			323		0		4,896
Earnings (losses) on limited partnerships	(1,292		)	(20	)	0		(1,312	)
Intersegment interest income (expense)	2,800			225		(3,025	)	0
Intersegment non-interest income	(246		)	5,282		(5,036	)	0
Interest expense	33,453			16		(3,025	)	30,444
Amortization of mortgage servicing rights and net valuation adjustments and servicing costs	758			0		0		758
Other non-interest expense	14,565			1,002		(576	)	14,991
Income tax expense (benefit)	2,852			(218	)	0		2,634
Minority interest	(383		)	0				(383	)
Net income	4,480			5,438		(4,460	)	5,458
Total assets	768,318			72,547		(119,751	)	721,114
Net interest margin	2.97		%	NM		NM		3.02	%
Return on average assets	0.69			NM		NM		0.75
Return on average realized common equity	9.24			NM		NM		7.57

NM – Not meaningful

40

INDEPENDENT AUDITOR’S REPORT

The Board of Directors

HMN Financial, Inc.

Rochester, Minnesota:

We have audited the accompanying consolidated balance sheets of HMN Financial, Inc. and subsidiaries (the Company) as of December 31, 2003 and 2002, and the related consolidated statements of income, comprehensive income, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2003. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of HMN Financial, Inc. and subsidiaries as of December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America.

As discussed in note 1 to the consolidated financial statements, the Company adopted the provisions of the Financial Accounting Standards Board’s Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, as of January 1, 2002.

	/s/ KPMG LLP
Minneapolis, Minnesota
March 12, 2004

41

SELECTED QUARTERLY FINANCIAL DATA

(Dollars in thousands, except per share data)	December 31, 2003			September 30, 2003		June 30, 2003
Selected Operations Data (3 months ended):
Interest income	$	11,922		11,507		11,036
Interest expense	5,165			5,065		5,108
Net interest income	6,757			6,442		5,928
Provision for loan losses	710			545		490
Net interest income after provision for loan losses	6,047			5,897		5,438
Noninterest income:
Fees and service charges	691			626		555
Mortgage servicing fees	282			261		239
Securities gains (losses), net	41			417		225
Gain on sales of loans	648			1,601		1,526
Earnings (losses) in limited partnerships	70			10		31
Other noninterest income	167			179		115
Total noninterest income	1,899			3,094		2,691
Noninterest expense:
Compensation and benefits	2,283			2,085		2,028
Occupancy	1,025			806		769
Federal deposit insurance premiums	18			18		18
Advertising	115			92		101
Data processing	238			311		290
Amortization of mortgage servicing rights and net valuation adjustments	277			(193	)	1,108
Other noninterest expense	974			1,211		867
Total noninterest expense	4,930			4,330		5,181
Income before income tax expense	3,016			4,661		2,948
Income tax expense	874			1,621		918
Income before minority interest	2,142			3,040		2,030
Minority interest	(3		)	0		0
Net income	$	2,145		3,040		2,030
Basic earnings per share	$	0.55		0.79		0.54
Diluted earnings per share	$	0.53		0.76		0.52
Financial Ratios:
Return on average assets(1)	1.03		%	1.53		1.06
Return on average equity(1)	10.45			15.12		10.45
Average equity to average assets	10.15			10.27		10.34
Dividend payout ratio	26.32			38.46		50.00
Net interest margin(1)(2)	3.39			3.41		3.24

(Dollars in thousands)
Selected Financial Condition Data:
Total assets	$	866,436	807,043	785,910
Securities available for sale:
Mortgage-backed and related securities	13,049		16,327	21,121
Other marketable securities	91,615		72,201	84,510
Loans held for sale	6,543		17,634	13,855
Loans receivable, net	688,951		645,715	606,931
Deposits	551,688		490,088	463,185
Federal Home Loan Bank advances	203,900		229,300	235,300
Stockholders’ equity	80,931		79,467	77,522

(1) Annualized

(2) Net interest income divided by average interest-earning assets.

42

(Dollars in thousands, except per share data)	March 31, 2003		December 31, 2002		September 30, 2002		June 30, 2002		March 31, 2002
Selected Operations Data (3 months ended):	10,472		10,583		10,633		10,511		11,141
Interest income	4,951		5,203		5,173		5,228		5,691
Interest expense	5,521		5,380		5,460		5,283		5,450
Net interest income	865		575		771		310		720
Provision for loan losses	4,656		4,805		4,689		4,973		4,730
Net interest income after provision for loan losses
Noninterest income:	432		511		418		390		404
Fees and service charges	216		193		184		177		160
Mortgage servicing fees	592		0		377		27		19
Securities gains (losses), net	1,465		1,102		432		498		1,044
Gain on sales of loans	(354	)	(455	)	(531	)	(52	)	379
Earnings (losses) in limited partnerships	220		65		123		151		258
Other noninterest income	2,571		1,416		1,003		1,191		2,264
Total noninterest income
Noninterest expense:	2,278		2,006		1,987		2,069		1,951
Compensation and benefits	824		899		801		726		683
Occupancy	19		18		18		19		20
Federal deposit insurance premiums	85		104		129		146		143
Advertising	271		283		273		287		264
Data processing
Amortization of mortgage servicing rights and net valuation adjustments	791		281		502		171		211
Other noninterest expense	944		1,031		845		1,108		873
Total noninterest expense	5,212		4,622		4,555		4,526		4,145
Income before income tax expense	2,015		1,599		1,137		1,638		2,849
Income tax expense	625		462		312		485		840
Income before minority interest	1,390		1,137		825		1,153		2,009
Minority interest	0		(1	)	(67	)	(115	)	41
Net income	1,390		1,138		892		1,268		1,968
Basic earnings per share	0.37		0.30		0.24		0.34		0.53
Diluted earnings per share	0.36		0.28		0.22		0.32		0.50
Financial Ratios:
Return on average assets(1)	0.76		0.62		0.51		0.72		1.11
Return on average equity(1)	7.21		5.81		4.58		6.75		10.92
Average equity to average assets	10.59		10.66		10.66		10.44		10.21
Dividend payout ratio	64.29		81.82		56.25		36.00		100.00
Net interest margin(1)(2)	3.20		3.09		3.29		3.17		3.23

(Dollars in thousands)
Selected Financial Condition Data:	761,399	737,523	719,469	693,723	718,781
Total assets
Securities available for sale:	15,049	51,896	61,882	65,565	65,533
Mortgage-backed and related securities	83,982	69,501	46,811	67,053	73,849
Other marketable securities	12,999	15,127	14,419	12,305	25,854
Loans held for sale	577,542	533,906	508,036	470,292	448,976
Loans receivable, net	448,083	432,951	422,347	399,530	414,024
Deposits	219,300	218,300	214,300	214,300	217,800
Federal Home Loan Bank advances	74,894	76,065	75,180	73,757	73,283
Stockholders’ equity

43

OTHER FINANCIAL DATA

The following table sets forth the maximum month-end balance and average balance of FHLB advances.

	Year Ended December 31,
(Dollars in thousands)	2003		2002	2001
Maximum Balance:
Federal Home Loan Bank advances	$	241,800	218,300	240,900
Federal Home Loan Bank short-term borrowings	69,400		64,400	38,000
Average Balance:
Federal Home Loan Bank advances	221,510		215,673	221,890
Federal Home Loan Bank short-term borrowings	41,169		36,290	20,470

The following table sets forth certain information as to the Bank’s FHLB advances.

	December 31,
	2003				2002			2001
(Dollars in thousands)	Amount		Weighted Average Rate		Amount	Weighted Average Rate		Amount	Weighted Average Rate
Federal Home Loan Bank short-term borrowings	$	33,000	5.01	%	64,400	3.20	%	9,500	4.42	%
Other Federal Home Loan Bank long-term advances	170,900		4.20		153,900	5.17		208,300	4.76
Total	$	203,900	4.33		218,300	4.59		217,800	4.75

Refer to Note 14 of the Notes to Consolidated Financial Statements for more information on the Bank’s FHLB advances.

COMMON STOCK INFORMATION

The common stock of HMN Financial, Inc. is listed on the Nasdaq Stock Market under the symbol: HMNF. The common stock outstanding is 9,128,662 shares of which 4,616,010 shares are in treasury stock at December 31, 2003.  As of December 31, 2003 there were 696 stockholders of record and 865 estimated beneficial stockholders. The following table represents the stock price information for HMN Financial, Inc. as furnished by Nasdaq for each quarter starting in December 31, 2003 and regressing back to March 31, 1998.

	Dec. 31, 2003		Sept. 30, 2003	June 30, 2003	March 31, 2003	Dec. 31, 2002	Sept. 30, 2002	June 28, 2002	March 29, 2002
HIGH	$	24.70	21.63	20.04	16.82	18.14	19.31	20.25	16.17
LOW	20.00		19.36	15.85	15.55	15.78	16.50	15.90	15.24
CLOSE	24.29		21.50	19.40	16.05	16.82	17.46	19.06	16.05

	Dec. 31, 2001		Sept. 28, 2001	June 29, 2001	March 30, 2001	Dec. 29, 2000	Sept. 29, 2000	June 30, 2000	March 31, 2000
HIGH	$	15.85	17.10	17.15	15.06	13.25	13.88	11.75	12.13
LOW	13.27		14.35	13.50	13.00	12.31	10.88	10.13	9.63
CLOSE	15.49		15.10	17.10	14.75	13.06	12.44	11.00	10.13

	Dec. 31, 1999		Sept. 30, 1999	June 30, 1999	March 31, 1999	Dec. 31, 1998	Sept. 30, 1998	June 30, 1998	March 31, 1998
HIGH	$	12.75	13.50	13.13	13.50	14.75	16.06	20.67	21.33
LOW	10.88		11.88	10.50	11.38	10.38	13.25	15.50	17.50
CLOSE	11.25		12.25	11.63	11.38	11.75	14.50	15.88	20.00

44

CORPORATE AND SHAREHOLDER INFORMATION

HMN FINANCIAL, INC.

1016 Civic Center Drive NW
Rochester, MN 55901
(507) 535-1200

ANNUAL MEETING

The annual meeting of shareholders will be held on Tuesday, April 27, 2004 at 10:00 a.m. (Central Time) at the
Rochester Golf and Country Club,
3100 W. Country Club Road,
Rochester, Minnesota.

LEGAL COUNSEL

Faegre & Benson LLP
2200 Wells Fargo Center
90 South Seventh St.
Minneapolis, MN 55402-3901

INDEPENDENT AUDITORS

KPMG LLP
4200 Wells Fargo Center
90 South Seventh St.
Minneapolis, MN 55402-3900

INVESTOR INFORMATION AND FORM 10-K

Additional information and HMN’s Form 10-K, filed with the Securities and Exchange Commission is available without charge upon request from:

HMN Financial, Inc.
Attn: Investor Relations
1016 Civic Center Drive NW
Rochester, MN  55901

TRANSFER AGENT & REGISTRAR

Inquiries regarding change of address, transfer requirements, and lost certificates should be directed to the transfer agent.

Wells Fargo Bank, N.A.
Shareowner Services
161 North Concord Exchange
South St. Paul, MN 55075
www.wellsfargo.com/
shareownerservices
(800) 468-9716

DIRECTORS

TIMOTHY R. GEISLER

HMN and Home Federal Savings Bank
Chairman of the Board
Unit Manager Foundation Accounting
Mayo Foundation

MICHAEL MCNEIL

HMN President and Home Federal Savings Bank President and CEO

ROGER P.WEISE

Retired Chairman, President and Chief Executive Officer
HMN and Home Federal Savings Bank

DUANE D. BENSON

Retired Executive Director
Minnesota Business Partnership

ALLAN R. DEBOER

Retired Chief Executive Officer
RCS of Rochester

MAHLON C. SCHNEIDER

Senior Vice President External Affairs and General Counsel
Hormel Foods Corporation

SUSAN K. KOLLING

Senior Vice President
Home Federal Savings Bank

MICHAEL J. FOGARTY

Chairman C.O. Brown Agency, Inc.

EXECUTIVE OFFICERS

MICHAEL MCNEIL

President

JON J. EBERLE

Senior Vice President,
Chief Financial Officer and Treasurer

DWAIN C. JORGENSEN

Senior Vice President

BRANCH OFFICES OF BANK

Albert Lea

143 West Clark St.

Albert Lea, MN 56007

(507) 377-3330

Austin

201 Oakland Avenue West

Austin, MN 55912

(507) 433-2355

LaCrescent

208 South Walnut

LaCrescent, MN 55947

(507) 895-4090

Marshalltown

303 West Main Street

Marshalltown, IA 50158

(515) 754-6000

Rochester

Crossroads Shopping Center

1201 South Broadway

Rochester, MN 55901

(507) 289-4025

1016 Civic Center Dr. NW

Rochester, MN 55901

(507) 285-1707

3900 55th St. NW

Rochester, MN 55901

(507) 535-3460

Spring Valley

715 North Broadway

Spring Valley, MN 55975

(507) 346-7345

Toledo

1301 S. County Road

Toledo, IA 52342

(515) 484-5141

Winona

175 Center Street

Winona, MN 55987

(507) 454-4912

1475 Service Road

Winona, MN  55987

(507) 454-9660

EAGLE CREST CAPITAL BANK, A DIVISION OFHOME FEDERAL SAVINGS BANK

5201 Eden Ave., Ste 170

Edina, MN  55436

(952) 848-5360

1016 Civic Center Dr. N.W.

Rochester, MN  55901

(507) 535-1280

EX-21

Exhibit 21

Subsidiaries of Registrant

Name & Address	Year & State Inc.	Date and% of Voting Shares, Partnership Interests, Voting Trust Certificates, Capital Contributions	Description of Activity
Home Federal Savings Bank 1016 Civic Center Drive NW Rochester, MN  55901	1934 Federal Charter	6/29/94 HMN owns 100% of voting shares	Federally Chartered Stock Savings Bank
Osterud Insurance Agency, Inc. DBA Home Federal Investment Svcs. 1016 Civic Center Drive NW Rochester, MN  55901	1983 MN	12/1983 Bank owns 100%	Investment products and financial planning
Home Federal Mortgage Services, LLC 1016 Civic Center Drive NW Rochester, MN  55901	2000 DE	1/31/01 Bank owns 51% of voting shares	Mortgage Servicing and Brokerage LLC
Home Federal Holding, Inc. Cardinal Avenue Grand Cayman Cayman Islands, BWI	2002 DE	2/4/2002 Home Federal owns 100% of voting shares	Holding company for real estate investment trust
Home Federal REIT 1016 Civic Center Drive NW Rochester, MN  55901	2002 DE	2/4/2002 Home Federal owns 100% of voting shares	Invests in real estate loans acquired from Bank
Federal Title Services, LLC 13911 Ridgedale Drive, Suite 450 Minnetonka, MN  55305	2003 MN	8/21/2003 Home Federal owns 80% of voting shares	Mortgage title LLC
Security Finance Corporation 1016 Civic Center Drive NW Rochester, MN  55901	1929 MN	12/29/95 HMN owns 100% of voting shares	Corporation invests in securities and loans

EX-23

Exhibit 23

Independent Auditors’ Consent

The Board of Directors

HMN Financial, Inc.:

We consent to incorporation by reference of our report dated March 12, 2004, relating to the consolidated balance sheets of HMN Financial, Inc. as of December 31, 2003 and 2002, and the related consolidated statements of income, comprehensive income, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2003, which report appears in the December 31, 2003 annual report on Form 10-K of HMN Financial, Inc., in the following Registration Statements of HMN Financial, Inc.: Nos. 33-88228, 33-94388, 33-94386 and 333-64232 on Form S-8. Our report refers to the adoption of Financial Accounting Standards Board Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets.

/s/ KPMG LLP

Minneapolis, Minnesota

March 12, 2004

EX-31.1

Exhibit 31.1

CERTIFICATIONS

I, Michael McNeil, President and Chief Executive Officer, certify that:

1.I have reviewed this annual report on Form 10-K of HMN Financial, Inc.

2.Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;

3.Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;

4.The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a)designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;

b)evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the “Evaluation Date”); and

c)presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5.The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

a)all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

b)any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

6.The registrant’s other certifying officer and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: March 12, 2004	By	/s/ Michael McNeil
			President/Chief Executive Officer

EX-31.2

Exhibit 31.2

CERTIFICATIONS

I, Jon Eberle, Treasurer and Chief Financial Officer, certify that:

1.I have reviewed this annual report on Form 10-K of HMN Financial, Inc.

2.Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;

3.Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;

4.The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a)designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;

b)evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the “Evaluation Date”); and

c)presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5.The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

a)all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

b)any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

6.The registrant’s other certifying officer and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: March 12, 2004	By	/s/ Jon Eberle
		Treasurer and Chief Financial Officer

EX-32.1

Exhibit 32.1

HMN FINANCIAL, INC.

CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Annual Report of HMN Financial, Inc. (the “Company”) on Form 10-K for the period ending December 31, 2003 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Michael McNeil, President of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that:

(1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company.

Date:  March 12, 2004	/s/ Michael McNeil
	Michael McNeil,
	President/Chief Executive Officer
	(Principal Executive Officer)

EX-32.2

Exhibit 32.2

HMN FINANCIAL, INC.

CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Annual Report of HMN Financial, Inc. (the “Company”) on Form 10-K for the period ending December 31, 2003 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Jon Eberle, Senior Vice President and CFO of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that:

(1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company.

Date: March 12, 2004	/s/ Jon Eberle
	Jon Eberle,
	Senior Vice President/Chief Financial Officer
	(Principal Financial Officer)