10-K

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2011

OR

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from             to             .

Commission file number: 0-24100.

HMN FINANCIAL, INC.

(Exact Name of Registrant as Specified in its Charter)

Delaware	41-1777397
(State or Other Jurisdiction of 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)

(507) 535-1200

Registrant’s Telephone Number, Including Area Code

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

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

Name of each exchange on which registered: Nasdaq Global Market

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    YES  ¨    NO  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.    YES  ¨    NO  x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such requirements for the past 90 days.    YES  x    NO  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    YES  x    NO  ¨

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer	¨	Accelerated filer	¨
Non-accelerated filer	¨  (Do not check if a smaller reporting company)	Smaller reporting company	x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    YES  ¨    NO  x

As of June 30, 2011, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was $7.9 million based on the closing stock price of $2.45 on such date as reported on the Nasdaq Global Market.

As of February 20, 2012, the number of outstanding shares of common stock of the registrant was 4,387,951.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s annual report to stockholders for the year ended December 31, 2011 (Annual Report), are incorporated by reference in Parts I, II and IV of this Form 10-K. Portions of the registrant’s definitive proxy statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the close of the registrant’s fiscal year ended December 31, 2011 are incorporated by reference in Part III of this Form 10-K.

TABLE OF CONTENTS

PART I

		Page
Item 1.	Business		4
	General		4
	Market Area		4
	Lending Activities		5
	Origination, Purchases and Sales of Mortgage-Backed and Related Securities		12
	Classified Assets and Delinquencies		14
	Investment Activities		16
	Sources of Funds		19
	Other Information
	Service Corporations of the Bank		22
	Competition		23
	Other Corporations Owned by the Company		23
	Employees		23
	Regulation and Supervision		23
	Executive Officers		31
Item 1A.	Risk Factors		32
Item 1B.	Unresolved Staff Comments		46
Item 2.	Properties		46
Item 3.	Legal Proceedings		46
Item 4.	Mine Safety Disclosures		49
	PART II
Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities		49
Item 6.	Selected Financial Data		50
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		50
Item 7A.	Quantitative and Qualitative Disclosure About Market Risk		51
Item 8.	Financial Statements and Supplementary Data		51
Item 9.	Changes in and Disagreements With Accountants on Accounting and Financial Disclosure		51
Item 9A.	Controls and Procedures		51
Item 9B.	Other Information		52
	PART III
Item 10.	Directors, Executive Officers and Corporate Governance		52
Item 11.	Executive Compensation		52
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters		52
Item 13.	Certain Relationships and Related Transactions		52
Item 14.	Principal Accountant Fees and Services		53
	PART IV
Item 15.	Exhibits and Financial Statement Schedules		54
Signatures			55
Index to Exhibits			56

2

Forward-Looking Statements

The information presented or incorporated by reference in this Form 10-K under the headings “Item 1. Business” and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934. These statements are often identified by such forward-looking terminology as “expect,” “intent,” “look,” “believe,” “anticipate,” “estimate,” “project,” “seek,” “may,” “will,” “would,” “could,” “should,” “trend,” “target,” and “goal” or similar statements or variations of such terms and include, but are not limited to, those relating to the adequacy and amount of available liquidity and capital resources to the Bank; the Company’s liquidity and capital requirements, our expectations for core capital and our strategies and potential strategies for improvement thereof; changes in the size of the Bank’s loan portfolio; the recovery of the valuation allowance on deferred tax assets; the amount and mix of the Bank’s non-performing assets and the appropriateness of the allowance therefor; future losses on non-performing assets; the amount of interest-earning assets; the amount and mix of brokered and other deposits (including the Company’s ability to renew brokered deposits); the availability of alternate funding sources; the payment of dividends; the future outlook for the Company; the amount of deposits that will be withdrawn from checking and money market accounts and how the withdrawn deposits will be replaced; the projected changes in net interest income based on rate shocks; the range that interest rates may fluctuate over the next twelve months; the net market risk of interest rate shocks; the future outlook for the issuer trust preferred securities held by the Bank; the change in Bank and Company primary banking regulators from the Office of Thrift Supervision to the Office of the Comptroller of the Currency (OCC) and Federal Reserve Board (FRB); the Bank’s compliance with regulatory standards generally (including the Bank’s status as “well-capitalized”), and supervisory agreements, individual minimum capital requirements or other supervisory directives or requirements to which the Company or the Bank are or may become expressly subject, specifically, and possible responses of the OCC and FRB and the Bank and the Company to any failure to comply with any such regulatory standard, agreement or requirement; and the anticipated timing of consummation of the Toledo, Iowa branch (Toledo Branch) transaction and the anticipated gain on sale, decrease in assets and increase in core capital therefrom. A number of factors could cause actual results to differ materially from the Company’s assumptions and expectations. These include but are not limited to the adequacy and marketability of real estate and other collateral securing loans to borrowers, possible legislative and regulatory changes, including changes in the degree and manner of regulatory supervision, the ability of the Company and the Bank to establish and adhere to plans and policies relating to, among other things, capital, business, non-performing assets, loan modifications, documentation of loan loss allowance and concentrations of credit that are satisfactory to the OCC and FRB, as applicable, in accordance with the terms of the Company and Bank supervisory agreements and to otherwise manage the operations of the Company and the Bank to ensure compliance with other requirements set forth in the supervisory agreements; the ability of the Company and the Bank to obtain required consents from the OCC and FRB, as applicable, under the supervisory agreements or other directives; the ability of the Bank to comply with its individual minimum capital requirement and other applicable regulatory capital requirements; enforcement activity of the OCC and FRB in the event of our non-compliance with any applicable regulatory standard, agreement or requirement; adverse economic, business and competitive developments such as shrinking interest margins, reduced collateral values, deposit outflows, changes in credit or other risks posed by the Company’s loan and investment portfolios, changes in costs associated with alternate funding sources, including changes in collateral advance rates and policies of the Federal Home Loan Bank, technological, computer-related or operational difficulties, results of litigation, and reduced demand for financial services and loan products; changes in accounting policies and guidelines, or monetary and fiscal policies of the federal government or tax laws; international economic developments; the Company’s access to and adverse changes in securities markets; the market for credit related assets; the timing of the Toledo Branch data conversion by a third party provider, the failure of either the Bank or Pinnacle Bank of Marshalltown, Iowa (Pinnacle) to fulfill the terms and conditions of the Toledo Branch sale agreement required to be satisfied prior to closing and changes in assets and liabilities at the Toledo Branch prior to closing; or other significant uncertainties. Additional factors that may cause actual results to differ from the Company’s assumptions and expectations include those set forth in this Form 10-K. All forward-looking statements are qualified by, and should be considered in conjunction with, such cautionary statements. For additional discussion of the risks and uncertainties applicable to the Company and Bank, see the “Risk Factors” section of this Form 10-K.

3

PART I

ITEM 1. BUSINESS

General

HMN Financial, Inc. (HMN or the Company) is a stock savings bank holding company that owns 100% 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 has one wholly owned subsidiary, Osterud Insurance Agency, Inc. (OIA) which offers financial planning products and services. HMN has another wholly owned subsidiary, Security Finance Corporation (SFC), which is currently not actively engaged in any activities. The Company was incorporated in Delaware in 1994.

As a community-oriented financial institution, the Company seeks to serve the financial needs of communities in its market area. The Company’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 as well as consumer, construction, and commercial business loans. The Company also invests in mortgage-backed and related securities, U.S. government agency obligations and other permissible investments. The executive offices of the Company are located at 1016 Civic Center Drive Northwest, Rochester, Minnesota 55901. Its telephone number at that address is (507) 535-1200. The Company’s website is located at www.hmnf.com. Information contained on the Company’s website is expressly not incorporated by reference into this Form 10-K.

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 ten branch offices located in Albert Lea, Austin, La Crescent, Rochester, Spring Valley and Winona, Minnesota. The portion of the Company’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 the Mayo Clinic, Hormel Foods (a food processing company), and IBM. The Company’s market area is also the home of Winona State University, Rochester Community and Technical College, University of Minnesota – Rochester, Winona State University – Rochester Center and Austin’s Riverland Community College.

The Company serves Dakota County, in the southern portion of the Minneapolis and St. Paul metropolitan area, from its office located in Eagan, Minnesota. Major employers in this market area include Delta Airlines, Cenex Harvest States (cooperative), Flint Hills Resources LP (oil refinery), Unisys Corp (computer software) and West Group, a Thomson Reuters business (legal research).

The Company serves the Iowa counties of Marshall and Tama through its branch offices located in Marshalltown and Toledo, Iowa. Major employers 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). The Bank has entered into a purchase and assumption agreement relating to substantially all the assets and assumption of substantially all the liabilities of the Toledo Branch. The transaction is scheduled to close in the first quarter of 2012 and thereafter the Bank will have no operations in that community. See Note 21 of the Notes to Consolidated Financial Statement in the Annual Report for more information on the Toledo Branch sale (incorporated by reference in Item 8 of Part II of this Form 10-K).

Based upon information obtained from the U.S. Census Bureau for 2010 (the last year for which information is available), the population of the six primary counties in the Company’s southern Minnesota market area was estimated as follows: Fillmore – 20,866; Freeborn – 31,255; Houston – 19,027; Mower – 39,163; Olmsted – 144,248; and Winona – 51,461. For these same six counties, the median household income from the U.S. Census Bureau for 2006-2010 ranged from $43,090 to $64,090. The population of Dakota County was 398,552 and the median household income was $72,850. With respect to Iowa, the population of Marshall County was 40,648 and the population of Tama County was 17,767. The median household income of these two counties ranged from $45,232 to $46,288.

4

The Company also serves a diverse high net worth customer base of individuals and businesses in Olmsted County from its private banking offices located 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 10 years, the Company has focused on managing interest rate risk and increasing interest income by increasing its investment in shorter term and generally higher yielding commercial real estate, commercial business and construction loans, while reducing its investment in longer term one-to-four family real estate loans. The Company continues to originate 15 and 30 year fixed rate mortgage loans and some shorter term fixed rate loans. The shorter term fixed and adjustable rate loans are placed into portfolio, while the majority of the 15 and 30 year fixed rate mortgage loans are sold in the secondary mortgage market. Mortgage interest rates were at historical lows in 2011 and very few 15 and 30 year loans were placed into portfolio as most were sold into the secondary market in order to manage the Company’s interest rate risk position. The Company also offers an array of consumer loan products that include both open and closed end home equity loans. Home equity lines of credit have adjustable interest rates based upon the prime rate, as published in the Wall Street Journal, plus a margin. Refer to Notes 4 and 5 of the Notes to Consolidated Financial Statements in the Annual Report for more information on the loan portfolio (incorporated by reference in Item 8 of Part II of this Form 10-K).

5

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

	2011					2010					2009					2008					2007
(Dollars in thousands)	Amount		Percent			Amount		Percent			Amount		Percent			Amount		Percent			Amount			Percent
Fixed rate Loans
Real estate:
One-to-four family	$	69,426		11.96	%	$	69,424		9.80	%	$	77,694		9.42	%	$	88,690		9.59	%	$	92,518			10.48	%
Multi-family		26,132		4.50			23,079		3.26			11,455		1.39			4,703		0.50			5,951			0.68
Commercial		94,535		16.29			110,267		15.56			103,036		12.49			91,835		9.93			69,275			7.84
Construction or development		5,145		0.89			5,743		0.81			11,148		1.35			29,344		3.17			16,520			1.87
Total real estate loans		195,238		33.64			208,513		29.43			203,333		24.65			214,572		23.19			184,264			20.87
Consumer loans:
Savings		576		0.10			534		0.07			324		0.04			277		0.03			358			0.04
Automobile		404		0.07			604		0.09			902		0.11			1,333		0.15			1,730			0.20
Home equity		13,426		2.31			18,126		2.56			21,396		2.59			22,961		2.48			20,249			2.29
Mobile home		657		0.11			764		0.11			977		0.12			1,316		0.14			1,699			0.19
Land/Lot loans		2,391		0.41			2,139		0.30			2,554		0.31			1,956		0.21			2,616			0.30
Other		2,532		0.44			2,791		0.39			4,777		0.58			3,087		0.33			2,007			0.23
Total consumer loans		19,986		3.44			24,958		3.52			30,930		3.75			30,930		3.34			28,659			3.25
Commercial business loans		54,604		9.41			68,962		9.73			76,936		9.33			90,458		9.77			90,688			10.27
Total non-real estate loans		74,590		12.85			93,920		13.25			107,866		13.08			121,388		13.12			119,347			13.52
Total fixed rate loans		269,828		46.49			302,433		42.68			311,199		37.73			335,960		36.30			303,611			34.39
Adjustable rate Loans
Real estate:
One-to-four family		49,640		8.55			59,111		8.34			66,937		8.12			73,299		7.92			60,456			6.85
Multi-family		9,385		1.62			25,187		3.56			47,811		5.80			24,589		2.66			23,120			2.62
Commercial		148,940		25.66			182,607		25.77			209,678		25.42			233,469		25.24			212,547			24.08
Construction or development		5,777		1.00			9,508		1.34			29,264		3.55			78,939		8.53			94,516			10.70
Total real estate loans		213,742		36.83			276,413		39.01			353,690		42.89			410,296		44.35			390,639			44.25
Consumer:
Home equity		41,429		7.14			44,647		6.30			50,061		6.07			52,194		5.64			51,322			5.81
Land/Lot loans		332		0.06			371		0.05			636		0.08			1,013		0.11			1,535			0.17
Other		414		0.07			627		0.09			588		0.07			2,464		0.27			3,393			0.39
Total consumer loans		42,175		7.27			45,645		6.44			51,285		6.22			55,671		6.02			56,250			6.37
Commercial business loans		54,655		9.41			84,077		11.87			108,589		13.16			123,317		13.33			132,271			14.99
Total non-real estate loans		96,830		16.68			129,722		18.31			159,874		19.38			178,988		19.35			188,521			21.36
Total adjustable rate loans		310,572		53.51			406,135		57.32			513,564		62.27			589,284		63.70			579,160			65.61
Total loans		580,400		100.00	%		708,568		100.00	%		824,763		100.00	%		925,244		100.00	%		882,771			100.00	%
Less
Loans in process*		0					0					0					0					3,011
Unamortized (premiums) discounts		93					413					177					569					(11	)
Net deferred loan fees		511					1,086					1,518					2,529					2,245
Allowance for losses on loans		23,888					42,828					23,812					21,257					12,438
Total loans receivable, net	$	555,908				$	664,241				$	799,256				$	900,889				$	865,088

* – Core data processing systems converted in 2008, loans in process amounts are reflected in loan amounts in table.

6

The following table illustrates the interest rate maturities of the Company’s loan portfolio at December 31, 2011. 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. The schedule does not reflect the effects of possible prepayments or enforcement of due-on-sale clauses.

	Real Estate
	One-to-four family					Multi-family and Commercial					Construction or Development					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
2012 (1)	$	16,436		5.82	%	$	50,619		5.23	%	$	4,494		4.19	%	$	3,545		7.84	%	$	67,836		5.79	%	$	142,930		5.60	%
2013		9,328		5.62			64,218		5.40			419		4.12			4,212		5.65			14,061		5.68			92,238		5.47
2014		3,336		4.14			24,452		4.93			187		5.56			4,045		6.54			9,062		5.91			41,082		5.24
2015 through 2016		3,912		3.98			51,909		4.42			2,605		4.12			6,256		6.70			11,670		6.12			76,352		4.83
2017 through 2021		15,458		4.91			55,125		5.93			1,922		6.29			4,246		7.15			5,665		6.50			82,416		5.85
2022 through 2036		39,001		4.16			27,669		5.40			640		6.00			39,849		5.53			965		6.18			108,124		5.01
2037 and thereafter		31,595		5.30			5,000		5.25			655		4.97			8		0.00			0		0.00			37,258		5.29
	$	119,066				$	278,992				$	10,922				$	62,161				$	109,259				$	580,400

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

The total amount of loans due after December 31, 2012 that have predetermined interest rates is $193.0 million, while the total amount of loans due after such date that have floating or adjustable interest rates is $244.5 million. At December 31, 2011, construction or development loans were $4.9 million for one-to-four family dwellings, $1.2 million for multi-family and $4.8 million for nonresidential.

7

The aggregate amount of loans and extensions of credit that the Bank is permitted to make to any one borrower is generally limited to 15% of unimpaired capital and surplus. In addition to the 15% limit, the Bank is permitted to lend an additional amount equal to 10% of unimpaired capital and surplus if the additional amount is fully secured by “readily marketable collateral” having a current market value of at least 100% of the loan or extension of credit. Similarly, the Bank is permitted to lend additional amounts equal to the lesser of 30% of unimpaired capital and surplus or $30 million for certain residential development loans. Applicable law establishes a number of rules for combining loans to separate borrowers. Loans or extensions of credit to one person may be attributed to other persons if: (i) the proceeds of a loan or extension of credit are used for the direct benefit of the other person; or (ii) a common enterprise is deemed to exist between persons. At December 31, 2011, based upon the 15% limitation, the Bank’s regulatory limit for loans to one borrower was approximately $11.9 million. At December 31, 2011, excluding loans subject to an exception to the 15% lending limit, loans to one borrower exceeded the current 15% limitation, by $1.7 million. This loan is not considered to be a violation of the regulatory lending limit requirements as it was within the Bank’s lending limit when it was originated and the Bank is making efforts to bring the loan balance into compliance with the current lending limit. As of December 31, 2011, other loans also exceeded the 15% limit but were subject to additional limits referenced above. At December 31, 2011, the Bank’s largest aggregate amount of loans to one borrower totaled $24.4 million. All of the loans for the largest borrower were performing in accordance with their terms and the borrower had no affiliation with the Bank other than its relationship as a borrower.

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 the use of credit reports, financial statements, tax returns or confirmations.

One-to-four family loans that are equal to or less than the conforming/saleable loan dollar limits as established by the Federal Home Loan Mortgage Corporation (FHLMC) or Federal National Mortgage Association (FNMA) may be approved by a designated underwriter. This limit was $417,000 for both 2011 and 2010. Loans up to and including $750,000 need the approval of the above personnel and a Retail Loan Committee Member. Loans over $750,000 need approval from a majority of the Retail Loan Committee.

The Bank’s individual commercial loan officers have the authority to approve loans that meet the guidelines established by the Bank’s commercial loan policy for loans up to $500,000 based on their individual delegated aggregate relationship authority. Individual delegated aggregate relationship authority varies by loan officer, with the highest individual authorities being $500,000. The aggregate relationship amount is determined by the total customer credit commitments outstanding plus the new loan request amount. The Business Banking Department Manager can approve loans up to a $500,000 aggregate relationship. The Chief Commercial Credit Officer and Limited Committee (consisting of the lender and the Business Banking Department Manager) or the Chief Credit Officer and Limited Committee have approval authorities up to $1.0 million aggregate and $2.0 million aggregate, respectively. New relationship loan requests greater than $2.0 million to our internal loan limit to one borrower of $4.5 million, or existing loan relationship requests greater than $2.0 million to $7.5 million, are approved by the Senior Loan Committee. Any loan requests greater than these limits must be approved by the Bank’s Executive 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, 2011, the Company’s one-to-four family real estate loans, consisting of both fixed rate and adjustable rate loans, totaled $119.1 million, a decrease of $9.4 million, from $128.5 million at December 31, 2010. The decrease in the one-to-four family loans in 2011 is the result of selling more of the loans that were originated into the secondary market, instead of placing them into the portfolio, in order to reduce the Company’s interest rate risk position. The Company’s short term strategy is to continue to sell the majority of the loans originated into the secondary market at least until market interest rates increase from their current levels.

8

The Company offers conventional fixed rate one-to-four family loans that have maximum terms of 30 years. In order to manage interest rate risk, the Company typically sells the majority of fixed rate loan originations with terms to maturity of 15 years or greater that are eligible for sale in the secondary market. The interest rates charged on the fixed rate loan products are based on the secondary market delivery rates, as well as other competitive factors. The Company also originates fixed rate loans with terms up to 30 years that are insured by the Federal Housing Authority (FHA), Veterans Administration, Minnesota Housing Finance Agency or Iowa Finance Authority.

The Company also offers one-year adjustable rate mortgages (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. The Company’s originated ARMs do not permit negative amortization of principal, generally do not contain prepayment penalties and are not convertible into fixed rate loans. Because of the low interest rate environment that has existed over the last couple of years, a limited number of ARM loans have been originated as consumers have opted for the longer term 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 appraisers. The Company originates residential mortgage loans with loan-to-value ratios up to 95% 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 exposure to 80% of value or less on most loans. In addition, all non-owner occupied properties must be self supporting using the debt service ratio requirements, which usually requires approximately a 50% down payment on one-to-four family dwellings. The Company generally seeks to underwrite its loans in accordance with secondary market or FHA 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 represent conventional fixed rate loans. At December 31, 2011, $4.4 million of the one-to-four family residential loan portfolio was non-performing compared to $4.8 million at December 31, 2010.

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 a limited amount of participations in 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, ethanol plants, manufacturing plants, office buildings, business facilities, shopping malls, nursing homes, golf courses, restaurants, warehouses and other non-residential building properties primarily located in the upper Midwestern portion of the United States.

Permanent commercial real estate and multi-family loans are generally originated for a maximum term of 10 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 that are tied to the prime rate or another 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 ratio is the ratio of net cash from operations to debt service payments. The Company may 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.

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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. 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.

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, 2011, $21.2 million of loans in the commercial real estate portfolio were non-performing compared to $31.1 million at December 31, 2010. The largest individual non-performing loans in this category as of December 31, 2011 were a $3.0 million loan secured by a residential development in Rochester, Minnesota and a $2.3 million loan secured by an office building outside of our primary market area.

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 a very limited number of 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. These loans are made on the same terms as residential loans, except that during the construction phase, which typically lasts up to twelve 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 and 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 90% of the loan proceeds can be disbursed until the building is completed. The Company 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.

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.

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At December 31, 2011, construction loans totaled $10.9 million, of which one-to-four family residential totaled $4.9 million, multi-family residential totaled $1.2 million and commercial real estate totaled $4.8 million.

The nature of construction loans makes them more difficult to evaluate and monitor, especially in a market where home prices have been declining. 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 that 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 these cases, the Company may be required to modify the terms of the loan. At December 31, 2011, $1.5 million of construction loans in the commercial real estate portfolio were nonperforming compared to $5.6 million at December 31, 2010.

Consumer Lending. The Company originates a variety of consumer loans, including home equity loans (open-end and closed-end), automobile, mobile home, lot loans, loans secured by deposit accounts 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 five 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 90% of the appraised value of the property or an internally established market value. Internal market values are established using current market data, including tax assessment values and recent sales data, and are typically lower than third party appraised values. 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 a 10-year draw period that requires “interest only” payments followed by a 10-year repayment period that 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 88.2% of the Company’s consumer loan portfolio at December 31, 2011.

The underwriting standards employed by the Company 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 that are unsecured or are secured by rapidly depreciable assets, such as automobiles or mobile homes. In these 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 that can be recovered on such loans. At December 31, 2011, $0.7 million of the consumer loan portfolio was non-performing compared to $0.2 million at December 31, 2010.

Commercial Business Lending. The Company maintains a portfolio of commercial business loans to borrowers associated with the real estate industry as well as to retail, 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 commercial business loans generally include personal guarantees and are usually, but not always, secured by business assets such as inventory, equipment, leasehold

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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 also purchases participation interests in commercial business loans originated outside of the Company’s market area 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 with more easily ascertainable value, 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, 2011, $6.2 million of loans in the commercial business loan portfolio were non-performing compared to $26.3 million at December 31, 2010.

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

Real estate loans are generally originated by the Company’s 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 and the number of adjustable rate loans remained low in 2011 due to the low long term fixed mortgage rates that existed during the year. The Company originated for its portfolio $3.9 million of one-to-four family adjustable rate loans during 2011, a decrease of $1.6 million, from $5.5 million in 2010. The Company also originated for its portfolio $20.2 million of fixed rate one-to-four family loans during 2011, an increase of $12.6 million, from $7.6 million for 2010. The increase in the fixed rate one-to-four family loans that were placed into the loan portfolio in 2011 when compared to 2010 is the result of having more refinancing activity in 2011 which resulted in having more loan originations with lower loan to value ratios and shorter terms to maturity that met our internal requirements for placement into the loan portfolio.

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 that are generally more beneficial to the Company in managing interest rate risk than single family fixed rate conventional loans. The Company originated $95.9 million of multi-family and commercial real estate, commercial business and consumer loans (which excludes commercial real estate loans in construction or development) during 2011, an increase of $23.4 million, from originations of $72.5 million for 2010. The increase in originations and participations sold primarily reflects $50.0 million in ethanol related loans that were refinanced in 2011 with $45.0 million of the originated amount being sold to participants.

In order to supplement loan demand in the Company’s market area and geographically diversify its loan portfolio, the Company purchases participations in real estate loans from selected sellers, with yields based upon then-current market rates. The Company reviews and underwrites all loans purchased to ensure that they meet the Company’s underwriting standards and the seller generally continues to service the loans. The Company has generally not experienced higher losses or credit quality issues historically with purchased participations than other loans originated by the Company. The Company purchased $4.2 million of loans during 2011, a decrease of $6.0 million, from $10.2 million during 2010. Purchases decreased in 2011 primarily as a result of the reduction in purchased commercial real estate loans in order to reduce commercial real estate concentrations. The commercial real estate and commercial business loans that were purchased have terms and interest rates that are similar in nature to the Company’s originated commercial and business portfolio. Refer to Notes 4 and 5 of the Notes to Consolidated Financial Statements in the Annual Report for more information on purchased loans (incorporated by reference in Item 8 of Part II of this Form 10-K).

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The Company has some mortgage-backed and related securities that are held, based on investment intent, in the “available for sale” portfolio. The Company did not purchase any mortgage-backed securities in 2011 or 2010. No mortgage-backed securities were purchased in 2011 as debt instruments issued by federal agencies, such as Fannie Mae and Freddie Mac, became more appealing to purchase due to their shorter duration given the low interest rate environment that existed in 2011. The Company did not sell any mortgage backed securities in 2011 or 2010. 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)	2011			2010			2009
Originations by type:
Adjustable rate:
Real estate –
– one-to-four family	$	3,892			5,539			11,300
– multi-family		0			0			1,357
– commercial		29,998			12,504			3,966
– construction or development		4,759			3,042			4,596
Non-real estate –
– consumer		12,596			9,413			20,295
– commercial business		31,568			11,539			18,881
Total adjustable rate		82,813			42,037			60,395
Fixed rate:
Real estate –
– one-to-four family		20,194			7,606			11,141
– multi-family		450			450			803
– commercial		5,817			15,165			8,142
– construction or development		5,227			6,492			1,917
Non-real estate –
– consumer		7,097			14,745			15,184
– commercial business		8,367			8,732			24,403
Total fixed rate		47,152			53,190			61,590
Total loans originated		129,965			95,227			121,985
Purchases:
Real estate –
– commercial		319			5,683			904
– construction or development		2,573			625			388
Non-real estate –
– commercial business		1,300			3,930			5,264
Total loans purchased		4,192			10,238			6,556
Sales, participations and repayments:
Real estate –
– one-to-four family		0			390			0
– multi-family		0			0			649
– commercial		29,350			3,921			3,579
– construction or development		700			0			0
Non-real estate –
– consumer		231			1,813			423
– commercial business		22,896			6,230			975
Total sales		53,177			12,354			5,626
Transfers to loans held for sale		2,681			4,478			5,228
Principal repayments		158,433			173,485			174,795
Total reductions		214,291			190,317			185,649
Decrease in other items, net		(48,034	)		(31,343	)		(43,373	)
Net decrease	$	(128,168	)		(116,195	)		(100,481	)

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LOANS HELD FOR SALE

	Year Ended December 31,
(Dollars in thousands)	2011			2010			2009
Originations by type:
Adjustable rate:
Real estate –
– one-to-four family	$	705			0			399
Total adjustable rate		705			0			399
Fixed rate:
Real estate –
– one-to-four family		56,120			81,659			113,025
Total fixed rate		56,120			81,659			113,025
Total loans originated		56,825			81,659			113,424
Sales and repayments:
Real estate –
– one-to-four family		58,582			86,367			118,202
Total sales		58,582			86,367			118,202
Transfers from loans held for investment		(2,681	)		(4,478	)		(5,228	)
Changes in deferred fees and market value		(56	)		7			33
Total reductions		55,845			81,896			113,007
Net increase (decrease)	$	980			(237	)		417

MORTGAGE-BACKED AND RELATED SECURITIES

	Year Ended December 31,
(Dollars in thousands)	2011			2010			2009
Purchases:
Mortgage-backed securities:
FNMA MBSs	$	0			0			0
Total purchases		0			0			0
Sales:
Mortgage-backed securities:
Fixed rate MBSs		0			0			(98	)
CMOs and REMICs		0			0			(2,039	)
Total sales		0			0			(2,137	)
Principal repayments		(12,861	)		(20,053	)		(25,905	)
Net decrease	$	(12,861	)		(20,053	)		(23,768	)

Classified Assets and Delinquencies

Classification of Assets. Federal regulations require that each savings institution evaluate and classify its assets on a regular basis. In addition, in connection with examinations of savings institutions, the Office of the Comptroller of the Currency (OCC) and the Federal Deposit Insurance Corporation (FDIC) examiners may identify problem assets and, if appropriate, require them to be classified with an adverse rating. There are three adverse classifications: 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 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 specific allowances for loan losses. If an asset, or portion thereof, is classified as loss, the institution must charge off such amount. If an institution does not agree with an OCC or FDIC examiner’s classification of an asset, it may appeal the determination to the OCC District Director or the appropriate FDIC personnel, depending on the regulator.

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On the basis of management’s review of its assets, at December 31, 2011, the Bank classified a total of $105.8 million of its loans and other assets as follows:

(Dollars in thousands)	One-to-Four Family		Real Estate Construction or Development		Commercial and Multi-family		Consumer		Commercial Business		Other Assets		Total
Substandard	$	11,129		1,516		57,800		857		14,528		16,616		102,446
Doubtful		738		0		1,113		224		1,149		0		3,224
Loss		0		0		0		124		0		0		124
Total	$	11,867		1,516		58,913		1,205		15,677		16,616		105,794

The Bank’s classified assets consist of non-performing loans and loans and other assets of concern discussed in Management’s Discussion and Analysis of Financial Condition and Results of Operations (incorporated by reference in Item 7 of Part II of this Form 10-K). See Note 5 of the Notes to Consolidated Financial Statements in the Annual Report for more information on classified assets. At December 31, 2011, these asset classifications were materially consistent with those of the OCC and FDIC.

Delinquency Procedures. Generally, the following procedures apply to delinquent one-to-four family real estate loans. 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 are 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 commercial real estate and commercial business 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 is typically 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 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 as real estate owned. 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, 2011 for loans past due 60 days or more.

	Loans Delinquent For:														Total Delinquent Loans
	60-89 Days							90 Days and Over
(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		3	$	305		0.26	%		6	$	1,297		1.09	%		9	$	1,602		1.35	%
Commercial real estate		2		79		0.03			12		13,281		5.46			14		13,360		5.49
Real estate construction or development		2		290		2.66			1		114		1.04			3		404		3.70
Consumer		6		374		0.60			5		387		0.62			11		761		1.22
Commercial business		3		112		0.10			7		4,026		3.69			10		4,138		3.79
Total		16	$	1,160		0.20	%		31	$	19,105		3.29	%		47	$	20,265		3.49	%

Loans delinquent for 90 days and over are non-accruing and are included in the Company’s non-performing asset total at December 31, 2011.

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Investment Activities

The Company and the Bank utilize the available for sale securities portfolio in virtually all aspects of asset/liability management. 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 the Company 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, 2011, the Company did not own any investment securities of a single issuer that 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 the Federal Reserve Bank of Minneapolis (FRB). Other investments include high grade medium-term (up to five years) federal agency notes, and a variety of other types of mutual funds that 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 may also invest 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 (incorporated by reference in Item 8 of Part II of this Form 10-K).

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

	December 31, 2011										December 31, 2010										December 31, 2009
(Dollars in thousands)	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	$	105,000		294			105,294		60.5	%	$	117,931		(48	)		117,883		82.7	%	$	105,023		845			105,868		85.0	%
Corporate preferred stock(1)		700		(525	)		175		0.1			700		(525	)		175		0.1			700		(525	)		175		0.1
Subtotal		105,700					105,469		60.6			118,631					118,058		82.8			105,723					106,043		85.1
Federal Home Loan Bank stock		4,222					4,222		2.4			6,743					6,743		4.7			7,286					7,286		5.8
Total investment securities and Federal Home Loan Bank stock		109,922					109,691		63.0			125,374					124,801		87.5			113,009					113,329		90.9
Average remaining life of investment securities excluding
Federal Home Loan Bank stock		1.23 years										0.41 years										0.53 years
Other interest earning assets:
Cash equivalents		64,449					64,449		37.0			17,796					17,796		12.5			11,316					11,316		9.1
Total	$	174,371					174,140		100.0	%	$	143,170					142,597		100.0	%	$	124,325					124,645		100.0	%
Average remaining life or term to repricing of investment securities and other interest earning assets, excluding
Federal Home Loan Bank stock		0.76 years										0.36 years										0.48 years

⁽¹⁾  Average life assigned to corporate preferred stock holdings is five years.

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

	December 31, 2011
	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(2)	$	85,001			19,999			0			0			0			105,000			294			105,294
Corporate preferred stock		0			0			0			0			700			700			(525	)		175
Total	$	85,001			19,999			0			0			700			105,700			(231	)		105,469
Weighted average yield(1)		1.11	%		1.06	%		0.00	%		0.00	%		4.74	%		1.13	%

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

⁽²⁾  Callable U.S. government agency securities maturity date based on first available call date if security is anticipated to be called.

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 U.S. Government Agency. The Company had $20.6 million of mortgage-backed and related securities classified as available for sale at December 31, 2011, compared to $33.5 million at December 31, 2010 and $53.6 million at December 31, 2009. The decrease in mortgage backed securities in 2011 and 2010 is the result of fewer purchases by the Company and normal repayments. Fewer mortgage-backed securities were purchased due to the low interest rate environment over the past several years and the Company’s desire to shorten the duration of new investment purchases. The collateralized mortgage obligations (CMOs) in the Company’s portfolio are issued by U.S. Government agencies and are not supported by subprime mortgages.

The contractual maturities of the mortgage-backed and related securities portfolio without any prepayment assumptions at December 31, 2011 are as follows:

(Dollars in thousands)	5 Years or Less			5 to 10 Years			10 to 20 Years			Over 20 Years			Dec. 31, 2011 Balance Outstanding
Securities available for sale:
Federal Home Loan Mortgage Corporation	$	7,446			4,418			0			0			11,864
Federal National Mortgage Association		2,953			5,215			0			0			8,168
Collateralized Mortgage Obligations		0			274			339			0			613
Total	$	10,399			9,907			339			0			20,645
Weighted average yield		4.20	%		4.43	%		5.50	%		0.00	%		4.33	%

At December 31, 2011, 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 term 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, therefore, the value of CMOs is subject to change.

At December 31, 2011, the Company had $0 invested in CMOs that have floating interest rates that change either monthly or quarterly, compared to $1,000 at December 31, 2010 and $5,000 at December 31, 2009.

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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, internet and brokered deposits, payments of loan principal, interest earned on loans and securities, repayments and maturities of securities, borrowings, sales of preferred shares and other funds provided from operations.

Deposits. The Bank offers a variety of deposit accounts to retail and commercial customers 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). The Bank relies primarily on competitive pricing policies and customer service to attract and retain these deposits.

The variety of deposit accounts offered by the Bank has allowed it to be competitive in obtaining funds and to respond with flexibility to changes in consumer demand. As customers have become more interest rate conscious, the Bank has become more susceptible to short-term fluctuations in deposit flows. The Bank manages the pricing of its deposits in keeping with its asset/liability management, profitability and growth objectives. Based on its experience, the Bank believes that its passbook and NOW accounts are relatively stable sources of deposits. However, the ability of the Bank to attract and maintain certificates of deposit and money market accounts, and the rates paid on these deposits, has been and will continue to be significantly affected by market conditions. The decrease in deposits in 2011, 2010 and 2009 are the direct result of the Bank decreasing the amount of outstanding loans in order to improve capital ratios. Brokered deposits decreased $39.6 million, $103.1 million, and $91.8 million in 2011, 2010 and 2009, respectively, as the proceeds from loan payoffs were used to pay off the outstanding brokered deposits that matured during the year. Pursuant to a regulatory directive, the Bank cannot renew any existing brokered deposits or accept any new brokered deposits without prior consent of the OCC (as successor to the OTS).

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

	Year Ended December 31,
(Dollars in thousands)	2011			2010			2009
Opening balance	$	683,230			796,011			880,505
Deposits		6,648,739			5,537,842			5,879,026
Withdrawals		(6,682,944	)		(5,662,903	)		(5,984,653	)
Interest credited		7,152			12,280			21,133
Ending balance		656,177			683,230			796,011
Net decrease	$	(27,053	)		(112,781	)		(84,494	)
Percent decrease		(3.96	)%		(14.17	)%		(9.60	)%

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

	2011					2010					2009
(Dollars in thousands) Transaction and Savings Deposits(1):	Amount		Percent of Total			Amount		Percent of Total			Amount		Percent of Total
Non-interest checking	$	113,188		18.3	%	$	96,581		14.1	%	$	80,330		10.1	%
NOW Accounts – 0.06%(2)		64,783		10.4			94,205		13.8			103,998		13.0
Passbook Accounts – 0.17%(3)		36,071		5.8			33,973		5.0			31,068		3.9
Money Market Accounts – 0.46%(4)		108,876		17.6			114,357		16.7			125,008		15.7
Total Non-Certificates	$	322,918		52.1	%	$	339,116		49.6	%	$	340,404		42.7	%
Certificates:
0.00 – 0.99%	$	72,768		11.7	%	$	41,311		6.1	%	$	16,615		2.1	%
1.00 – 1.99%		134,567		21.8			142,742		20.9			113,916		14.3
2.00 – 2.99%		65,842		10.6			105,126		15.4			135,311		17.0
3.00 – 3.99%		22,583		3.6			50,529		7.4			138,152		17.4
4.00 – 4.99%		1,450		0.2			4,113		0.6			47,692		6.0
5.00 – 5.99%		0		0.0			293		0.0			3,921		0.5
Total Certificates		297,210		47.9			344,114		50.4			455,607		57.3
Total Deposits	$	620,128		100.0	%	$	683,230		100.0	%	$	796,011		100.0	%

⁽¹⁾ Reflects weighted average rates paid on transaction and savings deposits at December 31, 2011.

⁽²⁾  The weighted average rate on NOW Accounts for 2010 was 0.11% and 2009 was 0.08%.

⁽³⁾ The weighted average rate on Passbook Accounts for 2010 was 0.15% and 2009 was 0.13%.

⁽⁴⁾ The weighted average rate on Money Market Accounts for 2010 was 0.75% and 2009 was 1.25%.

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The following table shows rate and maturity information for the Bank’s certificates of deposit as of December 31, 2011.

(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%			Total			Percent of Total
March 31, 2012	$	14,887			21,290			14,495			4,746			852			56,270			18.93	%
June 30, 2012		10,947			10,822			7,402			15,026			46			44,243			14.89
September 30, 2012		14,421			18,696			24,305			348			194			57,964			19.50
December 31, 2012		11,550			13,134			3,944			138			301			29,067			9.78
March 31, 2013		6,957			21,951			3,247			580			46			32,781			11.03
June 30, 2013		7,696			7,166			6,392			347			0			21,601			7.27
September 30, 2013		3,179			11,179			642			276			0			15,276			5.14
December 31, 2013		1,327			3,977			139			497			11			5,951			2.00
March 31, 2014		13			14,199			472			131			0			14,815			4.98
June 30, 2014		82			4,859			249			152			0			5,342			1.80
September 30, 2014		191			4,074			836			101			0			5,202			1.75
December 31, 2014		1,466			457			815			85			0			2,823			0.95
Thereafter		52			2,763			2,904			156			0			5,875			1.98
Total	$	72,768			134,567			65,842			22,583			1,450			297,210			100.00	%
Percent of total		24.48	%		45.28	%		22.15	%		7.60	%		0.49	%		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, 2011.

	Maturity
	3 Months or Less		Over 3 to 6 Months		Over 6 to 12 Months		Over 12 Months		Total
(Dollars in thousands)
Certificates of deposit less than $100,000	$	41,579		36,413		60,070		62,719		200,781
Certificates of deposit of $100,000 or more		14,294		7,676		26,438		46,944		95,352
Public funds less than $100,000(1)		48		11		218		3		280
Public funds of $100,000 or more(1)		348		144		305		0		797
Total certificates of deposit	$	56,269		44,244		87,031		109,666		297,210
Passbook of $100,000 or more	$	168,400		0		0		0		168,400
Accounts of $100,000 or more	$	183,042		7,820		26,743		46,944		264,549

⁽¹⁾  Deposits from governmental and other public entities.

For additional information regarding the composition of the Bank’s deposits, see Note 10 of the Notes to Consolidated Financial Statements in the Annual Report (incorporated by reference in Item 8 of Part II of this Form 10-K). For additional information on certificate maturities and the impact on the Company’s liquidity see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources” of the Annual Report (incorporated by reference in Item 7 of Part II of this Form 10-K).

Borrowings. The Bank’s other available sources of funds include advances from the FHLB and other borrowings from the Federal Reserve Bank (FRB). As a member of the FHLB of Des Moines, 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 fund loan demand and extend the term to maturity of its liabilities. The Bank also uses short-term FHLB and FRB borrowings to offset short term cash needs due to deposit outflows or loan fundings. At December 31, 2011, the Bank had $70.0 million of FHLB advances and no FRB borrowings outstanding. All of the outstanding advances at December 31, 2011 have quarterly 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. On such date, the Bank had a collateral pledge arrangement with the FHLB pursuant to which the Bank may borrow up to an additional $75.9 million for liquidity purposes, subject to approval from the FHLB. The Bank also had the ability to draw additional borrowings of $60.0 million from the FRB based upon the loans that were pledged as collateral at December 31, 2011. Refer to the information on pages 24 and 25 under the caption “Liquidity and Capital Resources” in the Annual Report and Note 11 of the Notes to Consolidated Financial Statements in the Annual Report for more information on FHLB advances and FRB borrowings (incorporated by reference in Items 7 and 8 of Part II of this Form 10-K).

Service Corporations of the Bank

As a federally chartered savings bank, the Bank is permitted by OCC 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 these 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.

OIA is the Bank’s sole subsidiary. OIA is a Minnesota corporation that was organized in 1983 and operated as an insurance agency until 1986 when its assets were sold. OIA remained inactive until 1993 when it began offering credit life insurance, annuity and mutual fund products to the Bank’s customers and others. OIA now offers a variety of financial planning products and services.

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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 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 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 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 the Company

HMN has one other wholly owned subsidiary, SFC, which is currently not actively engaged in any activities.

Employees

At December 31, 2011, the Company had a total of 219 employees, of which 192 were full-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, the Company is presently subject to regulation by the Federal Reserve Board (FRB). The Bank, a federally-chartered savings association, is also subject to extensive regulation and examination by the Office of the Comptroller of the Currency (OCC), which is the Bank’s primary federal regulator. The FDIC also has authority to regulate the Bank. Subsidiaries of the Company and the Bank may also be subject to state regulation and/or licensing in connection with certain insurance and investment activities. The Company and the Bank are subject to numerous laws and regulations. These laws and regulations impose restrictions on activities, set minimum capital 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. Changes in statutes, regulation or regulatory policies applicable to the Bank or the Company, including interpretation or implementation thereof, could have a material effect on the Company’s business.

The Dodd-Frank Wall Street Reform and Consumer Protection Act

On July 21, 2010, the President signed the Dodd-Frank Wall Street Reform and Consumer Protection Act ( Dodd-Frank Act). This new law significantly changes the regulatory structure for financial institutions and their holding companies and affects the lending, deposit, investment, trading and operating activities of financial institutions and their holding companies. The Dodd-Frank Act (i) restructured the federal bank regulatory structure and abolished the OTS; (ii) created a new consumer protection agency called the Consumer Financial Protection Bureau (CFPB); (iii) provided the U.S. Department of the Treasury, FDIC and the FRB orderly liquidation powers to close large financial (including non-bank) institutions; (iv) established a new Financial Stability Oversight Council (FSOC) to identify and respond to emerging risks throughout the financial system; (v) adopted new standards for the mortgage industry; (vi) established new federal regulation of the derivatives market; (vii) restricts proprietary trading by depository institutions and their holding companies; (viii) requires large, complex financial companies to prepare plans for their wind up; (ix) established new regulation of the securitization market requiring enhanced disclosure and retention of risk requirements; (x) places strict limits on debit card interchange

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fees charged by depository institutions to retailers; (xi) established new and enhanced compensation and corporate governance oversight for the financial services industry; (xii) adopted new federal hedge fund regulation; (xiii) established new fiduciary duties and regulation of broker dealers, investment companies and investment advisors; (xiv) requires the federal banking agencies to adopt new and enhanced capital standards for all depository institutions and, for the first time, requires specific capital standards for savings and loan holding companies; (xv) narrows the scope of federal preemption for national banks and federal thrifts; and (xvi) places a moratorium on ownership of industrial loan and credit card banks by non-financial companies. The Dodd-Frank Act requires various federal agencies to adopt a broad range of new implementing rules and regulations, and to prepare numerous studies and reports for Congress. The federal agencies are given significant discretion in drafting the implementing rules and regulations, and consequently, many of the details and much of the impact of the Dodd-Frank Act may not be known for many months or years.

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. The Company 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 (the GLB Act) was signed into law. The GLB Act made significant changes to laws regulating the financial services industry. Changes included (i) prohibitions on new unitary SLHCs from engaging in non-financial activities or affiliating with non-financial entities; and (ii) modifications to the Federal Home Loan Bank System. Unitary SLHCs, such as the Company, 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 the Company’s ability to control non-financial firms or engage in non-financial activities.

In accordance with the Dodd-Frank Act, the OTS was integrated into the Office of the Comptroller of the Currency (OCC) on July 21, 2011 and the primary banking regulator for the Company became the Federal Reserve Board. The FRB supervises and regulates all savings and loan holding companies, including the Company, that were formerly regulated by the OTS. The Dodd-Frank Act also codifies the FRB’s so-called “source of strength” doctrine. While the OTS has suggested the SLHCs were to serve as a “source of support”, the OTS did not have a formal policy. The source of strength doctrine requires financial institution holding companies, such as the Company, to provide financial assistance to their subsidiary financial institutions in the event of financial distress. The Dodd-Frank Act and applicable FRB regulations now subject all SLHCs to the source-of-strength doctrine. The regulation does not explicitly authorize the FRB to compel an SLHC to recapitalize a subsidiary savings association but the FRB does have broad enforcement authority over SLHCs. The practical impact of this for the Company is still unclear. It may mean that the Company should be able to demonstrate its ability to access the capital markets for additional funds. The Dodd-Frank Act does not directly alter grandfathered unitary SLHCs’ ability to engage in non-financial activities. However, the FRB now has the authority to require a grandfathered unitary SLHC to form an intermediate holding company to serve as the direct parent of a thrift and it is possible that the FRB would impose other restrictions if the Company sought to 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 FRB approval and the public must have an opportunity to comment on the proposed acquisition. Without prior approval from the FRB, the Company may not acquire, directly or indirectly, control of another savings association.

Examination and Reporting. Under HOLA and FRB regulations, the Company, as a SLHC, must file periodic reports with the FRB. In addition, the Company must comply with FRB record keeping requirements and is subject to holding company examination by the FRB. The FRB 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.

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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 the Company and the Company’s other subsidiaries. See “Transactions with Affiliates and Insiders”.

Capital Adequacy. The Company entered into a Supervisory Agreement with the OTS effective February 22, 2011. The Supervisory Agreement required that the Company submit a capital plan by May 31, 2011 (and thereafter the plan shall be updated on an annual basis commencing January 31, 2012) for approval by the OTS (the “Capital Plan”), which had to include a proposed minimum tangible equity capital ratio commensurate with the Company’s consolidated risk profile, projections demonstrating the Company’s ability to attain and maintain the minimum tangible equity capital ratio including detailed scenarios to stress-test such ratio. In addition, the Supervisory Agreement requires that the Company: (i) not declare, make or pay any cash dividends on any of its stock or make any other capital distributions or purchase or redeem any of its stock without the prior consent of the FRB; (ii) not incur any debt or pay any interest or principal payments thereon, increase any current lines of credit or guarantee the debt of any entity without the prior consent of the FRB; (iii) comply with existing notification requirements pursuant to the applicable rules and regulations of the FRB with respect to changes in directors and certain executive officers; (iv) not make any golden parachute payment unless such payment complies with the applicable rules and regulations of the FDIC; and (v) not enter into any new contractual arrangement or renew or revise any existing contractual arrangement related to compensation or benefits with any director or certain executive officers without the prior consent of the FRB, with any such arrangement to comply with all applicable rules and regulations of the FRB and FDIC. In addition, beginning in July 2015, for the first time SLHCs, including the Company, will be subject to formal capital requirements. As such, the Company will be required to hold capital in the same amount and of the same type that is required for insured depository institutions. The Bank is already subject to various capital requirements. See “Capital Requirements”. In accordance with the Company’s Supervisory Agreement, we submitted a two year capital plan by May 31, 2011 to the OTS upon which the FRB may make comments, and to which the FRB may require revisions. The Company submitted an updated two-year capital plan in January 2012. The failure of the Company to meet the anticipated earnings and capital forecasts set forth in its capital plan resulted in a single exception of noncompliance with its Supervisory Agreement as of December 31, 2011.

Bank Regulation

Pursuant to the Dodd-Frank Act, the OTS bank regulatory powers were transferred to other agencies on July 21, 2011, and the OTS was subsequently abolished. As a result, the OCC became the Bank’s primary federal regulator. Rulemaking with respect to consumer financial protection functions was transferred to the CFPB and examination and enforcement of consumer protection and safety and soundness requirements are with the OCC.

As a federally-chartered savings association, the Bank is subject to regulation and supervision by the OCC. 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.

Savings associations are expected to conduct lending activities in a prudent, safe and sound manner. The OCC regulates the safety and soundness of the Bank by enforcing statutory limits on the Bank’s lending and investment powers. OCC regulations set aggregate limits on certain types of loans including commercial business, commercial real estate, and consumer loans. OCC regulations also establish limits on loans to a single borrower. As of December 31, 2011, the Bank’s lending limit to one borrower was approximately $11.9 million. A federal savings association generally may not invest in 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.

The Bank entered into a Supervisory Agreement with the OTS effective February 22, 2011. The Supervisory Agreement required that the Bank submit an updated business plan by May 31, 2011 (and thereafter the plan shall be updated on an annual basis commencing January 31, 2012) for approval by the OTS (the “Business Plan”),

25

including strategies to ensure that the Bank has the financial and personnel resources necessary to implement the Business Plan and maintain compliance with applicable regulatory capital requirements, plans to improve the Bank’s core earnings and achieve profitability, financial projections and strategies to stress-test and adjust earnings forecasts based on results of operations, economic conditions and quality of the Bank’s loan portfolio. In addition, the Supervisory Agreement requires that the Bank (i) submit a detailed plan to reduce the Bank’s level of “problem assets” which must address quarterly targets for the level of problem assets as a percentage of Tier 1 (Core) Capital plus the allowance for loan and lease losses (“ALLL”) and a description of methods for attaining such targets as well as specific workout plans for certain adversely classified loans (generally those in excess of $1,000,000); (ii) revise its loan modification policy; (iii) revise its program for identifying, monitoring and controlling risk associated with concentrations of credit; (iv) revise its documentation of its policies and procedures relating to the calculation of ALLL; (v) not declare or pay any dividends or make any other capital distributions without at least 30 days prior written notice to, and approval of, the OCC; (vi) not increase its total assets during any quarter in excess of the net interest credited on deposit liabilities during the prior quarter without the consent of the OCC; and (vii) not enter into any significant arrangement or contract with a third party service provider without the prior consent of the OCC. The Supervisory Agreement also provides that the Bank is subject to restrictions on changes in directors and certain executive officers, golden parachute payments and employment and compensatory arrangements as applicable to the Company pursuant to the Company’s Supervisory Agreement. In accordance with the Bank’s Supervisory Agreement, the Bank submitted a two year business plan by May 31, 2011 and the OCC accepted the plan with the expectation that the Bank will meet the capital requirements in connection with the IMCR described below. The Bank submitted an updated two-year plan in January 2012 to the OCC. The failure of the Bank to meet the anticipated earnings and capital forecasts set forth in its business plan resulted in a single exception of noncompliance with its Supervisory Agreement as of December 31, 2011.

Qualified Thrift Lender Test. Savings associations, including the Bank, must be qualified thrift lenders (QTLs). 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 the Company would face certain limitations, including potential enforcement action by the OCC. As of December 31, 2011, the Bank met the QTL test.

OTS/OCC Assessments. HOLA authorized the OTS to charge assessments to recover the costs of examining savings associations, holding companies, and their affiliates. The assessment was done semi-annually, and was based on three factors: 1) asset size; 2) condition; and 3) complexity of the institution. The Bank’s and the Company’s OTS assessments for the year ended December 31, 2011, were approximately $179,000 for the period of time they were regulated by the OTS. While all SHLCs were subject to examination fees from the OTS, the FRB has not assessed fees for its examination function. The National Bank Act authorizes the OCC to fund the expenses of its operations through assessments and the Bank’s OCC assessments for the portion of 2011 that the Bank was regulated by the OCC were approximately $144,000.

Transactions with Affiliates and Insiders. Savings associations, like banks, 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 the Company, 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. The Dodd-Frank Act expanded the limitations on transactions with affiliates to cover transactions that create credit risk. Covered transaction now includes derivatives and the borrowing and lending of securities. Repurchase agreements with affiliates are now subject to collateralization requirements. This change is not expected to affect the Bank or the Company.

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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 OCC before payment of a dividend or approval of a proposed capital distribution by its board of directors and must obtain prior approval from the OCC if it fails to meet certain regulatory conditions. The Bank did not declare or distribute any dividends to the Company in 2011. In addition, the Bank Supervisory Agreement states that the Bank may not declare or pay any dividends or make any other capital distributions without at least 30 days prior written notice to, and approval of, the OCC.

The Bank is the primary source of cash for the Company. At December 31, 2011, the Company had $1.4 million in cash and other assets that could readily be turned into cash. The Company has deferred each payment on the outstanding series A preferred stock that was due since February 15, 2011 in order to preserve cash for potential future needs. If the Bank does not obtain regulatory approval for any future dividends from the Bank to the Company or is otherwise unable to fund future dividends, the Company may be required to find other sources of liquidity for the payment of expenses and other needs beyond 2012.

Deposit Insurance. The FDIC insures the deposits of the Bank through the Deposit Insurance Fund (DIF). The DIF is funded by assessments of FDIC members such as the Bank. The FDIC applies 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.

The Dodd-Frank Act instituted three significant changes that modify the way DIF is managed by the FDIC and capitalized. Some of the changes will not impact the Bank or the Company as they only apply to insured depository institutions with more than $10 billion is assets. The changes to DIF are as follows: (i) the assessment base on which deposit insurance is determined is modified to base assessments on the average total consolidated assets of an insured depository institution minus the sum of average tangible equity of the insured depository institution during the assessment period, which increases the assessment burden on larger banks (which tend to rely more heavily on non-deposit liabilities than smaller banks); (ii) the DIF reserve ratio floor is raised from 1.15% to 1.35% (complete implementation of the higher reserve ratio is to be fully implemented by September 30, 2020, offsetting for the impact of deposit insurance assessments on institutions with less than $10 billion in consolidated assets, meaning that assessments on larger institutions will be responsible for the 20 basis point increase); and (iii) a requirement that the FDIC pay dividends to insured depository institutions whenever the DIF exceeds a reserve ratio of 1.35% is repealed.

In December 2009, the Bank was required to make a prepayment of $5.0 million, which represented an estimate of FDIC assessments for the fourth quarter of 2009 and for the years 2010, 2011 and 2012. This amount was set up as a prepaid expense at December 31, 2009 and is being expensed quarterly as the FDIC charges are assessed. The amount of prepaid deposit insurance expense remaining at December 31, 2011 is approximately $1.6 million. During 2011, the Bank was assessed approximately $1.3 million for the DIF.

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 the FICO debt incurred in the 1980’s. The FICO assessment rate is adjusted quarterly. In 2011, the Bank paid a FICO assessment of approximately $60,000.

Other Deposit Insurance-Related Issues. On October 14, 2008, the FDIC announced a temporary program designed to maintain liquidity in the U.S. banking system. The FDIC referred to the program as the Temporary Liquidity Guarantee Program (TLGP) and it had two parts. Participation in both parts of the TLGP was voluntary, and the Company chose to participate in both parts. The first part of the program called the Transaction Account Guarantee Program (TAGP) provided unlimited FDIC insurance coverage on “non-interest bearing transaction accounts” through December 31, 2010. The second part of the program called the Debt Guarantee Program (DGP) allowed the Company to issue debt securities fully guaranteed by the FDIC. The DGP and a related guarantee facility expired in 2010. Neither the Company nor the Bank issued debt under the DGP or its related facility.

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Both parts of the TLGP are funded through assessments on participating institutions. During 2011, neither the Company nor the Bank paid premiums on the DGP as neither issued any guaranteed debt. No additional premiums were paid in 2011 relating to its participation in the TAGP as the FDIC incorporated these costs into the revised premium structure implemented during the year.

The Dodd-Frank Act provided for an extension of parts of the TAGP through December of 2012. The Dodd-Frank Act’s version of the TAGP includes a more restrictive definition of “noninterest-bearing transaction account” than was used previously by the FDIC. The revised TAGP covers only those transaction accounts that bear no interest and certain trust accounts that provide for payment of any interest earned to state legal aid programs. Finally, unlike the FDIC’s previous TAGP, the Bank cannot opt out of participation.

The Dodd-Frank Act also repealed the existing prohibition on banks paying interest on business checking accounts. Effective July 21, 2011, banks became eligible to pay interest on business checking accounts.

Capital Requirements and Prompt Corrective Action Requirements. 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 the Company’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. Quantitative measures established by regulations to ensure capital adequacy require the Bank to maintain minimum amounts and ratios of Tier I (Core) capital, and Risk-based capital (as defined in the regulations) to total assets (as defined). The Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

The Federal Deposit Insurance Corporation Improvement Act of 1991 (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 prompt corrective action capital 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 OCC) 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.

In addition to the capital standards of the prompt corrective action regulations, the OCC has established an individual minimum capital requirement (IMCR) for the Bank. An IMCR requires a bank to establish and maintain levels of capital greater than those generally required for a bank to be classified as “well-capitalized.” Effective December 31, 2011, the Bank was required to establish, and subsequently maintain, core capital at least equal to 8.5% of adjusted total assets, which was in excess of the Bank’s 7.14% core capital to adjusted total assets ratio at December 31, 2011. The Bank would have needed $10.8 million in additional capital at December 31, 2011 to meet the minimum core capital ratio set by the OCC. In February 2012, the Bank received a notice from the OCC arising out of its failure to establish and maintain its IMCR of 8.5% core capital to adjusted total assets at December 31, 2011. By April 30, 2012, the Bank must submit to the OCC a further written capital plan of how it will achieve and maintain its IMCR, and a contingency plan in the event the IMCR is not achieved through the Bank’s primary plan. The Bank’s failure to comply with the terms of the IMCR is deemed an unsafe and unsound banking practice.

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The Bank is also subject to a Supervisory Agreement with the OCC, more fully described above, which included requirements to submit a business plan. At December 31, 2011, the Bank was not in compliance with this plan because earnings and capital did not meet forecasted levels in this plan as of that date.

At December 31, 2011, the Bank’s capital amounts and ratios are presented for (a) actual capital, (b) required capital and ratios under the Prompt Corrective Actions regulations, and (c) required capital and ratios under the IMCR to which the Bank is subject:

						Prompt Corrective Action Regulations
	Actual					Required to be Adequately Capitalized					Required to be Well Capitalized					Individual Minimum Capital Requirement
(Dollars in thousands)	Amount		Percent of Assets(1)			Amount		Percent of Assets(1)			Amount		Percent  of Assets(1)			Amount		Percent  of Assets(1)
Tier I or core capital	$	56,314		7.14	%	$	31,560		4.00	%		39,450		5.00	%	$	67,064		8.50	%
Tier I risk-based capital		56,314		9.61			23,441		4.00			35,162		6.00			N/A		N/A
Risk-based capital to risk-weighted assets		63,639		10.86			46,883		8.00			58,603		10.00			N/A		N/A

(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.

Management believes that, as of December 31, 2011, the Bank’s capital ratios were in excess of those quantitative capital ratio standards set forth under the prompt corrective action regulations described above. Further, it is the Bank’s understanding that the failure of the Bank to satisfy the IMCR at December 31, 2011 does not by itself affect the Bank’s status as “well-capitalized” within the meaning of these prompt corrective action regulations. However, there can be no assurance that the Bank will continue to maintain such status in the future. In light of the failure to satisfy the IMCR and the Bank Supervisory Agreement and current operating and financial condition of the Bank, the OCC has extensive discretion in its supervisory and enforcement activities, and can downgrade the Bank’s prompt corrective action capital category by one level.

Under applicable banking regulations, the failure to satisfy the terms of the Supervisory Agreements and the IMCR, and failure to otherwise comply with applicable requirements as they arise, could subject the Company, the Bank and its directors and officers to such restrictions, legal actions or sanctions as the OCC considers appropriate. Possible sanctions include among others (i) the imposition of one or more cease and desist orders requiring corrective action, which are enforceable directives that may address any aspect of the Company or Bank management, operations or capital, including requirements to change management, raise equity capital, dispose of assets or effect a change of control; (ii) civil money penalties; and (iii) downgrades in the capital adequacy status of the Company and the Bank. These regulatory actions may significantly restrict the ability of the Company and the Bank to take operating and strategic actions that may be in the best interests of stockholders or compel the Company and the Bank to take operating and strategic actions that are not potentially in the best interests of stockholders.

Other Regulations and Examination Authority. The FDIC has adopted regulations to protect the DIF 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 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 OCC may sanction any OCC-regulated bank that does not operate in accordance with OCC 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, which is one of the 12 regional Federal Home Loan Banks (FHBs). The primary purpose of the FHBs is to provide funding to their saving association members in support of the home financing credit function of the members. Each FHB serves as a reserve or central bank for its members within its assigned region. FHBs are funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB System. FHBs make 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 an FHB 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, 2011, the Bank had $4.2 million in FHLB stock, which was in compliance with this requirement. The Bank receives dividends on its FHLB stock. In 2011, the dividend rate was 3.0%. Over the past five calendar years, dividends have averaged approximately 3.08%. However, the FHLB has notified its members that it is changing its dividend philosophy in 2012 which is anticipated to decrease the dividend rate paid on the Bank’s outstanding FHLB stock.

Other Regulation. Under Federal Reserve Board regulations, the Bank is required to maintain reserves against transaction accounts (primarily interest-bearing and noninterest-bearing checking accounts). Historically, reserves generally have been maintained in cash or in noninterest-bearing accounts, thereby effectively increasing 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. The policy of not paying interest on reserves was changed on October 6, 2008. The Federal Reserve Board will utilize the rate of interest paid on reserves to conduct monetary policy. 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, CFPB or the OCC 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 January 18, 2011 and the Bank received a “satisfactory” rating under the Intermediate Small Savings Association criteria.

Bank Secrecy Act. The Bank Secrecy Act (BSA) requires financial institutions to verify the identity of customers, 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. The impact on Bank operations from the BSA depends on the types of customers served by the Bank.

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Troubled Asset Relief Program – Capital Purchase Program

On October 3, 2008, the federal government enacted the Emergency Economic Stabilization Act of 2008 (EESA). EESA was enacted to provide liquidity to the U.S. financial system and lessen the impact of accelerating economic problems. The EESA included broad authority. The centerpiece of the EESA was the Troubled Asset Relief Program (TARP). EESA’s broad authority was interpreted to allow the U.S. Treasury to purchase equity interests in both healthy and troubled financial institutions. The equity purchase program is commonly referred to as the Capital Purchase Program (CPP). The Company elected to participate in the CPP and sold series A preferred stock to the U.S. Treasury in December 2008. As a participant in the CPP, the Company is subject to the regulatory requirements of the EESA, as amended, and the interim final rule published on June 15, 2009, 31 C.F.R. Part 30, TARP Standards for Compensation and Corporate Governance (“IFR”). Among other things, current executive compensation and corporate governance requirements (i) prohibit any bonus, retention award or incentive compensation to our five most highly compensated employees unless it is in the form of long-term restricted common stock that does not vest in the first two years after it is issued and that cannot be transferred except as permitted under a schedule based on the Company’s redemption of the preferred stock; (ii) prohibit payment of severance for any reason to our executive officers and any of the next five most highly compensated employees; (iii) require us to recover from our executive officers and the next 20 most highly compensated employees any bonus, retention award or incentive compensation when based on materially inaccurate earnings, revenues, gains or other criteria, (iv) require us to permit a non-binding stockholder vote on executive pay; (v) required Treasury to conduct a review of bonuses, retention awards and other compensation paid to our executive officers and the next 20 most highly compensated employees to determine whether such payments were inconsistent with the EESA and TARP or were otherwise contrary to the public interest and to seek their recovery if so; (vi) prohibit incentive compensation to executive officers that encourages unnecessary and excessive risks that threaten the value of our Company; (vii) require adoption of an excessive or luxury expenditures policy that sets forth written standards applicable to the Company and its employees regarding excessive expenditures for entertainment events, office and facilities renovations, aviation or other transportation services and other similar items, activities or events; (viii) prohibit tax gross ups to any executive officer or the next 20 most highly compensated employees; and (ix) require our compensation committee to periodically review employee compensation plans in light of the risks posed to the Company and take steps to limit those risks. These restrictions apply to us so long as Treasury holds any of our securities (unless it holds only our warrants). The Company deferred the payment on the outstanding series A preferred stock that was due on February 15, 2011 in order to preserve cash for potential future needs. Under the terms of the certificate of designations for the preferred stock, dividend payments may be deferred without default, but the dividend is cumulative and, if the Company fails to pay dividends for six quarters, whether or not consecutive, the Treasury will have the right to elect two persons to the Company’s board of directors. The Company has failed to make each required dividend payment on the outstanding series A preferred stock commencing with February 15, 2011. The five unpaid and accrued dividend payments total $1.6 million. At this time, the Company does not anticipate making any payment of dividends on the series A preferred stock during 2012. As a result, in accordance with the terms of the series A preferred stock, should the Company fail to make the May 15, 2012 dividend payment, the Treasury, as the sole holder of the series A preferred stock, will have the right at the next annual or special meeting of stockholders, and thereafter until all accrued and unpaid dividends are paid, to elect up to two persons to our board of directors.

EXECUTIVE OFFICERS

Officers are chosen by and serve at the discretion of the Board of Directors of the Company and the Bank. There are no family relationships among any of the directors or officers of the Company and the Bank. The business experience of each executive officer of both the Company and the Bank is set forth below.

Bradley C. Krehbiel, age 53. Mr. Krehbiel has been a director of the Company since November 2009 and he has been President of the Bank since January 2009 and President of the Company since April 2010. Prior to that, he had been the Executive Vice President of the Bank since 2004. Mr. Krehbiel joined the Bank as Vice President of Business Banking in 1998. Prior to his employment at the Bank, Mr. Krehbiel held several positions in the financial services industry, including six years as a private banking consultant.

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Jon J. Eberle, age 46. Mr. Eberle is Chief Financial Officer, Senior Vice President and Treasurer of the Company and the Bank. Mr. Eberle has held such positions since 2003. Prior to that he 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 the Company and the Bank. Prior to his employment at the Bank, Mr. Eberle worked for six years as a certified public accountant with a national accounting firm.

Lawrence D. McGraw, age 48. Mr. McGraw is the Chief Credit Officer and Senior Vice President of the Bank. Mr. McGraw has held such positions since February 2010. Prior to his employment at the Bank, Mr. McGraw served as Regional President and Chief Banking Officer of United Prairie Bank from January 2005 until February 2010. He also served as the President and Chief Executive Officer of their Owatonna location from January 2001 to January 2005. Prior to his tenure with United Prairie Bank, Mr. McGraw held various positions with Farmers and Merchants Savings Bank, Waukon State Bank and the FDIC.

Dwain C. Jorgensen, age 63. Mr. Jorgensen has served as Senior Vice President of Technology, Facilities and Compliance of the Company and Bank since 2007. From 1998 to 2007, he served as Senior Vice President of Operations of the Company and the Bank. From 1989 to 1998, he served as Vice President, Controller and Chief Accounting Officer of the Company and the Bank. From 1983 to 1989, Mr. Jorgensen was an Assistant Vice President and Operations Officer for the Bank.

Susan K. Kolling, age 60. Ms. Kolling has been a director of the Company since 2001. Ms. Kolling served as a Vice President of the Bank from 1992 to 1994 and has served as a Senior Vice President of the Bank and the Company since 1995. In addition, from 1997 to 2003, Ms. Kolling was an owner of Kolling Family Corp. which does business as Valley Home Improvement, a retail lumber yard. Ms. Kolling became a director of Kolling Family Corp. in 2004.

Available Information

The Company’s website is www.hmnf.com. The Company makes available, free of charge, through its website its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) of the Securities Exchange Act of 1934, as soon as reasonably practicable after it electronically files these materials with, or furnishes them to, the Securities and Exchange Commission (the SEC). Information contained on the Company’s website is expressly not incorporated by reference into this Form 10-K.

ITEM 1A. RISK FACTORS

Like all financial companies, the Company’s business and results of operations are subject to a number of risks, many of which are outside of the Company’s control. In addition to the other information in this report, readers should carefully consider that the following important factors, among others, could materially impact the Company’s business and future results of operations.

The Company and the Bank are subject to the restrictions and conditions of the Supervisory Agreements and IMCR with the Office of the Comptroller of the Currency (OCC) and the Federal Reserve Board (FRB). The Bank failed to comply with the IMCR at December 31, 2011 and the Bank and the Company are not in full compliance with the Supervisory Agreements. Failure to comply with the Supervisory Agreements and IMCR could result in enforcement actions against us, including the imposition of cease and desist orders and monetary penalties.

The Company and the Bank each entered into Supervisory Agreements effective February 22, 2011 with the Office of Thrift Supervision (OTS) (predecessor prior to July 21, 2011 to the OCC, the Bank’s primary banking

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regulator, and to the FRB, the Company’s primary banking regulator). The Supervisory Agreements supersede the memoranda of understanding between the Company and the Bank and the OTS dated December 9, 2009. In accordance with the Company’s Supervisory Agreement, the Company submitted a two year capital plan by May 31, 2011 to the OTS upon which the FRB may make comments, and to which the FRB may require revisions. The Company submitted an updated two-year capital plan in January of 2012. We must operate within the parameters of the final capital plan and are required to monitor and submit periodic reports on our compliance with the plan. Also, under the Company’s Supervisory Agreement, without the consent of the FRB, we may not incur or issue any debt, guarantee the debt of any entity, declare or pay any cash dividends or repurchase any of our capital stock, enter into any new contractual arrangement or renew or extend any existing arrangement relating to compensation or benefits with any director or executive officer, or make any golden parachute payments.

The Bank’s Supervisory Agreement primarily relates to the Bank’s financial performance and credit quality issues. In accordance with the Bank’s Supervisory Agreement, the Bank submitted a two year business plan and the OCC accepted the plan with the expectation that the Bank will meet the capital requirements in connection with the IMCR described below. The Bank submitted an updated two-year plan in January 2012 to the OCC. The Bank must operate within the parameters of the final business plan and is required to monitor and submit periodic reports on its compliance with the plan. The Bank also submitted a problem asset reduction plan that the OCC accepted. The Bank must operate within the parameters of the final problem asset plan and is required to monitor and submit periodic reports on its compliance with the plan. The Bank also revised its loan modification policies and their programs for identifying, monitoring and controlling risk associated with concentrations of credit and improve its documentation of the allowance for loan and lease losses. In addition, without the consent of the OCC, the Bank may not declare or pay any cash dividends, materially increase the total assets of the Bank, enter into any new contractual arrangement or renew or extend any existing arrangement related to compensation or benefits with any directors or officer, make any golden parachute payments, or enter into any significant contracts with a third party service provider.

The failure of the Company and the Bank to meet the anticipated earnings and capital forecasts set forth in their respective plans, resulted in a single exception of noncompliance with the Supervisory Agreements as of December 31, 2011.

In addition, the OCC established in August 2011 an individual minimum capital requirement (IMCR) for the Bank. An IMCR requires a bank to establish and maintain levels of capital greater than those generally required for a bank to be classified as “well-capitalized.” Effective December 31, 2011, the Bank was required to establish, and subsequently maintain, core capital at least equal to 8.5% of adjusted total assets, which was in excess of the Bank’s 7.14% core capital to adjusted total assets ratio at December 31, 2011. The Bank would have needed $10.8 million in additional capital at December 31, 2011 to meet the minimum core capital ratio set by the OCC.

In February 2012, the Bank received a notice from the OCC arising out of its failure to establish and maintain its IMCR of 8.5% core capital to adjusted total assets at December 31, 2011. By April 30, 2012, the Bank must submit to the OCC a further written capital plan of how it will achieve and maintain its IMCR, and a contingency plan in the event the IMCR is not achieved through the Bank’s primary plan. The Bank’s failure to comply with the terms of the IMCR is deemed an unsafe and unsound banking practice.

Under applicable banking regulations, the failure to satisfy the terms of the Supervisory Agreements and the IMCR, and failure to otherwise comply with applicable requirements as they arise, could subject the Company, the Bank and its directors and officers to such restrictions, legal actions or sanctions as the OCC considers appropriate. Possible sanctions include among others (i) the imposition of one or more cease and desist orders requiring corrective action, which are enforceable directives that may address any aspect of the Company or Bank management, operations or capital, including requirements to change management, raise equity capital, dispose of assets or effect a change of control; (ii) civil money penalties; and (iii) downgrades in the prompt corrective action capital category capital adequacy status of the Company and the Bank. These regulatory actions may significantly restrict the ability of the Company and the Bank to take operating and strategic actions that may be in the best interests of stockholders or compel the Company and the Bank to take operating and strategic actions that are not potentially in the best interests of stockholders.

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Our capital is not currently adequate to meet all our needs and requirements. We have taken a number of steps, and may be required to take additional steps, to meet our capital needs. These actions are expected to reduce our base of earning assets and core deposits and may dilute our shareholders or result in a change of control of the Company or the Bank. There can be no assurance that we will satisfactorily meet our required capital needs.

We are required by federal regulatory authorities to maintain adequate levels of capital to support our operations. As a result of significant losses in recent years, elevated levels of nonperforming and other classified assets, regulatory requirements, including the IMCR, and other capital demands, such as our preferred stock dividend requirements, we need to increase our capital and core capital ratio.

In order to improve its capital ratios and comply with its IMCR, the Bank is, among other things, working to improve its financial results, reduce non-performing assets, and decrease the asset size of the Bank. From December 31, 2008 to December 31, 2011, our assets decreased $355 million, from $1,144 million to $790 million. We anticipate this strategic direction to continue throughout 2012. This reduction in assets decreases our ability to earn net interest income, our primary source of income. The Bank has also entered into a definitive purchase and assumption agreement relating to its Toledo Branch as more fully described below. In light of its current capital condition and its failure to comply with the IMCR at December 31, 2011, the Bank may also determine it to be necessary or prudent to dispose of other non-strategic assets. These actions have resulted, and may result in changes in the Bank’s assets, liabilities and earnings, some of which may be material, during the period in which the action is taken or is consummated or over a longer period of time.

The Bank entered into a definitive purchase and assumption agreement on November 7, 2011 with Pinnacle which provides for the sale to Pinnacle of substantially all of the assets associated with the Toledo Branch of the Bank (approximately $1.6 million at December 31, 2011) and the assumption by Pinnacle of substantially all deposit liabilities of the Toledo Branch (approximately $36.0 million at December 31, 2011). The Bank will continue to own and operate its other Iowa and Minnesota branches. Regulatory approval for the transaction has been obtained, however, the transaction is subject to the scheduling of the required Toledo Branch data processing conversion. Subject to the foregoing and other customary terms and conditions, the transaction is anticipated to be consummated in the first quarter of 2012. The Bank anticipates that the transaction will be funded with available assets, result in a one-time gain on sale in the first quarter of 2012, result in a decrease in the Bank’s overall assets of approximately $34 million, and improve the Bank’s core capital ratio by 40 basis points.

We may also find it necessary, or be required by federal banking regulators, to raise capital through the issuance of additional shares of our common stock or other equity securities. This would dilute the ownership interests of existing stockholders and, given our current common stock trading price, would be expected to dilute the per share book value of our common stock, and could result in a change in control of the Company and the Bank. New investors may also have rights, preferences and privileges senior to our current stockholders which may adversely impact our current stockholders. Our ability to raise additional capital through the issuance of equity securities, if needed or required, will depend on conditions in the capital markets at that time, which are outside of our control, and on our financial performance. It may also depend potentially on our ability to increase our authorized common stock and make other changes to our Certificate of Incorporation requiring stockholder approval that may be needed to accommodate a significant investment by a person or group. Accordingly, we may not be able to raise additional capital, if needed, at all, on favorable economic terms, or other terms acceptable to us.

There can be no assurance that these or other actions we may take will be sufficient and timely in order to address our consolidated and Bank capital requirements and bring the Company and the Bank into compliance with the Supervisory Agreements, the IMCR or any further capital plan to be submitted by us. If we cannot satisfactorily address our capital needs as they arise, our ability to maintain or expand our operations, our ability to operate without additional regulatory sanctions or other restrictions, and our operating results, could be materially adversely affected.

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The Bank may not be able to meet its cash flow needs on a timely basis at a reasonable cost, and its cost of funds for banking operations may significantly increase as a result of general economic conditions, interest rates and competitive pressures; the Company on an unconsolidated basis has limited capital resources and currently is unable to satisfy its preferred stock dividend obligations or to assist the Bank with its liquidity and capital requirements.

Liquidity is the ability to meet cash flow needs on a timely basis and at a reasonable cost. The liquidity of the Bank is used to make loans and to repay deposit and borrowing liabilities as they become due, or are demanded by customers and creditors. Many factors affect the Bank’s ability to meet liquidity needs, including variations in the markets served by its network of offices, its mix of assets and liabilities, reputation and standing in the marketplace and general economic conditions.

The Bank’s primary source of funding is retail deposits, gathered through its network of fourteen banking offices. Wholesale funding sources principally consist of borrowing lines from the FHLB of Des Moines and the Federal Reserve Bank and brokered and internet certificates of deposit obtained from the national market. Pursuant to an OTS directive, the Bank may not renew existing brokered deposits or accept new brokered deposits without the consent of the OCC (as successor to the OTS). Borrowings from the FHLB are subject to the FHLB’s credit policies and procedures relating to the valuation of the loans securing advances as well as the amount of funds the FHLB will loan to the Bank. The current collateral pledged to secure advances may no longer be acceptable, the formulas for determining the excess pledged collateral may change or the Bank’s credit rating with the FHLB could decrease. In these cases, the Bank may not have sufficient collateral to pledge or borrowing capacity to meet its funding needs and may be required to rely upon alternate funding sources, such as the Federal Reserve Bank, which bear higher borrowing costs. The Bank’s securities and loan portfolios also provide a source of contingent liquidity that could be accessed in a reasonable time period through sales.

Significant changes in general economic conditions, market interest rates, competitive pressures or otherwise, could cause the Bank’s deposits to decrease relative to overall banking operations, and it would have to rely more heavily on borrowings in the future, which are typically more expensive than deposits.

The Bank actively manages its liquidity position and monitors it using cash flow forecasts. Changes in economic conditions, including consumer savings habits and availability or access to borrowed funds and the brokered deposit market, subject to OCC approval, and the internet deposit market could potentially have a significant impact on the Company’s liquidity position, which in turn could materially impact its financial condition, results of operations and cash flows.

The Holding Company’s primary source of cash is dividends from the Bank and, pursuant to the Bank’s Supervisory Agreement, the Bank is restricted from paying dividends to the Holding Company without obtaining prior consent of the OCC. At December 31, 2011, the Company had $1.4 million in cash and other assets that could readily be turned into cash. Primarily, the Company requires cash for the payment of expenses and dividends on the Company’s series A preferred stock. On February 15, 2011, the Company suspended payment of dividends on its series A preferred stock in order to preserve cash and liquidity at the Company, and has failed to pay each of the following required four dividend payments to and including February 15, 2012. The total amount of accrued but unpaid dividends totaled $1.3 million at December 31, 2011. The Company does not anticipate that it will have adequate liquid resources to make future preferred stock dividend payments in 2012, or, absent an external capital raising event, cash resources which would assist the Bank in meeting any liquidity or capital requirements. Failure to obtain OCC approval for any future dividends from the Bank to the Company could cause the Company to require other sources of liquidity for the payment of expenses and other needs beyond 2012. Further information about the Company’s liquidity position is available on page 24 in the “Liquidity and Capital Resources” section of the Annual Report.

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Our allowance for loan losses may prove to be insufficient to absorb losses or appropriately reflect at any given time the inherent risk of loss in our loan portfolio.

Our non-performing assets remained at an elevated level in 2011 at $50.6 million, or 6.4% of total assets at December 31, 2011 and $84.5 million, or 9.6% of total assets at December 31, 2010. Classified loans also remained at elevated levels at December 31, 2011 at $107.5 million, or 18.4% of total loans, compared to $118.1 million, or 16.7% of total loans at December 31, 2010. Classified loans represent special mention, performing substandard and nonperforming loans. The elevated level of non-performing and classified loans was primarily due to the weak economic recovery and the continued difficulties in the real estate markets we primarily serve. We also experienced a significant increase in charge offs in 2011. The increase in charge offs was due to a change in the fourth quarter of 2011in our charge off policy on non-performing loans, which required the charge off of previously established specific valuation allowances (SVAs), and to instances of deterioration in borrowers’ financial condition that warranted a charge off of the loan balance. If the economic recovery and/or the real estate markets continue to remain weak, these assets may not perform according to their terms and the value of the collateral may be insufficient to pay any remaining loan balance. If this occurs, we may experience losses or an increased risk of loss in our loan portfolio, which could have a negative effect on our results of operations. Like all financial institutions, we maintain an allowance for loan losses to provide for loans in our portfolio that may not be repaid in their entirety. Our allowance for loan losses may not be sufficient to cover actual loan losses or the inherent risk of loss in our loan portfolio, and future provision for loan losses could materially adversely affect our operating results.

In evaluating the appropriateness of our allowance for loan losses, we consider numerous quantitative factors, including our historical charge-off experience, growth of our loan portfolio, changes in the composition of loan portfolio and the volume of delinquent and classified loans. In addition, we use information about specific borrower situations, including their financial position and estimated collateral values, to estimate the risk and amount of loss for those borrowers. We also consider many qualitative factors, including general and economic business conditions, duration of the current business cycle, current general market collateral valuations, specific valuation reserves already established, trends apparent in any of the factors we take into account and other matters, which are, by nature, more subjective and fluid. Our estimates of the risk of loss and amount of loss on any loan are complicated by the significant uncertainties surrounding our borrowers’ abilities to successfully execute their business models through changing economic environments, competitive challenges and other factors. Because of the degree of uncertainty and susceptibility of these factors to change, our actual losses and estimates of risk of loss inherent in our loan portfolio have varied and are likely to continue to vary from our current estimates. Such variances may materially and adversely affect our financial condition and results of operations.

Federal regulators, as an integral part of their examination process, periodically review our allowance for loan losses and may require us to increase our allowance for loan losses by recognizing additional provisions for loan losses charged to expense, or to decrease our allowance for loan losses by recognizing loan charge-offs. Any such additional provisions for loan losses or charge-offs, as required by these regulatory agencies, can have a material adverse effect on our financial condition and results of operations.

The Company has concentrations in commercial business and commercial real estate loans, increasing the risk in its loan portfolio.

In order to enhance the yield and shorten the term-to-maturity of its loan portfolio, the Company expanded its commercial business and commercial real estate lending for a number of years prior to 2008 and represented over 50% of the total loans receivable in each of the past five years. Much of the increase in the Company’s commercial real estate portfolio over this period was in land development loans, while many of the Company’s commercial business loans were made to borrowers associated with the real estate industry. Commercial business and commercial real estate loans generally, and land development loans in particular, 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.

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Furthermore, the repayment of loans secured by 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 or properties intended for resale are not developed and sold), the borrower’s ability to repay the loan and the underlying collateral may be impaired. Commercial business loans to businesses that are dependant on the cash flow generated by the sale or leasing of real estate are similarly impacted. The Company’s commercial business and commercial real estate loan portfolios have experienced difficulties in recent years, which has adversely affected the Company’s results of operations and financial condition. At December 31, 2011, the Company classified $34.0 million of loans as non-performing, of which $28.9 million related to commercial business and commercial real estate loans. At December 31, 2011, total classified loans included $85.5 million of commercial business and commercial real estate loans. The level of non-performing and other classified loans increased our loan loss provision and had a negative impact on our earnings. The Company may experience actual losses in respect of these classified loans and further increases in the level of classified loans in our loan portfolio that may require further increases in our provision for loan losses.

Declines in home values have decreased our loan originations and increased delinquencies and defaults, including in our commercial business and commercial real estate loans.

Declines in home values in our markets have adversely impacted and may continue to impact our results from operations. Like all financial institutions, the Company is subject to the effects of any economic downturn, and in particular, the significant decline in home values. More stringent lending standards implemented by the mortgage industry and the Company has made it more difficult for borrowers with marginal credit to qualify for a mortgage. This, along with overall weakness in the economy, has reduced the demand for single family homes and their corresponding value and has resulted in a decrease in new home equity loan originations and increased delinquencies and defaults in both the consumer home equity loan and residential real estate loan portfolios. The decline in the value of single family homes has also significantly impacted the delinquencies and defaults of our commercial real estate loans due to the decrease in estimated value of the underlying collateral and the inability of such commercial borrowers to generate cash flows from the related real estate development, which is often contingent upon the sale of such property. In the current environment, sales of these properties has been, and is anticipated to continue to be difficult. Commercial business loans to businesses that are dependant on the cash flow generated by the sale or renting of residential real estate are similarly impacted.

Regional economic changes in the Company’s markets have adversely impacted, and may continue to adversely impact, results from operations.

Like all financial institutions, the Company is subject to the effects of any economic downturn, and in particular a significant decline in home values and reduced commercial development in the Company’s markets has had a negative effect on results of operations. The Company’s success depends primarily on the general economic conditions in the counties in which the Company conducts business, and in the southern Minnesota and northern Iowa areas in general. Unlike larger financial institutions that are more geographically diversified, the Company provides banking and financial services to customers primarily in the southern Minnesota counties of Fillmore, Freeborn, Houston, Mower, Olmsted and Winona and portions of Steele, Dodge, Goodhue and Wabasha counties, as well as Marshall and Tama counties in Iowa. The local economic conditions in these market areas have a significant impact on the Company’s ability to originate loans, the ability of the borrowers to repay these loans and the value of the collateral securing these loans. A significant decline in the general economic conditions caused by inflation, recession, unemployment or other factors beyond the Company’s control can affect and has affected these local economic conditions and adversely affected the Company’s financial condition and results of operations. The Company has a significant amount of commercial business and commercial real estate loans and decreases in tenant occupancy and development home sales have had a negative effect on the ability of many of the Company’s borrowers to make timely repayments of their loans and the value of the collateral held as security for these loans, which has adversely impacted the Company’s earnings.

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Because of the limited size of the Company, losses on a few large loans or lending relationships can cause significant volatility in earnings.

Due to the Company’s limited size, individual loan amounts can be large relative to the Company’s earnings for a particular period. If one or a few relatively large loans become non-performing in a period and the Company is required to increase its loss reserves, or to write off principal or interest relative to such loans, the operating results for that period could be significantly adversely affected. The effect on results of operations for any given period from a change in the performance of a small number of loans may be disproportionately larger than the impact of such loans on the quality of the Company’s overall loan portfolio. In 2009, our internal loan limits were lowered to $4.5 million per borrower. However, existing borrowers with relationships over that limit were “grandfathered” in and it will take time to reduce the size of all existing relationships below the new limit. The Bank’s largest borrowing relationship had outstanding loans totaling $24.4 million and was performing at December 31, 2011.

We operate in a highly regulated environment and may be adversely affected by changes in federal and state laws and regulations, including recent changes under federal law.

The Company and the Bank are subject to extensive examination, supervision and comprehensive regulation by federal bank regulatory agencies. Banking regulations are primarily intended to protect depositors’ funds, federal deposit insurance funds, and the banking system as a whole, and not holders of our common stock. These regulations affect our lending practices, capital structure, investment practices, dividend policy, and growth, among other things. See Item 1 “Business – Regulation and Supervision” for information regarding regulation affecting the Bank and the Company.

On July 21, 2010, the President signed the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). The Dodd-Frank Act is changing the current bank regulatory structure and affecting the lending, deposit, investment, trading and operating activities of financial institutions and their holding companies. The Dodd-Frank Act requires various federal agencies to adopt a broad range of new implementing rules and regulations, and to prepare numerous studies and reports for Congress. The federal agencies are given significant discretion in drafting the implementing rules and regulations, and consequently, many of the details and much of the impact of the Dodd-Frank Act may not be known for months or years.

On July 21, 2011 (the “Transition Date”), Title III of the Dodd-Frank Act transferred to the Federal Reserve Board (“FRB”) the supervisory functions of the Office of Thrift Supervision (“OTS”) related to savings and loan holding companies, like the Company, and their nondepository subsidiaries.

The Dodd-Frank Act provides that all orders, resolutions, determinations, agreements, and regulations, interpretive rules, other interpretations, guidelines, and other advisory materials issued, made, prescribed, or allowed to become effective by the OTS on or before the transfer date with respect to savings and loan holding companies and their non-depository subsidiaries will remain in effect and shall be enforceable until modified, terminated, set aside, or superseded in accordance with applicable law by the FRB, by any court of competent jurisdiction, or by operation of law. Accordingly, the Supervisory Agreement entered into by the Company with the OTS is enforced by the FRB.

On September 13, 2011, the FRB published a final interim rule to implement certain provisions of Title III of the Dodd-Frank Act. Section 316 of the Dodd-Frank Act provides that all orders, resolutions, determinations, agreements, and regulations, interpretive rules, other interpretations, guidelines, and other advisory materials issued, made, prescribed, or allowed to become effective by the OTS on or before the transfer date with respect to savings and loan holding companies and their non-depository subsidiaries will remain in effect and shall be enforceable until modified, terminated, set aside, or superseded in accordance with applicable law by the Board, by any court of competent jurisdiction, or by operation of law. In the final interim rule, the FRB largely duplicated provisions of existing OTS regulations and codified them in a new Regulation LL. Most of the changes were non-substantive or are not expected to have material impact on the Company, its shareholders or the Bank. For example, the interim final rule states that a savings and loan holding company such as the Company

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must serve as a source of financial and managerial strength to its subsidiary savings associations and may not conduct its operations in an unsafe and unsound manner. Although these concepts are consistent with OTS policy, the Dodd-Frank Act placed the requirement in statute. Regulation LL reflects this requirement. The extent and timing of any substantive changes may have an impact on the Company’s capital requirements and liquidity but the effects are difficult to predict at this time.

As part of its new supervisory function for savings and loan holding companies, the FRB has direct oversight of the Company. The FRB has announced that it will assess the condition, performance and activities of savings and loan holding companies in a manner that is consistent with its established risk-based approach regarding bank holding company supervision to ensure that savings and loan holding companies are effectively supervised and can serve as a source of strength for, and do not threaten the soundness of, subsidiary depository institutions.

On the Transition Date, the Dodd-Frank Act transferred to the Office of the Comptroller of the Currency the supervisory functions of the Bank’s former regulator, the OTS. The Dodd-Frank Act provides that all orders, resolutions, determinations, agreements, and regulations, interpretive rules, other interpretations, guidelines, and other advisory materials issued, made, prescribed, or allowed to become effective by the OTS on or before the transfer date with respect to savings associations will remain in effect and shall be enforceable until modified, terminated, set aside, or superseded in accordance with applicable law by the OCC, by any court of competent jurisdiction, or by operation of law. Accordingly, the Supervisory Agreement entered into by the Bank with the OTS is enforced by the OCC.

Also effective on the Transition Date, a provision of the Dodd-Frank Act became effective that eliminates the federal prohibitions on paying interest on demand deposits, thus allowing businesses to have interest bearing checking accounts. Depending on competitive responses, this significant change to existing law could have an adverse impact on the Company’s interest expense.

Congress and federal regulatory agencies continually review banking laws, regulations, and policies for possible changes. Changes to statutes, regulations, or regulatory policies, including changes in interpretation or implementation of statutes, regulations, or policies, could affect us in substantial and unpredictable ways. Such changes could subject us to additional costs, limit the types of financial services and products we may offer, restrict mergers and acquisitions, investments, access to capital, the location of banking offices, or increase the ability of non-banks to offer competing financial services and products, among other things. Failure to comply with laws, regulations or policies could result in sanctions by regulatory agencies, civil money penalties and/or reputational damage, which could have a material adverse effect on our business, financial condition and results of operations. While we have policies and procedures designed to prevent any such violations, there can be no assurance that such violations will not occur.

Changes to federal law and regulations may also limit the Bank’s flexibility on financial products and fees which could result in additional operational costs and a reduction in our non-interest income.

Further, our regulators have significant discretion and authority to prevent or remedy unsafe or unsound practices or violations of laws by financial institutions and holding companies in the performance of their supervisory and enforcement duties. Examples include limits on payment of dividends by banks and regulations governing compensation. Regulation of dividends would limit the liquidity of the Company and limits on compensation may adversely affect our ability to attract and retain employees. See the other risk factors included in this Item 1.A. of this Form 10-K for a discussion of risks related to the Company’s and the Bank’s Supervisory Agreements to which we have become subject, for a discussion regarding the Bank IMCR, and for a discussion of other restrictions to which the Company and the Bank have become subject.

We have a recent history of losses and earning asset contraction, our continued high level of classified and nonperforming assets, accruing and unpaid preferred stock dividends and regulatory restrictions make our return to profitability and ability to grow uncertain.

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We have experienced net losses in each of the last four years. These losses have been primarily due to loan losses in our commercial loan portfolios. We continue to have relatively high levels of nonperforming and other classified assets that pose a risk to our interest income. Unpaid and accruing dividends on our outstanding preferred stock have further increased the net loss available to common stockholders since February 2011. In addition, in order to improve our capital ratios, we have significantly contracted the size of the Bank through reductions in assets, primarily loans, and in liabilities, primarily brokered deposits and advances. Total assets have decreased $245 million and brokered deposits and advances decreased $205 million in the two years prior to December 31, 2011. These reductions in assets and liabilities have correspondingly reduced the base of earning assets from which we realize our primary source of income, net interest income. Further, pursuant to the Bank’s Supervisory Agreement, the Bank is prohibited from increasing its total assets during any quarter in excess of an amount equal to net interest credited on deposit liabilities during the previous quarter without the prior consent of the OCC. Other regulatory actions, including the Supervisory Agreements and our participation in the TARP Capital Purchase Program restrict, among other things, Company and Bank dividends and compensation. Our failure fully to comply with the Supervisory Agreements and the IMCR may result in the imposition of additional restrictions. These factors may make it more difficult for us to return in the short term to profitable operations and earnings growth that inure to the benefit of our common stockholders.

Our participation in the Capital Purchase Program (CPP) under the Troubled Asset Relief Program (TARP) imposes restrictions on us affecting our capital stock and our compensation practices that may be adverse, and greater restriction is possible in the future; our failure to pay required dividends on the outstanding series A preferred stock is anticipated to result in May 2012 in the right of the U.S. Treasury to elect up to two additional directors to our board of directors.

As a participant in the U.S. Treasury’s CPP program, we issued $26 million of series A preferred stock to the Treasury in December 2008. Among other limitations, we are subject to certain restrictions relating to distributions on or repurchase of our common stock. Without the consent of Treasury, the Company can not declare or pay a dividend or make any distribution on our common stock, so long as any shares of our series A preferred stock remain outstanding, unless all accrued and unpaid dividends for all prior dividend periods have been paid or are contemporaneously declared and paid in full on our series A preferred stock, we may not pay or declare any dividend on our common stock or other junior stock, other than a dividend payable solely in common stock. In addition, prior to the series A preferred stock being redeemed or transferred by the Treasury, we may not, without the consent of Treasury, redeem, purchase or acquire any shares of our common stock or other capital stock or other equity securities, or any trust preferred securities that we issued, other than for limited exceptions. These restrictions limit our ability to manage our capital resources generally and, specifically, to return capital to our common stockholders, and may adversely affect the value of an investment in our common stock.

In February 2011, the Company suspended payment of regular quarterly cash dividends on its series A preferred stock following discussions with the OTS in order to preserve cash for potential future needs. Further, pursuant to the Company’s Supervisory Agreement, the Company may not declare or pay any cash dividends, including those on the series A preferred stock, without the consent of the OCC (as successor to the OTS). The Company intends to re-evaluate the deferral of these dividend payments periodically in consultation with the OCC, taking into account the Company’s financial condition, applicable legal restrictions and other relevant factors. Under the terms of the series A preferred stock, the Company is required to pay dividends on a quarterly basis at a rate of 5% for the first five years, after which the dividend rate automatically increases to 9%. Dividend payments on the series A preferred stock may be deferred without default, but the dividend is cumulative and, if the Company fails to pay dividends for six quarters, whether or not consecutive, the Treasury will have the right to elect two persons to the Company’s board of directors. The Company has failed to make each required dividend payment on the outstanding preferred stock commencing with February 15, 2011. The five unpaid and accrued dividend payments total $1.6 million. At this time, the Company does not anticipate making any payment of dividends on the series A preferred stock during 2012. As a result, in accordance with the terms of the series A preferred stock, should the Company fail to make the May 15, 2012 dividend payment, the Treasury, as the sole holder of the series A preferred stock, will have the right at the next annual or special meeting of stockholders, and thereafter until all accrued and unpaid dividends are paid, to elect up to two persons to our board of directors.

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As a CPP participant, we are also subject to various executive compensation and corporate governance restrictions that limit our flexibility in determining appropriate compensation for our senior executive officers and other more highly compensated employees and may adversely affect the attraction and retention of management and other key employees. Among other things, the current restrictions (i) prohibit any bonus, retention award or incentive compensation to our five most highly compensated employees unless it is in the form of long-term restricted common stock that does not vest in the first two years after it is issued and that cannot be transferred except as permitted under a schedule that is based on our redemption of the preferred stock, (ii) prohibit payment of severance for any reason to our executive officers and any of the next five most highly compensated employees, (iii) require us to recover from our executive officers and the next 20 most highly compensated employees any bonus, retention award or incentive compensation when based on materially inaccurate earnings, revenues, gains or other criteria, (iv) require us to permit a non-binding stockholder vote on executive pay, (v) required Treasury to conduct a review of bonuses, retention awards and other compensation paid to our executive officers and the next 20 most highly compensated employees to determine whether such payments were inconsistent with the amended law or TARP or were otherwise contrary to the public interest and to seek their recovery if not, (vi) prohibit incentive compensation to executive officers that encourage unnecessary and excessive risks that threaten the value of our company, and require our compensation committee to periodically review employee compensation plans in light of the risks posed to the Company and take steps to limit those risks. These restrictions apply to us so long as Treasury holds any of our securities (unless it holds only our warrants). Treasury is required to adopt regulations requiring each recipient of CPP funds to meet appropriate standards for executive compensation and corporate governance, including those listed above. The Supervisory Agreements entered into by the Company and the Bank also impose limitations on entry into, or amendment of, certain compensatory and employment arrangements with directors and executive officers. Please see “Item 1 – Business – Regulation and Supervision – Bank Regulation” of this Form 10-K for additional information.

The securities purchase agreement with Treasury permits Treasury unilaterally to modify the agreement to the extent required to comply with any changes after its execution in applicable federal statutes. Whether by means of the foregoing, the exercise of general oversight powers or otherwise, additional, more restrictive legislative or regulatory changes are possible in the future with which we would be obligated to comply and which may affect adversely our operations, the ownership of our capital stock, our financial condition and results of operations, our management and other aspects of our business.

Changes in interest rates could negatively impact the Company’s results of operations.

The earnings of the Company are primarily dependent on net interest income, which is the difference between interest earned on loans and investments and interest paid on interest-bearing liabilities such as deposits and borrowings. Interest rates are highly sensitive to many factors, including government monetary and fiscal policies and domestic and international economic and political conditions. Conditions such as inflation, recession, unemployment, money supply, government borrowing and other factors beyond management’s control may also affect interest rates. If the Company’s interest-earning assets mature, reprice or prepay more quickly than interest-bearing liabilities in a given period, a decrease in market interest rates could adversely affect net interest income. Likewise, if interest-bearing liabilities mature or reprice, or, in the case of deposits, are withdrawn by the accountholder, more quickly than interest-earning assets in a given period, an increase in market interest rates could adversely affect net interest income. Given the Company’s mix of assets and liabilities as of December 31, 2011, a falling interest rate environment would negatively impact the Company’s results of operations. The effect on our deposits of decreases in interest rates generally lags the effect on our assets. The lagging effect of deposit rate changes is primarily due to the Bank’s deposits that are in the form of certificates of deposit, which do not re-price immediately when the federal funds rate changes.

Fixed rate loans increase the Company’s exposure to interest rate risk in a rising rate environment because interest-bearing liabilities would be subject to repricing before assets become subject to repricing. Adjustable rate loans decrease the risks to a lender associated with changes in interest rates but involve other risks. As interest

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rates rise, the payment by the borrower rises to the extent permitted by the terms of the loan, and the increased payment increases the potential for default. At the same time, for secured loans, the marketability of the underlying collateral may be adversely affected by higher interest rates. In a declining interest rate environment, there is likely to be an increase in prepayment activity on loans as the borrowers refinance their loans at lower interest rates. Under these circumstances, the Company’s results of operations could be negatively impacted.

Changes in interest rates also can affect the value of loans, investments and other interest-rate sensitive assets including mortgage servicing rights, and the Company’s ability to realize gains on the sale or resolution of assets. This type of income can vary significantly from quarter-to-quarter and year-to-year based on a number of different factors, including the interest rate environment. An increase in interest rates that adversely affects the ability of borrowers to pay the principal or interest on loans may lead to an increase in non-performing assets and increased loan loss reserve requirements that could have a material adverse effect on the Company’s results of operations.

Changes in interest rates or prepayment speeds could negatively impact the value of capitalized mortgage servicing rights.

The capitalization, amortization and impairment of mortgage servicing rights are subject to significant estimates. These estimates are based upon loan types, note rates and prepayment speed assumptions. Changes in interest rates or prepayment speeds may have a material effect on the net carrying value of mortgage servicing rights. In a declining interest rate environment, prepayment speed assumptions will increase and result in an acceleration in the amortization of the mortgage servicing rights as the assumed underlying portfolio declines and also may result in impairment as the value of the mortgage servicing rights declines.

The extended disruption or compromise of vital infrastructure, including the Company’s technology systems, could negatively impact the Company’s results of operations and financial condition.

The Company’s business depends on its ability to process, record and monitor a large number of transactions. The Company’s technological and physical infrastructures, which include its financial, accounting and other data processing systems, are vital to its operation. Extended disruption or compromise of its vital infrastructure by fire, power loss, natural disaster, telecommunications failure, computer hacking and viruses, terrorist activity or the domestic and foreign response to such activity, or other events outside of the Company’s control, could cause the Company to suffer regulatory consequences, reputational damage and financial losses, any of which, could have a material adverse effect either on the financial services industry as a whole, or on the Company’s business, financial condition and results of operations.

Strong competition within the Company’s market area may limit profitability or increase losses.

The Company faces significant competition both in attracting deposits and in the origination of loans, as described under the heading “Business – Competition.” Mortgage bankers, commercial banks, credit unions and other savings institutions, which have offices in the Bank’s market area have historically provided most of the Company’s competition for deposits and loans; however, the Company also competes with financial institutions that operate through Internet banking operations throughout the United States. In addition, and particularly in times of high interest rates, the Company faces additional and significant competition for funds 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 United States. Many competitors have substantially greater financial and other resources than the Company. Finally, credit unions do not pay federal or state income taxes and are subject to fewer regulatory constraints than savings banks and as a result, they may enjoy a competitive advantage over the Company. 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. This competitive strategy places significant competitive pressure on the prices of loans and deposits.

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Our reputation and its attributes are key assets of our business. Our recent operating performance, elevated level of non-performing assets and enhanced regulatory scrutiny and associated adverse publicity could adversely affect the perception of our customers and prospective customers in our markets, our employees, investors and other stakeholders.

Loss of large checking and money market deposit customers could increase cost of funds and have a negative effect on results of operations.

The Company has a number of large deposit customers that maintain balances in checking and money market accounts at the Bank. At December 31, 2011, there were $60.0 million in checking and money market accounts of customers that have relationship balances greater than $5 million. Approximately $20.7 million of the $60.0 million in deposits are expected to be sold as part of the Toledo Branch sale that is to be completed in the first quarter of 2012. The ability to attract and retain these types of deposits has a positive effect on the Company’s net interest margin as they provide a relatively low cost of funds to the Company compared to certificates of deposits or advances. If these depositors were to withdraw these funds and the Bank was not able to replace them with similar types of deposits, the Banks cost of funds would increase and the Company’s results of operation would be negatively impacted.

We are subject to the Community Reinvestment Act and fair lending laws, and failure to comply with these laws could lead to material penalties.

The Community Reinvestment Act (CRA) and fair lending laws and regulations impose nondiscriminatory lending requirements on financial institutions. The Department of Justice and other federal agencies are responsible for enforcing these laws and regulations. A successful challenge to an institution’s performance under the CRA or fair lending laws and regulations could result in a wide variety of sanctions, including the required payment of damages and civil money penalties, injunctive relief, imposition of restrictions on mergers and acquisitions activity, and restrictions on expansion activity. Private parties may also have the ability to challenge an institution’s performance under fair lending laws in private class action litigation.

The USA Patriot Act and Bank Secrecy Act may subject us to large fines for non-compliance.

The USA Patriot and Bank Secrecy Acts require financial institutions to develop programs to prevent financial institutions from being used for money laundering and terrorist activities. If these activities are detected, financial institutions are obligated to file suspicious activity reports with the U.S. Treasury Department’s Office of Financial Crimes Enforcement Network. These rules require financial institutions to establish procedures for identifying and verifying the identity of customers seeking to open new financial accounts. Failure to comply with these regulations could result in fines or sanctions. In recent years, several banking institutions have received large fines for non-compliance with these laws and regulations. Although the Company has developed policies and procedures designed to ensure compliance, regulators may take enforcement action against the Company in the event of noncompliance.

The price of our common stock has been volatile and could continue to fluctuate in the future.

During the year ended December 31, 2011, the closing price of our common stock on The NASDAQ Global Market ranged from $1.50 to $3.22 per share, and over the period from January 1, 2010 to December 31, 2011 it has ranged from $1.50 to $6.78. Our closing sale price on December 31, 2011 was $1.94 per share. Our stock generally trades in low volumes and its price may fluctuate in response to a number of events and factors, including, but not limited to, variations in operating results, litigation or governmental and regulatory proceedings, market perceptions of our financial reporting, changes in financial estimates and recommendations by securities analysts, the operating and stock price performance of other companies that investors may deem comparable to us, and news reports relating to trends in our markets or general economic conditions.

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We may issue additional stock, or reissue shares of treasury stock, without shareholder consent.

We have authorized 11,000,000 shares of common stock, of which 4,387,951 shares were issued and outstanding, 4,740,711 shares were held as treasury stock, and 1,871,338 shares were unissued, as of December 31, 2011. We have 70,821 shares reserved for issuance pursuant to outstanding warrants and our equity incentive plans. The board of directors has authority, without action or vote of the shareholders, to issue all or part of the authorized but unissued shares and to reissue all of the treasury shares. Additional shares may be issued, or treasury shares reissued, in connection with future financing, acquisitions, employee stock plans, or otherwise. Any such issuance, or reissuance, will dilute the percentage ownership of existing stockholders. We are also currently authorized to issue up to 500,000 shares of preferred stock. As of March 7, 2012, there were 26,000 shares issued and outstanding of our fixed rate cumulative perpetual preferred stock, series A. These shares have a preference in payment of dividends and proceeds of any liquidation relative to our common stock. Under our certificate of incorporation, our board of directors can issue additional preferred stock in one or more series and fix the terms of such stock without shareholder approval. Preferred stock may include the right to vote as a series on particular matters, preferences as to dividends and liquidation, conversion and redemption rights and sinking fund provisions. The issuance of preferred stock could adversely affect the rights of the holders of common stock and reduce the value of the common stock. In addition, specific rights granted to holders of preferred stock could be used to restrict our ability to merge with or sell our assets to a third party.

Future sale of shares of our common stock in the public market could depress our stock price.

Shares issuable upon exercise of the warrant issued to the U.S. Treasury in connection with its purchase of series A preferred stock represented beneficial ownership of approximately 16% of our common stock as of December 31, 2011. We have registered the resale of these warrants and underlying common stock under the Securities Act and these securities may also be eligible for sale publicly under Rule 144 under the Securities Act of 1933 in certain circumstances. Sales of substantial amounts of our common stock, whether under the foregoing registration statement or otherwise, or the perception that those sales could occur may adversely affect the market price of our common stock.

Our ability to pay dividends on or repurchase our common stock is significantly restricted; we have not paid a dividend on our common stock since 2008 and our current financial condition and results of operations and accrued and unpaid preferred dividends make payment of any such dividend unlikely in the foreseeable future.

We are a stock savings bank holding company and our operations are conducted primarily by our banking subsidiary, Home Federal Savings Bank. Since we receive substantially all of our revenue from dividends from our banking subsidiary, our ability to pay dividends on our common stock depends on our receipt of dividends from our banking subsidiary. Dividend payments from our banking subsidiary are subject to legal and regulatory limitations, generally based on net income and retained earnings. The ability of our banking subsidiary to pay dividends to us is also subject to its profitability, financial condition, capital expenditures and other cash flow requirements. The Bank is not currently permitted to pay dividends to the Company under applicable limitations, and the further restrictions described below. There is no assurance that our banking subsidiary will be able to pay dividends to us in the future or that we will generate adequate cash flow to pay dividends in the future. The inability to receive dividends from our banking subsidiary could have an adverse affect on our business and financial condition.

On October 20, 2008, we announced that our board of directors had decided to suspend the payment of quarterly cash dividends on shares of Company common stock. Since that time, the Company and the Bank have entered into the Supervisory Agreements which prohibit the declaration or payment of any cash dividend or repurchase or redemption of any equity stock of these entities without advance notice to the applicable banking regulator and receipt of written non-objection therefrom.

In addition, so long as any shares of our series A preferred stock remain outstanding, unless all accrued and unpaid dividends for all prior dividend periods have been paid or are contemporaneously declared and paid in full on our series A preferred stock, we may not pay or declare any dividend on our common stock or other junior stock, other than a dividend payable solely in common stock. Holders of shares of series A preferred stock are entitled to receive cumulative cash dividends at a rate per annum of 5% per share on a liquidation preference of $1,000 per share of series A preferred stock with respect to each dividend period from December 23, 2008 to, but

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excluding, February 15, 2014. From and after February 15, 2014, holders of shares of series A preferred stock are entitled to receive cumulative cash dividends at a rate per annum of 9% per share on a liquidation preference of $1,000 per share of series A preferred stock. Beginning with the dividend payment due February 15, 2011, the Company has failed to make any required series A preferred stock dividend payment. As of February 15, 2012, the aggregate accrued and unpaid series A preferred dividends totaled $1.6 million. No dividend is anticipated to be paid on the series A preferred stock in 2012. Any such series A preferred dividend which is accrued and unpaid is senior in right of payment to any common stock dividend and must be satisfied in full before any common stock dividend may be made.

These factors make payment of any common stock dividend unlikely in the foreseeable future.

Provisions of our certificate of incorporation and bylaws, as well as Delaware and federal law, may discourage, delay or prevent an acquisition of control of us, even in situations that may be viewed as desirable by our stockholders.

Provisions included in our certificate of incorporation and bylaws, as well as provisions of the Delaware General Corporation Law and federal law, may discourage, delay or prevent potential acquisitions of control of us, particularly when attempted in a transaction that is not negotiated directly with, and approved by, our board of directors, despite perceived short-term benefits to our stockholders, such as in increase in the trading price of our common stock.

Specifically, our certificate of incorporation and bylaws include provisions that:

• limit the voting power of shares held by a stockholder beneficially owning in excess of 10% of the outstanding shares of our common stock;

• require that, with limited exceptions, business combinations between us and a stockholder beneficially owning in excess of 10% of the outstanding shares of our stock entitled to vote in the election of directors be approved by at least 80% of the total number of our outstanding voting shares;

• require that prior to acquiring shares from a stockholder that owns 5% or more of our voting stock, with limited exception, holders of 80% or more of our voting stock outstanding, other than shares held by the selling stockholder, must approve the transaction;

• divide our board of directors, other than directors who may be elected by a class or series of preferred stock, into three classes serving staggered three-year terms and provide that a director may only be removed prior to the expiration of a term for cause by the affirmative vote of the holders of at least 80% of the voting power of all of the outstanding shares of capital stock entitled to vote in an election of directors;

• require that a special meeting of stockholders be called pursuant to a resolution adopted by a majority of our board of directors;

• require advance notice of nominations of directors to be made, or business to be brought, by stockholders at our annual meetings;

• authorize the issuance of preferred stock with such designations, rights and preferences as may be determined from time to time by our board of directors; and

• require that amendments to (i) our certificate of incorporation be approved by a two-thirds vote of our board of directors and by a majority of the outstanding shares of our voting stock or, with respect to the amendment of certain provisions (regarding, among other things, provisions relating to number, classification, election and removal of directors, amendment of the bylaws, call of special stockholder meetings, acquisitions of control, director liability, and certain business combinations), by 80% of the outstanding shares of our voting stock, and (ii) our bylaws be approved by a majority vote of our board of directors or the affirmative vote of at least 80% of the total votes eligible to be voted at a duly constituted meeting of stockholders.

We are subject to the provisions of Section 203 of the Delaware General Corporation Law, which prohibits a publicly-held Delaware corporation from engaging in a “business combination” with an “interested stockholder”

45

for a period of three years after the date of the transaction in which the person became an interested stockholder, unless the business combination is approved in a prescribed manner. For purposes of Section 203, a “business combination” includes a merger, asset sale or other transaction resulting in a financial benefit to the interested stockholder, and an “interested stockholder” is a person who, either alone or together with affiliates and associates, owns (or within the past three years, did own) 15% or more of the corporation’s voting stock.

Furthermore, federal law requires OCC approval prior to any direct or indirect acquisition of control (as defined in OTS regulations) of our banking subsidiary, including any acquisition of control of us.

Our outstanding preferred stock has a liquidation preference over our common stock.

In the event that we voluntarily or involuntarily liquidate, dissolve or wind up our affairs, holders of our series A preferred stock would be entitled to receive an amount per share, referred to as the total liquidation amount, equal to the fixed liquidation preference of $1,000 per share, plus any accrued and unpaid dividends, whether or not declared, to the date of payment. Holders of the series A preferred stock would be entitled to receive the total liquidation amount out of our assets that are available for distribution to stockholders, after payment or provision for payment of our debts and other liabilities but before any distribution of assets is made to holders of our common stock.

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

ITEM 2. PROPERTIES

The Company leases its corporate office in Rochester, Minnesota and owns the buildings and land for 9 of its 13 full service branches. The remaining four full service branches and one loan origination office are leased. These leased offices are located at 1016 Civic Center Drive NW, Rochester, Minnesota, 3900 55^th Street NW, Rochester, Minnesota and 2805 Dodd Road, Suite 160, Eagan, Minnesota. The Company’s leased private banking office is located at 100 1^st Ave Bldg., Suite 200, Rochester, Minnesota. The Company’s loan origination office is located at 50 14^th Avenue East, Suite 100, Sartell, Minnesota. The Bank uses all properties and they are all located in Minnesota, except for the two full service branches located in Iowa. A sale of substantially all of the assets of the Toledo Branch, including owned real estate, is expected to be consummated in the first quarter of 2012.

ITEM 3. LEGAL PROCEEDINGS

From time to time, the Company is party to legal proceedings arising out of its lending and deposit operations. The Company is, and expects to become, engaged in a number of foreclosure proceedings and other collection actions as part of its collection activities. Litigation is often unpredictable and the actual results of litigation cannot be determined with any certainty.

The Company entered into a written Supervisory Agreement with the OTS effective February 22, 2011. The Supervisory Agreement replaced the prior memorandum of understanding that the Company entered into with the OTS on December 9, 2009. The material requirements of the Company Supervisory Agreement are as follows:

• Submission of a written plan by May 31, 2011 for enhancing the consolidated capital of the Company for the period ending December 31, 2012 and review of performance no less than quarterly along with reports to the FRB (as successor to the OTS’ role as regulator of the Company) within 45 days after the end of each calendar quarter. The plan submitted by the Company prior to May 31, 2011 focused on improvement in capital levels primarily through improved earnings, reduction in non-performing assets and reduction in total assets. As required, the Company submitted an updated two-year capital plan in January 2012.

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• The Company may not declare, make or pay any cash dividends or repurchase or redeem any of the Company’s equity stock without providing advance notice to the FRB and receiving written non-objection.

• The Company may not incur, issue, renew, rollover or pay interest or principal on any debt or commit to do so nor may it increase any current lines of credit or guarantee the debt of any entity without prior written notice and written non-objection of the FRB.

• Limits were placed on contractual arrangements related to compensation or benefits with any directors or officers and the Company is prevented from making any golden parachute payments to officers, directors or employees.

The Bank also entered into a written Supervisory Agreement with the OTS, effective February 22, 2011. The Bank Supervisory Agreement replaced the prior memorandum of understanding that the Bank entered into with the OTS on December 9, 2009. The material requirements of the Bank Supervisory Agreement are as follows:

• Submission of a business plan by May 31, 2011, addressing strategies for supporting the Bank’s risk profile, improving earnings and profitability and stress testing. The Bank’s Board is to review performance no less than quarterly and report to the OCC (as successor to the OTS’s role as regulator of the Bank) within 45 days after the end of each calendar quarter. The plan submitted by the Bank prior to May 31, 2011 focused on improvement in capital levels primarily through improved earnings, reduction in non-performing assets and reduction in total assets. The OCC accepted the submitted plan with the expectation that the Bank will be in adherence with the OCC’s Notification of Establishment of Higher Minimum Capital Ratios, dated August 8, 2011, requiring a minimum core capital ratio of 8.5% by December 31, 2011. The Bank submitted an updated two-year business plan in January 2012 to the OCC.

• Submission of a detailed written plan prior to March 31, 2011 to reduce the Bank’s problem assets. The plan submitted by the Bank by March 31, 2011 was accepted by the OCC and focused on improvement in the level of problem assets as a result of continuing the actions taken in 2010 and early 2011 by the Board and management to improve credit quality and more effectively identify and manage problem loans in a proactive manner.

• Development of individual written specific workout plans for certain large adversely classified loans or groups of loans and for foreclosed real estate owned by the Bank within 30 days of the Supervisory Agreement effective date. The plans developed by the Bank focused on improving the ultimate collection of these items by improving the Bank’s collateral position or by an orderly liquidation of the collateral securing the assets.

• Beginning with the quarter ended June 30, 2011, the Bank is to submit quarterly asset reports to the OCC within 50 days of quarter end. The reports submitted by the Bank focused on status of workout plans, classified assets, actions taken to reduce problem assets and recommended revisions to the problem asset plan.

• Development by April 30, 2011 of a loan modification policy. The policy developed by the Bank focuses on enhanced supporting documentation and procedures relating to all loan restructurings, including those not determined to be Troubled Debt Restructurings.

• Revision of the Bank’s written credit concentration program and submission of the program by May 6, 2011 to the OTS. The plan addresses identifying, monitoring and controlling risk associated with concentrations of credit. The Bank has implemented the revisions and is monitoring the resulting information.

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• Improvement of the documentation relating to the allowance for loan and lease losses to ensure that it addressed OTS concerns. The documentation improvements related primarily to the inclusion of established specific reserves into the commercial loan migration charge-off analysis.

• The Bank may not declare or pay any dividends or make any other capital distributions without providing advance request to the OCC and receiving written approval. The Supervisory Agreement also limits the Bank’s growth in total assets in excess of specified amounts without prior regulatory approval. The Bank’s assets grew in excess of the allowable amount in the third quarter of 2011; however, the Bank obtained prior approval from the OCC.

• Limits are placed on contractual arrangements with third parties and contracts dealing with compensation or benefits with any directors or officers and the Bank is prevented from making any golden parachute payments to directors, officers and employees.

The Company and Bank timely submitted all plans and programs required by the Supervisory Agreements. The Company believes that it and the Bank are in compliance with all provisions of the Supervisory Agreements, except for their failure at December 31, 2011 to meet the earnings and capital forecasts contained in their respective capital and business plans, and the failure of the Bank to meet its Individual Minimum Capital Requirement, as described below. The applicable regulator may comment on and require revision of any submitted plan, program or policy. Neither the Company nor the Bank have taken any actions, or sought approval for such actions, where prior regulatory approval is required by the Supervisory Agreements other than the restriction related to asset growth and changes to the business plan. In the third quarter of 2011, the Bank requested and obtained a non-objection waiver from the OCC related to the unanticipated growth in assets during the third quarter in an amount greater than the net interest credited on deposit liabilities during the prior quarter. The Bank also received no supervisory objection to the change in the previously submitted business plan as a result of the increase in assets. The increase in assets was due to unanticipated increases in commercial deposits during the third quarter of 2011 as a result of increased cash being held by a few of the Bank’s commercial deposit customers.

The foregoing is merely a summary of the material terms of the Supervisory Agreements and reference is made to the full text of the Supervisory Agreements which are set forth as Exhibits 10.1 and 10.2 to the Company’s Current Report on Form 8-K dated February 10, 2011.

Dissolution of the OTS did not have any material impact on the Supervisory Agreements as the Supervisory Agreements are now enforced by the FRB in the case of the Company’s Supervisory Agreement and the OCC in the case of the Bank’s Supervisory Agreement.

The OCC has established an Individual Minimum Capital Requirement, or IMCR, for the Bank. An IMCR requires a bank to establish and maintain levels of capital greater than those generally required for a bank to be classified as “well-capitalized.” Effective December 31, 2011, the Bank was required to establish, and subsequently maintain, core capital at least equal to 8.5% of adjusted total assets, which was in excess of the Bank’s 7.14% core capital to adjusted total assets ratio at December 31, 2011. The Bank would have needed $10.8 million in additional capital at December 31, 2011 to meet the minimum core capital ratio set by the OCC. In February 2012, the Bank received a notice from the OCC arising out of its failure to establish and maintain its IMCR of 8.5% core capital to adjusted total assets at December 31, 2011. By April 30, 2012, the Bank must submit to the OCC a further written capital plan of how it will achieve and maintain its IMCR, and a contingency plan in the event the IMCR is not achieved through the Bank’s primary plan. The Bank’s failure to comply with the terms of the IMCR is deemed an unsafe and unsound banking practice.

Under applicable banking regulations, the failure to satisfy the terms of the Supervisory Agreements and the IMCR, and failure to otherwise comply with applicable requirements as they arise, could subject the Company, the Bank and its directors and officers to such restrictions, legal actions or sanctions as the OCC considers appropriate. Possible sanctions include among others (i) the imposition of one or more cease and desist orders

48

requiring corrective action, which are enforceable directives that may address any aspect of the Company or Bank management, operations or capital, including requirements to change management, raise equity capital, dispose of assets or effect a change of control; (ii) civil money penalties; and (iii) downgrades in the capital adequacy status of the Company and the Bank.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

PART II

ITEM 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

The information on page 28 under the caption “Dividends”, “Note 15 Stockholders’ Equity”, and page 76 under the caption “Common Stock Information” and the inside back cover page of the Annual Report is incorporated herein by reference. Under the terms of the Supervisory Agreement that the Company entered into with the OTS effective February 22, 2011, the Company may not declare or pay any cash dividend without prior notice to, and the consent of, the FRB (as successor to the OTS). The Bank, the Company’s primary source of cash flow to pay dividends, is also restricted from the declaration or payment of cash dividends to the Company by the terms of its Supervisory Agreement.

Furthermore, so long as any shares of our series A preferred stock remain outstanding, unless all accrued and unpaid dividends for all prior dividend periods have been paid or are contemporaneously declared and paid in full on our series A preferred stock, we may not pay or declare any dividend on our common stock or other junior stock, other than a dividend payable solely in common stock. Also, the Company deferred the dividend payment on the outstanding series A preferred stock that was due on February 15, 2011 in order to preserve cash for potential future needs. Under the terms of the certificate of designations for the series A preferred stock, dividend payments may be deferred without default, but the dividend is cumulative and, if the Company fails to pay dividends for six quarters, whether or not consecutive, the Treasury will have the right to elect two persons to the Company’s board of directors. The Company has failed to make each required dividend payment on the outstanding series A preferred stock commencing with February 15, 2011. The five unpaid and accrued dividend payments total $1.6 million. At this time, the Company does not anticipate making any payment of dividends on the series A preferred stock during 2012. As a result, in accordance with the terms of the series A preferred stock, should the Company fail to make the May 15, 2012 dividend payment, the Treasury, as the sole holder of the series A preferred stock, will have the right at the next annual or special meeting of stockholders, and thereafter until all accrued and unpaid dividends are paid, to elect up to two persons to our board of directors.

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STOCKHOLDER RETURN PERFORMANCE PRESENTATION

The following graph and table compares the total cumulative stockholders’ return on the Company’s common stock to the NASDAQ U.S. Stock Index (“NASDAQ Composite”), which includes all NASDAQ traded stocks of U.S. companies, and the SNL Bank NASDAQ Index. The graph and table assume that $100 was invested on December 31, 2006 and that all dividends were reinvested.

	Period Ending
Index	12/31/06		12/31/07		12/31/08		12/31/09		12/31/10		12/31/11
HMN Financial, Inc.		100.00		73.53		13.04		13.10		8.76		6.04
NASDAQ Composite		100.00		110.66		66.42		96.54		114.06		113.16
SNL Bank NASDAQ Index		100.00		78.51		57.02		46.25		54.57		48.42

ITEM 6. SELECTED FINANCIAL DATA

The information on page 5 under the caption “Five Year Consolidated Financial Highlights” of the Annual Report is incorporated herein by reference.

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

The table on page 7 and the tables regarding investment maturities on page 17 of Part 1 Item 1 of this report, as well as the information on pages 6 through 32 under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, other than the section captioned “Market Risk”, of the Annual Report is incorporated herein by reference.

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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

The information on pages 30 through 31 under the captions “Market Risk” and “Asset/Liability Management” of the Annual Report is incorporated herein by reference.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The financial statements (including the notes to the financial statements) on pages 33 through 70 of the Annual Report, 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 Bank’s President (our Principal Executive Officer) and our Chief Financial Officer (our Principal 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 report. Based on that evaluation, the Principal Executive Officer and Principal 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.

Management’s Annual Report on Internal Control over Financial Reporting. The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.

Internal control over financial reporting includes those policies and procedures that pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company; provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are only being made in accordance with authorizations of management and directors of the Company; and provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements.

Any control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. The design of a control system inherently has limitations, and the benefits of controls must be weighed against their costs. Additionally, controls can be circumvented by the individual acts of some persons by collusion of two or more people, or by management override of the control. Therefore, no assessment of a cost-effective system of internal controls can provide absolute assurance that all control issues and instances of fraud, if any, will be detected.

Under the supervision and with the participation of management, including the Principal Executive Officer and Principal Financial Officer, the Company conducted an evaluation of the effectiveness of its internal control over financial reporting based on the framework in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on the Company’s evaluation under this framework, the Company’s management concluded that the Company’s internal control over financial reporting was effective as of December 31, 2011. The Company has not included an attestation report of our independent

51

registered public accounting firm regarding internal control over financial reporting. Our independent registered public accounting firm is not required to attest to management’s report pursuant to Item 308(b) of Regulation S-K because the Company is not an accelerated filer or large accelerated filer.

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 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.

ITEM 9B. OTHER INFORMATION

None.

PART III

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

The information required by this Item is incorporated by reference from the information under the caption “Executive Officers” in Part I of this report and under the captions “Board of Directors,” “Committees of the Board of Directors” and “Section 16(a) Beneficial Ownership Reporting Compliance” in the Company’s definitive proxy statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the close of the Company’s fiscal year ended December 31, 2011.

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

ITEM 11. EXECUTIVE COMPENSATION

The information required by this Item is incorporated by reference from the information under the caption “2011 Executive Compensation”, “Compensation Discussion and Analysis”, “2011 Director Compensation”, “Compensation Committee Report” and “Compensation Committee Interlocks and Insider Participation” in the Company’s definitive proxy statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the close of the Company’s fiscal year ended December 31, 2011.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The information required by this Item is incorporated by reference from the information under the captions “Security Ownership of Management and Certain Beneficial Owners” and “Other Equity Compensation Plan Information” in the Company’s definitive proxy statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the close of the Company’s fiscal year ended December 31, 2011.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

The information required by this Item is incorporated by reference from the information under the captions “Proposal I – Election of Directors – Board of Directors” and “Corporate Governance – Committees of the Board of Directors; – Director Independence; –Related Person Transaction Approval Policy; and – Certain Transactions” in the Company’s definitive proxy statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the close of the Company’s fiscal year ended December 31, 2011.

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ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

The information required by this Item is incorporated by reference from the information under the captions “Corporate Governance – Independent Registered Public Accounting Firm Fees” and “Approval of Independent Registered Public Accounting Firm Services and Fees” in the Company’s definitive proxy statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the close of the Company’s fiscal year ended December 31, 2011.

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PART IV

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

1. Financial Statements

The following financial statements appearing in the Company’s Annual Report, are incorporated herein by reference.

Annual Report Section	Pages in 2011 Annual Report
Consolidated Balance Sheets – December 31, 2011 and 2010	33
Consolidated Statements of Loss – Each of the Years in the Three-Year Period Ended December  31, 2011	34
Consolidated Statements of Stockholders’ Equity and Comprehensive Loss – Each of the Years in the Three-Year Period Ended December 31, 2011	35
Consolidated Statements of Cash Flows – Each of the Years in the Three-Year Period Ended December  31, 2011	36
Notes to Consolidated Financial Statements	37
Report of Independent Registered Public Accounting Firm	72

2. Financial Statement Schedules

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

3. Exhibits

The exhibits filed with this report are set forth on the Exhibit Index filed as part of this report immediately following the signatures.

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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 7, 2012	By:	/s/ Bradley C. Krehbiel
		Bradley C. Krehbiel,
		President

Each of the undersigned hereby appoints Hugh C. Smith and Jon J. Eberle, and each of them (with full power to act alone), as attorneys and agents for the undersigned, with full power of substitution, for and in the name, place and stead of the undersigned, to sign and file with the Securities and Exchange Commission under the Securities Act of 1934, as amended, any and all amendments and exhibits to this Form 10-K and any and all applications, instruments, and other documents to be filed with the Securities and Exchange Commission pertaining to this Form 10-K or any amendments thereto, with full power and authority to do and perform any and all acts and things whatsoever requisite and necessary or desirable. Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities indicated on March 7, 2012.

Name	Title
/s/ Bradley C. Krehbiel     Bradley C. Krehbiel	President (Principal Executive Officer)
/s/ Jon J. Eberle     Jon J. Eberle	Senior Vice President, Chief Financial Officer and Treasurer (Principal Financial and Accounting Officer)
/s/ Hugh C. Smith     Hugh C. Smith	Chairman of the Board
/s/ Mahlon C. Schneider     Mahlon C. Schneider	Director
/s/ Michael J. Fogarty     Michael J. Fogarty	Director
/s/ Karen L. Himle     Karen L. Himle	Director
/s/ Susan K. Kolling     Susan K. Kolling	Director
/s/ Malcolm W. McDonald     Malcolm W. McDonald	Director
/s/ Bernard R. Nigon     Bernard R. Nigon	Director
/s/ Allen R. Berning     Allen R. Berning	Director

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INDEX TO EXHIBITS

Exhibit Number	Exhibit	Filing Status
3.1	Certificate of Incorporation, as amended April 28, 1998	Incorporated by Reference  (1)
3.2	Amended and Restated By-laws	Incorporated by Reference (2)
4.1	Form of Common Stock Certificate	Incorporated by Reference (3)
4.2	Certificate of Designations of Fixed Rate Cumulative Perpetual Preferred Stock, Series A	Incorporated by Reference (4)
4.3	Warrant to Purchase Common Stock, dated December 23, 2008	Incorporated by Reference (5)
10.2†	Form of Change in Control Agreement with executive officers	Incorporated by Reference (6)
10.3†	Directors Deferred Compensation Plan	Incorporated by Reference (7)
10.4†	Amended and Restated HMN Financial, Inc. Stock Option and Incentive Plan dated July 29, 1998	Incorporated by Reference (8)
10.5†	HMN Financial, Inc. 2001 Omnibus Stock Plan	Incorporated by Reference (9)
10.6†	Form of Incentive Stock Option Agreement for HMN Financial, Inc. 2001 Omnibus Stock	Incorporated by Reference  (10)
10.7†	Form of Non-Statutory Stock Option Agreement for HMN Financial, Inc. 2001 Omnibus Stock Plan	Incorporated by Reference (11)
10.8†	Form of Restricted Stock Agreement for HMN Financial, Inc. 2001 Omnibus Stock Plan	Incorporated by Reference (12)
10.9	HMN Financial, Inc. Employee Stock Ownership Plan (as amended through February 26, 2008)	Incorporated by Reference (13)
10.10	Letter Agreement, dated December 23, 2008, including Securities Purchase Agreement – Standard Terms incorporated therein by reference, between HMN Financial, Inc. and the United States Department of the Treasury	Incorporated by Reference (14)
10.11†	Form of Agreement with Senior Executive Officer to Amend Certain Benefit Plans of the Company	Incorporated by Reference (15)
10.12†	Form of Waiver by Senior Executive Officers	Incorporated by Reference (16)
10.13†	HMN Financial, Inc. 2009 Equity Incentive Plan	Incorporated by Reference (17)
10.14†	Form of Restricted Stock Agreement under HMN Financial, Inc. 2009 Equity Incentive Plan	Incorporated by Reference (18)
10.15†	Form of Incentive Stock Option Agreement under HMN Financial, Inc. 2009 Equity Incentive Plan	Incorporated by Reference (19)
10.16†	Form of Non-Statutory Stock Option Agreement under HMN Financial, Inc. 2009 Equity Incentive Plan	Incorporated by Reference (20)
10.17†	Description of Retention Awards for Certain Executive Officers	Incorporated by Reference (21)
10.18	Supervisory Agreement between HMN Financial, Inc. and the Office of Thrift Supervision	Incorporated by Reference (22)

56

Exhibit Number	Exhibit	Filing Status
10.19	Supervisory Agreement between Home Federal Savings Bank and the Office of Thrift Supervision	Incorporated by Reference (23)
13	Portions of Annual Report to Security Holders incorporated by reference	Filed Electronically
21	Subsidiaries of Registrant	Filed Electronically
23	Consent of KPMG LLP	Filed Electronically
24	Powers of Attorney	Included with Signatures
31.1	Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer	Filed Electronically
31.2	Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer	Filed Electronically
32	Section 1350 Certifications	Filed Electronically
99.1	Section 111(b)(4) Certifications of Chief Executive Officer	Filed Electronically
99.2	Section 111(b)(4) Certifications of Chief Financial Officer	Filed Electronically

^†  Management contract or compensatory arrangement

¹  Incorporated by reference to Exhibit 3(a) to the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 1998 (File No. 0-24100).

²  Incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K, dated March 5, 2012 (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 I}ncorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K dated December 19, 2008, filed on December 23, 2008 (File No. 0-24100).

⁵  Incorporated by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K dated December 19, 2008, filed on December 23, 2008 (File No. 0-24100).

⁶  Incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K dated May 27, 2008, filed on June 2, 2008 (File No. 0-24100).

⁷  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).

⁸  Incorporated by reference to Exhibit 10.1(b) to the Company’s Quarterly Report on Form 10-Q for the period ended September 30, 1998 (File No. 0-24100).

^{9 I}ncorporated 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).

¹⁰  Incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the period ended September 30, 2004 (File No. 0-24100).

¹¹  Incorporated by reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the period ended September 30, 2004 (File No. 0-24100).

¹²  Incorporated by reference to Exhibit 10.3 to the Company’s Current Report on Form 8-K dated January 24, 2005, filed on January 28, 2005 (File No. 0-24100).

¹³  Incorporated by reference to Exhibit 10.11 to the Company’s Annual Report on Form 10-K for the period ended December 31, 2007 (File No. 0-24100).

¹⁴  Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K dated December 19, 2008, filed on December 23, 2008 (File No. 0-24100).

¹⁵  Incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K dated December 19, 2008, filed on December 23, 2008 (File No. 0-24100).

¹⁶  Incorporated by reference to Exhibit 10.3 to the Company’s Current Report on Form 8-K dated December 19, 2008, filed on December 23, 2008 (File No. 0-24100).

¹⁷  Incorporated by reference to Exhibit A to the Company’s Proxy Statement for its Annual Meeting of Stockholders held on April 28, 2009 (File No. 0-24100).

57

¹⁸ Incorporated by reference to Exhibit 99.1 to the Company’s Current Report on Form 8-K dated May 6, 2009, filed on May 12, 2009 (File No. 0-24100).

¹⁹ Incorporated by reference to Exhibit 99.2 to the Company’s Current Report on Form 8-K dated May 6, 2009, filed on May 12, 2009 (File No. 0-24100).

²⁰ Incorporated by reference to Exhibit 99.3 to the Company’s Current Report on Form 8-K dated May 6, 2009, filed on May 12, 2009 (File No. 0-24100).

²¹ Incorporated by reference to Exhibit 10.18 to the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2011 (File No. 0-24100).

²² Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K dated February 10, 2011 filed on February 11, 2011 (File No. 0-24100).

²³ Incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K dated February 10, 2011 filed on February 11, 2011 (File No. 0-24100).

58

EX-13

F I V E- Y E A R    C O N S O L I  D A T E D    F I N A N C I A L    H I G H L I G H T S

Selected Operations Data:
	Year Ended December 31,
(Dollars in thousands, except per share data)	2011			2010			2009			2008			2007
Total interest income	$	39,541			48,270			57,771			66,512			77,523
Total interest expense		11,135			17,259			23,868			32,796			38,823
Net interest income		28,406			31,011			33,903			33,716			38,700
Provision for loan losses		17,278			33,381			26,699			26,696			3,898
Net interest income (loss) after provision for loan losses		11,128			(2,370	)		7,204			7,020			34,802
Fees and service charges		3,739			3,741			4,137			4,269			3,139
Loan servicing fees		987			1,067			1,042			955			1,054
Securities gains, net		0			0			5			479			0
Gain on sales of loans		1,656			1,987			2,273			651			1,514
Other non-interest income		487			476			625			749			1,205
Total non-interest income		6,869			7,271			8,082			7,103			6,912
Total non-interest expense		29,552			27,556			31,689			29,234			23,140
Income (loss) before income tax expense (benefit)		(11,555	)		(22,655	)		(16,403	)		(15,111	)		18,574
Income tax expense (benefit)		0			6,323			(5,607	)		(4,984	)		7,300
Net income (loss)		(11,555	)		(28,978	)		(10,796	)		(10,127	)		11,274
Preferred stock dividends and discount		(1,821	)		(1,784	)		(1,747	)		(37	)		0
Net income (loss) available to common shareholders	$	(13,376	)		(30,762	)		(12,543	)		(10,164	)		11,274
Basic earnings (loss) per common share	$	(3.47	)		(8.17	)		(3.39	)		(2.78	)		3.02
Diluted earnings (loss) per common share		(3.47	)		(8.17	)		(3.39	)		(2.78	)		2.89
Cash dividends per common share		0.00			0.00			0.00			0.75			1.00
Selected Financial Condition Data:
	December 31,
(Dollars in thousands, except per share data)	2011			2010			2009			2008			2007
Total assets	$	790,155			880,618			1,036,241			1,145,480			1,117,054
Securities available for sale		126,114			151,564			159,602			175,145			186,188
Loans held for sale		3,709			2,728			2,965			2,548			3,261
Loans receivable, net		555,908			664,241			799,256			900,889			865,088
Deposits		620,128			683,230			796,011			880,505			888,118
Deposits held for sale		36,048			0			0			0			0
FHLB advances and Federal Reserve borrowings		70,000			122,500			132,500			142,500			112,500
Stockholders’ equity		57,061			69,547			99,938			112,213			98,128
Book value per common share		7.36			10.51			17.94			21.31			23.50
Number of full service offices		13			14			14			16			15
Number of loan origination offices		1			1			2			2			2
Key Ratios (1)
Stockholders’ equity to total assets at year end		7.22	%		7.90	%		9.64	%		9.80	%		8.78	%
Average stockholders’ equity to average assets		8.19			9.40			9.73			8.58			8.89
Return (loss) on stockholders’ equity
(ratio of net income (loss) to average equity)		(16.94	)		(31.73	)		(10.33	)		(10.61	)		11.53
Return (loss) on assets (ratio of net income (loss) to average assets)		(1.39	)		(2.98	)		(1.00	)		(0.91	)		1.03
Dividend payout ratio (ratio of dividends paid to net income (loss))		NM			NM			NM			NM			34.72
(1) Average balances were calculated based upon amortized cost without the market value impact of ASC 320.
NM — Not meaningful

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This Annual Report, other reports filed by the Company with the Securities and Exchange Commission, and the Company’s proxy statement may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are often identified by such forward-looking terminology as “expect,” “intent,” “look,” “believe,” “anticipate,” “estimate,” “project,” “seek,” “may,” “will,” “would,” “could,” “should,” “trend,” “target,” and “goal” or similar statements or variations of such terms and include, but are not limited to, those relating to the adequacy and amount of available liquidity and capital resources to the Bank; the Company’s liquidity and capital requirements, our expectations for core capital and our strategies and potential strategies for improvement thereof; changes in the size of the Bank’s loan portfolio; the recovery of the valuation allowance on deferred tax assets; the amount and mix of the Bank’s non-performing assets and the appropriateness of the allowance therefor; future losses on non-performing assets; the amount of interest-earning assets; the amount and mix of brokered and other deposits (including the Company’s ability to renew brokered deposits); the availability of alternate funding sources; the payment of dividends; the future outlook for the Company; the amount of deposits that will be withdrawn from checking and money market accounts and how the withdrawn deposits will be replaced; the projected changes in net interest income based on rate shocks; the range that interest rates may fluctuate over the next twelve months; the net market risk of interest rate shocks; the future outlook for the issuer trust preferred securities held by the Bank; the change in Company and Bank primary banking regulators from the Office of Thrift Supervision to the Office of the Comptroller of the Currency (OCC) and Federal Reserve Board (FRB); the Bank’s compliance with regulatory standards generally (including the Bank’s status as “well-capitalized”), and supervisory agreements, individual minimum capital requirements or other supervisory directives or requirements to which the Company or the Bank are or may become expressly subject, specifically, and possible responses of the OCC and the Bank and the Company to any failure to comply with any such regulatory standard, agreement or requirement; and the anticipated timing of consummation of the Toledo, Iowa branch (Toledo Branch) transaction and the anticipated gain on sale, decrease in assets and increase in core capital therefrom.

A number of factors could cause actual results to differ materially from the Company’s assumptions and expectations. These include but are not limited to the adequacy and marketability of real estate and other collateral securing loans to borrowers, possible legislative and regulatory changes, including changes in the degree and manner of regulatory supervision, the ability of the Company and the Bank to establish and adhere to plans and policies relating to, among other things, capital, business, non-performing assets, loan modifications, documentation of loan loss allowance and concentrations of credit that are satisfactory to the OCC and FRB, as applicable, in accordance with the terms of the Company and Bank supervisory agreements and to otherwise manage the operations of the Company and the Bank to ensure compliance with other requirements set forth in the supervisory agreements; the ability of the Company and the Bank to obtain required consents from the OCC and FRB, as applicable, under the supervisory agreements or other directives; the ability of the Bank to comply with its individual minimum capital requirement and other applicable regulatory capital requirements; enforcement activity of the OCC and FRB in the event of our non-compliance with any applicable regulatory standard, agreement or requirement; adverse economic, business and competitive developments such as shrinking interest margins, reduced collateral values, deposit outflows, changes in credit or other risks posed by the Company’s loan and investment portfolios, changes in costs associated with alternate funding sources, including changes in collateral advance rates and policies of the Federal Home Loan Bank, technological, computer-related or operational difficulties, results of litigation, and reduced demand for financial services and loan products; changes in accounting policies and guidelines, or monetary and fiscal policies of the federal government or tax laws; international economic developments; the Company’s access to and adverse changes in securities markets; the market for credit related assets; the timing of the Toledo Branch data conversion by a third party provider, the failure of either the Bank or Pinnacle to fulfill the terms and conditions of the Toledo Branch sale agreement required to be satisfied prior to closing and changes in assets and liabilities at the Toledo Branch prior to closing; or other significant uncertainties. Additional factors that may cause actual results to differ from the Company’s assumptions and expectations

6

include those set forth in the Company’s most recent filings on Form 10-K and Form 10-Q with the Securities and Exchange Commission. All forward-looking statements are qualified by, and should be considered in conjunction with, such cautionary statements. For additional discussion of the risks and uncertainties applicable to the Company, see the “Risk Factors” sections of the Company’s Annual Report on Form 10-K for the year ended December 31, 2011.

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, private banking and loan production offices in Minnesota and Iowa. The earnings of the Company are primarily dependent on the Bank’s net interest income, which is the difference between interest earned on 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. Net interest income and net interest rate spread are affected by changes in interest rates, the volume and mix of interest-earning assets and interest-bearing liabilities, and the level of non-performing assets. The Company’s net income (loss) is also affected by the generation of non-interest income, which consists primarily of gains from the sale of loans, fees for servicing mortgage loans, and the generation of 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, deposit insurance, and amortization of mortgage servicing assets. The earnings of financial institutions, such as the Bank, are also 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 business credit, single family and commercial properties, competition among lenders, the level of interest rates and the availability of funds. 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.

Beginning with the Company’s 2008 fiscal year, the Company’s commercial business and commercial real estate loan portfolios have required significant charge offs due primarily to decreases in the estimated value of the underlying collateral supporting the loans, as many of these loans were made to borrowers in or associated with the real estate industry. The decrease in the estimated collateral value is primarily the result of reduced demand for real estate, particularly as it relates to single-family and commercial land developments. More stringent lending standards implemented by the mortgage industry in recent years have made it more difficult for some borrowers with marginal credit to qualify for a mortgage. This decrease in available credit and the overall weakness in the economy over the past several years reduced the demand for single family homes and the values of existing properties and developments where the Company’s commercial loan portfolio has concentrations. Consequently, our level of non-performing assets and the related provision for loan losses and charge-offs increased significantly in the past several years, relative to periods before 2008. The increased levels of non-performing assets, related provisions for loan losses and loan charge-offs and expenses associated with real estate owned, and allowances against deferred taxes arising from adverse results of operations, were the primary reasons for the net losses incurred by the Company in each of the years 2008 through 2011.

During this time, the Company has taken a number of measures to address its elevated level of non-performing assets and net losses and to establish adequate levels of liquidity and capital resources. In 2008, the Company obtained $26 million in additional capital through the sale of preferred stock to the United States Treasury, substantially all of which was contributed to the capital of the Bank. The Bank also began to reduce its asset size, which has been reduced $355 million since December 31, 2008, in order to enhance its capital ratios. The reduction in assets has primarily been in commercial loans and was accompanied by a corresponding reduction in interest-bearing liabilities, primarily because of a $235 million reduction in brokered deposits and a $72 million reduction in outstanding FHLB advances. In 2009, a new Bank President was appointed and additional personnel were

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hired in the commercial loan area to work through the increased level of non-performing assets. In addition, the Bank lowered its internal limit on the size of a loan it would grant to an individual borrower in an effort to reduce concentrations of credit risk associated with large borrowing relationships. The Bank also began the process of segmenting its loan portfolio and reduced lending in certain industries and loan types in order to further limit credit concentrations. In 2010, an experienced Chief Credit Officer was hired into a newly created position. Since that time, a new loan credit approval process and additional policies and procedures have been implemented in order to improve the credit quality of commercial loans being added to the Bank’s portfolio and reduce loan concentrations and non-performing assets. A more stringent commercial loan risk rating system was also implemented which resulted in some commercial loans being moved into a higher risk rating classification. In addition, an ongoing analysis of the Bank’s commercial loan charge off history resulted in higher reserve percentages for some risk rating classifications. A more aggressive and ongoing review process of existing commercial loan files was also implemented. These reviews focused on performing loans in certain industries and loan types that management determined to have the highest risk of loss to the Bank and, in some cases, resulted in corrective or preventative action being taken and additional loan loss reserves being established. Additional resources have also been allocated to establishing and maintaining remediation plans on all classified loans in order to improve the monitoring and ultimate collection of these loans. The remediation plans have focused on evaluating collateral levels and determining available cash flows as well as testing the validity of, and adherence to, established action plans. In 2011, the Bank’s Edina branch office was closed in order to reduce costs and the Bank entered into a definitive purchase and assumption agreement to sell substantially all of the assets and deposit liabilities associated with its Toledo, Iowa branch in order to further reduce costs and improve capital ratios. The sale of the Toledo branch is anticipated to be consummated in the first quarter of 2012. The Company also began deferring the dividend payments on the outstanding preferred stock, beginning with the February 15, 2011 dividend payment in order to preserve cash for potential future needs.

Despite these efforts, elevated levels of non-performing assets and related losses have persisted, primarily as a result of the relative weakness of the housing and commercial real estate markets that continues to cause reductions in the values of the collateral supporting some loans and adversely affecting the ability of some borrowers to comply with their loan payment requirements. Because of these issues, the Company and the Bank, effective February 22, 2011, each entered into a supervisory agreement (the “Company Supervisory Agreement” and the “Bank Supervisory Agreement”, respectively, and, collectively, the “Supervisory Agreements”) with the Office of Thrift Supervision (the “OTS”), their primary federal regulator at the time. The Supervisory Agreements supersede the memorandum of understanding between each of the Company and the Bank entered into with the OTS in December 2009. The Company Supervisory Agreement requires the Company to submit a capital plan by January 31 of each year for approval by the OTS, and without the prior consent of the OTS, prohibits the payment of dividends on the Company’s outstanding stock, restricts the incurrence of debt and limits certain employment and compensation actions involving directors and executive officers. In accordance with the Bank’s Supervisory Agreement, the Bank submitted an initial two year business plan that the OCC (as successor to the OTS) accepted with the expectation that the Bank would be in adherence with the OCC’s Notification of Establishment of Higher Minimum Capital Ratios, dated August 8, 2011, which required the Bank to establish and maintain a minimum core capital ratio of 8.5% by December 31, 2011, which was in excess of the Bank’s 7.14% core capital to adjusted total assets ratio at December 31, 2011. The Bank would have needed $10.8 million in additional capital at December 31, 2011 to meet the minimum core capital ratio set by the OCC.

Subsequent to year end, the Bank submitted a revised two year business plan to the OCC. The Bank must operate within the parameters of the final business plan and is required to monitor and submit periodic reports on its compliance with the plan. The Bank also submitted a problem asset reduction plan that the OCC has accepted. The Bank must operate within the parameters of the final problem asset plan and is required to monitor and submit periodic reports on its compliance with the plan. The Bank has also revised its loan modification policies and its program for identifying, monitoring and controlling risk associated with concentrations of credit, and improved the

8

documentation relating to the allowance for loan and lease losses as required by the agreement. In addition, without the consent of the OCC, the Bank may not declare or pay any cash dividends, materially increase the total assets of the Bank, enter into any new contractual arrangement or renew or extend any existing arrangement related to compensation or benefits with any director or officer, make any golden parachute payments, or enter into any significant contracts with a third party service provider. In February 2012, the Bank received a notice from the OCC arising out of its failure to establish and maintain its individual minimum capital requirement (IMCR) of 8.5% core capital to adjusted total assets at December 31, 2011. By April 30, 2012, the Bank must submit to the OCC a further written capital plan of how it will achieve and maintain its IMCR, and a contingency plan in the event the IMCR is not achieved through the Bank’s primary plan. The Bank’s failure to comply with the terms of the IMCR is deemed an unsafe and unsound banking practice and could subject it to further limits on growth and such legal actions or sanctions as the OCC considers appropriate. For a complete description of the Supervisory Agreements and IMCR, please see “Item 1 — Business — Regulation and Supervision” and “Item 3 — Legal Proceedings” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011.

References to the OTS shall mean, with respect to the Company, beginning July 21, 2011, the Federal Reserve Board (FRB) and mean, with respect to the Bank, beginning July 21, 2011, the Office of the Comptroller of the Currency (OCC). On July 21, 2011, the OTS was integrated into the OCC and the primary banking regulator for the Company became the FRB.

Critical Accounting Estimates

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. These critical accounting policies often involve estimates and assumptions that could have a material impact on the Company’s financial statements. The Company has identified the following critical accounting policies that management believes involve the most difficult, subjective, and/or complex judgments that are inherently uncertain. Therefore, actual financial results could differ significantly depending upon the estimates, assumptions and other factors 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 economic conditions, historical experience and observations made by the Company’s ongoing internal audit and regulatory exam processes. Loans are charged off to the extent they are deemed to be uncollectible. The Company has established separate processes to determine the appropriateness of the loan loss allowance for its homogeneous single-family and consumer loan portfolios and its non-homogeneous loan portfolios. The determination of the allowance for the non-homogeneous 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 based on the Company’s own loss experience and are assigned to all loans without identified credit weaknesses. For each non-performing loan, the Company also performs an individual analysis of impairment that is based on the expected cash flows or the value of the assets collateralizing the loans and establishes any necessary reserves or charges off all loans or portion thereof that are deemed uncollectable. 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 for all non-performing loans. The Company’s policies and procedures related to the allowance for loan losses are consistent with the Interagency Policy Statement on the Allowance for Loan and Lease Losses that was issued by the federal financial regulatory agencies in December 2006.

The appropriateness 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

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periods in which the adjustments become known. Because of the size of some loans, changes in estimates can have a significant impact on the loan loss provision. 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 additional reserves are not required. Although management believes that based on current conditions the allowance for loan losses is maintained at an appropriate amount to provide for probable loan losses inherent in the portfolio as of the balance sheet dates, future conditions may differ substantially from those anticipated in determining the allowance for loan losses and adjustments may be required in the future.

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.

The Company maintains significant net deferred tax assets for deductible temporary differences, the largest of which relates to the allowance for loan and real estate losses and net operating loss carryforwards. For income tax purposes, only net charge-offs are deductible, not the

entire provision for loan losses. Under generally accepted accounting principles, a valuation allowance is required to be recognized if it is “more likely than not” that the deferred tax asset will not be realized. The determination of the realizability of the deferred tax assets is highly subjective and dependent upon management’s judgment and evaluation of both positive and negative evidence, including the forecasts of future income, tax planning strategies and assessments of the current and future economic and business conditions. The Company considers both positive and negative evidence regarding the ultimate realizability of deferred tax assets. Positive evidence includes the ability to implement tax planning strategies to accelerate taxable income recognition and the probability that taxable income will be generated in future periods. Negative evidence includes the Company’s cumulative loss in the prior three year period, current financial performance, and the general business and economic trends. In the second quarter of 2010, the Company recorded a valuation allowance against the entire deferred tax asset balance and the Company continued to maintain a valuation reserve against the entire deferred tax asset balance at December 31, 2011. This determination was based primarily upon the existence of a three-year cumulative loss and continued operating losses in 2011. This three-year cumulative loss position is primarily attributable to significant provisions for loan losses incurred during the three years ended December 31, 2011. The creation of the valuation allowance, although it increased tax expense and similarly reduced tangible book value, does not have an effect on the Company’s cash flows, and may be recoverable in subsequent periods if the Company were to realize certain sustained future taxable income. It is possible that future conditions may differ substantially from those anticipated in determining the need for a valuation allowance on deferred tax assets and adjustments may be required in the future.

Determining the ultimate settlement of any tax position requires significant estimates and judgments in arriving at the amount of tax benefits to be recognized in the financial statements. It is possible that the tax benefits realized upon the ultimate resolution of a tax position may result in tax benefits that are significantly different from those estimated.

10

Results of Operations

Comparison of 2011 with 2010

The net loss was $11.6 million for 2011, an improvement of $17.4 million, from the $29.0 million loss for 2010. The net loss available to common shareholders was $13.4 million for the year ended December 31, 2011, an improvement of $17.4 million, from the net loss available to common shareholders of $30.8 million for 2010. Diluted loss per common share for the year ended December 31, 2011 was $3.47, an improvement of $4.70 from the $8.17 diluted loss per common share for the year ended December 31, 2010.

Net Interest Income

Net interest income was $28.4 million for 2011, a decrease of $2.6 million, or 8.4%, from $31.0 million for 2010. Interest income was $39.5 million for 2011, a decrease of $8.8 million, or 18.1%, from $48.3 million for 2010. Interest income decreased between the periods primarily because of a $132 million decrease in the average interest-earning assets and a decrease in the average yields between the periods. Average interest-earning assets decreased between the periods primarily because of a decrease in the commercial loan portfolio, which occurred because of declining loan demand and the Company’s focus on improving credit quality, managing net interest margin and improving capital ratios. The average yield earned on interest-earning

assets was 5.00% for the year ended December 31, 2011, a decrease of 23 basis points from the 5.23% average yield for 2010.

Interest expense was $11.1 million for the year ended December 31, 2011, a decrease of $6.2 million, or 35.5%, from $17.3 million for 2010. Interest expense decreased primarily because of a $115 million decrease in the average interest-bearing liabilities between the periods. The decrease in average interest-bearing liabilities is primarily the result of a decrease in the average outstanding borrowings and brokered deposits between the periods. The decrease in borrowings and brokered deposits between the periods was the result of using the proceeds from loan principal payments to fund maturing borrowings and brokered deposits. Interest expense also decreased because of the lower rates paid on retail money market accounts and certificates of deposits. The decreased rates were the result of the lower interest rate environment that existed during 2011. The average interest rate paid on interest-bearing liabilities was 1.47% for the year ended December 31, 2011, a decrease of 51 basis points from the 1.98% average rate paid for the same period of 2010. Net interest margin (net interest income divided by average interest-earning assets) was 3.59% for the year ended December 31, 2011, an increase of 23 basis points, from the 3.36% margin for 2010.

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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,
	2011								2010								2009
(Dollars in thousands)	Average Outstanding Balance		Interest Earned/ Paid			Average Yield/ Rate			Average Outstanding Balance		Interest Earned/ Paid			Average Yield/ Rate			Average Outstanding Balance		Interest Earned/ Paid			Average Yield/ Rate
Interest-earning assets:
Securities available for sale:
Mortgage-backed and related securities	$	25,546		1,098			4.30	%	$	42,117		1,813			4.30	%	$	63,725		2,768			4.34	%
Other marketable securities		113,927		1,451			1.27			112,573		2,023			1.80			82,758		3,039			3.67
Loans held for sale		2,200		87			3.95			2,561		117			4.57			3,161		163			5.16
Loans receivable, net(1)(2)		608,826		36,689			6.03			740,324		44,131			5.96			848,696		51,713			6.09
FHLB stock		5,384		180			3.34			7,262		182			2.51			7,286		87			1.19
Other, including cash equivalents		35,426		36			0.10			18,626		4			0.02			12,212		1			0.01
Total interest-earning assets	$	791,309		39,541			5.00		$	923,463		48,270			5.23		$	1,017,838		57,771			5.68
Interest-bearing liabilities:
NOW accounts	$	72,734		57			0.08	%	$	96,248		110			0.11	%	$	106,360		132			0.12	%
Passbooks		37,048		57			0.15			32,929		45			0.14			30,401		38			0.12
Money market accounts		118,821		746			0.63			133,113		1,341			1.01			105,854		1,430			1.35
Certificate accounts		250,142		3,841			1.54			240,590		5,415			2.25			257,085		7,652			2.98
Brokered deposits		85,587		2,146			2.51			152,584		4,370			2.86			232,829		8,327			3.58
FHLB advances and Federal Reserve Borrowings		92,604		4,288			4.63			131,480		5,978			4.55			155,681		6,289			4.04
Other interest-bearing liabilities		1,006		0			0.00			1,351		0			0.00			1,219		0			0.02
Total interest-bearing liabilities	$	657,942							$	788,295							$	889,429
Noninterest checking		101,230								85,585								70,364
Total interest-bearing liabilities and noninterest-bearing deposits	$	759,172		11,135			1.47		$	873,880		17,259			1.98		$	959,793		23,868			2.49
Net interest income				28,406								31,011								33,903
Net interest rate spread							3.53	%							3.26	%							3.19	%
Net earning assets	$	32,137							$	49,583							$	58,045
Net interest margin							3.59	%							3.36	%							3.33	%
Average interest-earning assets to average interest-bearing liabilities and noninterest-bearing deposits				104.23	%							105.67	%							106.05	%

⁽¹⁾  Tax exempt income was not significant; therefore, the yield was not presented on a tax equivalent basis for any of the years presented. The tax-exempt income was $0.4 million for 2011, $0.4 million for 2010, and $0.7 million for 2009.

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

Net interest margin increased to 3.59% in 2011 from 3.36% in 2010 primarily because the cost of interest-bearing liabilities decreased at a faster rate than the yield on interest-earning assets due to the lagging effect of deposit price changes in relation to loan price changes. Net interest margin was also positively impacted by a change in the deposit mix as a lower percentage of deposits were in higher priced brokered certificates of deposits in 2011 when compared to 2010. Brokered deposits decreased in 2011 as the proceeds from loan payoffs were used to pay off the outstanding brokered deposits that matured during the year. Average net earning assets decreased $17.5 million to $32.1 million in 2011 compared to $49.6 million for 2010. Net earning

assets decreased primarily because of increased loan charge offs during 2011.

The following table 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).

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	Year Ended December 31,
	2011 vs. 2010						Total Increase (Decrease)			2010 vs. 2009						Total Increase (Decrease)
	Increase (Decrease) Due to									Increase (Decrease) Due to
(Dollars in thousands)	Volume(1)			Rate(1)						Volume(1)			Rate(1)
Interest-earning assets:
Securities available for sale:
Mortgage-backed and related securities	$	(713	)		(2	)		(715	)		(939	)		(16	)		(955	)
Other marketable securities		24			(596	)		(572	)		1,095			(2,111	)		(1,016	)
Loans held for sale		(16	)		(14	)		(30	)		(31	)		(15	)		(46	)
Loans receivable, net		(7,706	)		265			(7,441	)		(6,391	)		(1,192	)		(7,583	)
Cash equivalents		4			27			31			1			3			4
FHLB stock		(47	)		45			(2	)		0			95			95
Total interest-earning assets	$	(8,454	)		(275	)		(8,729	)		(6,265	)		(3,236	)		(9,501	)
Interest-bearing liabilities:
NOW accounts	$	(37	)		(16	)		(53	)		(19	)		(3	)		(22	)
Passbooks		6			6			12			3			4			7
Money market accounts		(149	)		(447	)		(596	)		367			(456	)		(89	)
Certificates		(216	)		(1,358	)		(1,574	)		(651	)		(1,587	)		(2,238	)
Brokered deposits		(1,918	)		(305	)		(2,223	)		(2,869	)		(1,087	)		(3,956	)
FHLB advances and Federal Reserve borrowings		(1,766	)		76			(1,690	)		(166	)		(145	)		(311	)
Total interest-bearing liabilities		(4,080	)		(2,044	)		(6,124	)		(3,335	)		(3,274	)		(6,609	)
Increase (decrease) in net interest income	$	(4,374	)		1,769			(2,605	)		(2,930	)		38			(2,892	)

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

The following table sets forth the weighted average yields on the 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, 2011

Weighted average yield on:
Securities available for sale:
Mortgage-backed and related securities	4.21	%
Other marketable securities	1.10
Loans held for sale	3.32
Loans receivable, net	5.75
Federal Home Loan Bank stock	3.00
Other interest-earnings assets	0.25
Combined weighted average yield on interest-earning assets	4.56

Weighted average rate on:
NOW accounts	0.06	%
Passbooks	0.17
Money market accounts	0.46
Certificates	1.66
Federal Home Loan Bank advances	4.77
Combined weighted average rate on interest-bearing liabilities	1.22
Interest rate spread	3.34

Provision for Loan Losses

The provision for loan losses was $17.3 million for the year ended December 31, 2011, a decrease of $16.1 million, from $33.4 million for the year ended December 31, 2010. The provision decreased between the periods primarily because fewer loan losses were recognized due to fewer write downs on non-performing real estate loans in 2011 when compared to 2010. The

provision also decreased because of the $132 million decrease in the loan portfolio between the periods. Total non-performing assets were $50.6 million at December 31, 2011, a decrease of $33.9 million, or 40.0%, from $84.5 million at December 31, 2010. Non-performing loans decreased $34.1 million and foreclosed and repossessed assets increased $0.2 million

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M A N A G E M E N T    D I S C U S S I ON     A N D    A N A L Y S I S

during 2011. The non-performing loan and foreclosed and repossessed asset activity for 2011 was as follows:

	December 31,
(Dollars in thousands)	2011			2010
Non-performing loans:
Balance at beginning of year	$	68,074			61,127
Classified as non-performing		28,615			62,009
Charge offs		(39,302	)		(15,231	)
Principal payments received		(9,552	)		(13,733	)
Classified as accruing		(5,249	)		(10,972	)
Transferred to real estate owned		(8,593	)		(15,126	)
Balance at end of year	$	33,993			68,074
	December 31,
(Dollars in thousands)	2011			2010
Foreclosed and repossessed asset activity:
Balance at beginning of year	$	16,395			16,262
Transferred from non-performing loans		8,593			15,126
Other foreclosures/repossessions		138			1,158
Real estate sold		(5,444	)		(14,448	)
Net gain on sale of assets		407			747
Write downs		(3,473	)		(2,450	)
Balance at end of year	$	16,616			16,395

Loans classified as non-performing during the year decreased $34.1 million, from $68.1 million at December 31, 2010 to $34.0 million at December 31, 2011. The decrease in loans classified as non-performing reflects the decrease in additional loans being classified as non-performing as well as the Company’s increased level of charge-offs.

The following table reflects the activity in the allowance for loan losses for 2011 and 2010.

(Dollars in thousands)	2011			2010
Balance at January 1,		$42,828		$	23,812
Provision		17,278			33,381
Charge offs:
Commercial		(15,512	)		(7,006	)
Commercial real estate		(23,012	)		(7,095	)
Consumer		(270	)		(907	)
Single family mortgage		(508	)		(254	)
Recoveries		3,084			897
Balance at December 31,		$23,888		$	42,828
Unallocated allowance		$17,255		$	17,794
Allocated allowance		6,633			25,034
		$23,888		$	42,828

The allowance for loan losses decreased and charge offs increased in 2011 when compared to 2010 due primarily to two factors. The first factor was the modification in the fourth quarter of 2011 of our charge off policy on non-performing loans, which required the charge off of previously established specific valuation allowances

(SVAs). Previously, when a collateral-dependent loan was characterized as a loss, the Company typically established an SVA based on the estimated fair value of the underlying collateral, less any related selling costs and the actual charge off of the loan was not recorded until the foreclosure process was complete. The gross

14

loan balance for these non-performing loans was reported as an outstanding loan with any associated SVAs included in the financial statements as part of the allowance for loan losses. Under the modified policy, which is also acceptable under Generally Accepted Accounting Principles, SVAs are no longer recognized and any losses on loans secured by real estate are charged off in the period the loans, or portion thereof, are deemed uncollectible. All of these charge offs were previously included in the Company’s loss history as part of the evaluation of the allowance for loan losses. Therefore,

the additional charge offs did not affect the Company’s provision for loan losses or net loss for the period. The second factor was that in certain instances the borrower’s financial condition had deteriorated to the point that a charge off of the loan balance was warranted.

Non-Interest Income

Non-interest income was $6.9 million for the year ended December 31, 2011, a decrease of $0.4 million, or 5.5%, from $7.3 million for the year ended December 31, 2010. The following table presents the components of non-interest income:

	Year ended December 31,						Percentage Increase (Decrease)
(Dollars in thousands)	2011		2010		2009		2011/2010			2010/2009
Fees and service charges	$	3,739		3,741		4,137		(0.1	)%		(9.6	)%
Loan servicing fees		987		1,067		1,042		(7.5	)		2.4
Securities gains, net		0		0		5		N/A			(100.0	)
Gain on sales of loans		1,656		1,987		2,273		(16.7	)		(12.6	)
Other non-interest income		487		476		625		2.3			(23.8	)
Total non-interest income	$	6,869		7,271		8,082		(5.5	)		(10.0	)

Gain on sales of loans decreased $331,000 between the periods primarily because of a decrease in the gains recognized on the sale of single family mortgage loans caused by a decrease in loan originations and sales between the periods. Loan servicing fees decreased $80,000 between the periods due primarily to a decrease in the number of commercial loans that are being serviced for others.

Non-Interest Expense

Non-interest expense was $29.6 million for the year ended December 31, 2011, an increase of $2.0 million, or 7.2%, from $27.6 million for the same period in 2010. The following table presents the components of non-interest expense:

	Year ended December 31,						Percentage Increase (Decrease)
(Dollars in thousands)	2011		2010		2009		2011/2010			2010/2009
Compensation and benefits	$	13,553		13,516		13,432		0.3	%		0.6	%
Losses on real estate owned		2,681		1,165		3,873		130.1			(69.9	)
Occupancy		3,741		4,082		4,084		(8.4	)		(0.0	)
Deposit insurance		1,255		1,933		1,973		(35.1	)		(2.0	)
Data processing		1,221		1,040		1,182		17.4			(12.0	)
Other		7,101		5,820		7,145		22.0			(18.5	)
Total non-interest expense	$	29,552		27,556		31,689		7.2			(13.0	)

Losses on real estate owned increased $1.5 million between the periods primarily because of declines in the

fair market value of other real estate. Other non-interest expenses increased $1.3 million primarily because of

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M A N A G E M E N T    D I S C U S S I ON     A N D    A N A L Y S I S

increased real estate taxes and legal fees related to other real estate owned. Data processing expense increased $181,000 between the periods primarily because of a one time incentive that was received by the Company in the fourth quarter of 2010 when it changed its ATM and debit card vendor. Deposit insurance expense decreased $678,000 between the periods primarily because of a change in the FDIC’s insurance cost structure and also because of a decrease in assets between the periods. Occupancy expense decreased $341,000 primarily because of a decrease in depreciation expense.

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 assets and liabilities. Income tax expense decreased $6.3 million between the periods, from an expense of $6.3 million in 2010 to no expense in 2011. In the second quarter of 2010, the Company recorded a deferred tax asset valuation reserve against its entire deferred tax asset balance and the Company continued to maintain a valuation reserve against the entire deferred tax asset balance at December 31, 2011. Since the valuation reserve is established against the entire deferred tax asset balance, no income tax expense was recorded for 2011.

Net Loss Available to Common Shareholders

On December 23, 2008, the Company sold preferred stock and a related warrant to the United States Treasury for $26.0 million. The preferred shares are entitled to a 5% annual cumulative dividend for each of the first five years of the investment, increasing to 9% thereafter, unless HMN redeems the shares. The cumulative preferred dividends payable is $325,000 each quarter for the first five years the preferred shares are outstanding and increases to $585,000 each quarter after that if the shares are not redeemed. The Company paid all preferred dividends to the U.S. Treasury that were due in 2009 and 2010. The Company elected to defer the February 15, 2011, May 15, 2011, August 15, 2011, November 15, 2011, and February 15, 2012 dividend payments on the preferred stock after consulting with their primary regulator. The determination to defer the dividend payment was made in order to preserve cash for potential future needs. Under its Supervisory Agreement, the

Company may not pay any dividend on its outstanding preferred stock or common stock without the consent of the OCC. The dividends on the preferred stock are cumulative and, if the Company fails to pay dividends for six quarters, whether or not consecutive, the Treasury will have the right to appoint two representatives to the Company’s board of directors. Net loss available to common stockholders is the net loss less the preferred dividends paid or accrued for the period.

The net loss available to common shareholders was $13.4 million for the year ended December 31, 2011, an improvement of $17.4 million, from the net loss available to common shareholders of $30.8 million for 2010. The net loss available to common shareholders decreased primarily because of the decrease in the net loss between the periods.

Comparison of 2010 with 2009

The net loss was $29.0 million for 2010, an increased loss of $18.2 million, from the $10.8 million loss for 2009. The net loss available to common shareholders was $30.8 million for the year ended December 31, 2010, an increased loss of $18.3 million, from the net loss available to common shareholders of $12.5 million for 2009. Diluted loss per common share for the year ended December 31, 2010 was $8.17, an increased loss of $4.78 from the $3.39 diluted loss per common share for the year ended December 31, 2009. Loss on average assets for 2010 was 2.98%, compared to a 1.00% loss for 2009. Loss on average common equity was 31.73% for 2010, compared to a 10.33% loss for 2009.

Net interest income was $31.0 million for 2010, a decrease of $2.9 million, or 8.5%, from $33.9 million for 2009. Interest income was $48.3 million for 2010, a decrease of $9.5 million, or 16.4%, from $57.8 million for 2009. Interest income decreased between the periods primarily because of a $94 million decrease in the average interest-earning assets and to a lesser degree a decrease in the average yields between the periods. Average interest-earning assets decreased between the periods primarily because of a decrease in the commercial loan portfolio, which occurred because of declining loan demand and the Company’s focus on improving credit quality, managing net interest margin and improving capital ratios. Interest income also decreased because of a decline in the average yields earned on loans and investments. The decreased average yields are the result of the 400 basis point decrease in the prime interest rate that occurred in 2008. Decreases

16

in the prime rate decreased the rates on adjustable rate consumer and commercial loans in the portfolio and on the increasing percentage of new fixed rate loans and investments placed into portfolio in the ensuing years as pre-2008 loans matured or were repaid. The average yield earned on interest-earning assets was 5.23% for the year ended December 31, 2010, a decrease of 45 basis points from the 5.68% average yield for 2009.

Interest expense was $17.3 million for the year ended December 31, 2010, a decrease of $6.6 million, or 27.7%, from $23.9 million for 2009. Interest expense decreased because of the lower interest rates paid on money market accounts and certificates of deposit. The decreased rates were the result of the 400 basis point decrease in the federal funds rate that occurred in 2008. Decreases in the federal funds rate generally have a lagging effect and decrease the rates banks pay for deposits. The lagging effect of deposit rate changes is primarily due to the Bank’s deposits that are in the form of certificates of deposit, which do not re-price immediately when the federal funds rate changes. Interest expense also decreased because of an $86 million decrease in the average interest-bearing liabilities between the periods. The decrease in average interest-bearing liabilities is primarily the result of a decrease in the average outstanding brokered certificates of deposit between the periods. The decrease in brokered deposits in 2010 was the result of using the proceeds from loan principal payments to fund maturing brokered deposits. The average interest rate paid on interest-bearing liabilities was 1.98% for the year ended December 31, 2010, a decrease of 51 basis points from the 2.49% average rate paid for the same period of 2009. Net interest margin (net interest income divided by average interest-earning assets) was 3.36% for the year ended December 31, 2010, an increase of 3 basis points, from the 3.33% margin for 2009.

Net interest margin increased to 3.36% in 2010 from 3.33% in 2009 primarily because the cost of interest-bearing liabilities decreased at a faster rate than the yield on interest-earning assets due to the lagging effect of deposit price changes in relation to loan price changes. Net interest margin was also positively impacted by a change in the deposit mix as a lower percentage of deposits were in higher priced brokered certificates of deposits in 2010 when compared to 2009. Brokered deposits decreased in 2010 as the proceeds from loan payoffs were used to pay off the outstanding brokered

deposits that matured during the year. Average net earning assets decreased $8.4 million to $49.6 million in 2010 compared to $58.0 million for 2009. Net earning assets decreased primarily because of increases in non-performing assets and loan charge offs during 2010.

The provision for loan losses was $33.4 million for the year ended December 31, 2010, an increase of $6.7 million, from $26.7 million for the year ended December 31, 2009. The provision for loan losses remained elevated in 2010 primarily because of the $25.9 million in additional reserves established on commercial real estate and commercial business loans primarily as a result of decreases in the estimated value of the underlying collateral supporting the loans, $1.6 million in additional reserves established on a commercial loan due to the borrower filing bankruptcy and a $4.3 million increase in the reserves required for other risk rated commercial loans as a result of an internal analysis of our loan portfolio. Total non-performing assets were $84.5 million at December 31, 2010, an increase of $7.1 million from $77.4 million at December 31, 2009. Non-performing loans increased $7.0 million and foreclosed and repossessed assets increased $0.1 million during 2010. Loans classified as non-performing during the year increased $17.4 million, from $44.6 million in 2009 to $62.0 million in 2010. The increase in loans classified as non-performing reflects the relative weakness in the housing and commercial real estate markets that continued to cause reductions in the values of the collateral supporting some loans and adversely affecting the ability of some borrowers to comply with their loan payment requirements as well as the Company’s increased level of internal loan reviews.

The allowance for loan losses increased in 2010 primarily because of the $13.0 million increase in specific reserves established during the year due to decreases in the estimated value of the underlying collateral supporting the loans. The general allowance also increased because a periodic analysis of the commercial loan portfolio resulted in increased reserve percentages on performing loans due to the recent increase in charge off activity.

Non-interest income was $7.3 million in 2010, a decrease of $0.8 million, or 10.0%, from $8.1 million for 2009. Fees and service charges decreased $396,000 between the periods primarily because of decreased overdraft fees and decreased ATM fees as a result of

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exiting a customer ATM relationship in the first quarter of 2010. Gain on sales of loans decreased $286,000 between the periods primarily because of a decrease in the gains recognized on the sale of single family mortgage loans caused by a decrease in loan originations and sales between the periods. Other income decreased $149,000 primarily as a result of increased losses on asset sales and decreased revenue from the sale of uninsured investment products. Loan servicing fees increased $25,000 between the periods due to an increase in the single-family mortgage loans being serviced.

Non-interest expense was $27.6 million for 2010, a decrease of $4.1 million, or 13.0%, from $31.7 million for 2009. Losses on real estate owned decreased $2.7 million between the periods because of the decreases in the losses recognized on real estate sold. Other non-interest expenses decreased $1.3 million due primarily to the $1.2 million impact of the reversal of the accrued interest on a state tax assessment as a result of a favorable Minnesota Supreme Court ruling, a $122,000 decrease in item processing charges as a result of implementing improved clearing procedures and a $114,000 decrease in postage and printing supplies primarily as a result of increasing the number of customers receiving electronic statements. Compensation expense increased $84,000 between the periods primarily because of increased personnel in the commercial loan recovery area. Data processing expense decreased $142,000 between the periods primarily because of a change in the Company’s ATM and debit card vendor during the fourth quarter of 2010.

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 assets and liabilities. The effect of income taxes changed $11.9 million between the periods from a benefit of $5.6 million for 2009 to an expense of $6.3 million for 2010. During 2009, additional income tax expense of $1.0 million was recorded, which was a reduction of the overall tax benefit, as a result of an unfavorable tax court ruling related to the tax treatment of the inter-company dividends paid to the Bank by a former subsidiary in prior tax years. Excluding this adjustment, the effective tax rate would have been 40.3% for 2009. During 2010, income taxes increased $16.6 million as a result of recording a deferred tax asset valuation allowance, which was partially offset by a $1.2 million tax benefit recorded as a result of a favorable Minnesota Supreme Court tax ruling, which reversed the unfavorable tax court ruling from 2009. Excluding these adjustments, the effective tax rate would have been 39.7% for 2010.

The net loss available to common shareholders was $30.8 million for the year ended December 31, 2010, an increased loss of $18.3 million, from the net loss available to common shareholders of $12.5 million for 2009. The net loss available to common shareholders increased primarily because of the decrease in net income between the periods.

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Financial Condition

Loans Receivable, Net

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

	December 31,
	2011					2010					2009					2008					2007
(Dollars in thousands)	Amount		Percent			Amount		Percent			Amount		Percent			Amount		Percent			Amount			Percent
Real Estate Loans:
One-to-four family	$	119,066		20.52	%	$	128,535		18.14	%	$	144,631		17.54	%	$	161,989		17.51	%	$	152,974			17.33	%
Multi-family		35,517		6.12			48,266		6.81			59,266		7.18			29,292		3.17			29,073			3.29
Commercial		243,475		41.95			292,874		41.34			312,714		37.92			325,304		35.16			281,822			31.92
Construction or development		10,922		1.88			15,251		2.15			40,412		4.90			108,283		11.70			111,034			12.58
Total real estate loans		408,980		70.47			484,926		68.44			557,023		67.54			624,868		67.54			574,903			65.12
Other Loans:
Consumer Loans:
Automobile		404		0.07			604		0.08			902		0.11			1,333		0.14			1,730			0.20
Home equity line		41,429		7.14			44,933		6.34			50,369		6.11			52,243		5.65			51,317			5.81
Home equity		13,426		2.31			17,840		2.52			21,088		2.55			22,912		2.48			20,254			2.30
Mobile home		657		0.11			764		0.11			977		0.12			1,316		0.14			1,699			0.19
Land/lot loans		2,723		0.47			2,510		0.35			3,190		0.39			2,969		0.32			4,151			0.47
Other		3,522		0.61			3,952		0.56			5,689		0.69			5,828		0.63			5,758			0.65
Total consumer loans		62,161		10.71			70,603		9.96			82,215		9.97			86,601		9.36			84,909			9.62
Commercial business loans		109,259		18.82			153,039		21.60			185,525		22.49			213,775		23.10			222,959			25.26
Total other loans		171,420		29.53			223,642		31.56			267,740		32.46			300,376		32.46			307,868			34.88
Total loans		580,400		100.00	%		708,568		100.00	%		824,763		100.00	%		925,244		100.00	%		882,771			100.00	%
Less:
Loans in process **		0					0					0					0					3,011
Unamortized (premiums) discounts		93					413					177					569					(11	)
Net deferred loan fees		511					1,086					1,518					2,529					2,245
Allowance for losses		23,888					42,828					23,812					21,257					12,438
Total loans receivable, net	$	555,908				$	664,241				$	799,256				$	900,889				$	865,088
**   Core systems converted in 2008, loans in process after this date are reflected in loan amounts in table.

In 2011, the Company continued to focus on improving credit quality, managing interest rate risk and improving capital ratios which resulted in a decrease in outstanding loan balances. As a result of declining loan demand and the reasons noted above, it is anticipated that the size of our overall loan portfolio will continue to decline in 2012. Furthermore, pursuant to the Bank Supervisory Agreement, the Bank may not increase its total assets during any quarter in excess of the amount of net interest credited on deposit liabilities during the prior quarter, without OCC (as successor to OTS) approval.

The Company’s commercial business and commercial real estate loan portfolios continue to be impacted by the reduced demand for real estate, particularly as it relates to single-family and commercial land developments as many of these loans were made to borrowers associated with the real estate industry. More stringent lending standards implemented by the mortgage industry in recent years have made it more difficult for

some borrowers with marginal credit to qualify for a mortgage. This decrease in available credit and the overall weakness in the economy over the past several years reduced the demand for single family homes and the values of existing properties and developments and is reflected in the $50.6 million of Company assets that were classified as non-performing at December 31, 2011. We continue to work with the borrowers in order to resolve the non-performing status of these loans in the most cost effective manner. Because cash flow is dependent, in many cases, on the sale of the

properties, it will take some time to reduce some of the non-performing assets due to the limited demand for the properties.

One-to-four family real estate loans were $119.1 million at December 31, 2011, a decrease of $9.4 million, compared to $128.5 million at December 31, 2010. Mortgage loan refinance activity remained strong in 2011 due to the historically low mortgage rates experienced

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and almost all of the refinanced loans originated were sold into the secondary market and were not placed in the portfolio in order to manage the Company’s interest rate risk position. The increase in the amount of mortgage loans refinancing and subsequent sale was the primary reason for the decrease in the one-to-four family loan portfolio during 2011.

Multi-family real estate loans were $35.5 million at December 31, 2011, a decrease of $12.8 million, compared to $48.3 million at December 31, 2010. The decrease in multi-family real estate loans in 2011 is primarily the result of one large multi-family loan that obtained alternative financing and paid off their outstanding loan with the Bank in 2011.

Commercial real estate loans were $243.5 million at December 31, 2011, a decrease of $49.4 million, compared to $292.9 million at December 31, 2010. Commercial business loans were $109.3 million at December 31, 2011, a decrease of $43.7 million compared to $153.0 million at December 31, 2010. Decreased commercial loan demand and tighter underwriting and pricing guidelines resulted in a decrease in net commercial loan production and an increase in loan payoffs. Net commercial loan production, which is the principal amount retained by the Bank after deducting sold loan participations, was $49.1 million in 2011, compared to $59.8 million in 2010. Loan participations are sold in most cases in order to comply with lending limit restrictions and/or reduce loan concentrations. The decrease in net production along with the increase in loan payoffs and charge offs were the primary reasons for the decrease in the commercial business and commercial real estate loan balances in 2011.

Construction or development loans were $10.9 million at December 31, 2011, a decrease of $4.4 million, compared to $15.3 million at December 31, 2010. The decrease is primarily the result of three multi-family construction loans totaling $4.1 million where the projects were completed and the loans were moved to multi-family or single family real estate in 2011. These construction loans were not replaced with new construction loans due to a decrease in demand for construction and development loans in 2011.

Home equity line loans were $41.4 million at December 31, 2011, a decrease of $3.5 million, compared to $44.9 million at December 31, 2010. The open-end home equity lines are written with an

adjustable rate and a 10 year draw period which requires “interest only” payments followed by 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 $13.4 million at December 31, 2011, a decrease of $4.4 million, compared to $17.8 million at December 31, 2010. The decreases in the open and closed end equity loans is related primarily to a decrease in the originations of these type of loans and an increase in loan payoffs as a result of borrowers rolling these loan amounts into their first mortgages when they refinanced in 2011.

Allowance 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 entire loan portfolio and evaluates the need to establish allowances on the basis of these reviews.

Management actively monitors asset quality and, when appropriate, charges off loans against the allowance for loan losses. 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 loan losses.

The allowance for loan losses was $23.9 million, or 4.12% of gross loans at December 31, 2011, compared to $42.8 million, or 6.04% of gross loans at December 31, 2010. The allowance for loan losses and the related ratios decreased in 2011 due primarily to two factors. The first factor was the modification of our charge off policy in 2011 relating to non-performing loans, as described in the provision for loan loss discussion, which required the charge off of previously established specific valuation

20

allowances (SVAs). The second factor was that in certain instances the borrower’s financial condition or the

underlying collateral value had deteriorated to the point that a charge off of the loan balance was warranted.

The following table reflects the activity in the allowance for loan losses and selected statistics:

	December 31,
(Dollars in thousands)	2011			2010			2009			2008			2007
Balance at beginning of year	$	42,828			23,812			21,257			12,438			9,873
Provision for losses		17,278			33,381			26,699			26,696			3,898
Charge-offs:
One-to-four family		(508	)		(254	)		(82	)		(78	)		(42	)
Consumer		(270	)		(907	)		(1,980	)		(612	)		(840	)
Commercial business		(15,512	)		(7,006	)		(9,421	)		(13,784	)		(554	)
Commercial real estate		(23,012	)		(7,095	)		(13,548	)		(3,454	)		(245	)
Recoveries		3,084			897			887			51			348
Net charge-offs		(36,218	)		(14,365	)		(24,144	)		(17,877	)		(1,333	)
Balance at end of year	$	23,888			42,828			23,812			21,257			12,438
Year end allowance for loan losses as a percent of year end gross loan balance		4.12	%		6.04	%		2.89	%		2.30	%		1.41	%
Ratio of net loan charge-offs to average loans outstanding		5.62			1.87			2.76			1.98			0.16

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

	December 31,
	2011						2010						2009						2008						2007
	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			Allocated Allowance as a % of Loan Category			Percent of Loans in Each Category to Total Loans
One-to-four family		3.12	%		20.52	%		1.67	%		18.14	%		0.69	%		17.54	%		1.75	%		17.51	%		0.27	%		17.33	%
Commercial real estate		4.70			49.95			6.90			50.30			3.47			50.00			2.83			50.03			1.83			47.79
Consumer		1.86			10.71			1.31			9.96			1.55			9.97			1.83			9.36			1.70			9.62
Commercial busines		4.93			18.82			9.91			21.60			3.88			22.49			1.75			23.10			1.28			25.26
Total		4.12			100.00	%		6.04			100.00	%		2.89			100.00	%		2.30			100.00	%		1.41			100.00	%

The allocated percentage for commercial real estate and commercial business loans decreased in 2011 due primarily to the change in policy relating to the use of SVA’s which resulted in an increase in charge offs and a decrease in the related allowances. See “Results of Operations — Comparison of 2011 with 2010 — Provision for Loan Losses” above for a discussion of this change in policy. The allocation of the allowance for loan losses increased in 2011 for one-to-four family loans due primarily to the increases in the reserve percentages on certain risk rated loans at December 31, 2011 when compared to 2010. The allocation of the allowance for

loan losses increased in 2011 for consumer loans due to an increase in the number of classified consumer loans.

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, or fair value less estimated selling costs. Management periodically performs valuations and an allowance for losses is established if the carrying value of a property exceeds its fair value less estimated selling costs. The balance in the allowance for real estate losses was $6.5 million at

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M A N A G E M E N T    D I S C U S S I ON     A N D    A N A L Y S I S

December 31, 2011 and $4.5 million at December 31, 2010.

Non-performing Assets

Loans are reviewed at least quarterly and any loan whose collectability 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 collectability of the loan. Restructured loans include the

Bank’s troubled debt restructurings that involved forgiving a portion of interest or principal or making loans at a rate materially less than the market rate to borrowers whose financial condition had deteriorated. Foreclosed and repossessed assets include assets acquired in settlement of loans. Total non-performing assets were $50.6 million at December 31, 2011, a decrease of $33.9 million from $84.5 million at December 31, 2010 primarily due to charge-offs recorded in 2011.

Non-performing loans decreased $34.1 million and foreclosed and repossessed assets increased $0.2 million during 2011. The following table sets forth the amounts and categories of non-performing assets in the Company’s portfolio:

	December 31,
(Dollars in thousands)	2011			2010			2009			2008			2007
Non-accruing loans:
One-to-four family	$	4,435			4,844			2,132			7,251			1,196
Commercial real estate		22,658			36,737			37,122			46,953			15,641
Consumer		699			224			4,086			5,298			1,094
Commercial business		6,201			26,269			17,787			4,671			1,723
Total		33,993			68,074			61,127			64,173			19,654
Other assets		0			0			0			25			34
Foreclosed and repossessed assets:
One-to-four family		352			972			1,011			258			901
Commercial real estate		16,264			15,409			15,246			10,300			1,313
Consumer		0			14			5			0			33
Total		16,616			16,395			16,262			10,558			2,247
Total non-performing assets	$	50,609		$	84,469		$	77,389		$	74,756		$	21,935
Total as a percentage of total assets		6.40	%		9.59	%		7.47	%		6.53	%		1.96	%
Total non-performing loans	$	33,993		$	68,074		$	61,127		$	64,173		$	19,654
Total as a percentage of total loans receivable, net		6.10	%		10.25	%		7.65	%		7.12	%		2.27	%
Allowance for loan losses to non-performing loans		70.27	%		62.91	%		38.95	%		33.12	%		63.28	%

The following table summarizes the number and property types of commercial real estate loans that were non-performing (the largest category of non-performing loans) at December 31, 2011, 2010 and 2009. For 2011, 2010 and 2009, gross interest income which would have been recorded had the non-accruing loans been current in

accordance with their original terms amounted to $3.2 million for 2011, and $5.0 million for both 2010 and 2009. The amounts that were included in interest income on a cash basis for these loans were $0.7 million, $1.3 million and $0.9 million, respectively.

22

(Dollars in thousands)
Property Type	# of Relationships		Principal Amount of Loans at December 31, 2011		# of Relationships		Principal Amount of Loans at December 31, 2010		# of Relationships		Principal Amount of Loans at December 31, 2009
Developments/land		10	$	17,465		9	$	23,661		7	$	12,030
Single family homes		0		0		3		2,673		2		3,088
Hotels		0		0		0		0		1		4,999
Alternative fuel plants		0		0		1		4,994		2		12,834
Shopping centers/retail		2		1,315		3		1,099		2		1,136
Restaurants/bar		1		616		1		635		4		2,436
Office building		1		2,325		1		3,675		1		599
Other buildings		3		937		0		0		0		0
		17	$	22,658		18	$	36,737		19	$	37,122

The Company had allocated reserves established against the above commercial real estate loans of $2.9 million, $13.3 million and $7.7 million, respectively, at December 31, 2011, 2010 and 2009.

The following table summarizes the number of lending relationships and the industry of commercial business loans that were non-performing for the years ended December 31, 2011, 2010 and 2009.

(Dollars in thousands)
Industry Type	#		Principal Amount of Loans December 31, 2011		#		Principal Amount of Loans December 31, 2010		#		Principal Amount of Loans December 31, 2009
Residential/development		6	$	2,061		6	$	9,148		5	$	4,094
Finance		0		0		1		248		2		8,764
Alternative fuels		0		0		0		0		1		756
Retail		1		82		1		2,504		1		32
Banking		1		1,149		2		8,223		1		3,248
Entertainment		1		23		1		315		1		893
Utilities		1		2,792		1		4,614		0		0
Restaurant		0		0		4		1,217		0		0
Other		2		94		0		0		0		0
		12	$	6,201		16	$	26,269		11	$	17,787

The Company had allocated reserves established against the above commercial business loans of $1.5 million, $10.7 million and $3.4 million, respectively, at December 31, 2011, 2010 and 2009.

At December 31, 2011, 2010 and 2009, there were loans included in loans receivable, net, with terms that had been modified in a troubled debt restructuring totaling $29.2 million, $19.3 million and $5.3 million, respectively. For the loans that were restructured in 2011, $0.5 million were unclassified and performing, $2.0 million were classified and performing and $17.2 million were non-performing at December 31. The increase in troubled debt restructurings in 2011 relates primarily to multiple loans to two developers and a telecommunications company totaling $7.8 million. The restructurings included reducing loan rates and restructuring repayment schedules to improve such

borrower’s cash flow and the addition of collateral by such borrower. Of the loans that were modified in 2011, $11.6 million related to commercial real estate loans and the remaining modifications related to single family, consumer and commercial loans. Of the loans that were modified in 2010, $14.9 million related to commercial real estate loans and the remaining modifications related to single family, consumer, and commercial loans. Of the loans that were modified in 2009, $4.3 million related to a commercial real estate loan and the remaining loans related to single family and consumer loans. Some of these loans were not classified as non-performing as it is anticipated that the borrowers will be able to make all of the required principal and interest payments under the modified terms of the loan.

In addition to the troubled debt restructurings and the non-performing loans set forth in the table above of

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all non-performing assets, as of December 31, 2011, there were two other potential problem loan relationships. Potential problem loans are loans that are not in non-performing status; however, there are circumstances present to create doubt as to the ability of the borrower to comply with present repayment terms. The decision of management to include performing loans in potential problem loans does not necessarily mean that the Company expects losses to occur but that management recognized a higher degree of risk associated with these loans. The level of potential problem loans is another predominant factor in determining the relative level of the allowance for loan losses. The two loan relationships that have been reported as potential problem loans at December 31, 2011 are a $3.8 million loan to a financial institution and a group of loans totaling $5.0 million to a residential developer. At December 31, 2010, potential problem loans were a $6.0 million land development loan and a group of commercial loans to a related borrower totaling $0.5 million. At December 31, 2009, potential problem loans were a $5.0 million loan to a financial institution and a $1.7 million group of loans in which the personal guarantor’s financial condition had deteriorated.

Pursuant to the Bank Supervisory Agreement, the Bank submitted a problem asset reduction plan that was accepted by the OCC.

Liquidity and Capital Resources

The Company manages its liquidity position so 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, internet or brokered deposits or to borrow funds from third parties such as the Federal Home Loan Bank (FHLB) or the Federal Reserve Bank (FRB).

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 or mortgage servicing rights. Unpledged securities could also be pledged and used as collateral for additional

borrowings with the FHLB or FRB to generate additional cash.

The primary financing activity is the attraction of retail and internet deposits. The Bank has the ability to borrow additional funds from the FHLB or FRB by pledging additional securities or loans, subject to applicable borrowing base and collateral requirements. Refer to Note 11 of the Notes to Consolidated Financial Statements for more information on additional advances that could be drawn based upon existing collateral levels with the FHLB and the FRB. Information on outstanding advance maturities and related early call features is also included in Note 11.

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.

Cash and cash equivalents at December 31, 2011 were $67.8 million, an increase of $46.8 million, compared to $21.0 million at December 31, 2010. Net cash provided by operating activities during 2011 was $17.3 million. The Company conducted the following major investing activities during 2011: principal payments and maturity proceeds received on securities available for sale and FHLB stock were $171.9 million, purchases of securities available for sale and FHLB stock were $144.1 million, proceeds from the sale of premises and other real estate were $5.4 million, and loans receivable decreased $76.1 million. The Company spent $0.2 million for the purchase of equipment and updating its premises. Net cash provided by investing activities during 2011 was $109.2 million. The Company conducted the following major financing activities during 2011: received proceeds from borrowing and advances of $10.0 million, repaid advances and borrowings of $62.5 million and deposits decreased $27.3 million. Net cash used by financing activities was $79.7 million.

The Company has certificates of deposit with outstanding balances of $187.5 million that mature during 2012, of which $51.8 million were obtained from brokers. Based upon past experience, management anticipates that the majority of the deposits will renew for another term, with the exception of the brokered deposits that are not anticipated to renew due to management’s

24

desire to reduce the amount of outstanding brokered deposits. In addition, based on an OTS directive, the Bank may not renew existing brokered deposits, or accept new brokered deposits without the prior consent of the OCC (as successor to the OTS). The Company believes that deposits that do not renew will be paid off with the proceeds from loan principal payments or replaced with a combination of other customers’ deposits, FHLB advances or FRB borrowings. Proceeds from the sale of securities could also be used to fund unanticipated outflows of deposits.

The Company has deposits of $60.0 million in checking and money market accounts of customers that have relationship balances greater than $5 million. Approximately $20.7 million of the $60.0 million in deposits are expected to be sold as part of the Toledo branch sale that is to be completed in the first quarter of 2012. While the remaining funds may be withdrawn at any time, management anticipates that the majority of these deposits will remain on deposit with the Bank over the next twelve months based on past experience. If these deposits are withdrawn, it is anticipated that they would be funded with available cash or replaced with FHLB advances, FRB borrowings or deposits from other customers.

The Company has $70.0 million of FHLB advances with maturities beyond 2012 that have call features that may be exercised by the FHLB during 2012. 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.

The credit policy of the FHLB relating to the collateral value of the loans collateralizing the outstanding advances with 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 and the Bank may have to find alternative funding sources to replace some of the FHLB advances maturing in 2013. The FHLB could also reduce the amount of funds it will lend to the Bank. It is not anticipated that the Bank will need to find alternative funding sources in 2012 to replace the outstanding FHLB advances, but if needed, excess collateral currently pledged to the FHLB could be pledged to the FRB and the Bank could borrow

additional funds from the FRB based on the increased collateral levels or obtain additional deposits.

Under the Company Supervisory Agreement, the Company may not incur or issue any debt without prior notice to, and the consent of, the OCC (as successor to the OTS). Because FHLB advances are debt of the Bank, they are not affected by the Company’s restriction on incurring debt.

The Holding Company’s primary source of cash is dividends from the Bank and the Bank is restricted under the Bank Supervisory Agreement from paying dividends to the Company without obtaining prior regulatory approval. At December 31, 2011, the Company had $1.4 million in cash and other assets that could readily be turned into cash. The Company anticipates that its liquidity requirements for 2012 will be similar to the liquidity requirements in 2011, except that it is anticipated that $34 million of the Bank’s cash will be used to fund the outflow of deposits in connection with the sale of the Toledo, Iowa branch in the first quarter of 2012. The Company believes that the Bank’s available liquidity is adequate to provide the cash needed for funding the branch sale and the payment of its operating expenses in 2012. The Company’s primary use of cash is the payment of expenses and dividends on the preferred stock issued to the United States Treasury Department as part of the TARP Capital Purchase Program. The amount of the dividend on the preferred stock accumulates at the rate of $325,000 per quarter through February 14, 2014 and $585,000 per quarter thereafter, if the shares of preferred stock are not redeemed. If the accumulated dividends on the preferred stock have not been paid for an aggregate of six quarterly dividend periods or more, whether or not consecutive, the number of authorized directors of the Company automatically will be increased by two, and the holders of the preferred shares (currently the United States Treasury) will have the right to elect two directors to fill the newly created directorships. The Company deferred the February 15, 2011, May 15, 2011, August 15, 2011, November 15, 2011 and February 15, 2012 regular quarterly cash dividends and the total amount of accrued but unpaid dividends totaled $1.3 million at December 31, 2011. The Company determined to defer such payments following discussions with its primary regulator. In addition, under the terms of the Company’s Supervisory Agreement, the Company may not declare or pay any cash dividends without prior

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notice to, and consent of, the OCC (as successor to the OTS).

The previously authorized stock repurchase program expired on January 26, 2010. No treasury stock purchases were made in 2011 and none are anticipated in 2012 due to restrictions on stock repurchases by the United States Treasury in connection with its preferred stock investment in the Company. In addition, under the terms of the Company’s Supervisory Agreement, the Company may not repurchase or redeem any capital stock without

prior notice to, and consent of, the OCC (as successor to the OTS).

Contractual Obligations and Commercial Commitments

The Company has certain obligations and commitments to make future payments under existing contracts. At December 31, 2011, the aggregate contractual obligations (excluding bank deposits) and commercial commitments were 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	$	70,000		0		70,000		0		0
Branch sale obligations		34,465		34,465		0		0		0
Annual rental commitments under non-cancellable operating leases		3,279		778		1,392		1,103		6
	$	107,744		35,243		71,392		1,103		6
	Amount of Commitments -Expiring by Period
Other Commercial Commitments:
Commercial lines of credit	$	24,917		15,862		6,650		2,405		0
Commitments to lend		6,229		5,664		20		146		399
Standby letters of credit		1,535		1,505		30		0		0
	$	32,681		23,031		6,700		2,551		399

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 ratio of 5% or greater, and (iv) is not subject to any order or written directive by the OCC (as successor to the OTS) to meet and maintain a specific capital level for any capital measure. Refer to Note 16 of the Notes to Consolidated Financial Statements for a table which reflects the Bank’s capital compared to these capital requirements.

As required by the Company Supervisory Agreement, the Company submitted an updated two-year

capital plan in January of 2012 that the Federal Reserve Board (as successor to the OTS) may make comments upon, and to which it may require revisions. The Company must operate within the parameters of the final capital plan and is required to monitor and submit periodic reports on its compliance with the plan. In addition, the OCC has established an individual minimum capital requirement (IMCR) for the Bank. An IMCR requires a bank to establish and maintain levels of capital greater than those generally required for a bank to be classified as “well-capitalized.” Effective December 31, 2011, the Bank was required to establish, and subsequently maintain, core capital at least equal to 8.5% of adjusted total assets, which was in excess of the Bank’s 7.14% core capital to adjusted total assets ratio at December 31, 2011. The Bank would have needed $10.8 million in additional capital at December 31, 2011 to meet the minimum core capital ratio set by the OCC. In February 2012, the Bank received a notice from the OCC arising out of its failure to establish and maintain its

26

IMCR of 8.5% core capital to adjusted total assets at December 31, 2011. By April 30, 2012, the Bank must submit to the OCC a further written capital plan of how it will achieve and maintain its IMCR, and a contingency plan in the event the IMCR is not achieved through the Bank’s primary plan. The Bank’s failure to comply with the terms of the IMCR is deemed an unsafe and unsound banking practice and could subject it to further limits on growth and such legal actions or sanctions as the OCC considers appropriate.

Management believes that, as of December 31, 2011, the Bank’s capital ratios were in excess of those quantitative capital ratio standards set forth under the prompt corrective action regulations described above. The failure of the Bank to satisfy the IMCR at December 31, 2011 does not by itself affect the Bank’s status as “well-capitalized” within the meaning of these prompt corrective action regulations. However, there can be no assurance that the Bank will continue to maintain such status in the future. The OCC has extensive discretion in its supervisory and enforcement activities, and can adjust the requirement to be “well-capitalized” in the future.

In order to improve its capital ratios and comply with its IMCR, the Bank is, among other things, working to improve its financial results, reduce non-performing assets, and decrease the asset size of the Bank. The Bank has also entered into a definitive purchase and assumption agreement relating to its Toledo, Iowa branch as more fully described below. In light of its current capital condition and its failure to comply with the IMCR at December 31, 2011, the Bank may also determine it to be necessary or prudent to dispose of other non-strategic assets. These actions have resulted, and may result in changes in the Bank’s assets, liabilities and earnings, some of which may be material, during the period in which the action is taken or is consummated or over a longer period of time.

The Bank entered into a definitive purchase and assumption agreement on November 7, 2011 with Pinnacle Bank (Pinnacle) of Marshalltown, Iowa which provides for the sale to Pinnacle of substantially all of the assets associated with the Toledo, Iowa branch (the Branch) of the Bank (approximately $1.6 million at December 31, 2011) and the assumption by Pinnacle of substantially all deposit liabilities of the Branch

(approximately $36.0 million at December 31, 2011). The Bank will continue to own and operate its other Iowa and Minnesota branches. Regulatory approval for the transaction has been obtained, however, the transaction is subject to the scheduling of the required Branch data processing conversion. Subject to the foregoing and other customary terms and conditions, the transaction is anticipated to be consummated in the first quarter of 2012. The Bank anticipates that the transaction will be funded with available assets, result in a one time gain on sale in the first quarter of 2012, result in a decrease in the Bank’s overall assets of approximately $34 million, and improve the Bank’s core capital ratio by approximately 40 basis points.

The Company also serves as a source of capital, liquidity and financial support to the Bank. Based on the operating performance of the Bank or other capital demands, including the Bank’s failure to comply with the outstanding IMCR, the Company may need, or be required by supervising bank regulators, to raise additional capital. If the Company raises capital through the issuance of additional shares of common stock or other equity securities, it would dilute the ownership interests of existing stockholders and, given our current common stock trading price, would be expected to dilute the per share book value of the Company’s common stock and could result in a change of control of the Company and the Bank. New investors may also have rights, preferences and privileges senior to the Company’s current stockholders, which may adversely impact the Company’s current stockholders. The Company’s ability to raise additional capital through the issuance of equity securities, if needed, will depend on conditions in the capital markets at that time, which are outside of its control, and on the Company’s financial performance. Accordingly, the Company may not be able to raise additional capital, if needed, on favorable economic terms, or other terms acceptable to it. If the Company or the Bank cannot satisfactorily address their respective capital needs as they arise, the Company’s ability to maintain or expand its operations, their ability to meet the Company’s capital plan and the Bank IMCR, operate without additional regulatory or other restrictions, and its operating results, could be materially adversely affected.

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Dividends

The declaration of dividends is 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. Under the Bank Supervisory Agreement, no dividends can be declared or paid by the Bank to the Company without prior regulatory approval. Refer to Note 15 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 by the Company is dependent upon the Company having adequate cash or other assets that can be converted to cash to pay dividends to its stockholders. The Company suspended the dividend payments to common stockholders in the fourth quarter of 2008 due to the net operating loss experienced and the challenging economic environment. The Company has also suspended the past five regular quarterly cash dividends on the preferred stock issued to the Treasury as part of the TARP Capital Purchase Program. Under the terms of the certificate of designations for the preferred stock, dividend payments may be deferred without default, but the dividend is cumulative and, if the Company fails to pay dividends for six quarters, whether or not consecutive, the Treasury will have the right to appoint two representatives to the Company’s board of directors. As of February 15, 2012, the Company had failed to pay dividends for five quarters. Under the terms of the Company Supervisory Agreement, the Company may not declare or pay any cash dividends, or purchase or redeem any capital stock, without prior notice to, and consent of, the OCC (as successor to OTS). The Company does not anticipate requesting consent from the OCC (as successor to OTS) to make any payments of dividends on, or purchase of, its common or preferred stock in 2012.

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 Pronouncements

In July 2010, the FASB issued ASU 2010-20, Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses, which requires significant new disclosures about the allowance for credit losses and the credit quality of financing receivables. The requirements are intended to enhance transparency regarding credit losses and the credit quality of loan and lease receivables. Under this statement, allowance for credit losses and fair value are to be disclosed by portfolio segment, while credit quality information, impaired financing receivables and nonaccrual status are to be presented by class of financing receivable. Disclosure of the nature and extent, the financial impact and segment information of troubled debt restructurings are also required. The disclosures are to be presented at the level of disaggregation that management uses when assessing and monitoring the portfolio’s risk and performance. This ASU is effective for interim and annual reporting periods after December 15, 2010 and the related disclosures are included in Note 5 of the consolidated financial statements in this report.

In April 2011, the FASB issued ASU 2011-02, Receivables (Topic 310), A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring. This ASU provides guidance on evaluating whether a restructuring constitutes a troubled debt restructuring. It indicates that if a creditor separately concludes that a restructuring constitutes a concession and that the debtor is experiencing financial difficulties that the restructuring is a troubled debt restructuring. It also clarifies guidance on a creditor’s evaluation of the above two items. For public entities, such as HMN, the amendments in this ASU are effective for the first interim or annual period beginning on or after June 15, 2011, and should be applied retrospectively to the beginning of the annual period of adoption. In addition, this ASU requires that the disclosures about troubled debt restructurings that were delayed by ASU 2011-01 in January 2011 be disclosed for interim and annual periods beginning on or after June 15, 2011. The implementation of the guidance in this ASU and the related disclosures are included in Note 5 of this report.

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In April 2011, the FASB issued ASU 2011-03, Transfers and Servicing (Topic 860), Reconsideration of Effective Control for Repurchase Agreements. Topic 860, Transfers and Servicing, which prescribes when an entity may or may not recognize a sale upon the transfer of financial assets subject to repurchase agreements. That determination is based, in part, on whether the entity has maintained effective control over the transferred assets. The amendments in this ASU removed from the assessment of effective control (1) the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee, and (2) the collateral maintenance implementation guidance related to that criterion. Other criteria applicable to the assessment of effective control are not changed by the amendments in this ASU. This ASU is effective for the first interim or annual period beginning on or after December 15, 2011 and should be applied prospectively to transactions or modification of existing transactions that occur on or after the effective date. The adoption of this ASU in the first quarter of 2012 did not have a material impact on the Company’s consolidated financial statements.

In May 2011, the FASB issued ASU 2011-04, Fair Value Measurement (Topic 820), Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. The amendments in this ASU change the wording used to describe the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements in order to improve consistency in wording between U.S. GAAP and IFRS. This ASU is effective for interim or annual period beginning on or after December 15, 2011. The adoption of this ASU in the first quarter of 2012 did not have a material impact on the Company’s consolidated financial statements other than to change the disclosures relating to fair value measurements.

In June 2011, the FASB issued ASU 2011-05, Comprehensive Income (Topic 220), Presentation of Comprehensive Income. Current U.S. GAAP allows reporting entities three alternatives for presenting other comprehensive income and its components in financial statements. The first two options are to present this information in a single continuous statement of comprehensive income or in two separate but consecutive statements. The third option, which is used by the

Company, is to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity. This ASU eliminates the third option and therefore the Company will have to adopt one of the two remaining methods for presentation. This ASU is effective for fiscal years, and interim periods beginning after December 15, 2011. The adoption of this ASU in the first quarter of 2012 did not have a material impact on the Company’s consolidated financial statements other than to change the presentation of other comprehensive income as discussed above.

In September 2011, the FASB issued ASU 2011-09, Compensation — Retirement Benefits — Multiemployer Plans (Subtopic 715-80). The amendments in this ASU require additional disclosures about an employer’s participation in a multiemployer plan. For public entities, such as HMN, this ASU is effective for annual periods for fiscal years ending after December 15, 2011. The adoption of this ASU in the fourth quarter of 2011 did not have a material impact on the Company’s consolidated financial statements. The presentation of the additional disclosures relating to the multiemployer retirement plan (sponsored by the Financial Institutions Retirement Fund (FIRF)) in which the Company participates is included in Note 13 of this report.

In December 2011, the FASB issued ASU 2011-11, Balance Sheet (Topic 210). The objective of this ASU is to provide enhanced disclosures that will enable users of its financial statements to evaluate the effect or potential effect of rights of setoff associated with an entity’s financial position. This includes the effect or potential effect of rights of setoff associated with an entity’s recognized assets and recognized liabilities within the scope of this ASU. The amendments require enhanced disclosures by requiring improved information about financial instruments and derivative instruments that are either (1) offset in accordance with either Section 210-20-45 or Section 815-10-45 or (2) subject to an enforceable master netting arrangement or similar agreement, irrespective of whether they are offset in accordance with either Section 210-20-45 or Section 815-10-45. An entity is required to apply the amendments for annual reporting periods beginning on or after January 1, 2013, and interim periods with those annual periods. The adoption of this ASU in the first quarter of 2013 is not anticipated to have any impact on the Company’s consolidated financial statements as it currently has no outstanding rights of setoff.

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In December 2011, the FASB issued ASU 2011-12, Comprehensive Income (Topic 220). The amendments in this ASU supersede certain pending paragraphs in ASU 2011-5, Comprehensive Income (Topic 220): Presentation of Comprehensive Income, to effectively defer only those changes in ASU 2011-05 that relate to the presentation of reclassification adjustments out of accumulated other comprehensive income. All other requirements in ASU 2011-05 are not affected by this ASU, including the requirement to report comprehensive income either in a single continuous financial statement or in two separate but consecutive financial statements. The amendments will be temporary to allow the Board time to redeliberate the presentation requirements for reclassifications out of accumulated other comprehensive income for annual and interim financial statements for public, private, and non-profit entities. The adoption of this ASU in the first quarter of 2012 did not have a material impact on the Company’s consolidated financial statements other than to change the presentation of other comprehensive income as discussed above.

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 Management’s Discussion and Analysis discloses the Company’s projected changes in net interest income based upon immediate interest rate changes called rate shocks.

The Company utilizes a model that 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 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, 2011.

(Dollars in thousands) Basis point change in interest rates	Market Value
	-100			0			+100			+200
Total market-risk sensitive assets	$	804,852			796,019			783,763			768,623
Total market-risk sensitive liabilities		743,606			731,694			719,454			706,703
Off-balance sheet financial instruments		(435	)		0			(56	)		(80	)
Net market risk	$	61,681			64,325			64,365			62,000
Percentage change from current market value		(4.11	)%		0.00	%		0.06	%		(3.61	)%

The preceding table was prepared utilizing the following assumptions (the Model Assumptions) regarding prepayment and decay ratios that were determined by management based upon their review of historical prepayment speeds and future prepayment projections. Fixed rate loans were assumed to prepay at annual rates of between 8% and 71%, depending on the note rate and the period to maturity. Adjustable rate

mortgages (ARMs) were assumed to prepay at annual rates of between 13% and 34%, 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

30

until maturity. Passbook and money market accounts were assumed to decay at annual rates of 22% and 28%, respectively. Non-interest checking and NOW accounts were assumed to decay at annual rates of 23% and 16%, respectively. Commercial non-interest checking was assumed to decay at an annual rate of 23%. Commercial NOW and MMDA accounts were assumed to decay at annual rates of 16% and 28%, respectively. 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 11 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 that 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 or floors could be different from the values calculated in the table. Certain liabilities, such as certificates of deposit, have fixed rates that restrict interest rate changes until maturity. 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 increase in interest rates.

Asset/Liability Management

The Company’s management reviews the impact that changing interest rates will have on the net interest income projected for the twelve months following December 31, 2011 to determine if its current level of interest rate risk is acceptable. The following table projects the estimated impact on net interest income

during the 12 month period ending December 31, 2012 of immediate interest rate changes called rate shocks:

Rate Shock Table
(Dollars in thousands)
Rate Shock in Basis Points	Net Interest Change			Percent Change
+200	$	495			2.10	%
+100		412			1.75
0		0			0.00
-100		(983	)		(4.17	)

The preceding table was prepared utilizing the Model Assumptions. 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. The increase in interest income in a rising rate environment is because there are more adjustable rate loans that would reprice to higher interest rates in the next twelve months than there are certificates of deposit that would reprice.

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 that 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 that 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 may, at times, depending on the relationship between long and short-term interest rates, market conditions and consumer preference, 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

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mismatch in the maturity of its asset and liability portfolios can, in certain situations, provide high enough returns to justify the increased exposure to sudden and unexpected changes in interest rates.

To the extent consistent with its interest rate spread objectives, the Bank attempts to manage its interest rate risk and has taken a number of steps to restructure its balance sheet in order to better match the maturities of its assets and liabilities. In the past, more fixed rate loans were placed into the single family loan portfolio. In 2011, the Bank has primarily focused its fixed rate one-to-four family residential lending program on loans that are saleable to third parties and generally placed only those fixed rate loans

that met certain risk characteristics into its loan portfolio. The Bank’s commercial loan production continued to be primarily in adjustable rate loans with minimum interest rate floors; however, more of these loans were structured to reprice every one, two, or three years.

Off-Balance Sheet Arrangements

The Company has no off-balance sheet arrangements other than commitments to originate and sell loans in the ordinary course of business which are more fully discussed in Note 17 of the Notes to Consolidated Financial Statements.

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C O N S O L I D A T E D    B A L  A N C E    S H E E T S

December 31 (Dollars in thousands)	2011			2010
ASSETS
Cash and cash equivalents	$	67,840			20,981
Securities available for sale:
Mortgage-backed and related securities
(amortized cost $19,586 and $32,036)		20,645			33,506
Other marketable securities
(amortized cost $105,700 and $118,631)		105,469			118,058
		126,114			151,564
Loans held for sale		3,709			2,728
Loans receivable, net		555,908			664,241
Accrued interest receivable		2,449			3,311
Real estate, net		16,616			16,382
Federal Home Loan Bank stock, at cost		4,222			6,743
Mortgage servicing rights, net		1,485			1,586
Premises and equipment, net		7,967			9,450
Prepaid expenses and other assets		2,262			3,632
Assets held for sale		1,583			0
Deferred tax assets, net		0			0
Total assets	$	790,155			880,618
LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits	$	620,128			683,230
Deposits held for sale		36,048			0
Federal Home Loan Bank advances and Federal Reserve borrowings		70,000			122,500
Accrued interest payable		780			1,092
Customer escrows		933			818
Accrued expenses and other liabilities		5,205			3,431
Total liabilities		733,094			811,071
Commitments and contingencies
Stockholders’ equity:
Serial preferred stock: ($.01 par value)
Authorized 500,000 shares; issued shares 26,000		24,780			24,264
Common stock ($.01 par value):
Authorized 11,000,000; issued shares 9,128,662		91			91
Additional paid-in capital		53,462			56,420
Retained earnings, subject to certain restrictions		42,983			55,838
Accumulated other comprehensive income		471			541
Unearned employee stock ownership plan shares		(3,191	)		(3,384	)
Treasury stock, at cost 4,740,711 and 4,818,263 shares		(61,535	)		(64,223	)
Total stockholders’ equity		57,061			69,547
Total liabilities and stockholders’ equity	$	790,155			880,618

See accompanying notes to consolidated financial statements.

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C O N S O L I D A T E D    S T A T E M E  N T S    OF    L O S S

Years ended December 31 (Dollars in thousands)	2011			2010			2009
Interest income:
Loans receivable	$	36,776			44,248			51,876
Securities available for sale:
Mortgage-backed and related		1,098			1,813			2,768
Other marketable		1,451			2,023			3,039
Cash equivalents		36			4			1
Other		180			182			87
Total interest income		39,541			48,270			57,771
Interest expense:
Deposits		6,847			11,281			17,579
Federal Home Loan Bank advances and Federal Reserve borrowings		4,288			5,978			6,289
Total interest expense		11,135			17,259			23,868
Net interest income		28,406			31,011			33,903
Provision for loan losses		17,278			33,381			26,699
Net interest income (loss) after provision for loan losses		11,128			(2,370	)		7,204
Non-interest income:
Fees and service charges		3,739			3,741			4,137
Loan servicing fees		987			1,067			1,042
Securities gains, net		0			0			5
Gain on sales of loans		1,656			1,987			2,273
Other		487			476			625
Total non-interest income		6,869			7,271			8,082
Non-interest expense:
Compensation and benefits		13,553			13,516			13,432
Losses on real estate owned		2,681			1,165			3,873
Occupancy		3,741			4,082			4,084
Deposit insurance		1,255			1,933			1,973
Data processing		1,221			1,040			1,182
Other		7,101			5,820			7,145
Total noninterest expense		29,552			27,556			31,689
Loss before income tax expense (benefit)		(11,555	)		(22,655	)		(16,403	)
Income tax expense (benefit)		0			6,323			(5,607	)
Net loss	$	(11,555	)		(28,978	)		(10,796	)
Preferred stock dividends and discount		(1,821	)		(1,784	)		(1,747	)
Net loss available to common stockholders	$	(13,376	)		(30,762	)		(12,543	)
Basic loss per common share	$	(3.47	)		(8.17	)		(3.39	)
Diluted loss per common share	$	(3.47	)		(8.17	)		(3.39	)

See accompanying notes to consolidated financial statements.

34

C O N S O L I D A T E D    S T A T E M E  N T S    OF    S T O C K H O L D E R S’     E Q U I T Y    A N D    C O M P R E H E N S I V E    L O S S

(Dollars in thousands)	Preferred Stock		Common Stock		Additional Paid-in Capital			Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Unearned Employee Stock Ownership Plan			Treasury Stock			Total Stock- holders’ Equity
Balance, December 31, 2008	$	23,384		91		60,687			98,067			2,091			(3,771	)		(68,336	)		112,213
Net loss									(10,796	)											(10,796	)
Other comprehensive loss, net of tax:
Net unrealized losses on securities available for sale												(861	)								(861	)
Total comprehensive loss																					(11,657	)
Preferred stock discount amortization		401				(401	)														0
Unearned compensation restricted stock awards						(2,181	)											2,181			0
Restricted stock awards forfeited						127												(127	)		0
Restricted stock awards dividend forfeited									7												7
Stock compensation expense						27															27
Amortization of restricted stock awards						373															373
Earned employee stock ownership plan shares						(56	)								194						138
Preferred stock dividends									(1,163	)											(1,163	)
Balance, December 31, 2009	$	23,785		91		58,576			86,115			1,230			(3,577	)		(66,282	)		99,938
Net loss									(28,978	)											(28,978	)
Other comprehensive loss, net of tax:
Net unrealized losses on securities available for sale												(689	)								(689	)
Total comprehensive loss																					(29,667	)
Preferred stock discount amortization		479				(479	)														0
Stock compensation expense						63															63
Unearned compensation restricted stock awards						(2,237	)											2,237			0
Restricted stock awards forfeited						178												(178	)		0
Restricted stock awards dividend Forfeited									1												1
Amortization of restricted stock awards						370															370
Earned employee stock ownership plan shares						(51	)								193						142
Preferred stock dividends									(1,300	)											(1,300	)
Balance, December 31, 2010	$	24,264		91		56,420			55,838			541			(3,384	)		(64,223	)		69,547
Net loss									(11,555	)											(11,555	)
Other comprehensive loss, net of tax:
Net unrealized losses on securities available for sale												(70	)								(70	)
Total comprehensive loss																					(11,625	)
Preferred stock discount amortization		516				(516	)														0
Stock compensation expense						29															29
Unearned compensation restricted stock awards						(2,700	)											2,700			0
Restricted stock awards forfeited						12												(12	)		0
Amortization of restricted stock awards						298															298
Earned employee stock ownership plan shares						(81	)								193						112
Preferred stock dividends									(1,300	)											(1,300	)
Balance, December 31, 2011	$	24,780		91		53,462			42,983			471			(3,191	)		(61,535	)		57,061

See accompanying notes to consolidated financial statements.

35

C O N S O L I D A T E D    S T A T E M E  N T S    O F    C A S H    F L O W S

Years ended December 31 (Dollars in thousands)	2011			2010			2009
Cash flows from operating activities:
Net loss	$	(11,555	)		(28,978	)		(10,796	)
Adjustments to reconcile net loss to cash provided by operating activities:
Provision for loan losses		17,278			33,381			26,699
Depreciation		1,267			1,593			1,837
Amortization of premiums, net		297			571			465
Amortization of deferred loan fees		(465	)		(319	)		(972	)
Amortization of mortgage servicing rights		562			482			556
Capitalized mortgage servicing rights		(461	)		(753	)		(1,143	)
Deferred income tax expense (benefit)		0			12,043			(2,516	)
Securities gains, net		0			0			(5	)
Loss on sales of real estate and premises		2,681			1,165			3,731
Gain on sales of loans		(1,656	)		(1,987	)		(2,273	)
Proceeds from sales of loans held for sale		64,890			90,797			122,491
Disbursements on loans held for sale		(58,588	)		(85,384	)		(119,475	)
Amortization of restricted stock awards		298			370			373
Amortization of unearned ESOP shares		193			193			194
Earned ESOP shares priced below original cost		(81	)		(51	)		(56	)
Stock option compensation expense		29			63			27
Decrease in accrued interest receivable		862			713			1,544
Decrease in accrued interest payable		(312	)		(1,016	)		(4,199	)
Decrease (increase) in other assets		1,342			3,084			(2,041	)
Increase (decrease) in other liabilities		380			(774	)		912
Other, net		379			362			95
Net cash provided by operating activities		17,340			25,555			15,448
Cash flows from investing activities:
Proceeds from sales of securities available for sale		0			0			2,141
Principal collected on securities available for sale		12,466			19,820			22,213
Proceeds collected on maturity of securities available for sale		156,900			115,000			78,350
Purchases of securities available for sale		(144,051	)		(128,059	)		(88,446	)
Purchase of Federal Home Loan Bank stock		(17	)		(2,420	)		0
Redemption of Federal Home Loan Bank stock		2,538			2,963			0
Proceeds from sales of real estate and premises		5,440			14,532			10,749
Net decrease in loans receivable		76,114			82,591			56,329
Purchases of premises and equipment		(201	)		(292	)		(558	)
Net cash provided by investing activities		109,189			104,135			80,778
Cash flows from financing activities:
Decrease in deposits		(27,285	)		(113,218	)		(85,162	)
Dividends paid to preferred stockholders		0			(1,300	)		(1,163	)
Proceeds from borrowings		10,002			87,000			1,099,000
Repayment of borrowings		(62,502	)		(97,000	)		(1,109,000	)
Increase (decrease) in customer escrows		115			(609	)		788
Net cash used by financing activities		(79,670	)		(125,127	)		(95,537	)
Increase in cash and cash equivalents		46,859			4,563			689
Cash and cash equivalents, beginning of year		20,981			16,418			15,729
Cash and cash equivalents, end of year	$	67,840			20,981			16,418
Supplemental cash flow disclosures:
Cash paid for interest	$	11,447			18,275			28,067
Cash paid for income taxes		0			39			33
Supplemental noncash flow disclosures:
Loans transferred to loans held for sale		5,509			3,195			1,234
Transfer of loans to real estate		8,732			16,167			18,342
Assets transferred to assets held for sale		1,583			0			0
Deposits transferred to deposits held for sale		36,048			0			0

See accompanying notes to consolidated financial statements.

36

N O T E S    T O    C O N S O  L I D A T E D    F I N A N C I A L    S T A T E M E N T S

December 31, 2011, 2010 and 2009

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 and loan production facilities in Minnesota and Iowa. The Bank has one wholly owned subsidiary, Osterud Insurance Agency, Inc. (OIA), which offers financial planning products and services. HMN has another wholly owned subsidiary, Security Finance Corporation (SFC), which is currently not actively engaged in any activities.

The consolidated financial statements included herein are for HMN, SFC, the Bank and OIA. All significant intercompany accounts and transactions have been eliminated in consolidation.

The Company evaluated subsequent events through the filing date of our annual 10-K with the Securities and Exchange Commission on March 7, 2012.

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.

An estimate that is particularly susceptible to change relates to the determination of the allowance for loan losses. Management believes that the allowance for loan losses is appropriate 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 and other factors. 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.

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 and a new cost basis is established.

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 rates, 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 and a new cost basis is established.

Management monitors the investment security portfolio for impairment on an individual security basis and has a process in place to identify securities that could potentially have a credit impairment that is other than temporary. This process involves analyzing the length of time and extent to which the fair value has been less than the amortized cost basis, the market liquidity for the security, the financial condition and near-term prospects of the issuer, expected cash flows, and the Company’s intent and ability to hold the investment for a period of time sufficient to recover the temporary loss, including determining whether it is more-likely-than-not that the Company will be required to sell the security prior to recovery. To the extent it is determined that a security is

deemed to be other-than-temporarily impaired, an impairment loss is recognized.

Loans Held for Sale    Mortgage loans originated or purchased which are intended for sale in the secondary

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N O T E S    T O    C O N S O L I D A  T E D    F I N A N C I A L    S T A T E M E N T S

market are carried at the lower of cost or estimated market value in the aggregate. Net fees and costs associated with acquiring 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 on the sale of loans 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 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 purchased 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 to be appropriate 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 a quarterly analysis of the loan portfolio. 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, demand for single family homes, demand for commercial real estate and building lots, loan portfolio composition and historical loss experience. In connection with the determination of the allowance for loan losses, management obtains independent appraisals for significant properties or other collateral securing delinquent loans. The allowance for loan losses is established for known problem loans, as well as for loans which are not currently known to require an allowance. Loans are charged off to the extent they are deemed to be uncollectible. The appropriateness 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 collectability 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, the impaired amount is charged off. 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 on non-accrual, delinquent as to principal and interest for 90 days or greater or restructured in a troubled debt restructuring involving a modification of terms. All non-accruing loans are reviewed for impairment on an individual basis.

Included in loans receivable, net, are certain loans that have been modified in order to maximize collection of the loan balances. The Company evaluates all loan modifications and if the Company, for legal or economic reasons related to the borrower’s financial difficulties, grants a concession compared to the original terms and conditions of the loan that the Company would not otherwise consider, the modified loan is considered a troubled debt restructuring (TDR) and classified as an impaired loan. If the TDR loan was performing (accruing) prior to the modification, it typically will remain accruing after the modification as long as it continues to perform according to the modified terms. If the TDR loan was non-performing (non-accruing) prior to the modification, it will remain non-accruing after the modification for a minimum of six months. If the loan performs according to the modified terms for a minimum of six months, it typically will be returned to accruing status. In general, there are two conditions in which a TDR loan is no longer considered to be a TDR and potentially not classified as impaired. The first condition

38

is whether the loan is refinanced with terms that reflect normal terms for the type of credit involved. The second condition is whether the loan is repaid or charged off.

Mortgage Servicing Rights    Mortgage servicing rights are capitalized at fair value and amortized in proportion to, and over the period of, estimated net servicing income. The Company evaluates its capitalized mortgage servicing rights for impairment each quarter. Loan type and note rate are the 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 foreclosure is initially recorded at the lower of the related loan balance or the fair value less estimated selling costs. Valuations are reviewed quarterly 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.

Assets and Deposits Held for Sale    In the fourth quarter of 2011, the Bank entered into a definitive purchase and assumption agreement to sell certain assets and the deposits of its Toledo, Iowa branch. Until the consummation of the sale, which is anticipated to be completed in the first quarter of 2012, these assets and deposits are reported as held for sale and are carried at the lower of their cost basis or estimated fair market value.

Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of    The Company 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    The Company had investments in limited partnerships that invested in low to moderate income housing projects that generated tax

credits for the Company. The Company accounted for the earnings or losses from the limited partnerships on the equity method. The Company’s limited partnership investments were liquidated in the fourth quarter of 2011.

Stock Based Compensation    The Company recognizes the grant-date fair value of stock option and restricted stock awards issued as compensation expense, amortized over the vesting period.

Employee Stock Ownership Plan (ESOP)    The Company has an ESOP that borrowed funds from the Company and purchased shares of HMN common stock. The Company makes quarterly principal and interest payments on the ESOP loan. As the debt is repaid, ESOP shares that were pledged as collateral for the debt are released from collateral and allocated to eligible employees based on the proportion of debt service paid in the year. The Company accounts for its ESOP in accordance with ASC 718, 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, the Company reports compensation expense equal to the current market price of the shares, and the shares become outstanding for earnings per share computations.

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. A valuation allowance is required to be recognized if it is “more likely than not” that the deferred tax asset will not be realized. The determination of the realizability of the deferred tax asset is subjective and dependent upon judgment concerning management’s evaluation of both positive and negative evidence regarding the ultimate realizability of deferred tax assets.

Preferred Stock Dividends and Discount    The proceeds received from the preferred stock and warrant issued to the U.S. Treasury were allocated between the preferred

39

N O T E S    T O    C O N S O L I D A  T E D    F I N A N C I A L    S T A T E M E N T S

stock and the warrant based on their relative fair values at the time of issuance in accordance with the requirements of ASC 470, Accounting for Convertible Debt Issued with Stock Purchase Warrants. Because of the increasing rate dividend feature of the preferred shares, the discount on the warrant is amortized using the constant effective yield method over the five year period preceding the scheduled rate increase on the preferred stock in accordance with the requirements of ASC 505.

Loss per Share    Basic loss per common share excludes dilution and is computed by dividing the loss available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted loss per common share 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. Options and restricted stock awards are excluded from the loss per share calculation when a net loss is incurred as their inclusion in the calculation would be anti-dilutive and result in a lower loss per common share.

Comprehensive Income (Loss)    Comprehensive income (loss) is defined as the change in equity during a period from transactions and other events from nonowner sources. Comprehensive income (loss) is the total of net loss and other comprehensive income (loss), which for the Company is comprised of unrealized gains and losses on securities available for sale.

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 Pronouncements    In July 2010, the FASB issued ASU 2010-20, Disclosures about the Credit

Quality of Financing Receivables and the Allowance for Credit Losses, which requires significant new disclosures about the allowance for credit losses and the credit quality of financing receivables. The requirements are intended to enhance transparency regarding credit losses and the credit quality of loan and lease receivables. Under this statement, allowance for credit losses and fair value are to be disclosed by portfolio segment, while credit quality information, impaired financing receivables and nonaccrual status are to be presented by class of financing receivable. Disclosure of the nature and extent, the financial impact and segment information of troubled debt restructurings are also required. The disclosures are to be presented at the level of disaggregation that management uses when assessing and monitoring the portfolio’s risk and performance. This ASU is effective for interim and annual reporting periods after December 15, 2010 and the related disclosures were included in Note 5 of the consolidated financial statements in this report.

In April 2011, the FASB issued ASU 2011-02, Receivables (Topic 310), A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring. This ASU provides guidance on evaluating whether a restructuring constitutes a troubled debt restructuring. It indicates that if a creditor separately concludes that a restructuring constitutes a concession and that the debtor is experiencing financial difficulties that the restructuring is a troubled debt restructuring. It also clarifies guidance on a creditor’s evaluation of the above two items. For public entities, such as HMN, the amendments in this ASU are effective for the first interim or annual period beginning on or after June 15, 2011, and should be applied retrospectively to the beginning of the annual period of adoption. In addition, this ASU requires that the disclosures about troubled debt restructurings that were delayed by ASU 2011-01 in January 2011 be disclosed for interim and annual periods beginning on or after June 15, 2011. The implementation of the guidance in this ASU and the related disclosures are included in Note 5 of this report.

In April 2011, the FASB issued ASU 2011-03, Transfers and Servicing (Topic 860), Reconsideration of Effective Control for Repurchase Agreements. Topic 860, Transfers and Servicing, which prescribes when an entity may or may not recognize a sale upon the transfer of financial assets subject to repurchase agreements. That

40

determination is based, in part, on whether the entity has maintained effective control over the transferred assets. The amendments in this ASU removed from the assessment of effective control (1) the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee, and (2) the collateral maintenance implementation guidance related to that criterion. Other criteria applicable to the assessment of effective control are not changed by the amendments in this ASU. This ASU is effective for the first interim or annual period beginning on or after December 15, 2011 and should be applied prospectively to transactions or modification of existing transactions that occur on or after the effective date. The adoption of this ASU in the first quarter of 2012 did not have a material impact on the Company’s consolidated financial statements.

In May 2011, the FASB issued ASU 2011-04, Fair Value Measurement (Topic 820), Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. The amendments in this ASU change the wording used to describe the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements in order to improve consistency in wording between U.S. GAAP and IFRS. This ASU is effective for interim or annual period beginning on or after December 15, 2011. The adoption of this ASU in the first quarter of 2012 did not have a material impact on the Company’s consolidated financial statements other than to change the disclosures relating to fair value measurements.

In June 2011, the FASB issued ASU 2011-05, Comprehensive Income (Topic 220), Presentation of Comprehensive Income. Current U.S. GAAP allows reporting entities three alternatives for presenting other comprehensive income and its components in financial statements. The first two options are to present this information in a single continuous statement of comprehensive income or in two separate but consecutive statements. The third option, which is used by the Company, is to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity. This ASU eliminates the third option and therefore the Company will have to adopt one of the two remaining methods for presentation. This ASU is effective for fiscal years, and interim

periods beginning after December 15, 2011. The adoption of this ASU in the first quarter of 2012 did not have a material impact on the Company’s consolidated financial statements other than to change the presentation of other comprehensive income as discussed above.

In September 2011, the FASB issued ASU 2011-09, Compensation — Retirement Benefits — Multiemployer Plans (Subtopic 715-80). The amendments in this ASU require additional disclosures about an employer’s participation in a multiemployer plan. For public entities, such as HMN, this ASU is effective for annual periods for fiscal years ending after December 15, 2011. The adoption of this ASU in the fourth quarter of 2011 did not have a material impact on the Company’s consolidated financial statements. The presentation of the additional disclosures relating to the multiemployer retirement plan (sponsored by the Financial Institutions Retirement Fund (FIRF)) in which the Company participates is included in Note 13 of this report.

In December 2011, the FASB issued ASU 2011-11, Balance Sheet (Topic 210). The objective of this ASU is to provide enhanced disclosures that will enable users of its financial statements to evaluate the effect or potential effect of rights of setoff associated with an entity’s financial position. This includes the effect or potential effect of rights of setoff associated with an entity’s recognized assets and recognized liabilities within the scope of this ASU. The amendments require enhanced disclosures by requiring improved information about financial instruments and derivative instruments that are either (1) offset in accordance with either Section 210-20-45 or Section 815-10-45 or (2) subject to an enforceable master netting arrangement or similar agreement, irrespective of whether they are offset in accordance with either Section 210-20-45 or Section 815-10-45. An entity is required to apply the amendments for annual reporting periods beginning on or after January 1, 2013, and interim periods with those annual periods. The adoption of this ASU in the first quarter of 2013 is not anticipated to have any impact on the Company’s consolidated financial statements as it currently has no outstanding rights of setoff.

In December 2011, the FASB issued ASU 2011-12, Comprehensive Income (Topic 220). The amendments in this ASU supersede certain pending paragraphs in ASU 2011-5, Comprehensive Income (Topic 220): Presentation of Comprehensive Income, to effectively defer only those changes in ASU 2011-05 that relate to the presentation of reclassification adjustments out of

41

N O T E S    T O    C O N S O L I D A  T E D    F I N A N C I A L    S T A T E M E N T S

accumulated other comprehensive income. All other requirements in ASU 2011-05 are not affected by this ASU, including the requirement to report comprehensive income either in a single continuous financial statement or in two separate but consecutive financial statements. The amendments will be temporary to allow the Board time to redeliberate the presentation requirements for reclassifications out of accumulated other comprehensive income for annual and interim financial statements for public, private, and non-profit entities. The adoption of this ASU in the first quarter of 2012 did not have a material impact on the Company’s consolidated financial

statements other than to change the presentation of other comprehensive income as discussed above.

Derivative Financial Instruments    The Company 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. The Company may also from time to time use interest rate swaps to manage interest rate risk. Derivative financial instruments include commitments to extend credit and forward mortgage loan sales commitments.

NOTE 2 Other Comprehensive Loss

The components of other comprehensive loss and the related tax effects were as follows:

	For the years ended December 31,
	2011								2010									2009
(Dollars in thousands) Securities available for sale:	Before Tax			Tax Effect		Net of Tax			Before Tax			Tax Effect			Net of Tax			Before Tax			Tax Effect			Net of Tax
Gross unrealized losses arising during the period	$	(70	)		0		(70	)		(1,142	)		(453	)		(689	)		(1,490	)		(632	)		(858	)
Less reclassification of net gains included in net loss		0			0		0			0			0			0			5			2			3
Net unrealized losses arising during the period		(70	)		0		(70	)		(1,142	)		(453	)		(689	)		(1,495	)		(634	)		(861	)
Other comprehensive loss	$	(70	)		0		(70	)		(1,142	)		(453	)		(689	)		(1,495	)		(634	)		(861	)

42

NOTE 3 Securities Available for Sale

A summary of securities available for sale at December 31, 2011 and 2010 is as follows:

(Dollars in thousands)	Amortized cost		Gross unrealized gains		Gross unrealized losses			Fair value
December 31, 2011:
Mortgage-backed securities:
FHLMC	$	11,310		553		0			11,863
FNMA		7,670		499		0			8,169
Collateralized mortgage obligations:
FHLMC		335		4		0			339
FNMA		271		3		0			274
		19,586		1,059		0			20,645
Other marketable securities:
U.S. Government agency obligations		105,000		294		0			105,294
Corporate preferred stock		700		0		(525	)		175
		105,700		294		(525	)		105,469
		$125,286		1,353		(525	)		126,114
December 31, 2010:
Mortgage-backed securities:
FHLMC	$	17,555		719		0			18,274
FNMA		12,800		692		0			13,492
Collateralized mortgage obligations:
FHLMC		1,299		44		0			1,343
FNMA		382		15		0			397
		32,036		1,470		0			33,506
Other marketable securities:
U.S. Government agency obligations		117,931		218		(266	)		117,883
Corporate preferred stock		700		0		(525	)		175
		118,631		218		(791	)		118,058
	$	150,667		1,688		(791	)		151,564

The Company did not hold any investments in European sovereign debt as of December 31, 2011.

The Company did not sell any available for sale securities and did not recognize any gains or losses on investments in 2011 or 2010. Proceeds from securities available for sale which were sold in 2009 were $2.1 million resulting in gross gains of $5,000.

The following table presents amortized cost and estimated fair value of securities available for sale at December 31, 2011 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:

(Dollars in thousands)	Amortized Cost		Fair Value
Due less than one year	$	44,912		45,521
Due after one year through five years		79,148		79,862
Due after five years through ten years		526		556
Due after ten years		700		175
Total	$	125,286		126,114

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.

43

N O T E S    T O    C O N S O L I D A  T E D    F I N A N C I A L    S T A T E M E N T S

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, 2011 and 2010:

	Less Than Twelve Months							Twelve Months or More							Total
(Dollars in thousands)	# of Investments		Fair Value		Unrealized Losses			# of Investments		Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
December 31, 2011
Other marketable securities:
U.S. Government agency obligations		0	$	0		0			0	$	0		0		$	0		0
Corporate preferred stock		0		0		0			1		175		(525	)		175		(525	)
Total temporarily impaired securities		0	$	0		0			1	$	175		(525	)	$	175		(525	)
December 31, 2010
Other marketable securities:
U.S. Government agency obligations		10	$	47,610		(266	)		0	$	0		0		$	47,610		(266	)
Corporate preferred stock		0		0		0			1		175		(525	)		175		(525	)
Total temporarily impaired securities		10	$	47,610		(266	)		1	$	175		(525	)	$	47,785		(791	)

We review our investment portfolio on a quarterly basis for indications of impairment. This review includes analyzing the length of time and the extent to which the fair value has been lower than the cost, the market liquidity for the investment, the financial condition and near-term prospects of the issuer, including any specific events which may influence the operations of the issuer, and our intent and ability to hold the investment for a period of time sufficient to recover the temporary loss. The unrealized losses reported for corporate preferred stock at December 31, 2011 relates to a single trust preferred security that was issued by the holding company of a small community bank. Typical of most trust preferred issuances, the issuer has the ability to defer interest payments for up to five years with interest payable on the deferred balance. In October 2009, the issuer elected to defer its scheduled interest payments as allowed by the terms of the security agreement. The issuer’s subsidiary bank has incurred operating losses over the past several years due to increased provisions for

loan losses but still met the regulatory requirements to be considered “adequately capitalized” based on its most recent regulatory filing in 2011. In addition, the owners of the issuing bank appear to have the ability to make additional capital contributions to enhance the issuing bank’s capital position. Based on a review of the issuer, it was determined that the trust preferred security was not other-than-temporarily impaired at December 31, 2011. The Company does not intend to sell the preferred stock and has the intent and ability to hold it for a period of time sufficient to recover the temporary loss. Management believes that the Company will receive all principal and interest payments contractually due on the security and that the decrease in the market value is primarily due to a lack of liquidity in the market for trust preferred securities and the deferral of interest by the issuer. Management will continue to monitor the credit risk of the issuer and may be required to recognize other-than-temporary impairment charges on this security in future periods.

44

NOTE 4 Loans Receivable, Net

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

(Dollars in thousands)	2011			2010
Residential real estate loans:
1-4 family conventional	$	118,524			128,087
1-4 family FHA		494			399
1-4 family VA		48			49
		119,066			128,535
Commercial real estate:
Lodging		31,905			34,447
Retail/office		80,436			86,768
Nursing home/health care		6,455			5,512
Land developments		45,197			72,810
Golf courses		8,326			8,161
Restaurant/bar/café		3,102			2,684
Alternative fuel plants		18,882			31,123
Warehouse		16,555			17,197
Construction:
1-4 family builder		4,926			10,684
Multi family		1,156			3,874
Commercial real estate		4,840			693
Manufacturing		8,557			8,538
Churches/community service		6,058			6,132
Multi family		35,517			48,266
Other		18,002			19,502
		289,914			356,391
Consumer:
Autos		404			604
Home equity line		41,429			44,933
Home equity		13,426			17,840
Consumer — secured		1,409			1,304
Land/lot loans		2,723			2,510
Savings		576			534
Mobile home		657			764
Consumer — unsecured		1,537			2,114
		62,161			70,603
Commercial business		109,259			153,039
Total loans		580,400			708,568
Less:
Unamortized discounts		93			413
Net deferred loan fees		511			1,086
Allowance for loan losses		23,888			42,828
Total loans receivable, net	$	555,908			664,241
Commitments to originate or purchase loans	$	5,925			629
Commitments to deliver loans to secondary market	$	7,263			3,413
Weighted average contractual rate of loans in portfolio		5.52	%		5.52	%

Included in total commitments to originate or purchase loans are fixed rate loans aggregating $5.9 million and $0.6 million as of December 31, 2011 and 2010, respectively. The interest rates on these loan commitments ranged from 3.00% to 6.79% at December 31, 2011 and from 3.88% to 5.13% at December 31, 2010.

The aggregate amounts of loans to executive officers and directors of the Company was $4.0 million at

December 31, 2011 and $4.1 million at December 31, 2010 and December 31, 2009. During 2011, repayments on loans to executive officers and directors were $86,000, new loans to executive officers and directors totaled $665,500 and sales of executive officer and director loans were $415,500. During 2010, the only activity was $12,000 in repayments on loans to executive officers and directors. 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, 2011, 2010 and 2009, the Company was servicing loans for others with aggregate unpaid principal balances of approximately $417.4 million, $508.0 million and $566.0 million, respectively.

The Company originates residential, commercial real estate and other loans primarily in Minnesota and Iowa. At December 31, 2011 and 2010, the Company had in its portfolio single-family and multi-family residential loans located in the following states:

	2011					2010
(Dollars in thousands)	Amount		Percent of Total			Amount		Percent of Total
Iowa	$	4,664		3.9	%	$	4,684		3.6	%
Minnesota		109,632		92.1			118,305		92.0
Wisconsin		2,130		1.8			1,879		1.5
Other states		2,640		2.2			3,667		2.9
Total	$	119,066		100.0	%	$	128,535		100.0	%

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

At December 31, 2011 and 2010, the Company had in its portfolio commercial real estate loans located in the following states:

	2011					2010
(Dollars in thousands)	Amount		Percent of Total			Amount		Percent of Total
California	$	4,943		1.7	%	$	4,916		1.4	%
Florida		2,792		1.0			2,855		0.8
Idaho		4,423		1.5			4,483		1.3
Indiana		7,206		2.5			7,694		2.2
Iowa		6,139		2.1			11,160		3.1
Kansas		1,036		0.4			1,064		0.3
Minnesota		244,798		84.4			303,101		85.0
Nebraska		0		0.0			4,994		1.4
North Carolina		7,075		2.4			7,303		2.0
Tennessee		326		0.1			1,700		0.5
Utah		1,324		0.5			1,414		0.4
Wisconsin		8,413		2.9			5,087		1.4
Other states		1,439		0.5			620		0.2
Total	$	289,914		100.0	%	$	356,391		100.0	%

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

45

N O T E S    T O    C O N S O L I D A  T E D    F I N A N C I A L    S T A T E M E N T S

NOTE 5 Allowance for Loan Losses and Credit Quality Information

The allowance for loan losses is summarized as follows:

(Dollars in thousands)	1-4 Family			Commercial Real Estate			Consumer			Commercial Business			Total
Balance, December 31, 2008	$	2,830			13,095			1,585			3,747			21,257
Provision for losses		(1,753	)		14,217			1,451			12,784			26,699
Charge-offs		(82	)		(13,548	)		(1,980	)		(9,421	)		(25,031	)
Recoveries		5			565			222			95			887
Balance, December 31, 2009		1,000			14,329			1,278			7,205			23,812
Provision for losses		1,399			16,692			481			14,809			33,381
Charge-offs		(254	)		(7,095	)		(907	)		(7,006	)		(15,262	)
Recoveries		0			664			72			161			897
Balance, December 31, 2010		2,145			24,590			924			15,169			42,828
Provision for losses		2,081			11,785			482			2,930			17,278
Charge-offs		(508	)		(23,012	)		(270	)		(15,512	)		(39,302	)
Recoveries		0			259			23			2,802			3,084
Balance, December 31, 2011	$	3,718			13,622			1,159			5,389			23,888
Allocated to:
Specific reserves	$	993			13,263			76			10,702			25,034
General reserves		1,152			11,327			848			4,467			17,794
Balance, December 31, 2010	$	2,145			24,590			924			15,169			42,828
Allocated to:
Specific reserves	$	1,086			3,559			367			1,621			6,633
General reserves		2,632			10,063			792			3,768			17,255
Balance, December 31, 2011	$	3,718			13,622			1,159			5,389			23,888
Loans receivable at December 31, 2010:
Individually reviewed for impairment	$	6,729			45,077			299			26,855			78,960
Collectively reviewed for impairment		121,806			311,314			70,304			126,184			629,608
Ending balance	$	128,535			356,391			70,603			153,039			708,568
Loans receivable at December 31, 2011:
Individually reviewed for impairment	$	6,241			30,495			1,205			6,855			44,796
Collectively reviewed for impairment		112,825			259,419			60,956			102,404			535,604
Ending balance	$	119,066			289,914			62,161			109,259			580,400

The following table summarizes the amount of classified and unclassified loans at December 31:

	December 31, 2011
	Classified										Unclassified
(Dollars in thousands)	Special Mention		Substandard		Doubtful		Loss		Total		Total		Total Loans
1-4 family	$	8,870		11,129		738		0		20,737		98,329		119,066
Commercial real estate:
Residential developments		444		39,709		1,113		0		41,266		11,480		52,746
Alternative fuels		0		0		0		0		0		18,882		18,882
Other		5,789		19,607		0		0		25,396		192,890		218,286
Consumer		0		857		224		124		1,205		60,956		62,161
Commercial business:
Construction/development		0		2,722		0		0		2,722		2,064		4,786
Banking		0		3,750		1,149		0		4,899		0		4,899
Other		3,203		8,056		0		0		11,259		88,315		99,574
	$	18,306		85,830		3,224		124		107,484		472,916		580,400

46

	December 31, 2010
	Classified										Unclassified
(Dollars in thousands)	Special Mention		Substandard		Doubtful		Loss		Total		Total		Total Loans
1-4 family	$	7,395		8,228		0		0		15,623		112,912		128,535
Commercial real estate:
Residential developments		8,373		34,515		0		0		42,888		44,218		87,106
Alternative fuels		0		11,069		0		0		11,069		20,054		31,123
Other		6,268		6,614		0		0		12,882		225,280		238,162
Consumer		0		248		31		27		306		70,297		70,603
Commercial business:
Construction/development		1,776		4,907		0		0		6,683		5,117		11,800
Banking		0		4,975		3,248		0		8,223		5,830		14,053
Other		4,712		15,689		67		0		20,468		106,718		127,186
	$	28,524		86,245		3,346		27		118,142		590,426		708,568

Classified loans represent special mention, performing substandard and non-performing loans. Loans classified substandard are loans that are generally inadequately protected by the current net worth and paying capacity of the obligor, or by the collateral

pledged, if any. Assets so classified must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.

The aging of past due loans at December 31 are summarized as follows:

(Dollars in thousands)	30-59 Days Past Due		60-89 Days Past Due		90 Days or More Past Due		Total Past Due		Current Loans		Total Loans		Loans 90 Days or More Past Due and Still Accruing
2011
1-4 family	$	1,876		305		1,297		3,478		115,588		119,066		0
Commercial real estate:
Residential developments		107		290		8,211		8,608		44,138		52,746		0
Alternative fuels		0		0		0		0		18,882		18,882		0
Other		350		79		5,184		5,613		212,673		218,286		0
Consumer		658		374		387		1,419		60,742		62,161		0
Commercial business:
Construction/development		286		0		0		286		4,500		4,786		0
Banking		0		0		1,149		1,149		3,750		4,899		0
Other		351		112		2,877		3,340		96,234		99,574		0
	$	3,628		1,160		19,105		23,893		556,507		580,400		0
2010
1-4 family	$	2,313		695		3,500		6,508		122,027		128,535		178
Commercial real estate:
Residential developments		444		3,899		15,523		19,866		67,240		87,106		0
Alternative fuels		0		0		4,994		4,994		26,129		31,123		0
Other		75		264		3,914		4,253		233,909		238,162		0
Consumer		446		163		207		816		69,787		70,603		0
Commercial business:
Construction/development		0		0		4,809		4,809		6,991		11,800		0
Banking		0		0		8,223		8,223		5,830		14,053		0
Other		311		45		7,876		8,232		118,954		127,186		576
	$	3,589		5,066		49,046		57,701		650,867		708,568		754

47

N O T E S    T O    C O N S O L I D A  T E D    F I N A N C I A L    S T A T E M E N T S

Impaired loans include loans that are non-performing (non-accruing) and loans that have been modified in a troubled debt restructuring. The following

table summarizes impaired loans and related allowances for the years ended December 31, 2011 and 2010:

	December 31, 2011
(Dollars in thousands)	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
Loans with no related allowance recorded:
1-4 family	$	2,651		2,972		0		1,611		91
Commercial real estate:
Residential developments		6,900		9,855		0		6,679		94
Alternative fuels		0		0		0		906		0
Other		3,745		4,381		0		1,174		144
Consumer		489		489		0		216		21
Commercial business:
Construction/development		340		2,311		0		294		0
Banking		1,149		3,248		0		854		0
Other		598		1,607		0		878		19
Loans with an allowance recorded:
1-4 family		3,590		3,590		1,086		4,212		157
Commercial real estate:
Residential developments		13,889		14,017		2,546		17,514		373
Alternative fuels		0		0		0		1,998		0
Other		5,961		8,272		1,013		6,408		97
Consumer		716		716		367		403		54
Commercial business:
Construction/development		0		0		0		2,443		0
Banking		0		0		0		3,424		0
Other		4,768		7,145		1,621		9,740		45
Total:
1-4 family		6,241		6,562		1,086		5,823		248
Commercial real estate:
Residential developments		20,789		23,872		2,546		24,193		467
Alternative fuels		0		0		0		2,904		0
Other		9,706		12,653		1,013		7,582		241
Consumer		1,205		1,205		367		619		75
Commercial business:
Construction/development		340		2,311		0		2,737		0
Banking		1,149		3,248		0		4,278		0
Other		5,366		8,752		1,621		10,618		64
		$44,796		58,603		6,633		58,754		1,095

48

	December 31, 2010
(Dollars in thousands)	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
Loans with no related allowance recorded:
1-4 family	$	932		932		0		721		28
Commercial real estate:
Residential developments		6,486		6,486		0		8,674		220
Alternative fuels		0		0		0		148		0
Other		119		119		0		3,356		4
Consumer		104		104		0		1,354		7
Commercial business:
Construction/development		99		99		0		793		5
Banking		0		0		0		0		0
Other		397		397		0		1,293		5
Loans with an allowance recorded:
1-4 family		5,797		5,797		994		3,207		272
Commercial real estate:
Residential developments		27,147		27,147		9,673		16,720		557
Alternative fuels		4,994		4,994		2,441		7,993		0
Other		6,331		7,287		1,148		5,812		156
Consumer		195		195		76		571		13
Commercial business:
Construction/development		4,809		4,809		2,668		3,937		0
Banking		8,223		8,223		4,985		7,232		0
Other		13,327		13,878		3,049		12,154		478
Total:
1-4 family		6,729		6,729		994		3,928		300
Commercial real estate:
Residential developments		33,633		33,633		9,673		25,394		777
Alternative fuels		4,994		4,994		2,441		8,141		0
Other		6,450		7,406		1,148		9,168		160
Consumer		299		299		76		1,925		20
Commercial business:
Construction/development		4,908		4,908		2,668		4,730		5
Banking		8,223		8,223		4,985		7,232		0
Other		13,724		14,275		3,049		13,447		483
		$78,960		80,467		25,034		73,965		1,745

At December 31, 2011, 2010 and 2009, non-accruing loans totaled $34.0 million, $68.1 million and $61.1 million, respectively, for which the related allowance for loan losses was $5.2 million, $25.0 million and $12.1 million, respectively. Non-accruing loans for which no specific allowance has been recorded because management determined that the value of the collateral was sufficient to repay the loan totaled $14.8 million, $8.1 million and $15.3 million, respectively. Had the loans performed in accordance with their original terms, the Company would have recorded gross interest income on the loans of $3.2 million, $5.0 million and $5.0 million in 2011, 2010 and 2009, respectively. For the years ended December 31, 2011, 2010 and 2009, the Company recognized interest income on these loans of $0.7 million, $1.3 million and $0.9 million, respectively. All of the interest income that was recognized for non-accruing loans was recognized using the cash basis

method of income recognition. Non-accrual loans also include some of the loans that have had terms modified in a troubled debt restructuring.

The following table summarizes non-accrual loans at December 31:

(Dollars in thousands)	2011		2010
1-4 family	$	4,435	$	4,844
Commercial real estate:
Residential developments		13,412		25,980
Alternative fuels		0		4,994
Other		9,246		5,763
Consumer		699		224
Commercial business:
Construction/development		340		4,907
Banking		1,149		8,223
Other		4,712		13,139
	$	33,993	$	68,074

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Included in loans receivable, net, are certain loans that have been modified in order to maximize collection of loan balances. If the Company, for legal or economic reasons related to the borrower’s financial difficulties, grants a concession compared to the original terms and conditions of the loan, the modified loan is considered a troubled debt restructuring (TDR).

During the third quarter of 2011, the Company adopted Accounting Standards Update (ASU) 2011-02, A Creditor’s Determination of Whether a Restructuring is a Troubled Debt Restructuring (Topic 310), which modified guidance for identifying restructurings of receivables that constitute a TDR. No additional loans modified since December 31, 2010 were identified as TDR’s as a result of adopting these provisions.

At December 31, 2011 and 2010 there were loans included in loans receivable, net, with terms that had been modified in a troubled debt restructuring totaling $29.2 million and $19.3 million, respectively. Had these loans been performing in accordance with their original terms throughout 2011 and 2010, the Company would have recorded gross interest income of $2.5 million and $1.2 million, respectively. During 2011 and 2010, the Company recorded interest income of $0.6 million and $0.8 million on these loans, respectively. For the loans that were modified in 2011, $0.5 million are not classified and performing, $2.0 million are classified but performing, and $17.2 million are non-performing at December 31, 2011.

The following table summarizes troubled debt restructurings at December 31:

(Dollars in thousands)	2011		2010
1-4 family	$	3,805		2,589
Commercial real estate:
Residential developments		14,460		14,209
Other		5,598		662
Consumer		578		75
Commercial business:
Construction/development		385		100
Other		4,378		1,656
	$	29,204		19,291

TDR concessions can include reduction of interest rates, extension of maturity dates, forgiveness of principal and/or interest due, or acceptance of real estate or other assets in full or partial satisfaction of the debt. Loan modifications are not reported as TDR’s after 12 months if the loan was modified at a market rate of

interest for comparable risk loans, and the loan is performing in accordance with the terms of the restructured agreement. All loans classified as TDR’s are considered to be impaired.

When a loan is modified as a TDR, there may be a direct, material impact on the loans within the Statements of Financial Condition, as principal balances may be partially forgiven. The financial effects of TDR’s are presented in the following table and represent the difference between the outstanding recorded balance pre-modification and post-modification, for the period ending December 31, 2011:

	Year ended December 31, 2011
(Dollars in thousands)	Number of Contracts		Pre- modification Outstanding Recorded Investment		Post- modification Outstanding Recorded Investment
Troubled debt restructurings:
1-4 family		17	$	4,567		4,246
Commercial real estate:
Residential developments		11		8,118		7,908
Other		9		7,473		6,432
Consumer		17		626		598
Commercial business:
Construction /development		3		2,361		1,096
Other		21		10,316		8,849
Total		78	$	33,461		29,129

Loans that were restructured within the 12 months preceding December 31, 2011 and defaulted during the year are presented in the table below:

	Year ended December 31, 2011
(Dollars in thousands)	Number of Contracts		Outstanding Recorded Investment
Troubled debt restructurings that subsequently defaulted:
1-4 family		1	$	250
Commercial real estate:
Residential developments		5		4,501
Other		3		4,465
Consumer		1		4
Commercial business:
Other		3		506
Total		13	$	9,726

The Company considers a loan to have defaulted when it becomes 90 or more days past due under the modified terms, when it is placed in non-accrual status, when it becomes other real estate owned, or when it becomes non-compliant with some other material requirement of the modification agreement.

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Loans that were non-accrual prior to modification remain non-accrual for at least six months following modification. Non-accrual TDR loans that have performed according to the modified terms for six months may be returned to accruing status. Loans that were accruing prior to modification remain on accrual status after the modification as long as the loan continues to perform under the new terms.

TDR’s are reviewed for impairment following the same methodology as other impaired loans. For loans that are collateral dependent, the value of the collateral is reviewed and additional reserves may be added as needed. Loans that are not collateral dependent may have additional reserves established if deemed necessary. The allocated allowance for TDR’s was $3.5 million, or 14.6%, of the total $23.9 million in allowance for loan losses at December 31, 2011, and $1.9 million, or 4.4%, of the total $42.8 million in loan loss reserves at December 31, 2010.

NOTE 6 Accrued Interest Receivable

Accrued interest receivable at December 31 is summarized as follows:

(Dollars in thousands)	2011		2010
Securities available for sale	$	553		626
Loans receivable		1,896		2,685
	$	2,449		3,311

NOTE 7 Mortgage Servicing Rights, Net

A summary of mortgage servicing activity is as follows:

(Dollars in thousands)	2011			2010
Mortgage servicing rights:
Balance, beginning of year	$	1,586		$	1,315
Originations		461			753
Amortization		(562	)		(482	)
Balance, end of year		1,485			1,586
Valuation reserve		0			0
Mortgage servicing rights, net	$	1,485		$	1,586
Fair value of mortgage servicing rights	$	1,878		$	2,263

All of the single family loans sold where the Company continues to service the loans are 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, 2011:

(Dollars in thousands)	Loan Principal Balance		Weighted Average Interest Rate			Weighted Average Remaining Term (months)		Number of Loans
Original term 30 year fixed rate	$	205,727		5.09	%		298		1,803
Original term 15 year fixed rate		98,645		4.40			128		1,395
Adjustable rate		598		3.25			285		9

The gross carrying amount of mortgage servicing rights and the associated accumulated amortization at December 31, 2011 and 2010 are presented in the following table. Amortization expense for mortgage servicing rights was $562,000 and $482,000 for the years ended December 31, 2011 and 2010, respectively.

(Dollars in thousands)	Gross Carrying Amount		Accumulated Amortization			Unamortized Intangible Assets
December 31, 2011
Mortgage servicing rights	$	3,417		(1,932	)		1,485
Total	$	3,417		(1,932	)		1,485
December 31, 2010
Mortgage servicing rights	$	4,172		(2,586	)		1,586
Total	$	4,172		(2,586	)		1,586

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

(Dollars in thousands) Year ended December 31,	Mortgage Servicing Rights
2012	$	345
2013		326
2014		300
2015		259
2016		167
Thereafter		88
	$	1,485

Projections of amortization are based on asset balances and the interest rate environment that existed at December 31, 2011. The Company’s actual experience may be significantly different depending upon changes in mortgage interest rates and other market conditions.

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NOTE 8 Real Estate

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

	2011									2010
(Dollars in thousands)	Residential			Commercial & Other			Total			Residential			Commercial & Other			Total
Real estate in judgement subject to redemption	$	49			4,227			4,276			333			0			333
Real estate acquired through foreclosure		2,411			10,754			13,165			4,182			10,536			14,718
Real estate acquired through deed in lieu of foreclosure		45			5,498			5,543			375			5,307			5,682
Real estate acquired in satisfaction of debt		0			106			106			0			106			106
		2,505			20,585			23,090			4,890			15,949			20,839
Allowance for losses		(556	)		(5,918	)		(6,474	)		(979	)		(3,478	)		(4,457	)
	$	1,949			14,667			16,616			3,911			12,471			16,382

NOTE 9 Premises and Equipment

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

(Dollars in thousands)	2011			2010
Land	$	1,978			2,070
Office buildings and improvements		8,637			9,199
Furniture and equipment		12,558			12,985
		23,173			24,254
Accumulated depreciation		(15,206	)		(14,804	)
	$	7,967			9,450

NOTE 10 Deposits

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

	2011								2010
(Dollars in thousands)	Weighted Average Rate			Amount		Percent of Total			Weighted Average Rate			Amount		Percent of Total
Noninterest checking		0.00	%	$	113,188		18.3	%		0.00	%	$	96,581		14.1	%
NOW accounts		0.06			64,783		10.4			0.11			94,205		13.8
Savings accounts		0.17			36,071		5.8			0.15			33,973		5.0
Money market accounts		0.46			108,876		17.6			0.75			114,357		16.7
					322,918		52.1						339,116		49.6
Certificates:
0-0.99%					72,768		11.7						41,311		6.1
1-1.99%					134,567		21.8						142,742		20.9
2-2.99%					65,842		10.6						105,126		15.4
3-3.99%					22,583		3.6						50,529		7.4
4-4.99%					1,450		0.2						4,113		0.6
5-5.99%					0		0.0						293		0.0
Total certificates		1.60			297,210		47.9			2.07			344,114		50.4
Total deposits		0.87		$	620,128		100.0	%		1.20		$	683,230		100.0	%

At December 31, 2011 and 2010, the Company had $264.5 million and $256.3 million, respectively, of deposit accounts with balances of $100,000 or more. At December 31, 2011 and 2010, the Company had $67.8 million and $107.5 million of certificate accounts,

respectively, that had been acquired through a broker. The Company is currently restricted from renewing existing brokered deposits, or accepting new brokered deposits without the prior consent of the OCC.

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Certificates had the following maturities at December 31:

(Dollars in thousands)	2011					2010
Remaining term to maturity	Amount		Weighted Average Rate			Amount		Weighted Average Rate
1-6 months	$	100,513		1.78	%	$	103,567		2.10	%
7-12 months		87,031		1.70			73,470		1.77
13-36 months		103,791		1.33			159,896		2.18
Over 36 months		5,875		2.05			7,181		2.44
	$	297,210		1.60		$	344,114		2.07

At December 31, 2011, mortgage loans and mortgage-backed and related securities with an amortized cost of approximately $28.9 million were pledged as

collateral for certain deposits. An additional $1.0 million of letters of credit from the Federal Home Loan Bank (FHLB) were pledged as collateral on Bank deposits.

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

(Dollars in thousands)	2011		2010		2009
NOW accounts	$	57		110		132
Savings accounts		57		45		38
Money market accounts		746		1,341		1,430
Certificates		5,987		9,785		15,979
	$	6,847		11,281		17,579

NOTE 11 Federal Home Loan Bank Advances and Federal Reserve Borrowings

Fixed and variable rate Federal Home Loan Bank advances and Federal Reserve borrowings consisted of the following at December 31:

(Dollars in thousands)	2011				2010
Year of Maturity	Amount		Rate		Amount		Rate
2011					$	52,500		4.00	%
2013		70,000		4.77		70,000		4.77
		70,000		4.77		122,500		4.44
Lines of Credit – Federal Reserve/Federal Home Loan Bank		0		0.00		0		0.00
	$	70,000		4.77	$	122,500		4.44

All of the outstanding advances at December 31, 2011 have quarterly 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. At December 31, 2011, the advances from the FHLB were collateralized by the Bank’s FHLB stock and mortgage loans and investments with a borrowing capacity of approximately $146.9 million. The Bank has

the ability to draw additional borrowings of $75.9 million from the FHLB, based upon the mortgage loans and securities that are currently pledged, subject to approval from the FHLB and a requirement to purchase additional FHLB stock. The Bank also has the ability to draw additional borrowings of $60.0 million from the Federal Reserve Bank, based upon the loans that are currently pledged with them, subject to approval from the FRB.

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N O T E S    T O    C O N S O L I D A  T E D    F I N A N C I A L    S T A T E M E N T S

NOTE 12 Income Taxes

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

(Dollars in thousands)	2011			2010			2009
Current:
Federal	$	0			(3,956	)		(4,551	)
State		0			(1,764	)		1,460
Total current		0			(5,720	)		(3,091	)
Deferred:
Federal		(4,010	)		(2,773	)		(1,213	)
State		(873	)		(1,781	)		(1,303	)
Total deferred		(4,883	)		(4,554	)		(2,516	)
Change in valuation allowance		4,883			16,597			0
Income tax expense (benefit)	$	0			6,323			(5,607	)

The reasons for the difference between expected income tax benefit utilizing the federal corporate tax rate of 34% for 2011 and 2010, and 35% for 2009 and the actual income tax expense are as follows:

(Dollars in thousands)	2011			2010			2009
Expected federal income tax benefit	$	(3,929	)		(7,703	)		(5,741	)
Items affecting federal income tax:
State income taxes, net of federal income tax expense (benefit)		(645	)		(2,474	)		170
Tax exempt interest		(123	)		(133	)		(235	)
Increase in valuation allowance		4,883			16,597			0
Other, net		(186	)		36			199
Income tax expense (benefit)	$	0			6,323			(5,607	)

A reconciliation of the change in the gross amount, before related tax effects, of unrecognized tax benefits for 2011 and 2010 is as follows:

(Dollars in thousands)	2011		2010
Balance at January 1	$	0		2,210
Settlement of tax position		0		(2,210	)
Balance at December 31	$	0		0

There were no unrecognized tax benefits for 2011. The $2.2 million decrease in unrecognized tax benefits during 2010 relates to the tax benefits recorded as a result of a favorable Minnesota Supreme Court tax ruling in 2010, which reversed an unfavorable tax court ruling from 2009. Of the $2.2 million benefit recorded in 2010, $1.4 million affected the effective tax rate as the remaining $0.8 million related to the federal tax impact of the state tax benefit. The Company also recognized a

$0.7 million reduction in other operating expenses in the 2010 consolidated financial statements to reflect the reversal of the accrued interest that had been recorded on the previously unrecognized tax benefits. The tax effects of temporary differences that give rise to the deferred tax assets and deferred tax liabilities are as follows at December 31:

(Dollars in thousands)	2011			2010
Deferred tax assets:
Allowances for loan and real estate losses	$	12,401			9,088
Deferred compensation costs		322			314
Deferred ESOP loan asset		702			682
Restricted stock expense		130			164
Nonaccruing loan interest		416			84
Federal net operating loss carry forward		5,936			5,043
State net operating loss carry forward		3,301			3,295
Other		162			88
Total gross deferred tax assets		23,370			18,758
Deferred tax liabilities:
Net unrealized gain on securities available for sale		328			356
Deferred loan fees and costs		317			263
Premises and equipment basis difference		407			636
Originated mortgage servicing rights		607			648
Other		231			258
Total gross deferred tax liabilities		1,890			2,161
Net deferred tax assets		21,480			16,597
Valuation allowance		(21,480	)		(16,597	)
Deferred tax assets, net of valuation allowance	$	0			0

The Company has cumulative federal net operating loss carryforwards of $19.6 million at December 31, 2011 that expire beginning in 2029. The Company also has state net operating loss carryforwards of $36.7 million at December 31, 2011 that expire beginning in 2023.

Retained earnings at December 31, 2011 included approximately $8.8 million 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.

54

The Company considers the determination of the deferred tax asset amount and the need for any valuation reserve to be a critical accounting policy that requires significant judgment. The Company has, in its judgment, made reasonable assumptions and considered both positive and negative evidence relating to the ultimate realization of deferred tax assets. Positive evidence includes the ability to implement tax planning strategies to accelerate taxable income recognition and the probability that taxable income will be generated in future periods. Negative evidence includes the Company’s cumulative loss in the prior three year period, continued operating losses in 2011 and the general business and economic trends. Based upon this evaluation, the Company determined that a full valuation allowance was required with respect to the net deferred tax assets at December 31, 2011.

NOTE 13 Employee Benefits

All eligible full-time employees of the Bank that were hired prior to 2002 were included in a noncontributory retirement plan sponsored by the Financial Institutions Retirement Fund (FIRF). The Home Federal Savings Bank (Employer #8006) plan participates in the Pentegra Defined Benefit Plan for Financial Institutions (the Pentegra DB Plan). The Pentegra DB Plan’s Employer Identification Number is 13-5645888 and the Plan number is 333. The Pentegra DB Plan operates as a multi-employer plan for accounting purposes and as a multi-employer plan under the Employee Retirement Income Security Act of 1974 and the Internal Revenue Code. There are no collective

bargaining agreements in place that require contributions to the Pentegra DB Plan.

The Pentegra DB Plan is a single plan under Internal Revenue Code Section 413(c) and, as a result, all of the assets stand behind all of the liabilities. Accordingly, under the Pentegra DB Plan, contributions made by the participating employer may be used to provide benefits to participants of other participating employers.

Effective September 1, 2002, the accrual of benefits for existing participants was frozen and no new enrollments were permitted into the plan. The actuarial present value of accumulated plan benefits and net assets available for benefits relating to the Bank’s employees was not available at December 31, 2011 because such information is not accumulated for each participating institution. As of June 30, 2011, the Pentegra DB Plan valuation report reflected that the Bank was obligated to make a contribution totaling $291,000 which was expensed during 2011.

Funded status (market value of plan assets divided by funding target) as of July 1 for the 2011 and 2010 plan years were 80.39% and 83.20%, respectively. Market value of plan assets reflects any contribution received through June 30, 2011.

Total employer contributions made to the Pentegra DB Plan, as reported on Form 5500, equal $203,582,000 and $133,930,000 for the plan years ended June 30, 2010 and June 30, 2009, respectively. The Bank’s contributions to the Pentegra DB Plan are not more than 5% of the total contributions to the Pentegra DB Plan. There is no funding improvement plan or rehabilitation plan as part of this multi-employer plan.

The following contributions were paid by the Bank during the fiscal years ending December 31,

(Dollars in thousands)
2011		2010		2009
Date Paid	Amount	Date Paid	Amount	Date Paid	Amount
10/14/2011	$57**	12/30/2010	$237	12/29/2009	$156
Total	$57		$237		$156

** - An additional contribution of $234,000 was accrued at December 31, 2011 and paid in the first quarter of 2012.

The Company 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 401(k) 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 $16,500 for 2011. The Company matches 25% of each participant’s contributions up to a maximum of 8% of the

55

N O T E S    T O    C O N S O L I D A  T E D    F I N A N C I A L    S T A T E M E N T S

participant’s annual salary. Participant contributions and earnings are fully and immediately vested. The Company’s contributions are vested on a three year cliff basis, are expensed over the vesting period, and were $159,000, $165,000 and $177,000, in 2011, 2010 and 2009, respectively.

The Company has adopted an Employee Stock Ownership Plan (the ESOP) that meets the requirements of Section 4975(e)(7) of the Internal Revenue Code and Section 407(d)(6) of the Employee Retirement Income Security Act of 1974, as amended (ERISA) and, as such, the ESOP is empowered to borrow in order to finance purchases of the common stock of HMN. The ESOP borrowed $6.1 million from the Company 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 $1.5 million to purchase an additional 76,933 shares of HMN common stock to account for the additional employees and avoid dilution of the benefit provided by the ESOP. The ESOP debt requires quarterly payments of principal plus interest at 7.52%. The Company has committed to make quarterly contributions to the ESOP necessary to repay the loans including interest. The Company contributed $525,000 in 2011, 2010 and 2009.

As the debt is repaid, ESOP shares that were pledged as collateral for the debt are released from collateral and allocated to eligible employees based on the proportion of debt service paid in the year. The Company accounts for its ESOP in accordance with ASU 718, 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, the Company reports compensation expense equal to the current market price of the shares, and the shares become outstanding for earnings per share computations. ESOP compensation expense was $58,000, $109,000 and $100,000, respectively, for 2011, 2010 and 2009.

All employees of the Bank are eligible to participate in the ESOP after they attain age 18 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:

	2011			2010			2009
Shares allocated to participants beginning of the year		335,453			333,678			320,937
Shares allocated to participants		24,317			24,317			24,317
Shares purchased		42			38			0
Shares distributed to participants		(19,821	)		(22,580	)		(11,576	)
Shares allocated to participants end of year		339,991			335,453			333,678
Unreleased shares beginning of the year		425,769			450,086			474,403
Shares released during year		(24,317	)		(24,317	)		(24,317	)
Unreleased shares end of year		401,452			425,769			450,086
Total ESOP shares end of year		741,443			761,222			783,764
Fair value of unreleased shares at December 31	$	778,817			1,196,411			1,890,361

In June 1995, the Company adopted the 1995 Stock Option and Incentive Plan (1995 Plan). The provisions of the 1995 Plan expired on April 25, 2005 and options may no longer be granted from the 1995 Plan. At December 31, 2011, there were 15,000 vested options under the 1995 Plan that remained unexercised. These options expire 10 years from the date of grant and have an exercise price of $16.25.

In March 2001, the Company adopted the HMN Financial, Inc. 2001 Omnibus Stock Plan (2001 Plan). In April 2009, this plan was superseded by the HMN Financial, Inc. 2009 Equity and Incentive Plan (2009 Plan) and options or restricted shares may no longer be awarded from the 2001 Plan. As of December 31, 2011, there were 66,934 vested and 72,516 unvested options under the 2001 Plan that remained unexercised. These options expire 10 years from the date of grant and have an average exercise price of $20.07. As of December 31, 2011, all shares of restricted stock granted under the 2001 Plan have vested.

56

In April 2009, the Company adopted the 2009 Plan. The purpose of the 2009 Plan is to provide key personnel and advisors with an opportunity to acquire a proprietary interest in the Company. The opportunity to acquire a proprietary interest in the Company will aid in attracting, motivating and retaining key personnel and advisors, including non-employee directors, and will align their interest with those of the Company’s stockholders.

350,000 shares of HMN common stock were initially available for distribution under the 2009 Plan in either restricted stock or stock options, subject to adjustment for future stock splits, stock dividends and similar changes to the capitalization of the Company. Additionally, shares of restricted stock that are awarded are counted as 1.2 shares for purposes of determining the total shares available for issue under the 2009 Plan.

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N O T E S    T O    C O N S O L I D A  T E D    F I N A N C I A L    S T A T E M E N T S

A summary of activities under all plans for the past three years is as follows:

												Unvested options
	Shares available for grant			Restricted shares outstanding			Options outstanding			Award value/ weighted average exercise price		Number			Weighted average grant date fair value		Vesting Period
1995 Plan
December 31, 2008		0			0			105,500		$	12.12		0		$	0
Forfeited/expired		0			0			(65,000	)		11.50		0			0
December 31, 2009		0			0			40,500			13.10		0			0
Forfeited/expired		0			0			(25,500	)		11.25		0			0
December 31, 2010		0			0			15,000			16.25		0			0
Forfeited/expired		0			0			0			0		0			0
December 31, 2011		0			0			15,000			16.25		0			0
2001 Plan
December 31, 2008		155,353			34,293			184,148		$	19.43		141,088		$	1.55
Forfeited/expired					(4,734	)		(33,777	)		16.13		(32,257	)		1.43
Forfeited/expired								(5,000	)		27.64					2.10
Termination of new awards under plan		(155,353	)
Vested					(15,044	)							(6,000	)		3.11
December 31, 2009		0			14,515			145,371			19.91		102,831			1.49
Forfeited/expired		0			0			(5,921	)		16.13		(5,921	)		1.43
Forfeited/expired		0			(170	)		0
Vested					(8,904	)							(3,102	)		3.52
December 31, 2010		0			5,441			139,450			20.07		93,808			1.43
Forfeited/expired		0			0			0			0		0			0
Vested		0			(5,441	)		0			0		(21,292	)		1.43
December 31, 2011		0			0			139,450			20.07		72,516			1.43
2009 Plan
April 28, 2009		350,000
Granted May 6, 2009		(15,000	)					15,000		$	4.77		15,000		$	4.41		5 years
Granted May 6, 2009		(98,866	)		82,388						N/A							3 years
December 31, 2009		236,134			82,388			15,000			4.77		15,000			4.41
Granted January 26, 2010		(85,290	)		71,075			0			N/A							3 years
Forfeited/expired		7,118			(5,790	)		0
Forfeited/expired		5,921			0			0
Vested		0			(13,630	)		0					(3,000	)		4.41
December 31, 2010		163,883			134,043			15,000			4.77		12,000			4.41
Granted January 27, 2011		(93,600	)		78,000			0			N/A		0			0
Forfeited/expired		538			(448	)		0					0			0
Vested		0			(48,825	)		0					(3,000	)		4.41
December 31, 2011		70,821			162,770			15,000			4.77		9,000			4.41
Total all plans		70,821			162,770			169,450		$	18.38		81,516		$	1.76

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The following table summarizes information about stock options outstanding at December 31, 2011:

Exercise Price	Number Outstanding		Weighted Average Remaining Contractual Life in  Years		Number Exercisable		Number Unexercisable		Unrecognized Compensation Expense		Weighted Average Years Over Which Unrecognized Compensation will be Recognized
$16.13		93,910		0.4		21,394		72,516	$	0		N/A
16.25		15,000		0.4		15,000		0		0		N/A
27.66		15,540		2.2		15,540		0		0		N/A
26.98		15,000		2.6		15,000		0		0		N/A
30.00		15,000		3.4		15,000		0		0		N/A
4.77		15,000		7.4		6,000		9,000		12,175		2.4
		169,450				87,934		81,516	$	12,175

The Company will issue shares from treasury upon the exercise of outstanding options.

Prior to January 1, 2006, the Company used the intrinsic value method as described in APB Opinion No. 25 and related interpretations to account for its stock incentive plans. Accordingly, there were 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. On January 1, 2006, the Company adopted FAS No. 123(R) (ASC 718), which replaced FAS No. 123 and supersedes APB Opinion No. 25. In accordance with this standard, the Company recognized compensation expense in 2011, 2010 and

2009 relating to stock options over the vesting period. The amount of the expense was determined under the fair value method.

The fair value for each option grant is estimated on the date of the grant using a Black Scholes option valuation model. There were no options granted in 2011 or 2010. The following table shows the assumptions that were used in determining the fair value of options granted during 2009:

	2009
Risk-free interest rate		3.15%
Expected life		9 years
Expected volatility		114.0%
Expected dividends		0.0%

NOTE 14 Loss per Common Share

The following table reconciles the weighted average shares outstanding and net loss for basic and diluted loss per common share:

	Year ended December 31,
(Dollars in thousands, except per share data)	2011			2010			2009
Weighted average number of common shares outstanding used in basic earnings per common share calculation		3,853,491			3,766,756			3,695,827
Net dilutive effect of:
Options		0			0			0
Restricted stock awards		0			0			0
Weighted average number of common shares outstanding adjusted for effect of dilutive securities		3,853,491			3,766,756			3,695,827
Net loss available to common shareholders	$	(13,376	)		(30,762	)		(12,543	)
Basic loss per common share	$	(3.47	)		(8.17	)		(3.39	)
Diluted loss per common share	$	(3.47	)		(8.17	)		(3.39	)

Options and restricted stock awards are excluded from the loss per share calculation when a net loss is incurred as their inclusion in the calculation would be anti-dilutive and result in a lower loss per common share. Therefore, options and restricted stock awards are zero in all of the above loss per common share calculations.

NOTE 15 Stockholders’ Equity

The Company did not repurchase any shares of its common stock in the open market during 2011, 2010 or 2009. The Company suspended dividend payments on common stock in the fourth quarter of 2008 due to the net operating loss experienced and the challenging economic

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environment. Because of the unknown duration of the economic slow down, the continued losses experienced in 2010 and 2011, and the limitation on the payment of dividends set forth in the Supervisory Agreements (as described below and in Note 16), it is not known when any future dividends may be paid by the Company.

The Company’s certificate of incorporation authorizes the issuance of up to 500,000 shares of preferred stock, and on December 23, 2008, the Company completed the sale of 26,000 shares of cumulative perpetual preferred stock to the United States Treasury. The preferred stock has a liquidation value of $1,000 per share and a related warrant was also issued to purchase 833,333 shares of HMN common stock at an exercise price of $4.68 per share. The transaction was part of the United States Treasury’s capital purchase program under the Emergency Economic Stabilization Act of 2008. Under the terms of the sale, the preferred shares are entitled to a 5% annual cumulative dividend for each of the first five years of the investment, increasing to 9% thereafter, unless HMN redeems the shares. The Company made all required dividend payments to the Treasury on the outstanding preferred stock in 2009 and 2010 but began deferring the payment of dividends beginning with the February 15, 2011 dividend date. The Company has since deferred payment of the May 15, 2011, August 15, 2011, November 15, 2011 and February 15, 2012 dividends. The amount of accrued but unpaid dividends totaled $1.3 million at December 31, 2011. Under the terms of the certificate of designations for the preferred stock, dividend payments may be deferred without default, but the dividend is cumulative and, if the Company fails to pay dividends for six quarters, whether or not consecutive, the Treasury will have the right to appoint two representatives to the Company’s board of directors. The preferred stock may be redeemed in whole or in part, at par plus accrued and unpaid dividends. The preferred stock is non-voting, other than certain class voting rights. The warrant may be exercised at any time over its ten-year term. The discount on the common stock warrant is being amortized over five years and Treasury has agreed not to vote any shares of common stock acquired upon exercise of the warrant. Both the preferred securities and the warrant qualify as Tier 1 capital.

Under the terms of the written Supervisory Agreements that the Company and the Bank each entered

into with the Office of Thrift Supervision (OTS) effective February 22, 2011 as described in Note 16, neither the Company or the Bank may declare or pay any cash dividends, or repurchase or redeem any capital stock, without prior notice to, and consent of, the OCC (as successor to the OTS). The Company does not anticipate requesting consent from the OCC to make any payments of dividends on, or purchase of, its common or preferred stock in 2012.

The OCC has established an individual minimum capital requirement (IMCR) for the Bank as described in Note 16, which required the Bank to establish and maintain core capital at least equal to 8.5% of adjusted total assets at December 31, 2011. This was in excess of the Bank’s 7.14% core capital to adjusted total assets ratio at December 31, 2011.

In order to grant a priority to eligible accountholders in the event of future liquidation, the Bank, at the time of conversion to a stock savings bank, 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 decrease as the balance of eligible accountholders is reduced subsequent to the conversion, based on an annual determination of such balance.

NOTE 16 Regulatory Matters/Supervisory Agreements, IMCR and Federal Home Loan Bank Investment

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 are carried at cost, in the Federal Home Loan Bank of Des Moines. The Bank met this requirement at December 31, 2011. The capital stock investment in the Federal Home Loan Bank of Des Moines was reviewed for any other than temporary impairment as of December 31, 2011 and it was determined that it was not impaired.

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 the Company’s

60

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.

The Bank entered into a written Supervisory Agreement with its primary regulator, the OTS, effective February 22, 2011 that primarily relates to the Bank’s financial performance and credit quality issues. This agreement replaced the prior memorandum of understanding that the Bank entered into with the OTS on December 9, 2009. In accordance with the agreement, the Bank submitted a two year business plan in May of 2011 that the OCC (as successor to the OTS) accepted with the expectation that the Bank would be in adherence with the OCC’s Notification of Establishment of Higher Minimum Capital Ratios, dated August 8, 2011, also known as an individual minimum capital requirement or IMCR, which required the Bank to establish and maintain a minimum core capital ratio of 8.5% by December 31, 2011. The IMCR and the Bank’s failure to achieve and maintain the IMCR are discussed more fully below. As required by the Supervisory Agreement, the Bank submitted an updated two year capital plan in January of 2012 that the OCC may make comments upon, and require revisions to. The Bank must operate within the parameters of the final business plan and is required to monitor and submit periodic reports on its compliance with the plan. The Bank also submitted a problem asset reduction plan that the OCC has accepted. The Bank must operate within the parameters of the final problem asset plan and is required to monitor and submit periodic reports on its compliance with the plan. The Bank has also revised its loan modification policies and its program for identifying, monitoring and controlling risk associated with concentrations of credit, and improved the documentation relating to the allowance for loan and lease losses as required by the agreement. In addition, without the consent of the OCC, the Bank may not declare or pay any cash dividends, increase its total assets during any quarter in excess of the amount of the net interest credited on deposit liabilities during the prior quarter, enter into any new contractual arrangement or

renew or extend any existing arrangement related to compensation or benefits with any directors or officer, make any golden parachute payments, or enter into any significant contracts with a third party service provider. The Bank believes it was in compliance with all requirements of its Supervisory Agreement at December 31, 2011, with the exception that actual earnings performance and capital adequacy are not in adherence with the business plan.

The Company also entered into a written Supervisory Agreement with the OTS effective February 22, 2011. This agreement replaced the prior memorandum of understanding that the Company entered into with the OTS on December 9, 2009. As required by the Supervisory Agreement, the Company submitted an updated two year capital plan in January of 2012 that the Federal Reserve Board (as successor to the OTS) may make comments upon, and to which it may require revisions. The Company must operate within the parameters of the final capital plan and is required to monitor and submit periodic reports on its compliance with the plan. In addition, without the consent of the Federal Reserve Board, the Company may not incur or issue any debt, guarantee the debt of any entity, declare or pay any cash dividends or repurchase any of the Company’s capital stock, enter into any new contractual arrangement or renew or extend any existing arrangement related to compensation or benefits with any directors or officer, or make any golden parachute payments. The Company believes it was in compliance with all requirements of its Supervisory Agreement at December 31, 2011, with the exception that actual earnings performance and capital adequacy were not in adherence with the capital plan.

References to the OTS shall mean, with respect to the Company, beginning July 21, 2011, the Federal Reserve Board (FRB) and mean, with respect to the Bank, beginning July 21, 2011, the Office of the Comptroller of the Currency (OCC). On July 21, 2011, the OTS was integrated into the OCC and the primary banking regulator for the Company became the FRB. It is not anticipated that the change in primary regulators as a result of the OTS being abolished will have any significant impact on the Company, the Bank, or our shareholders.

Quantitative measures established by regulations to ensure capital adequacy require the Bank to maintain

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minimum amounts and ratios (set forth in the following table) of Tier I (Core) capital, and Risk-based capital (as defined in the regulations) to total assets (as defined).

At December 31, 2011 and 2010, the Bank’s capital amounts and ratios are 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 Action Provisions
(Dollars in thousands)	Amount		Percent  of Assets(1)			Amount		Percent of Assets(1)			Amount		Percent  of Assets(1)			Amount		Percent  of Assets(1)
December 31, 2011
Tier I or core capital	$	56,314		7.14	%	$	31,560		4.00	%	$	24,754		3.14	%	$	39,450		5.00	%
Tier I risk-based capital		56,314		9.61			23,441		4.00			32,873		5.61			35,162		6.00
Risk-based capital to risk-weighted assets		63,639		10.86			46,883		8.00			16,756		2.86			58,603		10.00
December 31, 2010
Tier I or core capital	$	66,824		7.60	%	$	35,181		4.00	%	$	31,643		3.60	%	$	43,977		5.00	%
Tier I risk-based capital		66,824		9.72			27,507		4.00			39,317		5.72			41,261		6.00
Risk-based capital to risk-weighted assets		75,420		10.97			55,014		8.00			20,406		2.97			68,768		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.

The OCC has established an individual minimum capital requirement (IMCR) for the Bank. An IMCR requires a bank to establish and maintain levels of capital greater than those generally required for a bank to be classified as “well-capitalized.” Effective December 31, 2011, the Bank was required to establish, and subsequently maintain, core capital at least equal to 8.5% of adjusted total assets, which is in excess of the Bank’s 7.14% core capital to adjusted total assets ratio at December 31, 2011. The Bank would have needed $10.8 million in additional capital at December 31, 2011 to meet the minimum core capital ratio set by the OCC. In February 2012, the Bank received a Notice of Failure from the OCC arising out of its failure to establish and maintain its IMCR of 8.5% core capital to adjusted total assets at December 31, 2011. By April 30, 2012, the Bank must submit to the OCC a further written capital plan of how it will achieve and maintain its IMCR, and a contingency plan in the event the IMCR is not achieved through the Bank’s primary plan. The Bank’s failure to comply with the terms of the IMCR is deemed an unsafe and unsound banking practice and could subject it to further limits on growth and such legal actions or sanctions as the OCC considers appropriate. Possible sanctions include among others (i) the imposition of one or more cease and desist orders requiring corrective action, which are enforceable directives that may address any aspect of the Company or Bank management,

operations or capital, including requirements to change management, raise equity capital, dispose of assets or effect a change of control; (ii) civil money penalties; and (iii) downgrades in the capital adequacy status of the Company and the Bank. These regulatory actions may significantly restrict the ability of the Company and the Bank to take operating and strategic actions that may be in the best interests of stockholders or compel the Company and the Bank to take operating and strategic actions that are not potentially in the best interests of stockholders.

Management believes that, as of December 31, 2011, the Bank’s capital ratios were in excess of those quantitative capital ratio standards set forth under the prompt corrective action regulations referenced above. The failure of the Bank to satisfy the IMCR at December 31, 2011 does not by itself affect the Bank’s status as “well-capitalized” within the meaning of these prompt corrective action regulations. However, there can be no assurance that the Bank will continue to maintain such status in the future. The OCC has extensive discretion in its supervisory and enforcement activities, and can adjust the requirement to be “well-capitalized” in the future.

In order to improve its capital ratios and comply with its IMCR, the Bank is, among other things, working to improve its financial results, reduce non-performing assets, and decrease the asset size of the Bank. In

62

November 2011, the Bank also entered into a definitive purchase and assumption agreement to sell substantially all the assets associated with its Toledo, Iowa branch, subject to assumption of substantially all deposit liabilities of that branch as described in Note 21. In light of its current capital condition and its failure to comply with the IMCR at December 31, 2011, the Bank may also determine it to be necessary or prudent to dispose of other non-strategic assets. These actions have resulted, and may result, in changes in the Bank’s assets, liabilities and earnings, some of which may be material, during the period in which the action is taken or is consummated or over a longer period of time. Further, the Company may need, or be required by supervising banking regulators, to raise additional capital of which there can be no assurance that, if raised, it would be on terms favorable to the Company. If the Company raises capital through the issuance of additional shares of common stock or other equity securities, it would dilute the ownership interests of existing stockholders and, given our current common stock trading price, would be expected to dilute the per share book value of the Company’s common stock and could result in a change of control of the Company and the Bank.

NOTE 17 Financial Instruments with Off-Balance Sheet Risk

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

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

	December 31, Contract Amount
(Dollars in thousands)	2011		2010
Financial instruments whose contract amount represents credit risk:
Commitments to originate, fund or purchase loans:
1-4 family mortgages	$	3,554		629
Commercial real estate mortgages		2,371		0
Undisbursed balance of loans closed		7,209		12,659
Unused lines of credit		76,444		76,670
Letters of credit		1,535		2,355
Total commitments to extend credit	$	91,113		92,313
Forward commitments	$	7,263		3,413

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.

Forward commitments represent commitments to sell loans to a third party and are entered into in the normal course of business by the Bank.

The Bank issued standby letters of credit which guarantee the performance of customers to third parties. The standby letters of credit outstanding expire over the next 19 months and totaled $1.5 million at December 31, 2011 and $2.3 million at December 31, 2010. The letters of credit are 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.

NOTE 18 Derivative Instruments and Hedging Activities

The Company originates and purchases single-family residential loans for sale into the secondary market and enters into commitments to sell or securitize

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those loans in order to mitigate the interest rate risk associated with holding the loans until they are sold. The Company accounts for its commitments in accordance with ASC 815, Accounting for Derivative Instruments and Hedging Activities.

The Company had commitments outstanding to extend credit to future borrowers that had not closed prior to the end of the year, which is referred to as its mortgage pipeline. As commitments to originate loans enter the mortgage pipeline, the Company 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, 2011, the Company recorded an increase in other liabilities of $21,000, an increase in other assets of $29,000 and a net gain on the sales of loans of $8,000.

As of December 31, 2011, 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, the Company recorded an increase in loans held for sale of $56,000, a decrease in other assets of $56,000, an increase in other liabilities of $72,000 and a net loss on the sales of loans $72,000.

NOTE 19 Fair Value Measurement

The Company has adopted ASC 820, Fair Value Measurements, which establishes a framework for measuring the fair value of assets and liabilities using a hierarchy system consisting of three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:

Level 1 — Valuation is based upon quoted prices for identical instruments traded in active markets that the Company has the ability to access.

Level 2 — Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which significant assumptions are observable in the market.

Level 3 — Valuation is generated from model-based techniques that use significant assumptions not observable in the market and are used only to the extent that observable inputs are not available. These unobservable assumptions reflect our own estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.

The following table summarizes the assets of the Company for which fair values are determined on a recurring basis as of December 31, 2011 and 2010.

	Carrying Value at December 31, 2011
(Dollars in thousands)	Total			Level 1		Level 2			Level 3
Securities available for sale	$	126,114			613		125,501			0
Mortgage loan commitments		(94	)		0		(94	)		0
Total	$	126,020			613		125,407			0

	Carrying Value at December 31, 2010
	Total			Level 1		Level 2			Level 3
Securities available for sale	$	151,564			1,740		149,824			0
Mortgage loan commitments		(1	)		0		(1	)		0
Total	$	151,563			1,740		149,823			0

The Company may also be required, from time to time, to measure certain other financial assets at fair value on a nonrecurring basis in accordance with generally accepted accounting principles. These adjustments to fair value usually result from the application of the lower-of-cost-or-market accounting or

write-downs of individual assets. For assets measured at fair value on a nonrecurring basis in 2011 that were still held at December 31, the following table provides the level of valuation assumptions used to determine each adjustment and the carrying value of the related individual assets or portfolios at December 31, 2011 and 2010.

64

	Carrying Value at December 31, 2011								Year Ended December 31, 2011 Total gains (losses)
(Dollars in thousands)	Total		Level 1		Level 2		Level 3
Loans held for sale	$	3,709		0		3,709		0		129
Mortgage servicing rights		1,485		0		1,485		0		0
Loans(1)		38,162		0		38,162		0		(4,167	)
Real estate, net(2)		16,616		0		16,616		0		(2,690	)
Assets held for sale		1,583		0		1,583		0		0
Deposits held for sale		36,048		0		36,048		0		0
Total	$	97,603		0		97,603		0		(6,728	)

	Carrying Value at December 31, 2010								Year Ended December 31, 2010 Total losses
	Total		Level 1		Level 2		Level 3
Loans held for sale	$	2,728		0		2,728		0		(6	)
Mortgage servicing rights		1,586		0		1,586		0		0
Loans(1)		43,039		0		43,039		0		(18,855	)
Real estate, net(2)		16,382		0		16,382		0		(1,782	)
Total	$	63,735		0		63,735		0		(20,643	)

⁽¹⁾  Represents carrying value and related specific reserves on loans for which adjustments are based on the appraised value of the collateral. The carrying value of loans fully charged-off is zero.

⁽²⁾  Represents the fair value and related losses of foreclosed real estate and other collateral owned that were measured at fair value subsequent to their initial classification as foreclosed assets.

NOTE 20 Fair Value of Financial Instruments

ASC 825, Disclosures about Fair Values of Financial Instruments, requires disclosure of estimated fair values of the Company’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, 2011 and 2010 based upon relevant market information, if available, and upon the characteristics of the financial instruments themselves. Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based upon judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. The estimates are subjective in nature and involve

uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

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

The estimated fair value of the Company’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.

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	December 31,
	2011								2010
(Dollars in thousands)	Carrying Amount			Estimated Fair Value			Contract Amount		Carrying Amount			Estimated Fair Value			Contract Amount
Financial assets:
Cash and cash equivalents	$	67,840			67,840					20,981			20,981
Securities available for sale		126,114			126,114					151,564			151,564
Loans held for sale		3,709			3,709					2,728			2,728
Loans receivable, net		555,908			566,266					664,241			655,508
Federal Home Loan Bank stock		4,222			4,222					6,743			6,743
Accrued interest receivable		2,449			2,449					3,311			3,311
Assets held for sale		1,583			1,605					0			0
Financial liabilities:
Deposits		620,128			620,128					683,230			683,230
Deposits held for sale		36,048			36,048					0			0
Federal Home Loan Bank advances		70,000			74,433					122,500			129,893
Accrued interest payable		780			780					1,092			1,092
Off-balance sheet financial instruments:
Commitments to extend credit		29			29			91,113		56			56			92,313
Commitments to sell loans		(94	)		(94	)		7,263		(1	)		(1	)		3,413

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. This method of estimating fair value does not incorporate the exit-price concept of fair value prescribed by ASC 820, Fair Value Measurements and Disclosures.

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    The fair value of demand deposits, savings accounts and certain money market account deposits is

the amount payable on demand at the reporting date. The fair value of fixed maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities. If the fair value of the fixed maturity certificates of deposit is calculated at less than the carrying amount, the carrying value of these deposits is reported as the fair value.

The fair value estimate for deposits does not include the benefit that results from the low cost funding provided by the Company’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 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 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 are estimated using the quoted market prices for loans with similar interest rates and terms to maturity.

66

NOTE 21 Assets and Deposits Held for Sale

The Bank entered into a definitive purchase and assumption agreement on November 7, 2011 with Pinnacle Bank (Pinnacle) of Marshalltown, Iowa which provides for the sale to Pinnacle of substantially all of the assets associated with the Toledo, Iowa branch (the Branch) of the Bank and the assumption by Pinnacle of substantially all deposit liabilities of the Branch. The Bank will continue to own and operate its other Iowa and

Minnesota branches. Regulatory approval for the transaction has been obtained and the transaction is anticipated to be consummated in the first quarter of 2012. The Bank anticipates that the transaction will be funded with available assets, the sale will result in a one time gain on sale in the first quarter of 2012 and a decrease in the Bank’s overall assets of approximately $34 million.

67

N O T E S    T O    C O N S O L I D A  T E D    F I N A N C I A L    S T A T E M E N T S

NOTE 22 HMN Financial, Inc. Financial Information (Parent Company Only)

The following are the condensed financial statements for the parent company only as of

December 31, 2011 and 2010 and for the years ended December 31, 2011, 2010 and 2009.

(Dollars in thousands)	2011			2010			2009
Condensed Balance Sheets
Assets:
Cash and cash equivalents	$	94			478
Investment in subsidiaries		57,465			68,053
Loans receivable, net		1,400			1,500
Prepaid expenses and other assets		35			49
Deferred tax asset, net		0			0
Total assets	$	58,994			70,080
Liabilities and Stockholders’ Equity:
Accrued expenses and other liabilities	$	1,933			533
Total liabilities		1,933			533
Serial preferred stock		24,780			24,264
Common stock		91			91
Additional paid-in capital		53,462			56,420
Retained earnings		42,983			55,838
Net unrealized gains on securities available for sale		471			541
Unearned employee stock ownership plan shares		(3,191	)		(3,384	)
Treasury stock, at cost, 4,740,711 and 4,818,263 shares		(61,535	)		(64,223	)
Total stockholders’ equity		57,061			69,547
Total liabilities and stockholders’ equity	$	58,994			70,080
Condensed Statements of Loss
Interest income	$	4			4			15
Equity losses of subsidiaries		(10,519	)		(27,833	)		(10,168	)
Other income		0			0			2
Compensation and benefits		(263	)		(236	)		(236	)
Occupancy		(24	)		(24	)		(24	)
Data processing		(6	)		(6	)		(6	)
Other		(747	)		(551	)		(470	)
Loss before income tax expense (benefit)		(11,555	)		(28,646	)		(10,887	)
Income tax expense (benefit)		0			332			(91	)
Net loss	$	(11,555	)		(28,978	)		(10,796	)
Condensed Statements of Cash Flows
Cash flows from operating activities:
Net loss	$	(11,555	)		(28,978	)		(10,796	)
Adjustments to reconcile net loss to cash provided (used) by operating activities:
Equity losses of subsidiaries		10,519			27,833			10,168
Deferred income tax expense		0			172			220
Earned employee stock ownership shares priced below original cost		(81	)		(51	)		(56	)
Stock option compensation		29			63			27
Amortization of restricted stock awards		298			370			373
Decrease in unearned ESOP shares		193			193			194
Increase (decrease) in accrued expenses and other liabilities		101			(15	)		(284	)
Decrease (increase) in other assets		13			791			(829	)
Other, net		(1	)		1			7
Net cash provided (used) by operating activities		(484	)		379			(976	)

68

(Dollars in thousands)	2011			2010			2009
Cash flows from investing activities:
Decrease in loans receivable, net		100			1,200			1,700
Net cash provided by investing activities		100			1,200			1,700
Cash flows from financing activities:
Dividends paid to preferred stockholders		0			(1,300	)		(1,163	)
Net cash used by financing activities		0			(1,300	)		(1,163	)
Increase (decrease) in cash and cash equivalents		(384	)		279			(439	)
Cash and cash equivalents, beginning of year		478			199			638
Cash and cash equivalents, end of year	$	94			478			199

NOTE 23 Business Segments

The Bank has been identified as a reportable operating segment in accordance with the provisions of ASC 280. SFC and HMN, the holding company, did not meet the quantitative thresholds for a reportable segment and therefore are included in the “Other” category.

The Company 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.

69

N O T E S    T O    C O N S O L I D A  T E D    F I N A N C I A L    S T A T E M E N T S

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

(Dollars in thousands)	Home Federal Savings Bank			Other			Eliminations			Consolidated Total
At or for the year ended December 31, 2011:
Interest income — external customers	$	39,541			0			0			39,541
Non-interest income — external customers		6,863			0			0			6,863
Gain on limited partnerships		6			0			0			6
Intersegment interest income		0			4			(4	)		0
Intersegment non-interest income		186			(10,519	)		10,333			0
Interest expense		11,139			0			(4	)		11,135
Amortization of mortgage servicing rights, net		562			0			0			562
Other non-interest expense		28,127			1,049			(186	)		28,990
Income tax expense		0			0			0			0
Net loss		(10,510	)		(11,564	)		10,519			(11,555	)
Total assets		790,115			59,005			(58,965	)		790,155
At or for the year ended December 31, 2010:
Interest income — external customers	$	48,270			0			0			48,270
Non-interest income — external customers		7,302			0			0			7,302
Loss on limited partnerships		(31	)		0			0			(31	)
Intersegment interest income		0			4			(4	)		0
Intersegment non-interest income		174			(27,833	)		27,659			0
Interest expense		17,263			0			(4	)		17,259
Amortization of mortgage servicing rights, net		482			0			0			482
Other non-interest expense		26,423			825			(174	)		27,074
Income tax expense		5,991			332			0			6,323
Net loss		(27,825	)		(28,986	)		27,833			(28,978	)
Total assets		880,570			70,100			(70,052	)		880,618
At or for the year ended December 31, 2009:
Interest income — external customers	$	57,770			1			0			57,771
Non-interest income — external customers		8,134			2			0			8,136
Loss on limited partnerships		(54	)		0			0			(54	)
Intersegment interest income		0			15			(15	)		0
Intersegment non-interest income		174			(10,168	)		9,994			0
Interest expense		23,883			0			(15	)		23,868
Amortization of mortgage servicing rights, net		556			0			0			556
Other non-interest expense		30,563			744			(174	)		31,133
Income tax benefit		(5,513	)		(94	)		0			(5,607	)
Net loss		(10,163	)		(10,801	)		10,168			(10,796	)
Total assets		1,035,152			100,515			(99,426	)		1,036,241

70

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71

Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders

HMN Financial, Inc.:

We have audited the accompanying consolidated balance sheets of HMN Financial, Inc. (the Company) as of December 31, 2011 and 2010, and the related consolidated statements of loss, stockholders’ equity and comprehensive loss, and cash flows for each of the years in the three-year period ended December 31, 2011. 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 the standards of the Public Company Accounting Oversight Board (United States). 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. as of December 31, 2011 and 2010, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2011, in conformity with U.S. generally accepted accounting principles.

Minneapolis, Minnesota

March 7, 2012

72

OTHER FINANCIAL DATA

The following tables set forth certain information as to the Bank’s Federal Home Loan Bank (FHLB) advances and Federal Reserve Bank (FRB) borrowings.

	Year Ended December 31,
(Dollars in thousands)	2011		2010		2009
Maximum Balance:
FHLB and FRB advances and borrowings	$	122,500		137,500		210,500
FHLB and FRB short-term borrowings		52,500		62,500		78,000
Average Balance:
FHLB and FRB advances and borrowings		92,542		129,408		155,574
FHLB and FRB short-term borrowings		22,604		37,023		26,288

	December 31,
	2011					2010					2009
(Dollars in thousands)	Amount		Weighted Average Rate			Amount		Weighted Average Rate			Amount		Weighted Average Rate
FHLB and FRB short-term borrowings	$	0		0.00	%	$	52,500		4.00	%	$	10,000		6.48	%
FHLB long-term advances		70,000		4.77			70,000		4.77			122,500		4.44
Total	$	70,000		4.77	%	$	122,500		4.44	%	$	132,500		4.59	%

Refer to Note 11 of the Notes to Consolidated Financial Statements for more information on the Bank’s FHLB advances and FRB borrowings.

73

S E L E C T E D    Q U A R T E R  L Y    F I N A N C I A L    D A T A

(Dollars in thousands, except per share data)	December 31, 2011			September 30, 2011			June 30, 2011
Selected Operations Data (3 months ended):
Interest income	$	9,210			9,572			10,045
Interest expense		2,332			2,488			3,046
Net interest income		6,878			7,084			6,999
Provision for loan losses		7,609			4,260			3,463
Net interest income (loss) after provision for loan losses		(731	)		2,824			3,536
Noninterest income:
Fees and service charges		912			978			925
Loan servicing fees		240			247			250
Gain on sales of loans		672			188			301
Other noninterest income		151			106			113
Total noninterest income		1,975			1,519			1,589
Noninterest expense:
Compensation and benefits		3,205			3,276			3,512
Losses (gains) on real estate owned		2,380			111			143
Occupancy		955			930			916
Deposit insurance		254			190			407
Data processing		337			326			305
Other noninterest expense		1,739			1,565			2,209
Total noninterest expense		8,870			6,398			7,492
Income (loss) before income tax expense (benefit)		(7,626	)		(2,055	)		(2,367	)
Income tax expense (benefit)		0			0			(76	)
Net income (loss)		(7,626	)		(2,055	)		(2,291	)
Preferred stock dividends and discount		(459	)		(456	)		(457	)
Net loss available to common stockholders	$	(8,085	)		(2,511	)		(2,748	)
Basic loss per common share	$	(2.08	)		(0.65	)		(0.72	)
Diluted loss per common share	$	(2.08	)		(0.65	)		(0.72	)
Financial Ratios:
Loss on average assets(1)		(3.75	)%		(1.02	)%		(1.08	)%
Loss on average common equity(1)		(45.87	)		(12.10	)		(13.27	)
Average equity to average assets		8.19			8.20			8.11
Net interest margin(1)(2)		3.55			3.71			3.48
(Dollars in thousands)
Selected Financial Condition Data:
Total assets	$	790,155			818,384			807,374
Securities available for sale:
Mortgage-backed and related securities		20,645			23,681			26,780
Other marketable securities		105,469			120,452			107,467
Loans held for sale		3,709			4,031			1,075
Loans receivable, net		555,908			591,265			601,787
Deposits		620,128			630,606			647,115
Federal Home Loan Bank advances and Federal Reserve borrowing		70,000			70,000			85,000
Stockholders’ equity		57,061			65,169			67,571

⁽¹⁾ Annualized

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

74

March 31, 2011			December 31, 2010			September 30, 2010			June 30, 2010			March 31, 2010
	10,714			10,834			11,963			12,569			12,904
	3,269			3,547			4,189			4,580			4,943
	7,445			7,287			7,774			7,989			7,961
	1,946			10,542			11,946			4,360			6,533
	5,499			(3,255	)		(4,172	)		3,629			1,428
	924			1,007			972			920			842
	250			261			264			274			268
	495			655			551			467			314
	117			101			105			120			150
	1,786			2,024			1,892			1,781			1,574
	3,560			3,300			3,356			3,411			3,449
	47			1,509			384			33			(761	)
	940			961			1,055			1,035			1,031
	404			439			458			519			517
	253			174			292			298			276
	1,588			1,836			1,445			1,034			1,505
	6,792			8,219			6,990			6,330			6,017
	493			(9,450	)		(9,270	)		(920	)		(3,015	)
	76			482			97			6,912			(1,168	)
	417			(9,932	)		(9,367	)		(7,832	)		(1,847	)
	(449	)		(449	)		(447	)		(448	)		(440	)
	(32	)		(10,381	)		(9,814	)		(8,280	)		(2,287	)
	(0.01	)		(2.73	)		(2.60	)		(2.20	)		(0.61	)
	(0.01	)		(2.73	)		(2.60	)		(2.20	)		(0.61	)
	0.19	%		(4.41	)%		(3.89	)%		(3.12	)%		(0.73	)%
	2.41			(49.64	)		(42.01	)		(32.14	)		(7.50	)
	8.05			9.40			9.56			9.70			9.70
	3.62			3.39			3.37			3.37			3.31
	878,756			880,618			907,401			975,243			1,028,476
	29,641			33,506			39,152			43,867			48,368
	128,002			118,058			108,676			112,925			113,714
	1,624			2,728			3,405			2,940			2,386
	634,282			664,241			699,877			744,629			774,336
	688,078			683,230			686,012			746,448			789,792
	115,000			122,500			134,000			132,500			132,500
	69,641			69,547			80,156			89,854			97,690

75

C O M M O N    S T O C K    I  N F O R M A T I O N

The common stock of HMN Financial, Inc. is listed on the Nasdaq Stock Market under the symbol HMNF. As of December 31, 2011, the Company had 9,128,662 shares of common stock issued and 4,740,711 shares in treasury stock. As of December 31, 2011, there were 603 stockholders of record and 864 estimated beneficial stockholders. The following table represents the stock price information for HMN Financial, Inc. as furnished by Nasdaq for each quarter starting with the quarter ended December 31, 2011 and regressing back to March 31, 2010.

	December 31, 2011		September 30, 2011		June 30, 2011		March 31, 2011		December 31, 2010		September 30, 2010		June 30, 2010		March 31, 2010
HIGH	$	2.37		3.22		3.01		3.14		3.80		5.00		6.78		5.99
LOW		1.61		1.50		2.35		2.02		2.47		3.06		4.28		4.02
CLOSE		1.94		1.88		2.45		2.75		2.81		3.16		4.58		5.50

The graph assumes that $100 was invested on December 31, 2006 and that all dividends were reinvested.

	Period Ending
Index	12/31/06		12/31/07		12/31/08		12/31/09		12/31/10		12/31/11
HMN Financial, Inc.		100.00		73.53		13.04		13.10		8.76		6.04
NASDAQ Composite		100.00		110.66		66.42		96.54		114.06		113.16
SNL Bank NASDAQ Index		100.00		78.51		57.02		46.25		54.57		48.42

76

EX-21

Exhibit 21

Subsidiaries of Registrant

Name & Address	Year & State Inc.
Home Federal Savings Bank 1016 Civic Center Drive NW Rochester, MN 55901	1934 Federal Charter
Osterud Insurance Agency, Inc. DBA Home Federal Investment Svcs. 1016 Civic Center Drive NW Rochester, MN 55901	1983 MN
Security Finance Corporation 1016 Civic Center Drive NW Rochester, MN 55901	1929 MN

EX-23

Exhibit 23

Consent of Independent Registered Public Accounting Firm

The Board of Directors

HMN Financial, Inc.:

We consent to the incorporation by reference of our report dated March 7, 2012, with respect to the consolidated balance sheets of HMN Financial, Inc. as of December 31, 2011 and 2010, and the related consolidated statements of loss, stockholders’ equity and comprehensive loss, and cash flows for each of the years in the three-year period ended December 31, 2011, which report appears in the December 31, 2011 annual report on Form 10-K of HMN Financial, Inc., in the following Registration Statements of HMN Financial, Inc.: Nos. 333-88228, 33-94388, 33-94386, 33-64232, and 333-158893 on Form S-8 and No. 333-156883 on Form S-3.

/s/ KPMG LLP

Minneapolis, Minnesota

March 7, 2012

EX-31.1

EXHIBIT 31.1

CERTIFICATIONS

I, Bradley Krehbiel, certify that:

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

2. Based on my knowledge, this 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 report;

3. Based on my knowledge, the financial statements, and other financial information included in this 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 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-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-(f)) for the registrant and have:

(a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared;

(b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

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

a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: March 7, 2012	By:	/s/ Bradley Krehbiel
		Bradley Krehbiel
		President HMN Financial, Inc.

EX-31.2

EXHIBIT 31.2

CERTIFICATIONS

I, Jon J. Eberle, certify that:

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

2. Based on my knowledge, this 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 report;

3. Based on my knowledge, the financial statements, and other financial information included in this 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 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-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared;

(b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

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

a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: March 7, 2012	By:	/s/Jon J. Eberle
		Jon J. Eberle
		Senior Vice President, Chief Financial Officer and Treasurer

EX-32

Exhibit 32

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, 2011 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), we, Bradley Krehbiel, President HMN Financial, Inc. (Principal Executive Officer of the Company), and Jon Eberle, Senior Vice President, Chief Financial Officer and Treasurer 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 results of operations of the Company.

Date: March 7, 2012	/s/ Bradley Krehbiel
	Bradley Krehbiel
	President HMN Financial, Inc.
	(Principal Executive Officer)
	/s/ Jon Eberle
	Jon Eberle
	Senior Vice President/Chief Financial Officer and Treasurer
	(Principal Financial Officer)

EX-99.1

EXHIBIT 99.1

HMN FINANCIAL, INC.

CERTIFICATIONS PURSUANT TO SECTION 111(b)(4) OF

THE EMERGENCY ECONOMIC STABILIZATION ACT OF 2008

I, Bradley Krehbiel, certify, based on my knowledge, that:

(i) The compensation committee of HMN Financial, Inc. has discussed, reviewed, and evaluated with senior risk officers at least every six months during any part of the most recently completed fiscal year that was a TARP period, senior executive officer (SEO) compensation plans and employee compensation plans and the risks these plans pose to HMN Financial, Inc.;

(ii) The compensation committee of HMN Financial, Inc. has identified and limited during any part of the most recently completed fiscal year that was a TARP period any features of the SEO compensation plans that could lead SEOs to take unnecessary and excessive risks that could threaten the value of HMN Financial, Inc. and has identified any features of the employee compensation plans that pose risks to HMN Financial, Inc. and has limited those features to ensure that HMN Financial, Inc. is not unnecessarily exposed to risks;

(iii) The compensation committee has reviewed, at least every six months during any part of the most recently completed fiscal year that was a TARP period, the terms of each employee compensation plan and identified any features of the plan that could encourage the manipulation of reported earnings of HMN Financial, Inc. to enhance the compensation of an employee, and has limited any such features;

(iv) The compensation committee of HMN Financial, Inc. will certify to the reviews of the SEO compensation plans and employee compensation plans required under (i) and (iii) above;

(v) The compensation committee of HMN Financial, Inc. will provide a narrative description of how it limited during any part of the most recently completed fiscal year that was a TARP period the features in:

(A) SEO compensation plans that could lead SEOs to take unnecessary and excessive risks that could threaten the value of HMN Financial, Inc.;

(B) Employee compensation plans that unnecessarily expose HMN Financial, Inc. to risks; and

(C) Employee compensation plans that could encourage the manipulation of reported earnings of HMN Financial, Inc. to enhance the compensation of an employee;

(vi) HMN Financial, Inc. has required that bonus payments to SEOs or any of the next twenty most highly compensated employees, as defined in the regulations and guidance

established under section 111 of EESA (bonus payments), be subject to a recovery or “clawback” provision during any part of the most recently completed fiscal year that was a TARP period if the bonus payments were based on materially inaccurate financial statements or any other materially inaccurate performance metric criteria;

(vii) HMN Financial, Inc. has prohibited any golden parachute payment, as defined in the regulations and guidance established under section 111 of EESA, to a SEO or any of the next five most highly compensated employees during any part of the most recently completed fiscal year that was a TARP period;

(viii) HMN Financial, Inc. and its employees have complied with the excessive or luxury expenditures policy, as defined in the regulations and guidance established under section 111 of EESA, during any part of the most recently completed fiscal year that was a TARP period; and any expenses that, pursuant to the policy, required approval of the board of directors, a committee of the board of directors, an SEO, or an executive officer with a similar level of responsibility were properly approved;

(ix) HMN Financial, Inc. and its employees have complied with the excessive or luxury expenditures policy, as defined in the regulations and guidance established under section 111 of EESA, during any part of the most recently completed fiscal year that was a TARP period, and that any expenses requiring approval of the board of directors, a committee of the board of directors, an SEO, or an executive officer with a similar level of responsibility, were properly approved;

(x) HMN Financial, Inc. will permit a non-binding shareholder resolution in compliance with any applicable federal securities rules and regulations on the disclosures provided under the federal securities laws related to SEO compensation paid or accrued during any part of the most recently completed fiscal year that was a TARP period;

(xi) HMN Financial, Inc. will disclose the amount, nature, and justification for the offering, during any part of the most recently completed fiscal year that was a TARP period, of any perquisites, as defined in the regulations and guidance established under section 111 of EESA, whose total value exceeds $25,000 for any employee who is subject to the bonus payment limitations identified in paragraph (viii);

(xii) HMN Financial, Inc. will disclose whether HMN Financial, Inc., the board of directors of HMN Financial, Inc., or the compensation committee of HMN Financial, Inc. has engaged during any part of the most recently completed fiscal year that was a TARP period a compensation consultant; and the services the compensation consultant or any affiliate of the compensation consultant provided during this period;

(xiii) HMN Financial, Inc. has prohibited the payment of any gross-ups, as defined in the regulations and guidance established under section 111 of EESA, to the SEOs and the next twenty most highly compensated employees during any part of the most recently completed fiscal year that was a TARP period;

(xiv) HMN Financial, Inc. has substantially complied with all other requirements related to employee compensation that are provided in the agreement between HMN Financial, Inc. and Treasury, including any amendments;

(xv) HMN Financial, Inc. has submitted to Treasury a complete and accurate list of the SEOs and the twenty next most highly compensated employees for the current fiscal year, with the non-SEOs ranked in descending order of level of annual compensation, and with the name, title, and employer of each SEO and most highly compensated employee identified;

(xvi) I understand that a knowing and willful false or fraudulent statement made in connection with this certification may be punished by fine, imprisonment, or both. (See, for example 18 USC 1001).

Date: March 7, 2012	By:	/s/ Bradley Krehbiel
		Bradley Krehbiel
		President

EX-99.2

EXHIBIT 99.2

HMN FINANCIAL, INC.

CERTIFICATIONS PURSUANT TO SECTION 111(b)(4) OF

THE EMERGENCY ECONOMIC STABILIZATION ACT OF 2008

I, Jon J. Eberle, certify, based on my knowledge, that:

(i) The compensation committee of HMN Financial, Inc. has discussed, reviewed, and evaluated with senior risk officers at least every six months during any part of the most recently completed fiscal year that was a TARP period, senior executive officer (SEO) compensation plans and employee compensation plans and the risks these plans pose to HMN Financial, Inc.;

(ii) The compensation committee of HMN Financial, Inc. has identified and limited during any part of the most recently completed fiscal year that was a TARP period any features of the SEO compensation plans that could lead SEOs to take unnecessary and excessive risks that could threaten the value of HMN Financial, Inc. and has identified any features of the employee compensation plans that pose risks to HMN Financial, Inc. and has limited those features to ensure that HMN Financial, Inc. is not unnecessarily exposed to risks;

(iii) The compensation committee has reviewed, at least every six months during any part of the most recently completed fiscal year that was a TARP period, the terms of each employee compensation plan and identified any features of the plan that could encourage the manipulation of reported earnings of HMN Financial, Inc. to enhance the compensation of an employee, and has limited any such features;

(iv) The compensation committee of HMN Financial, Inc. will certify to the reviews of the SEO compensation plans and employee compensation plans required under (i) and (iii) above;

(v) The compensation committee of HMN Financial, Inc. will provide a narrative description of how it limited during any part of the most recently completed fiscal year that was a TARP period the features in:

(A) SEO compensation plans that could lead SEOs to take unnecessary and excessive risks that could threaten the value of HMN Financial, Inc.;

(B) Employee compensation plans that unnecessarily expose HMN Financial, Inc. to risks; and

(C) Employee compensation plans that could encourage the manipulation of reported earnings of HMN Financial, Inc. to enhance the compensation of an employee;

(vi) HMN Financial, Inc. has required that bonus payments to SEOs or any of the next twenty most highly compensated employees, as defined in the regulations and guidance

established under section 111 of EESA (bonus payments), be subject to a recovery or “clawback” provision during any part of the most recently completed fiscal year that was a TARP period if the bonus payments were based on materially inaccurate financial statements or any other materially inaccurate performance metric criteria;

(vii) HMN Financial, Inc. has prohibited any golden parachute payment, as defined in the regulations and guidance established under section 111 of EESA, to a SEO or any of the next five most highly compensated employees during any part of the most recently completed fiscal year that was a TARP period;

(viii) HMN Financial, Inc. and its employees have complied with the excessive or luxury expenditures policy, as defined in the regulations and guidance established under section 111 of EESA, during any part of the most recently completed fiscal year that was a TARP period; and any expenses that, pursuant to the policy, required approval of the board of directors, a committee of the board of directors, an SEO, or an executive officer with a similar level of responsibility were properly approved;

(ix) HMN Financial, Inc. and its employees have complied with the excessive or luxury expenditures policy, as defined in the regulations and guidance established under section 111 of EESA, during any part of the most recently completed fiscal year that was a TARP period, and that any expenses requiring approval of the board of directors, a committee of the board of directors, an SEO, or an executive officer with a similar level of responsibility, were properly approved;

(x) HMN Financial, Inc. will permit a non-binding shareholder resolution in compliance with any applicable federal securities rules and regulations on the disclosures provided under the federal securities laws related to SEO compensation paid or accrued during any part of the most recently completed fiscal year that was a TARP period;

(xi) HMN Financial, Inc. will disclose the amount, nature, and justification for the offering, during any part of the most recently completed fiscal year that was a TARP period, of any perquisites, as defined in the regulations and guidance established under section 111 of EESA, whose total value exceeds $25,000 for any employee who is subject to the bonus payment limitations identified in paragraph (viii);

(xii) HMN Financial, Inc. will disclose whether HMN Financial, Inc., the board of directors of HMN Financial, Inc., or the compensation committee of HMN Financial, Inc. has engaged during any part of the most recently completed fiscal year that was a TARP period a compensation consultant; and the services the compensation consultant or any affiliate of the compensation consultant provided during this period;

(xiii) HMN Financial, Inc. has prohibited the payment of any gross-ups, as defined in the regulations and guidance established under section 111 of EESA, to the SEOs and the next twenty most highly compensated employees during any part of the most recently completed fiscal year that was a TARP period;

(xiv) HMN Financial, Inc. has substantially complied with all other requirements related to employee compensation that are provided in the agreement between HMN Financial, Inc. and Treasury, including any amendments;

(xv) HMN Financial, Inc. has submitted to Treasury a complete and accurate list of the SEOs and the twenty next most highly compensated employees for the current fiscal year, with the non-SEOs ranked in descending order of level of annual compensation, and with the name, title, and employer of each SEO and most highly compensated employee identified;

(xvi) I understand that a knowing and willful false or fraudulent statement made in connection with this certification may be punished by fine, imprisonment, or both. (See, for example 18 USC 1001).

Date: March 7, 2012	By:	/s/Jon J. Eberle
		Jon J. Eberle
		Senior Vice President, Chief Financial Officer and Treasurer

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Fair Value Measurement

12 Months Ended

Dec. 31, 2011

Fair Value Measurement [Abstract]

Fair Value Measurement

NOTE 19 Fair Value Measurement

The Company has adopted ASC 820, Fair Value Measurements, which establishes a framework for measuring the fair value of assets and liabilities using a hierarchy system consisting of three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:

Level 1 — Valuation is based upon quoted prices for identical instruments traded in active markets that the Company has the ability to access.

Level 2 — Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which significant assumptions are observable in the market.

Level 3 — Valuation is generated from model-based techniques that use significant assumptions not observable in the market and are used only to the extent that observable inputs are not available. These unobservable assumptions reflect our own estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.

The following table summarizes the assets of the Company for which fair values are determined on a recurring basis as of December 31, 2011 and 2010.

	Carrying Value at December 31, 2011
(Dollars in thousands)	Total			Level 1		Level 2			Level 3
Securities available for sale	$	126,114			613		125,501			0
Mortgage loan commitments		(94	)		0		(94	)		0
Total	$	126,020			613		125,407			0

	Carrying Value at December 31, 2010
	Total			Level 1		Level 2			Level 3
Securities available for sale	$	151,564			1,740		149,824			0
Mortgage loan commitments		(1	)		0		(1	)		0
Total	$	151,563			1,740		149,823			0

The Company may also be required, from time to time, to measure certain other financial assets at fair value on a nonrecurring basis in accordance with generally accepted accounting principles. These adjustments to fair value usually result from the application of the lower-of-cost-or-market accounting or write-downs of individual assets. For assets measured at fair value on a nonrecurring basis in 2011 that were still held at December 31, the following table provides the level of valuation assumptions used to determine each adjustment and the carrying value of the related individual assets or portfolios at December 31, 2011 and 2010.

	Carrying Value at December 31, 2011								Year Ended December 31, 2011 Total gains (losses)
(Dollars in thousands)	Total		Level 1		Level 2		Level 3
Loans held for sale	$	3,709		0		3,709		0		129
Mortgage servicing rights		1,485		0		1,485		0		0
Loans(1)		38,162		0		38,162		0		(4,167	)
Real estate, net(2)		16,616		0		16,616		0		(2,690	)
Assets held for sale		1,583		0		1,583		0		0
Deposits held for sale		36,048		0		36,048		0		0
Total	$	97,603		0		97,603		0		(6,728	)

	Carrying Value at December 31, 2010								Year Ended December 31, 2010 Total losses
	Total		Level 1		Level 2		Level 3
Loans held for sale	$	2,728		0		2,728		0		(6	)
Mortgage servicing rights		1,586		0		1,586		0		0
Loans(1)		43,039		0		43,039		0		(18,855	)
Real estate, net(2)		16,382		0		16,382		0		(1,782	)
Total	$	63,735		0		63,735		0		(20,643	)

⁽¹⁾  Represents carrying value and related specific reserves on loans for which adjustments are based on the appraised value of the collateral. The carrying value of loans fully charged-off is zero.

⁽²⁾  Represents the fair value and related losses of foreclosed real estate and other collateral owned that were measured at fair value subsequent to their initial classification as foreclosed assets.

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Securities Available for Sale

12 Months Ended

Dec. 31, 2011

Securities Available for Sale [Abstract]

Securities Available for Sale

NOTE 3 Securities Available for Sale

A summary of securities available for sale at December 31, 2011 and 2010 is as follows:

(Dollars in thousands)	Amortized cost		Gross unrealized gains		Gross unrealized losses			Fair value
December 31, 2011:
Mortgage-backed securities:
FHLMC	$	11,310		553		0			11,863
FNMA		7,670		499		0			8,169
Collateralized mortgage obligations:
FHLMC		335		4		0			339
FNMA		271		3		0			274
		19,586		1,059		0			20,645
Other marketable securities:
U.S. Government agency obligations		105,000		294		0			105,294
Corporate preferred stock		700		0		(525	)		175
		105,700		294		(525	)		105,469
		$125,286		1,353		(525	)		126,114
December 31, 2010:
Mortgage-backed securities:
FHLMC	$	17,555		719		0			18,274
FNMA		12,800		692		0			13,492
Collateralized mortgage obligations:
FHLMC		1,299		44		0			1,343
FNMA		382		15		0			397
		32,036		1,470		0			33,506
Other marketable securities:
U.S. Government agency obligations		117,931		218		(266	)		117,883
Corporate preferred stock		700		0		(525	)		175
		118,631		218		(791	)		118,058
	$	150,667		1,688		(791	)		151,564

The Company did not hold any investments in European sovereign debt as of December 31, 2011.

The Company did not sell any available for sale securities and did not recognize any gains or losses on investments in 2011 or 2010. Proceeds from securities available for sale which were sold in 2009 were $2.1 million resulting in gross gains of $5,000.

The following table presents amortized cost and estimated fair value of securities available for sale at December 31, 2011 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:

(Dollars in thousands)	Amortized Cost		Fair Value
Due less than one year	$	44,912		45,521
Due after one year through five years		79,148		79,862
Due after five years through ten years		526		556
Due after ten years		700		175
Total	$	125,286		126,114

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.

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, 2011 and 2010:

	Less Than Twelve Months							Twelve Months or More							Total
(Dollars in thousands)	# of Investments		Fair Value		Unrealized Losses			# of Investments		Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
December 31, 2011
Other marketable securities:
U.S. Government agency obligations		0	$	0		0			0	$	0		0		$	0		0
Corporate preferred stock		0		0		0			1		175		(525	)		175		(525	)
Total temporarily impaired securities		0	$	0		0			1	$	175		(525	)	$	175		(525	)
December 31, 2010
Other marketable securities:
U.S. Government agency obligations		10	$	47,610		(266	)		0	$	0		0		$	47,610		(266	)
Corporate preferred stock		0		0		0			1		175		(525	)		175		(525	)
Total temporarily impaired securities		10	$	47,610		(266	)		1	$	175		(525	)	$	47,785		(791	)

We review our investment portfolio on a quarterly basis for indications of impairment. This review includes analyzing the length of time and the extent to which the fair value has been lower than the cost, the market liquidity for the investment, the financial condition and near-term prospects of the issuer, including any specific events which may influence the operations of the issuer, and our intent and ability to hold the investment for a period of time sufficient to recover the temporary loss. The unrealized losses reported for corporate preferred stock at December 31, 2011 relates to a single trust preferred security that was issued by the holding company of a small community bank. Typical of most trust preferred issuances, the issuer has the ability to defer interest payments for up to five years with interest payable on the deferred balance. In October 2009, the issuer elected to defer its scheduled interest payments as allowed by the terms of the security agreement. The issuer’s subsidiary bank has incurred operating losses over the past several years due to increased provisions for loan losses but still met the regulatory requirements to be considered “adequately capitalized” based on its most recent regulatory filing in 2011. In addition, the owners of the issuing bank appear to have the ability to make additional capital contributions to enhance the issuing bank’s capital position. Based on a review of the issuer, it was determined that the trust preferred security was not other-than-temporarily impaired at December 31, 2011. The Company does not intend to sell the preferred stock and has the intent and ability to hold it for a period of time sufficient to recover the temporary loss. Management believes that the Company will receive all principal and interest payments contractually due on the security and that the decrease in the market value is primarily due to a lack of liquidity in the market for trust preferred securities and the deferral of interest by the issuer. Management will continue to monitor the credit risk of the issuer and may be required to recognize other-than-temporary impairment charges on this security in future periods.

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Business Segments

12 Months Ended

Dec. 31, 2011

Business Segments [Abstract]

Business Segments

NOTE 23 Business Segments

The Bank has been identified as a reportable operating segment in accordance with the provisions of ASC 280. SFC and HMN, the holding company, did not meet the quantitative thresholds for a reportable segment and therefore are included in the “Other” category.

The Company 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 loss and assets for each of the Company’s reportable segments.

(Dollars in thousands)	Home Federal Savings Bank			Other			Eliminations			Consolidated Total
At or for the year ended December 31, 2011:
Interest income — external customers	$	39,541			0			0			39,541
Non-interest income — external customers		6,863			0			0			6,863
Gain on limited partnerships		6			0			0			6
Intersegment interest income		0			4			(4	)		0
Intersegment non-interest income		186			(10,519	)		10,333			0
Interest expense		11,139			0			(4	)		11,135
Amortization of mortgage servicing rights, net		562			0			0			562
Other non-interest expense		28,127			1,049			(186	)		28,990
Income tax expense		0			0			0			0
Net loss		(10,510	)		(11,564	)		10,519			(11,555	)
Total assets		790,115			59,005			(58,965	)		790,155
At or for the year ended December 31, 2010:
Interest income — external customers	$	48,270			0			0			48,270
Non-interest income — external customers		7,302			0			0			7,302
Loss on limited partnerships		(31	)		0			0			(31	)
Intersegment interest income		0			4			(4	)		0
Intersegment non-interest income		174			(27,833	)		27,659			0
Interest expense		17,263			0			(4	)		17,259
Amortization of mortgage servicing rights, net		482			0			0			482
Other non-interest expense		26,423			825			(174	)		27,074
Income tax expense		5,991			332			0			6,323
Net loss		(27,825	)		(28,986	)		27,833			(28,978	)
Total assets		880,570			70,100			(70,052	)		880,618
At or for the year ended December 31, 2009:
Interest income — external customers	$	57,770			1			0			57,771
Non-interest income — external customers		8,134			2			0			8,136
Loss on limited partnerships		(54	)		0			0			(54	)
Intersegment interest income		0			15			(15	)		0
Intersegment non-interest income		174			(10,168	)		9,994			0
Interest expense		23,883			0			(15	)		23,868
Amortization of mortgage servicing rights, net		556			0			0			556
Other non-interest expense		30,563			744			(174	)		31,133
Income tax benefit		(5,513	)		(94	)		0			(5,607	)
Net loss		(10,163	)		(10,801	)		10,168			(10,796	)
Total assets		1,035,152			100,515			(99,426	)		1,036,241

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

12 Months Ended

Dec. 31, 2011

HMN Financial, Inc. Financial Information (Parent Company Only) [Abstract]

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

NOTE 22 HMN Financial, Inc. Financial Information (Parent Company Only)

The following are the condensed financial statements for the parent company only as of December 31, 2011 and 2010 and for the years ended December 31, 2011, 2010 and 2009.

(Dollars in thousands)	2011			2010			2009
Condensed Balance Sheets
Assets:
Cash and cash equivalents	$	94			478
Investment in subsidiaries		57,465			68,053
Loans receivable, net		1,400			1,500
Prepaid expenses and other assets		35			49
Deferred tax asset, net		0			0
Total assets	$	58,994			70,080
Liabilities and Stockholders’ Equity:
Accrued expenses and other liabilities	$	1,933			533
Total liabilities		1,933			533
Serial preferred stock		24,780			24,264
Common stock		91			91
Additional paid-in capital		53,462			56,420
Retained earnings		42,983			55,838
Net unrealized gains on securities available for sale		471			541
Unearned employee stock ownership plan shares		(3,191	)		(3,384	)
Treasury stock, at cost, 4,740,711 and 4,818,263 shares		(61,535	)		(64,223	)
Total stockholders’ equity		57,061			69,547
Total liabilities and stockholders’ equity	$	58,994			70,080
Condensed Statements of Loss
Interest income	$	4			4			15
Equity losses of subsidiaries		(10,519	)		(27,833	)		(10,168	)
Other income		0			0			2
Compensation and benefits		(263	)		(236	)		(236	)
Occupancy		(24	)		(24	)		(24	)
Data processing		(6	)		(6	)		(6	)
Other		(747	)		(551	)		(470	)
Loss before income tax expense (benefit)		(11,555	)		(28,646	)		(10,887	)
Income tax expense (benefit)		0			332			(91	)
Net loss	$	(11,555	)		(28,978	)		(10,796	)
Condensed Statements of Cash Flows
Cash flows from operating activities:
Net loss	$	(11,555	)		(28,978	)		(10,796	)
Adjustments to reconcile net loss to cash provided (used) by operating activities:
Equity losses of subsidiaries		10,519			27,833			10,168
Deferred income tax expense		0			172			220
Earned employee stock ownership shares priced below original cost		(81	)		(51	)		(56	)
Stock option compensation		29			63			27
Amortization of restricted stock awards		298			370			373
Decrease in unearned ESOP shares		193			193			194
Increase (decrease) in accrued expenses and other liabilities		101			(15	)		(284	)
Decrease (increase) in other assets		13			791			(829	)
Other, net		(1	)		1			7
Net cash provided (used) by operating activities		(484	)		379			(976	)
Cash flows from investing activities:
Decrease in loans receivable, net		100			1,200			1,700
Net cash provided by investing activities		100			1,200			1,700
Cash flows from financing activities:
Dividends paid to preferred stockholders		0			(1,300	)		(1,163	)
Net cash used by financing activities		0			(1,300	)		(1,163	)
Increase (decrease) in cash and cash equivalents		(384	)		279			(439	)
Cash and cash equivalents, beginning of year		478			199			638
Cash and cash equivalents, end of year	$	94			478			199

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Other Comprehensive Income (Loss)

12 Months Ended

Dec. 31, 2011

Other Comprehensive Income (Loss) and Stockholders' Equity [Abstract]

Other Comprehensive Income (Loss)

NOTE 2 Other Comprehensive Loss

The components of other comprehensive loss and the related tax effects were as follows:

	For the years ended December 31,
	2011								2010									2009
(Dollars in thousands) Securities available for sale:	Before Tax			Tax Effect		Net of Tax			Before Tax			Tax Effect			Net of Tax			Before Tax			Tax Effect			Net of Tax
Gross unrealized losses arising during the period	$	(70	)		0		(70	)		(1,142	)		(453	)		(689	)		(1,490	)		(632	)		(858	)
Less reclassification of net gains included in net loss		0			0		0			0			0			0			5			2			3
Net unrealized losses arising during the period		(70	)		0		(70	)		(1,142	)		(453	)		(689	)		(1,495	)		(634	)		(861	)
Other comprehensive loss	$	(70	)		0		(70	)		(1,142	)		(453	)		(689	)		(1,495	)		(634	)		(861	)

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Consolidated Balance Sheets (USD $) In Thousands, unless otherwise specified	Dec. 31, 2011	Dec. 31, 2010
ASSETS
Cash and cash equivalents	$ 67,840	$ 20,981
Securities available for sale:
Mortgage-backed and related securities (amortized cost $19,586 and $32,036)	20,645	33,506
Other marketable securities (amortized cost $105,700 and $118,631)	105,469	118,058
Total securities available for sale	126,114	151,564
Loans held for sale	3,709	2,728
Loans receivable, net	555,908	664,241
Accrued interest receivable	2,449	3,311
Real estate, net	16,616	16,382
Federal Home Loan Bank stock, at cost	4,222	6,743
Mortgage servicing rights, net	1,485	1,586
Premises and equipment, net	7,967	9,450
Prepaid expenses and other assets	2,262	3,632
Assets held for sale	1,583	0
Deferred tax assets, net	0	0
Total assets	790,155	880,618
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits	620,128	683,230
Deposits held for sale	36,048	0
Federal Home Loan Bank advances and Federal Reserve borrowings	70,000	122,500
Accrued interest payable	780	1,092
Customer escrows	933	818
Accrued expenses and other liabilities	5,205	3,431
Total liabilities	733,094	811,071
Commitments and contingencies
Stockholders' equity:
Serial preferred stock: ($.01 par value) Authorized 500,000 shares; issued shares 26,000	24,780	24,264
Common stock ($.01 par value): Authorized 11,000,000; issued shares 9,128,662	91	91
Additional paid-in capital	53,462	56,420
Retained earnings, subject to certain restrictions	42,983	55,838
Accumulated other comprehensive income	471	541
Unearned employee stock ownership plan shares	(3,191)	(3,384)
Treasury stock, at cost 4,740,711 and 4,818,263 shares	(61,535)	(64,223)
Total stockholders' equity	57,061	69,547
Total liabilities and stockholders' equity	$ 790,155	$ 880,618

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Consolidated Statements of Cash Flows (USD $) In Thousands, unless otherwise specified	12 Months Ended
	Dec. 31, 2011	Dec. 31, 2010	Dec. 31, 2009
Cash flows from operating activities:
Net loss	$ (11,555)	$ (28,978)	$ (10,796)
Adjustments to reconcile net loss to cash provided by operating activities:
Provision for loan losses	17,278	33,381	26,699
Depreciation	1,267	1,593	1,837
Amortization of premiums, net	297	571	465
Amortization of deferred loan fees	(465)	(319)	(972)
Amortization of mortgage servicing rights	562	482	556
Capitalized mortgage servicing rights	(461)	(753)	(1,143)
Deferred income tax expense (benefit)	0	12,043	(2,516)
Securities gains, net	0	0	(5)
Loss on sales of real estate and premises	2,681	1,165	3,731
Gain on sales of loans	(1,656)	(1,987)	(2,273)
Proceeds from sales of loans held for sale	64,890	90,797	122,491
Disbursements on loans held for sale	(58,588)	(85,384)	(119,475)
Amortization of restricted stock awards	298	370	373
Amortization of unearned ESOP shares	193	193	194
Earned ESOP shares priced below original cost	(81)	(51)	(56)
Stock option compensation expense	29	63	27
Decrease in accrued interest receivable	862	713	1,544
Decrease in accrued interest payable	(312)	(1,016)	(4,199)
Decrease (increase) in other assets	1,342	3,084	(2,041)
Increase (decrease) in other liabilities	380	(774)	912
Other, net	379	362	95
Net cash provided by operating activities	17,340	25,555	15,448
Cash flows from investing activities:
Proceeds from sales of securities available for sale	0	0	2,141
Principal collected on securities available for sale	12,466	19,820	22,213
Proceeds collected on maturity of securities available for sale	156,900	115,000	78,350
Purchases of securities available for sale	(144,051)	(128,059)	(88,446)
Purchase of Federal Home Loan Bank stock	(17)	(2,420)	0
Redemption of Federal Home Loan Bank stock	2,538	2,963	0
Proceeds from sales of real estate and premises	5,440	14,532	10,749
Net decrease in loans receivable	76,114	82,591	56,329
Purchases of premises and equipment	(201)	(292)	(558)
Net cash provided by investing activities	109,189	104,135	80,778
Cash flows from financing activities:
Decrease in deposits	(27,285)	(113,218)	(85,162)
Dividends paid to preferred stockholders	0	(1,300)	(1,163)
Proceeds from borrowings	10,002	87,000	1,099,000
Repayment of borrowings	(62,502)	(97,000)	(1,109,000)
Increase (decrease) in customer escrows	115	(609)	788
Net cash used by financing activities	(79,670)	(125,127)	(95,537)
Increase in cash and cash equivalents	46,859	4,563	689
Cash and cash equivalents, beginning of year	20,981	16,418	15,729
Cash and cash equivalents, end of year	67,840	20,981	16,418
Supplemental cash flow disclosures:
Cash paid for interest	11,447	18,275	28,067
Cash paid for income taxes	0	39	33
Supplemental noncash flow disclosures:
Loans transferred to loans held for sale	5,509	3,195	1,234
Transfer of loans to real estate	8,732	16,167	18,342
Assets transferred to assets held for sale	1,583	0	0
Deposits transferred to deposits held for sale	$ 36,048	$ 0	$ 0

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Regulatory Matters/Supervisory Agreements and Federal Home Loan Bank Investment

12 Months Ended

Dec. 31, 2011

Deposits and Regulatory Matters/Supervisory Agreements and Federal Home Loan Bank Investment [Abstract]

Regulatory Matters/Supervisory Agreements and Federal Home Loan Bank Investment

NOTE 16 Regulatory Matters/Supervisory Agreements, IMCR and Federal Home Loan Bank Investment

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 are carried at cost, in the Federal Home Loan Bank of Des Moines. The Bank met this requirement at December 31, 2011. The capital stock investment in the Federal Home Loan Bank of Des Moines was reviewed for any other than temporary impairment as of December 31, 2011 and it was determined that it was not impaired.

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 the Company’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.

The Bank entered into a written Supervisory Agreement with its primary regulator, the OTS, effective February 22, 2011 that primarily relates to the Bank’s financial performance and credit quality issues. This agreement replaced the prior memorandum of understanding that the Bank entered into with the OTS on December 9, 2009. In accordance with the agreement, the Bank submitted a two year business plan in May of 2011 that the OCC (as successor to the OTS) accepted with the expectation that the Bank would be in adherence with the OCC’s Notification of Establishment of Higher Minimum Capital Ratios, dated August 8, 2011, also known as an individual minimum capital requirement or IMCR, which required the Bank to establish and maintain a minimum core capital ratio of 8.5% by December 31, 2011. The IMCR and the Bank’s failure to achieve and maintain the IMCR are discussed more fully below. As required by the Supervisory Agreement, the Bank submitted an updated two year capital plan in January of 2012 that the OCC may make comments upon, and require revisions to. The Bank must operate within the parameters of the final business plan and is required to monitor and submit periodic reports on its compliance with the plan. The Bank also submitted a problem asset reduction plan that the OCC has accepted. The Bank must operate within the parameters of the final problem asset plan and is required to monitor and submit periodic reports on its compliance with the plan. The Bank has also revised its loan modification policies and its program for identifying, monitoring and controlling risk associated with concentrations of credit, and improved the documentation relating to the allowance for loan and lease losses as required by the agreement. In addition, without the consent of the OCC, the Bank may not declare or pay any cash dividends, increase its total assets during any quarter in excess of the amount of the net interest credited on deposit liabilities during the prior quarter, enter into any new contractual arrangement or renew or extend any existing arrangement related to compensation or benefits with any directors or officer, make any golden parachute payments, or enter into any significant contracts with a third party service provider. The Bank believes it was in compliance with all requirements of its Supervisory Agreement at December 31, 2011, with the exception that actual earnings performance and capital adequacy are not in adherence with the business plan.

The Company also entered into a written Supervisory Agreement with the OTS effective February 22, 2011. This agreement replaced the prior memorandum of understanding that the Company entered into with the OTS on December 9, 2009. As required by the Supervisory Agreement, the Company submitted an updated two year capital plan in January of 2012 that the Federal Reserve Board (as successor to the OTS) may make comments upon, and to which it may require revisions. The Company must operate within the parameters of the final capital plan and is required to monitor and submit periodic reports on its compliance with the plan. In addition, without the consent of the Federal Reserve Board, the Company may not incur or issue any debt, guarantee the debt of any entity, declare or pay any cash dividends or repurchase any of the Company’s capital stock, enter into any new contractual arrangement or renew or extend any existing arrangement related to compensation or benefits with any directors or officer, or make any golden parachute payments. The Company believes it was in compliance with all requirements of its Supervisory Agreement at December 31, 2011, with the exception that actual earnings performance and capital adequacy were not in adherence with the capital plan.

References to the OTS shall mean, with respect to the Company, beginning July 21, 2011, the Federal Reserve Board (FRB) and mean, with respect to the Bank, beginning July 21, 2011, the Office of the Comptroller of the Currency (OCC). On July 21, 2011, the OTS was integrated into the OCC and the primary banking regulator for the Company became the FRB. It is not anticipated that the change in primary regulators as a result of the OTS being abolished will have any significant impact on the Company, the Bank, or our shareholders.

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 (Core) capital, and Risk-based capital (as defined in the regulations) to total assets (as defined).

At December 31, 2011 and 2010, the Bank’s capital amounts and ratios are 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 Action Provisions
(Dollars in thousands)	Amount		Percent  of Assets(1)			Amount		Percent of Assets(1)			Amount		Percent  of Assets(1)			Amount		Percent  of Assets(1)
December 31, 2011
Tier I or core capital	$	56,314		7.14	%	$	31,560		4.00	%	$	24,754		3.14	%	$	39,450		5.00	%
Tier I risk-based capital		56,314		9.61			23,441		4.00			32,873		5.61			35,162		6.00
Risk-based capital to risk-weighted assets		63,639		10.86			46,883		8.00			16,756		2.86			58,603		10.00
December 31, 2010
Tier I or core capital	$	66,824		7.60	%	$	35,181		4.00	%	$	31,643		3.60	%	$	43,977		5.00	%
Tier I risk-based capital		66,824		9.72			27,507		4.00			39,317		5.72			41,261		6.00
Risk-based capital to risk-weighted assets		75,420		10.97			55,014		8.00			20,406		2.97			68,768		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.

The OCC has established an individual minimum capital requirement (IMCR) for the Bank. An IMCR requires a bank to establish and maintain levels of capital greater than those generally required for a bank to be classified as “well-capitalized.” Effective December 31, 2011, the Bank was required to establish, and subsequently maintain, core capital at least equal to 8.5% of adjusted total assets, which is in excess of the Bank’s 7.14% core capital to adjusted total assets ratio at December 31, 2011. The Bank would have needed $10.8 million in additional capital at December 31, 2011 to meet the minimum core capital ratio set by the OCC. In February 2012, the Bank received a Notice of Failure from the OCC arising out of its failure to establish and maintain its IMCR of 8.5% core capital to adjusted total assets at December 31, 2011. By April 30, 2012, the Bank must submit to the OCC a further written capital plan of how it will achieve and maintain its IMCR, and a contingency plan in the event the IMCR is not achieved through the Bank’s primary plan. The Bank’s failure to comply with the terms of the IMCR is deemed an unsafe and unsound banking practice and could subject it to further limits on growth and such legal actions or sanctions as the OCC considers appropriate. Possible sanctions include among others (i) the imposition of one or more cease and desist orders requiring corrective action, which are enforceable directives that may address any aspect of the Company or Bank management, operations or capital, including requirements to change management, raise equity capital, dispose of assets or effect a change of control; (ii) civil money penalties; and (iii) downgrades in the capital adequacy status of the Company and the Bank. These regulatory actions may significantly restrict the ability of the Company and the Bank to take operating and strategic actions that may be in the best interests of stockholders or compel the Company and the Bank to take operating and strategic actions that are not potentially in the best interests of stockholders.

Management believes that, as of December 31, 2011, the Bank’s capital ratios were in excess of those quantitative capital ratio standards set forth under the prompt corrective action regulations referenced above. The failure of the Bank to satisfy the IMCR at December 31, 2011 does not by itself affect the Bank’s status as “well-capitalized” within the meaning of these prompt corrective action regulations. However, there can be no assurance that the Bank will continue to maintain such status in the future. The OCC has extensive discretion in its supervisory and enforcement activities, and can adjust the requirement to be “well-capitalized” in the future.

In order to improve its capital ratios and comply with its IMCR, the Bank is, among other things, working to improve its financial results, reduce non-performing assets, and decrease the asset size of the Bank. In November 2011, the Bank also entered into a definitive purchase and assumption agreement to sell substantially all the assets associated with its Toledo, Iowa branch, subject to assumption of substantially all deposit liabilities of that branch as described in Note 21. In light of its current capital condition and its failure to comply with the IMCR at December 31, 2011, the Bank may also determine it to be necessary or prudent to dispose of other non-strategic assets. These actions have resulted, and may result, in changes in the Bank’s assets, liabilities and earnings, some of which may be material, during the period in which the action is taken or is consummated or over a longer period of time. Further, the Company may need, or be required by supervising banking regulators, to raise additional capital of which there can be no assurance that, if raised, it would be on terms favorable to the Company. If the Company raises capital through the issuance of additional shares of common stock or other equity securities, it would dilute the ownership interests of existing stockholders and, given our current common stock trading price, would be expected to dilute the per share book value of the Company’s common stock and could result in a change of control of the Company and the Bank.

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Derivative Instruments and Hedging Activities

12 Months Ended

Dec. 31, 2011

Derivative Instruments and Hedging Activities [Abstract]

Derivative Instruments and Hedging Activities

NOTE 18 Derivative Instruments and Hedging Activities

The Company 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. The Company accounts for its commitments in accordance with ASC 815, Accounting for Derivative Instruments and Hedging Activities.

The Company had commitments outstanding to extend credit to future borrowers that had not closed prior to the end of the year, which is referred to as its mortgage pipeline. As commitments to originate loans enter the mortgage pipeline, the Company 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, 2011, the Company recorded an increase in other liabilities of $21,000, an increase in other assets of $29,000 and a net gain on the sales of loans of $8,000.

As of December 31, 2011, 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, the Company recorded an increase in loans held for sale of $56,000, a decrease in other assets of $56,000, an increase in other liabilities of $72,000 and a net loss on the sales of loans $72,000.

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Description of the Business and Summary of Significant Accounting Policies

12 Months Ended

Dec. 31, 2011

Description of the Business and Summary of Significant Accounting Policies [Abstract]

Description of the Business and Summary of Significant Accounting Policies

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 and loan production facilities in Minnesota and Iowa. The Bank has one wholly owned subsidiary, Osterud Insurance Agency, Inc. (OIA), which offers financial planning products and services. HMN has another wholly owned subsidiary, Security Finance Corporation (SFC), which is currently not actively engaged in any activities.

The consolidated financial statements included herein are for HMN, SFC, the Bank and OIA. All significant intercompany accounts and transactions have been eliminated in consolidation.

The Company evaluated subsequent events through the filing date of our annual 10-K with the Securities and Exchange Commission on March 7, 2012.

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.

An estimate that is particularly susceptible to change relates to the determination of the allowance for loan losses. Management believes that the allowance for loan losses is appropriate 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 and other factors. 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.

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 and a new cost basis is established.

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 rates, 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 and a new cost basis is established.

Management monitors the investment security portfolio for impairment on an individual security basis and has a process in place to identify securities that could potentially have a credit impairment that is other than temporary. This process involves analyzing the length of time and extent to which the fair value has been less than the amortized cost basis, the market liquidity for the security, the financial condition and near-term prospects of the issuer, expected cash flows, and the Company’s intent and ability to hold the investment for a period of time sufficient to recover the temporary loss, including determining whether it is more-likely-than-not that the Company will be required to sell the security prior to recovery. To the extent it is determined that a security is

deemed to be other-than-temporarily impaired, an impairment loss is recognized.

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 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 on the sale of loans 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 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 purchased 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 to be appropriate 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 a quarterly analysis of the loan portfolio. 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, demand for single family homes, demand for commercial real estate and building lots, loan portfolio composition and historical loss experience. In connection with the determination of the allowance for loan losses, management obtains independent appraisals for significant properties or other collateral securing delinquent loans. The allowance for loan losses is established for known problem loans, as well as for loans which are not currently known to require an allowance. Loans are charged off to the extent they are deemed to be uncollectible. The appropriateness 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 collectability 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, the impaired amount is charged off. 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 on non-accrual, delinquent as to principal and interest for 90 days or greater or restructured in a troubled debt restructuring involving a modification of terms. All non-accruing loans are reviewed for impairment on an individual basis.

Included in loans receivable, net, are certain loans that have been modified in order to maximize collection of the loan balances. The Company evaluates all loan modifications and if the Company, for legal or economic reasons related to the borrower’s financial difficulties, grants a concession compared to the original terms and conditions of the loan that the Company would not otherwise consider, the modified loan is considered a troubled debt restructuring (TDR) and classified as an impaired loan. If the TDR loan was performing (accruing) prior to the modification, it typically will remain accruing after the modification as long as it continues to perform according to the modified terms. If the TDR loan was non-performing (non-accruing) prior to the modification, it will remain non-accruing after the modification for a minimum of six months. If the loan performs according to the modified terms for a minimum of six months, it typically will be returned to accruing status. In general, there are two conditions in which a TDR loan is no longer considered to be a TDR and potentially not classified as impaired. The first condition

is whether the loan is refinanced with terms that reflect normal terms for the type of credit involved. The second condition is whether the loan is repaid or charged off.

Mortgage Servicing Rights    Mortgage servicing rights are capitalized at fair value and amortized in proportion to, and over the period of, estimated net servicing income. The Company evaluates its capitalized mortgage servicing rights for impairment each quarter. Loan type and note rate are the 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 foreclosure is initially recorded at the lower of the related loan balance or the fair value less estimated selling costs. Valuations are reviewed quarterly 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.

Assets and Deposits Held for Sale    In the fourth quarter of 2011, the Bank entered into a definitive purchase and assumption agreement to sell certain assets and the deposits of its Toledo, Iowa branch. Until the consummation of the sale, which is anticipated to be completed in the first quarter of 2012, these assets and deposits are reported as held for sale and are carried at the lower of their cost basis or estimated fair market value.

Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of    The Company 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    The Company had investments in limited partnerships that invested in low to moderate income housing projects that generated tax credits for the Company. The Company accounted for the earnings or losses from the limited partnerships on the equity method. The Company’s limited partnership investments were liquidated in the fourth quarter of 2011.

Stock Based Compensation    The Company recognizes the grant-date fair value of stock option and restricted stock awards issued as compensation expense, amortized over the vesting period.

Employee Stock Ownership Plan (ESOP)    The Company has an ESOP that borrowed funds from the Company and purchased shares of HMN common stock. The Company makes quarterly principal and interest payments on the ESOP loan. As the debt is repaid, ESOP shares that were pledged as collateral for the debt are released from collateral and allocated to eligible employees based on the proportion of debt service paid in the year. The Company accounts for its ESOP in accordance with ASC 718, 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, the Company reports compensation expense equal to the current market price of the shares, and the shares become outstanding for earnings per share computations.

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. A valuation allowance is required to be recognized if it is “more likely than not” that the deferred tax asset will not be realized. The determination of the realizability of the deferred tax asset is subjective and dependent upon judgment concerning management’s evaluation of both positive and negative evidence regarding the ultimate realizability of deferred tax assets.

Preferred Stock Dividends and Discount    The proceeds received from the preferred stock and warrant issued to the U.S. Treasury were allocated between the preferred stock and the warrant based on their relative fair values at the time of issuance in accordance with the requirements of ASC 470, Accounting for Convertible Debt Issued with Stock Purchase Warrants. Because of the increasing rate dividend feature of the preferred shares, the discount on the warrant is amortized using the constant effective yield method over the five year period preceding the scheduled rate increase on the preferred stock in accordance with the requirements of ASC 505.

Loss per Share    Basic loss per common share excludes dilution and is computed by dividing the loss available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted loss per common share 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. Options and restricted stock awards are excluded from the loss per share calculation when a net loss is incurred as their inclusion in the calculation would be anti-dilutive and result in a lower loss per common share.

Comprehensive Income (Loss)    Comprehensive income (loss) is defined as the change in equity during a period from transactions and other events from nonowner sources. Comprehensive income (loss) is the total of net loss and other comprehensive income (loss), which for the Company is comprised of unrealized gains and losses on securities available for sale.

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 Pronouncements    In July 2010, the FASB issued ASU 2010-20, Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses, which requires significant new disclosures about the allowance for credit losses and the credit quality of financing receivables. The requirements are intended to enhance transparency regarding credit losses and the credit quality of loan and lease receivables. Under this statement, allowance for credit losses and fair value are to be disclosed by portfolio segment, while credit quality information, impaired financing receivables and nonaccrual status are to be presented by class of financing receivable. Disclosure of the nature and extent, the financial impact and segment information of troubled debt restructurings are also required. The disclosures are to be presented at the level of disaggregation that management uses when assessing and monitoring the portfolio’s risk and performance. This ASU is effective for interim and annual reporting periods after December 15, 2010 and the related disclosures were included in Note 5 of the consolidated financial statements in this report.

In April 2011, the FASB issued ASU 2011-02, Receivables (Topic 310), A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring. This ASU provides guidance on evaluating whether a restructuring constitutes a troubled debt restructuring. It indicates that if a creditor separately concludes that a restructuring constitutes a concession and that the debtor is experiencing financial difficulties that the restructuring is a troubled debt restructuring. It also clarifies guidance on a creditor’s evaluation of the above two items. For public entities, such as HMN, the amendments in this ASU are effective for the first interim or annual period beginning on or after June 15, 2011, and should be applied retrospectively to the beginning of the annual period of adoption. In addition, this ASU requires that the disclosures about troubled debt restructurings that were delayed by ASU 2011-01 in January 2011 be disclosed for interim and annual periods beginning on or after June 15, 2011. The implementation of the guidance in this ASU and the related disclosures are included in Note 5 of this report.

In April 2011, the FASB issued ASU 2011-03, Transfers and Servicing (Topic 860), Reconsideration of Effective Control for Repurchase Agreements. Topic 860, Transfers and Servicing, which prescribes when an entity may or may not recognize a sale upon the transfer of financial assets subject to repurchase agreements. That determination is based, in part, on whether the entity has maintained effective control over the transferred assets. The amendments in this ASU removed from the assessment of effective control (1) the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee, and (2) the collateral maintenance implementation guidance related to that criterion. Other criteria applicable to the assessment of effective control are not changed by the amendments in this ASU. This ASU is effective for the first interim or annual period beginning on or after December 15, 2011 and should be applied prospectively to transactions or modification of existing transactions that occur on or after the effective date. The adoption of this ASU in the first quarter of 2012 did not have a material impact on the Company’s consolidated financial statements.

In May 2011, the FASB issued ASU 2011-04, Fair Value Measurement (Topic 820), Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. The amendments in this ASU change the wording used to describe the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements in order to improve consistency in wording between U.S. GAAP and IFRS. This ASU is effective for interim or annual period beginning on or after December 15, 2011. The adoption of this ASU in the first quarter of 2012 did not have a material impact on the Company’s consolidated financial statements other than to change the disclosures relating to fair value measurements.

In June 2011, the FASB issued ASU 2011-05, Comprehensive Income (Topic 220), Presentation of Comprehensive Income. Current U.S. GAAP allows reporting entities three alternatives for presenting other comprehensive income and its components in financial statements. The first two options are to present this information in a single continuous statement of comprehensive income or in two separate but consecutive statements. The third option, which is used by the Company, is to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity. This ASU eliminates the third option and therefore the Company will have to adopt one of the two remaining methods for presentation. This ASU is effective for fiscal years, and interim periods beginning after December 15, 2011. The adoption of this ASU in the first quarter of 2012 did not have a material impact on the Company’s consolidated financial statements other than to change the presentation of other comprehensive income as discussed above.

In September 2011, the FASB issued ASU 2011-09, Compensation — Retirement Benefits — Multiemployer Plans (Subtopic 715-80). The amendments in this ASU require additional disclosures about an employer’s participation in a multiemployer plan. For public entities, such as HMN, this ASU is effective for annual periods for fiscal years ending after December 15, 2011. The adoption of this ASU in the fourth quarter of 2011 did not have a material impact on the Company’s consolidated financial statements. The presentation of the additional disclosures relating to the multiemployer retirement plan (sponsored by the Financial Institutions Retirement Fund (FIRF)) in which the Company participates is included in Note 13 of this report.

In December 2011, the FASB issued ASU 2011-11, Balance Sheet (Topic 210). The objective of this ASU is to provide enhanced disclosures that will enable users of its financial statements to evaluate the effect or potential effect of rights of setoff associated with an entity’s financial position. This includes the effect or potential effect of rights of setoff associated with an entity’s recognized assets and recognized liabilities within the scope of this ASU. The amendments require enhanced disclosures by requiring improved information about financial instruments and derivative instruments that are either (1) offset in accordance with either Section 210-20-45 or Section 815-10-45 or (2) subject to an enforceable master netting arrangement or similar agreement, irrespective of whether they are offset in accordance with either Section 210-20-45 or Section 815-10-45. An entity is required to apply the amendments for annual reporting periods beginning on or after January 1, 2013, and interim periods with those annual periods. The adoption of this ASU in the first quarter of 2013 is not anticipated to have any impact on the Company’s consolidated financial statements as it currently has no outstanding rights of setoff.

In December 2011, the FASB issued ASU 2011-12, Comprehensive Income (Topic 220). The amendments in this ASU supersede certain pending paragraphs in ASU 2011-5, Comprehensive Income (Topic 220): Presentation of Comprehensive Income, to effectively defer only those changes in ASU 2011-05 that relate to the presentation of reclassification adjustments out of accumulated other comprehensive income. All other requirements in ASU 2011-05 are not affected by this ASU, including the requirement to report comprehensive income either in a single continuous financial statement or in two separate but consecutive financial statements. The amendments will be temporary to allow the Board time to redeliberate the presentation requirements for reclassifications out of accumulated other comprehensive income for annual and interim financial statements for public, private, and non-profit entities. The adoption of this ASU in the first quarter of 2012 did not have a material impact on the Company’s consolidated financial statements other than to change the presentation of other comprehensive income as discussed above.

Derivative Financial Instruments    The Company 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. The Company may also from time to time use interest rate swaps to manage interest rate risk. Derivative financial instruments include commitments to extend credit and forward mortgage loan sales commitments.

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Consolidated Balance Sheets (Parenthetical) (USD $) In Thousands, except Share data, unless otherwise specified	Dec. 31, 2011	Dec. 31, 2010
Consolidated Balance Sheets [Abstract]
Amortized cost of mortgage-backed and related securities	$ 19,586	$ 32,036
Amortized cost of other marketable securities	$ 105,700	$ 118,631
Serial preferred stock, par value	$ 0.01	$ 0.01
Serial preferred stock, shares authorized	500,000	500,000
Serial preferred stock, shares issued	26,000	26,000
Common stock, par value	$ 0.01	$ 0.01
Common stock, shares authorized	11,000,000	11,000,000
Common stock, shares issued	9,128,662	9,128,662
Treasury stock, shares	4,740,711	4,818,263

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Federal Home Loan Bank Advances and Federal Reserve Borrowings

12 Months Ended

Dec. 31, 2011

Federal Home Loan Bank Advances and Federal Reserve Borrowings [Abstract]

Federal Home Loan Bank Advances and Federal Reserve Borrowings

NOTE 11 Federal Home Loan Bank Advances and Federal Reserve Borrowings

Fixed and variable rate Federal Home Loan Bank advances and Federal Reserve borrowings consisted of the following at December 31:

(Dollars in thousands)	2011				2010
Year of Maturity	Amount		Rate		Amount		Rate
2011					$	52,500		4.00	%
2013		70,000		4.77		70,000		4.77
		70,000		4.77		122,500		4.44
Lines of Credit – Federal Reserve/Federal Home Loan Bank		0		0.00		0		0.00
	$	70,000		4.77	$	122,500		4.44

All of the outstanding advances at December 31, 2011 have quarterly 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. At December 31, 2011, the advances from the FHLB were collateralized by the Bank’s FHLB stock and mortgage loans and investments with a borrowing capacity of approximately $146.9 million. The Bank has the ability to draw additional borrowings of $75.9 million from the FHLB, based upon the mortgage loans and securities that are currently pledged, subject to approval from the FHLB and a requirement to purchase additional FHLB stock. The Bank also has the ability to draw additional borrowings of $60.0 million from the Federal Reserve Bank, based upon the loans that are currently pledged with them, subject to approval from the FRB.

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Document and Entity Information (USD $) In Millions, except Share data, unless otherwise specified	12 Months Ended
	Dec. 31, 2011	Feb. 20, 2012	Jun. 30, 2011
Document and Entity Information [Abstract]
Entity Registrant Name	HMN FINANCIAL INC
Entity Central Index Key	0000921183
Document Type	10-K
Document Period End Date	Dec. 31, 2012
Amendment Flag	false
Document Fiscal Year Focus	2011
Document Fiscal Period Focus	FY
Current Fiscal Year End Date	--12-31
Entity Well-known Seasoned Issuer	No
Entity Voluntary Filers	No
Entity Current Reporting Status	Yes
Entity Filer Category	Smaller Reporting Company
Entity Public Float			$ 7.9
Entity Common Stock, Shares Outstanding		4,387,951

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Income Taxes

12 Months Ended

Dec. 31, 2011

Income Taxes [Abstract]

Income Taxes

NOTE 12 Income Taxes

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

(Dollars in thousands)	2011			2010			2009
Current:
Federal	$	0			(3,956	)		(4,551	)
State		0			(1,764	)		1,460
Total current		0			(5,720	)		(3,091	)
Deferred:
Federal		(4,010	)		(2,773	)		(1,213	)
State		(873	)		(1,781	)		(1,303	)
Total deferred		(4,883	)		(4,554	)		(2,516	)
Change in valuation allowance		4,883			16,597			0
Income tax expense (benefit)	$	0			6,323			(5,607	)

The reasons for the difference between expected income tax benefit utilizing the federal corporate tax rate of 34% for 2011 and 2010, and 35% for 2009 and the actual income tax expense are as follows:

(Dollars in thousands)	2011			2010			2009
Expected federal income tax benefit	$	(3,929	)		(7,703	)		(5,741	)
Items affecting federal income tax:
State income taxes, net of federal income tax expense (benefit)		(645	)		(2,474	)		170
Tax exempt interest		(123	)		(133	)		(235	)
Increase in valuation allowance		4,883			16,597			0
Other, net		(186	)		36			199
Income tax expense (benefit)	$	0			6,323			(5,607	)

A reconciliation of the change in the gross amount, before related tax effects, of unrecognized tax benefits for 2011 and 2010 is as follows:

(Dollars in thousands)	2011		2010
Balance at January 1	$	0		2,210
Settlement of tax position		0		(2,210	)
Balance at December 31	$	0		0

There were no unrecognized tax benefits for 2011. The $2.2 million decrease in unrecognized tax benefits during 2010 relates to the tax benefits recorded as a result of a favorable Minnesota Supreme Court tax ruling in 2010, which reversed an unfavorable tax court ruling from 2009. Of the $2.2 million benefit recorded in 2010, $1.4 million affected the effective tax rate as the remaining $0.8 million related to the federal tax impact of the state tax benefit. The Company also recognized a $0.7 million reduction in other operating expenses in the 2010 consolidated financial statements to reflect the reversal of the accrued interest that had been recorded on the previously unrecognized tax benefits. The tax effects of temporary differences that give rise to the deferred tax assets and deferred tax liabilities are as follows at December 31:

(Dollars in thousands)	2011			2010
Deferred tax assets:
Allowances for loan and real estate losses	$	12,401			9,088
Deferred compensation costs		322			314
Deferred ESOP loan asset		702			682
Restricted stock expense		130			164
Nonaccruing loan interest		416			84
Federal net operating loss carry forward		5,936			5,043
State net operating loss carry forward		3,301			3,295
Other		162			88
Total gross deferred tax assets		23,370			18,758
Deferred tax liabilities:
Net unrealized gain on securities available for sale		328			356
Deferred loan fees and costs		317			263
Premises and equipment basis difference		407			636
Originated mortgage servicing rights		607			648
Other		231			258
Total gross deferred tax liabilities		1,890			2,161
Net deferred tax assets		21,480			16,597
Valuation allowance		(21,480	)		(16,597	)
Deferred tax assets, net of valuation allowance	$	0			0

The Company has cumulative federal net operating loss carryforwards of $19.6 million at December 31, 2011 that expire beginning in 2029. The Company also has state net operating loss carryforwards of $36.7 million at December 31, 2011 that expire beginning in 2023.

Retained earnings at December 31, 2011 included approximately $8.8 million 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 considers the determination of the deferred tax asset amount and the need for any valuation reserve to be a critical accounting policy that requires significant judgment. The Company has, in its judgment, made reasonable assumptions and considered both positive and negative evidence relating to the ultimate realization of deferred tax assets. Positive evidence includes the ability to implement tax planning strategies to accelerate taxable income recognition and the probability that taxable income will be generated in future periods. Negative evidence includes the Company’s cumulative loss in the prior three year period, continued operating losses in 2011 and the general business and economic trends. Based upon this evaluation, the Company determined that a full valuation allowance was required with respect to the net deferred tax assets at December 31, 2011.

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Consolidated Statements of Loss (USD $) In Thousands, except Per Share data, unless otherwise specified	12 Months Ended
	Dec. 31, 2011	Dec. 31, 2010	Dec. 31, 2009
Interest income:
Loans receivable	$ 36,776	$ 44,248	$ 51,876
Securities available for sale:
Mortgage-backed and related	1,098	1,813	2,768
Other marketable	1,451	2,023	3,039
Cash equivalents	36	4	1
Other	180	182	87
Total interest income	39,541	48,270	57,771
Interest expense:
Deposits	6,847	11,281	17,579
Federal Home Loan Bank advances and Federal Reserve borrowings	4,288	5,978	6,289
Total interest expense	11,135	17,259	23,868
Net interest income	28,406	31,011	33,903
Provision for loan losses	17,278	33,381	26,699
Net interest income (loss) after provision for loan losses	11,128	(2,370)	7,204
Non-interest income:
Fees and service charges	3,739	3,741	4,137
Loan servicing fees	987	1,067	1,042
Securities gains, net	0	0	5
Gain on sales of loans	1,656	1,987	2,273
Other	487	476	625
Total non-interest income	6,869	7,271	8,082
Non-interest expense:
Compensation and benefits	13,553	13,516	13,432
Losses on real estate owned	2,681	1,165	3,873
Occupancy	3,741	4,082	4,084
Deposit insurance	1,255	1,933	1,973
Data processing	1,221	1,040	1,182
Other	7,101	5,820	7,145
Total noninterest expense	29,552	27,556	31,689
Loss before income tax expense (benefit)	(11,555)	(22,655)	(16,403)
Income tax expense (benefit)	0	6,323	(5,607)
Net loss	(11,555)	(28,978)	(10,796)
Preferred stock dividends and discount	(1,821)	(1,784)	(1,747)
Net loss available to common stockholders	$ (13,376)	$ (30,762)	$ (12,543)
Basic loss per common share	$ (3.47)	$ (8.17)	$ (3.39)
Diluted loss per common share	$ (3.47)	$ (8.17)	$ (3.39)

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Accrued Interest Receivable

12 Months Ended

Dec. 31, 2011

Accrued Interest Receivable [Abstract]

Accrued Interest Receivable

NOTE 6 Accrued Interest Receivable

Accrued interest receivable at December 31 is summarized as follows:

(Dollars in thousands)	2011		2010
Securities available for sale	$	553		626
Loans receivable		1,896		2,685
	$	2,449		3,311

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Allowance for Loan Losses and Credit Quality Information

12 Months Ended

Dec. 31, 2011

Allowance for Loan Losses and Credit Quality Information [Abstract]

Allowance for Loan Losses and Credit Quality Information

NOTE 5 Allowance for Loan Losses and Credit Quality Information

The allowance for loan losses is summarized as follows:

(Dollars in thousands)	1-4 Family			Commercial Real Estate			Consumer			Commercial Business			Total
Balance, December 31, 2008	$	2,830			13,095			1,585			3,747			21,257
Provision for losses		(1,753	)		14,217			1,451			12,784			26,699
Charge-offs		(82	)		(13,548	)		(1,980	)		(9,421	)		(25,031	)
Recoveries		5			565			222			95			887
Balance, December 31, 2009		1,000			14,329			1,278			7,205			23,812
Provision for losses		1,399			16,692			481			14,809			33,381
Charge-offs		(254	)		(7,095	)		(907	)		(7,006	)		(15,262	)
Recoveries		0			664			72			161			897
Balance, December 31, 2010		2,145			24,590			924			15,169			42,828
Provision for losses		2,081			11,785			482			2,930			17,278
Charge-offs		(508	)		(23,012	)		(270	)		(15,512	)		(39,302	)
Recoveries		0			259			23			2,802			3,084
Balance, December 31, 2011	$	3,718			13,622			1,159			5,389			23,888
Allocated to:
Specific reserves	$	993			13,263			76			10,702			25,034
General reserves		1,152			11,327			848			4,467			17,794
Balance, December 31, 2010	$	2,145			24,590			924			15,169			42,828
Allocated to:
Specific reserves	$	1,086			3,559			367			1,621			6,633
General reserves		2,632			10,063			792			3,768			17,255
Balance, December 31, 2011	$	3,718			13,622			1,159			5,389			23,888
Loans receivable at December 31, 2010:
Individually reviewed for impairment	$	6,729			45,077			299			26,855			78,960
Collectively reviewed for impairment		121,806			311,314			70,304			126,184			629,608
Ending balance	$	128,535			356,391			70,603			153,039			708,568
Loans receivable at December 31, 2011:
Individually reviewed for impairment	$	6,241			30,495			1,205			6,855			44,796
Collectively reviewed for impairment		112,825			259,419			60,956			102,404			535,604
Ending balance	$	119,066			289,914			62,161			109,259			580,400

The following table summarizes the amount of classified and unclassified loans at December 31:

	December 31, 2011
	Classified										Unclassified
(Dollars in thousands)	Special Mention		Substandard		Doubtful		Loss		Total		Total		Total Loans
1-4 family	$	8,870		11,129		738		0		20,737		98,329		119,066
Commercial real estate:
Residential developments		444		39,709		1,113		0		41,266		11,480		52,746
Alternative fuels		0		0		0		0		0		18,882		18,882
Other		5,789		19,607		0		0		25,396		192,890		218,286
Consumer		0		857		224		124		1,205		60,956		62,161
Commercial business:
Construction/development		0		2,722		0		0		2,722		2,064		4,786
Banking		0		3,750		1,149		0		4,899		0		4,899
Other		3,203		8,056		0		0		11,259		88,315		99,574
	$	18,306		85,830		3,224		124		107,484		472,916		580,400

	December 31, 2010
	Classified										Unclassified
(Dollars in thousands)	Special Mention		Substandard		Doubtful		Loss		Total		Total		Total Loans
1-4 family	$	7,395		8,228		0		0		15,623		112,912		128,535
Commercial real estate:
Residential developments		8,373		34,515		0		0		42,888		44,218		87,106
Alternative fuels		0		11,069		0		0		11,069		20,054		31,123
Other		6,268		6,614		0		0		12,882		225,280		238,162
Consumer		0		248		31		27		306		70,297		70,603
Commercial business:
Construction/development		1,776		4,907		0		0		6,683		5,117		11,800
Banking		0		4,975		3,248		0		8,223		5,830		14,053
Other		4,712		15,689		67		0		20,468		106,718		127,186
	$	28,524		86,245		3,346		27		118,142		590,426		708,568

Classified loans represent special mention, performing substandard and non-performing loans. Loans classified substandard are loans that are generally inadequately protected by the current net worth and paying capacity of the obligor, or by the collateral pledged, if any. Assets so classified must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.

The aging of past due loans at December 31 are summarized as follows:

(Dollars in thousands)	30-59 Days Past Due		60-89 Days Past Due		90 Days or More Past Due		Total Past Due		Current Loans		Total Loans		Loans 90 Days or More Past Due and Still Accruing
2011
1-4 family	$	1,876		305		1,297		3,478		115,588		119,066		0
Commercial real estate:
Residential developments		107		290		8,211		8,608		44,138		52,746		0
Alternative fuels		0		0		0		0		18,882		18,882		0
Other		350		79		5,184		5,613		212,673		218,286		0
Consumer		658		374		387		1,419		60,742		62,161		0
Commercial business:
Construction/development		286		0		0		286		4,500		4,786		0
Banking		0		0		1,149		1,149		3,750		4,899		0
Other		351		112		2,877		3,340		96,234		99,574		0
	$	3,628		1,160		19,105		23,893		556,507		580,400		0
2010
1-4 family	$	2,313		695		3,500		6,508		122,027		128,535		178
Commercial real estate:
Residential developments		444		3,899		15,523		19,866		67,240		87,106		0
Alternative fuels		0		0		4,994		4,994		26,129		31,123		0
Other		75		264		3,914		4,253		233,909		238,162		0
Consumer		446		163		207		816		69,787		70,603		0
Commercial business:
Construction/development		0		0		4,809		4,809		6,991		11,800		0
Banking		0		0		8,223		8,223		5,830		14,053		0
Other		311		45		7,876		8,232		118,954		127,186		576
	$	3,589		5,066		49,046		57,701		650,867		708,568		754

Impaired loans include loans that are non-performing (non-accruing) and loans that have been modified in a troubled debt restructuring. The following table summarizes impaired loans and related allowances for the years ended December 31, 2011 and 2010:

	December 31, 2011
(Dollars in thousands)	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
Loans with no related allowance recorded:
1-4 family	$	2,651		2,972		0		1,611		91
Commercial real estate:
Residential developments		6,900		9,855		0		6,679		94
Alternative fuels		0		0		0		906		0
Other		3,745		4,381		0		1,174		144
Consumer		489		489		0		216		21
Commercial business:
Construction/development		340		2,311		0		294		0
Banking		1,149		3,248		0		854		0
Other		598		1,607		0		878		19
Loans with an allowance recorded:
1-4 family		3,590		3,590		1,086		4,212		157
Commercial real estate:
Residential developments		13,889		14,017		2,546		17,514		373
Alternative fuels		0		0		0		1,998		0
Other		5,961		8,272		1,013		6,408		97
Consumer		716		716		367		403		54
Commercial business:
Construction/development		0		0		0		2,443		0
Banking		0		0		0		3,424		0
Other		4,768		7,145		1,621		9,740		45
Total:
1-4 family		6,241		6,562		1,086		5,823		248
Commercial real estate:
Residential developments		20,789		23,872		2,546		24,193		467
Alternative fuels		0		0		0		2,904		0
Other		9,706		12,653		1,013		7,582		241
Consumer		1,205		1,205		367		619		75
Commercial business:
Construction/development		340		2,311		0		2,737		0
Banking		1,149		3,248		0		4,278		0
Other		5,366		8,752		1,621		10,618		64
		$44,796		58,603		6,633		58,754		1,095

	December 31, 2010
(Dollars in thousands)	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
Loans with no related allowance recorded:
1-4 family	$	932		932		0		721		28
Commercial real estate:
Residential developments		6,486		6,486		0		8,674		220
Alternative fuels		0		0		0		148		0
Other		119		119		0		3,356		4
Consumer		104		104		0		1,354		7
Commercial business:
Construction/development		99		99		0		793		5
Banking		0		0		0		0		0
Other		397		397		0		1,293		5
Loans with an allowance recorded:
1-4 family		5,797		5,797		994		3,207		272
Commercial real estate:
Residential developments		27,147		27,147		9,673		16,720		557
Alternative fuels		4,994		4,994		2,441		7,993		0
Other		6,331		7,287		1,148		5,812		156
Consumer		195		195		76		571		13
Commercial business:
Construction/development		4,809		4,809		2,668		3,937		0
Banking		8,223		8,223		4,985		7,232		0
Other		13,327		13,878		3,049		12,154		478
Total:
1-4 family		6,729		6,729		994		3,928		300
Commercial real estate:
Residential developments		33,633		33,633		9,673		25,394		777
Alternative fuels		4,994		4,994		2,441		8,141		0
Other		6,450		7,406		1,148		9,168		160
Consumer		299		299		76		1,925		20
Commercial business:
Construction/development		4,908		4,908		2,668		4,730		5
Banking		8,223		8,223		4,985		7,232		0
Other		13,724		14,275		3,049		13,447		483
		$78,960		80,467		25,034		73,965		1,745

At December 31, 2011, 2010 and 2009, non-accruing loans totaled $34.0 million, $68.1 million and $61.1 million, respectively, for which the related allowance for loan losses was $5.2 million, $25.0 million and $12.1 million, respectively. Non-accruing loans for which no specific allowance has been recorded because management determined that the value of the collateral was sufficient to repay the loan totaled $14.8 million, $8.1 million and $15.3 million, respectively. Had the loans performed in accordance with their original terms, the Company would have recorded gross interest income on the loans of $3.2 million, $5.0 million and $5.0 million in 2011, 2010 and 2009, respectively. For the years ended December 31, 2011, 2010 and 2009, the Company recognized interest income on these loans of $0.7 million, $1.3 million and $0.9 million, respectively. All of the interest income that was recognized for non-accruing loans was recognized using the cash basis method of income recognition. Non-accrual loans also include some of the loans that have had terms modified in a troubled debt restructuring.

The following table summarizes non-accrual loans at December 31:

(Dollars in thousands)	2011		2010
1-4 family	$	4,435	$	4,844
Commercial real estate:
Residential developments		13,412		25,980
Alternative fuels		0		4,994
Other		9,246		5,763
Consumer		699		224
Commercial business:
Construction/development		340		4,907
Banking		1,149		8,223
Other		4,712		13,139
	$	33,993	$	68,074

Included in loans receivable, net, are certain loans that have been modified in order to maximize collection of loan balances. If the Company, for legal or economic reasons related to the borrower’s financial difficulties, grants a concession compared to the original terms and conditions of the loan, the modified loan is considered a troubled debt restructuring (TDR).

During the third quarter of 2011, the Company adopted Accounting Standards Update (ASU) 2011-02, A Creditor’s Determination of Whether a Restructuring is a Troubled Debt Restructuring (Topic 310), which modified guidance for identifying restructurings of receivables that constitute a TDR. No additional loans modified since December 31, 2010 were identified as TDR’s as a result of adopting these provisions.

At December 31, 2011 and 2010 there were loans included in loans receivable, net, with terms that had been modified in a troubled debt restructuring totaling $29.2 million and $19.3 million, respectively. Had these loans been performing in accordance with their original terms throughout 2011 and 2010, the Company would have recorded gross interest income of $2.5 million and $1.2 million, respectively. During 2011 and 2010, the Company recorded interest income of $0.6 million and $0.8 million on these loans, respectively. For the loans that were modified in 2011, $0.5 million are not classified and performing, $2.0 million are classified but performing, and $17.2 million are non-performing at December 31, 2011.

The following table summarizes troubled debt restructurings at December 31:

(Dollars in thousands)	2011		2010
1-4 family	$	3,805		2,589
Commercial real estate:
Residential developments		14,460		14,209
Other		5,598		662
Consumer		578		75
Commercial business:
Construction/development		385		100
Other		4,378		1,656
	$	29,204		19,291

TDR concessions can include reduction of interest rates, extension of maturity dates, forgiveness of principal and/or interest due, or acceptance of real estate or other assets in full or partial satisfaction of the debt. Loan modifications are not reported as TDR’s after 12 months if the loan was modified at a market rate of interest for comparable risk loans, and the loan is performing in accordance with the terms of the restructured agreement. All loans classified as TDR’s are considered to be impaired.

When a loan is modified as a TDR, there may be a direct, material impact on the loans within the Statements of Financial Condition, as principal balances may be partially forgiven. The financial effects of TDR’s are presented in the following table and represent the difference between the outstanding recorded balance pre-modification and post-modification, for the period ending December 31, 2011:

	Year ended December 31, 2011
(Dollars in thousands)	Number of Contracts		Pre- modification Outstanding Recorded Investment		Post- modification Outstanding Recorded Investment
Troubled debt restructurings:
1-4 family		17	$	4,567		4,246
Commercial real estate:
Residential developments		11		8,118		7,908
Other		9		7,473		6,432
Consumer		17		626		598
Commercial business:
Construction /development		3		2,361		1,096
Other		21		10,316		8,849
Total		78	$	33,461		29,129

Loans that were restructured within the 12 months preceding December 31, 2011 and defaulted during the year are presented in the table below:

	Year ended December 31, 2011
(Dollars in thousands)	Number of Contracts		Outstanding Recorded Investment
Troubled debt restructurings that subsequently defaulted:
1-4 family		1	$	250
Commercial real estate:
Residential developments		5		4,501
Other		3		4,465
Consumer		1		4
Commercial business:
Other		3		506
Total		13	$	9,726

The Company considers a loan to have defaulted when it becomes 90 or more days past due under the modified terms, when it is placed in non-accrual status, when it becomes other real estate owned, or when it becomes non-compliant with some other material requirement of the modification agreement.

Loans that were non-accrual prior to modification remain non-accrual for at least six months following modification. Non-accrual TDR loans that have performed according to the modified terms for six months may be returned to accruing status. Loans that were accruing prior to modification remain on accrual status after the modification as long as the loan continues to perform under the new terms.

TDR’s are reviewed for impairment following the same methodology as other impaired loans. For loans that are collateral dependent, the value of the collateral is reviewed and additional reserves may be added as needed. Loans that are not collateral dependent may have additional reserves established if deemed necessary. The allocated allowance for TDR’s was $3.5 million, or 14.6%, of the total $23.9 million in allowance for loan losses at December 31, 2011, and $1.9 million, or 4.4%, of the total $42.8 million in loan loss reserves at December 31, 2010.

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Financial Instruments with Off-Balance Sheet Risk

12 Months Ended

Dec. 31, 2011

Financial Instruments with Off-Balance Sheet Risk [Abstract]

Financial Instruments with Off-Balance Sheet Risk

NOTE 17 Financial Instruments with Off-Balance Sheet Risk

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

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

	December 31, Contract Amount
(Dollars in thousands)	2011		2010
Financial instruments whose contract amount represents credit risk:
Commitments to originate, fund or purchase loans:
1-4 family mortgages	$	3,554		629
Commercial real estate mortgages		2,371		0
Undisbursed balance of loans closed		7,209		12,659
Unused lines of credit		76,444		76,670
Letters of credit		1,535		2,355
Total commitments to extend credit	$	91,113		92,313
Forward commitments	$	7,263		3,413

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.

Forward commitments represent commitments to sell loans to a third party and are entered into in the normal course of business by the Bank.

The Bank issued standby letters of credit which guarantee the performance of customers to third parties. The standby letters of credit outstanding expire over the next 19 months and totaled $1.5 million at December 31, 2011 and $2.3 million at December 31, 2010. The letters of credit are 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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Employee Benefits

12 Months Ended

Dec. 31, 2011

Employee Benefits [Abstract]

Employee Benefits

NOTE 13 Employee Benefits

All eligible full-time employees of the Bank that were hired prior to 2002 were included in a noncontributory retirement plan sponsored by the Financial Institutions Retirement Fund (FIRF). The Home Federal Savings Bank (Employer #8006) plan participates in the Pentegra Defined Benefit Plan for Financial Institutions (the Pentegra DB Plan). The Pentegra DB Plan’s Employer Identification Number is 13-5645888 and the Plan number is 333. The Pentegra DB Plan operates as a multi-employer plan for accounting purposes and as a multi-employer plan under the Employee Retirement Income Security Act of 1974 and the Internal Revenue Code. There are no collective bargaining agreements in place that require contributions to the Pentegra DB Plan.

The Pentegra DB Plan is a single plan under Internal Revenue Code Section 413(c) and, as a result, all of the assets stand behind all of the liabilities. Accordingly, under the Pentegra DB Plan, contributions made by the participating employer may be used to provide benefits to participants of other participating employers.

Effective September 1, 2002, the accrual of benefits for existing participants was frozen and no new enrollments were permitted into the plan. The actuarial present value of accumulated plan benefits and net assets available for benefits relating to the Bank’s employees was not available at December 31, 2011 because such information is not accumulated for each participating institution. As of June 30, 2011, the Pentegra DB Plan valuation report reflected that the Bank was obligated to make a contribution totaling $291,000 which was expensed during 2011.

Funded status (market value of plan assets divided by funding target) as of July 1 for the 2011 and 2010 plan years were 80.39% and 83.20%, respectively. Market value of plan assets reflects any contribution received through June 30, 2011.

Total employer contributions made to the Pentegra DB Plan, as reported on Form 5500, equal $203,582,000 and $133,930,000 for the plan years ended June 30, 2010 and June 30, 2009, respectively. The Bank’s contributions to the Pentegra DB Plan are not more than 5% of the total contributions to the Pentegra DB Plan. There is no funding improvement plan or rehabilitation plan as part of this multi-employer plan.

The following contributions were paid by the Bank during the fiscal years ending December 31,

(Dollars in thousands)
2011		2010		2009
Date Paid	Amount	Date Paid	Amount	Date Paid	Amount
10/14/2011	$57**	12/30/2010	$237	12/29/2009	$156
Total	$57		$237		$156

** - An additional contribution of $234,000 was accrued at December 31, 2011 and paid in the first quarter of 2012.

The Company 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 401(k) 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 $16,500 for 2011. The Company matches 25% of each participant’s contributions up to a maximum of 8% of the participant’s annual salary. Participant contributions and earnings are fully and immediately vested. The Company’s contributions are vested on a three year cliff basis, are expensed over the vesting period, and were $159,000, $165,000 and $177,000, in 2011, 2010 and 2009, respectively.

The Company has adopted an Employee Stock Ownership Plan (the ESOP) that meets the requirements of Section 4975(e)(7) of the Internal Revenue Code and Section 407(d)(6) of the Employee Retirement Income Security Act of 1974, as amended (ERISA) and, as such, the ESOP is empowered to borrow in order to finance purchases of the common stock of HMN. The ESOP borrowed $6.1 million from the Company 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 $1.5 million to purchase an additional 76,933 shares of HMN common stock to account for the additional employees and avoid dilution of the benefit provided by the ESOP. The ESOP debt requires quarterly payments of principal plus interest at 7.52%. The Company has committed to make quarterly contributions to the ESOP necessary to repay the loans including interest. The Company contributed $525,000 in 2011, 2010 and 2009.

As the debt is repaid, ESOP shares that were pledged as collateral for the debt are released from collateral and allocated to eligible employees based on the proportion of debt service paid in the year. The Company accounts for its ESOP in accordance with ASU 718, 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, the Company reports compensation expense equal to the current market price of the shares, and the shares become outstanding for earnings per share computations. ESOP compensation expense was $58,000, $109,000 and $100,000, respectively, for 2011, 2010 and 2009.

All employees of the Bank are eligible to participate in the ESOP after they attain age 18 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:

	2011			2010			2009
Shares allocated to participants beginning of the year		335,453			333,678			320,937
Shares allocated to participants		24,317			24,317			24,317
Shares purchased		42			38			0
Shares distributed to participants		(19,821	)		(22,580	)		(11,576	)
Shares allocated to participants end of year		339,991			335,453			333,678
Unreleased shares beginning of the year		425,769			450,086			474,403
Shares released during year		(24,317	)		(24,317	)		(24,317	)
Unreleased shares end of year		401,452			425,769			450,086
Total ESOP shares end of year		741,443			761,222			783,764
Fair value of unreleased shares at December 31	$	778,817			1,196,411			1,890,361

In June 1995, the Company adopted the 1995 Stock Option and Incentive Plan (1995 Plan). The provisions of the 1995 Plan expired on April 25, 2005 and options may no longer be granted from the 1995 Plan. At December 31, 2011, there were 15,000 vested options under the 1995 Plan that remained unexercised. These options expire 10 years from the date of grant and have an exercise price of $16.25.

In March 2001, the Company adopted the HMN Financial, Inc. 2001 Omnibus Stock Plan (2001 Plan). In April 2009, this plan was superseded by the HMN Financial, Inc. 2009 Equity and Incentive Plan (2009 Plan) and options or restricted shares may no longer be awarded from the 2001 Plan. As of December 31, 2011, there were 66,934 vested and 72,516 unvested options under the 2001 Plan that remained unexercised. These options expire 10 years from the date of grant and have an average exercise price of $20.07. As of December 31, 2011, all shares of restricted stock granted under the 2001 Plan have vested.

In April 2009, the Company adopted the 2009 Plan. The purpose of the 2009 Plan is to provide key personnel and advisors with an opportunity to acquire a proprietary interest in the Company. The opportunity to acquire a proprietary interest in the Company will aid in attracting, motivating and retaining key personnel and advisors, including non-employee directors, and will align their interest with those of the Company’s stockholders. 350,000 shares of HMN common stock were initially available for distribution under the 2009 Plan in either restricted stock or stock options, subject to adjustment for future stock splits, stock dividends and similar changes to the capitalization of the Company. Additionally, shares of restricted stock that are awarded are counted as 1.2 shares for purposes of determining the total shares available for issue under the 2009 Plan.

A summary of activities under all plans for the past three years is as follows:

												Unvested options
	Shares available for grant			Restricted shares outstanding			Options outstanding			Award value/ weighted average exercise price		Number			Weighted average grant date fair value		Vesting Period
1995 Plan
December 31, 2008		0			0			105,500		$	12.12		0		$	0
Forfeited/expired		0			0			(65,000	)		11.50		0			0
December 31, 2009		0			0			40,500			13.10		0			0
Forfeited/expired		0			0			(25,500	)		11.25		0			0
December 31, 2010		0			0			15,000			16.25		0			0
Forfeited/expired		0			0			0			0		0			0
December 31, 2011		0			0			15,000			16.25		0			0
2001 Plan
December 31, 2008		155,353			34,293			184,148		$	19.43		141,088		$	1.55
Forfeited/expired					(4,734	)		(33,777	)		16.13		(32,257	)		1.43
Forfeited/expired								(5,000	)		27.64					2.10
Termination of new awards under plan		(155,353	)
Vested					(15,044	)							(6,000	)		3.11
December 31, 2009		0			14,515			145,371			19.91		102,831			1.49
Forfeited/expired		0			0			(5,921	)		16.13		(5,921	)		1.43
Forfeited/expired		0			(170	)		0
Vested					(8,904	)							(3,102	)		3.52
December 31, 2010		0			5,441			139,450			20.07		93,808			1.43
Forfeited/expired		0			0			0			0		0			0
Vested		0			(5,441	)		0			0		(21,292	)		1.43
December 31, 2011		0			0			139,450			20.07		72,516			1.43
2009 Plan
April 28, 2009		350,000
Granted May 6, 2009		(15,000	)					15,000		$	4.77		15,000		$	4.41		5 years
Granted May 6, 2009		(98,866	)		82,388						N/A							3 years
December 31, 2009		236,134			82,388			15,000			4.77		15,000			4.41
Granted January 26, 2010		(85,290	)		71,075			0			N/A							3 years
Forfeited/expired		7,118			(5,790	)		0
Forfeited/expired		5,921			0			0
Vested		0			(13,630	)		0					(3,000	)		4.41
December 31, 2010		163,883			134,043			15,000			4.77		12,000			4.41
Granted January 27, 2011		(93,600	)		78,000			0			N/A		0			0
Forfeited/expired		538			(448	)		0					0			0
Vested		0			(48,825	)		0					(3,000	)		4.41
December 31, 2011		70,821			162,770			15,000			4.77		9,000			4.41
Total all plans		70,821			162,770			169,450		$	18.38		81,516		$	1.76

The following table summarizes information about stock options outstanding at December 31, 2011:

Exercise Price	Number Outstanding		Weighted Average Remaining Contractual Life in  Years		Number Exercisable		Number Unexercisable		Unrecognized Compensation Expense		Weighted Average Years Over Which Unrecognized Compensation will be Recognized
$16.13		93,910		0.4		21,394		72,516	$	0		N/A
16.25		15,000		0.4		15,000		0		0		N/A
27.66		15,540		2.2		15,540		0		0		N/A
26.98		15,000		2.6		15,000		0		0		N/A
30.00		15,000		3.4		15,000		0		0		N/A
4.77		15,000		7.4		6,000		9,000		12,175		2.4
		169,450				87,934		81,516	$	12,175

The Company will issue shares from treasury upon the exercise of outstanding options.

Prior to January 1, 2006, the Company used the intrinsic value method as described in APB Opinion No. 25 and related interpretations to account for its stock incentive plans. Accordingly, there were 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. On January 1, 2006, the Company adopted FAS No. 123(R) (ASC 718), which replaced FAS No. 123 and supersedes APB Opinion No. 25. In accordance with this standard, the Company recognized compensation expense in 2011, 2010 and 2009 relating to stock options over the vesting period. The amount of the expense was determined under the fair value method.

The fair value for each option grant is estimated on the date of the grant using a Black Scholes option valuation model. There were no options granted in 2011 or 2010. The following table shows the assumptions that were used in determining the fair value of options granted during 2009:

	2009
Risk-free interest rate		3.15%
Expected life		9 years
Expected volatility		114.0%
Expected dividends		0.0%

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Premises and Equipment

12 Months Ended

Dec. 31, 2011

Premises and Equipment [Abstract]

Premises and Equipment

NOTE 9 Premises and Equipment

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

(Dollars in thousands)	2011			2010
Land	$	1,978			2,070
Office buildings and improvements		8,637			9,199
Furniture and equipment		12,558			12,985
		23,173			24,254
Accumulated depreciation		(15,206	)		(14,804	)
	$	7,967			9,450

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Mortgage Servicing Rights, Net

12 Months Ended

Dec. 31, 2011

Mortgage Servicing Rights, Net [Abstract]

Mortgage Servicing Rights, Net

NOTE 7 Mortgage Servicing Rights, Net

A summary of mortgage servicing activity is as follows:

(Dollars in thousands)	2011			2010
Mortgage servicing rights:
Balance, beginning of year	$	1,586		$	1,315
Originations		461			753
Amortization		(562	)		(482	)
Balance, end of year		1,485			1,586
Valuation reserve		0			0
Mortgage servicing rights, net	$	1,485		$	1,586
Fair value of mortgage servicing rights	$	1,878		$	2,263

All of the single family loans sold where the Company continues to service the loans are 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, 2011:

(Dollars in thousands)	Loan Principal Balance		Weighted Average Interest Rate			Weighted Average Remaining Term (months)		Number of Loans
Original term 30 year fixed rate	$	205,727		5.09	%		298		1,803
Original term 15 year fixed rate		98,645		4.40			128		1,395
Adjustable rate		598		3.25			285		9

The gross carrying amount of mortgage servicing rights and the associated accumulated amortization at December 31, 2011 and 2010 are presented in the following table. Amortization expense for mortgage servicing rights was $562,000 and $482,000 for the years ended December 31, 2011 and 2010, respectively.

(Dollars in thousands)	Gross Carrying Amount		Accumulated Amortization			Unamortized Intangible Assets
December 31, 2011
Mortgage servicing rights	$	3,417		(1,932	)		1,485
Total	$	3,417		(1,932	)		1,485
December 31, 2010
Mortgage servicing rights	$	4,172		(2,586	)		1,586
Total	$	4,172		(2,586	)		1,586

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

(Dollars in thousands) Year ended December 31,	Mortgage Servicing Rights
2012	$	345
2013		326
2014		300
2015		259
2016		167
Thereafter		88
	$	1,485

Projections of amortization are based on asset balances and the interest rate environment that existed at December 31, 2011. The Company’s actual experience may be significantly different depending upon changes in mortgage interest rates and other market conditions.

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Real Estate

12 Months Ended

Dec. 31, 2011

Real Estate [Abstract]

Real Estate

NOTE 8 Real Estate

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

	2011									2010
(Dollars in thousands)	Residential			Commercial & Other			Total			Residential			Commercial & Other			Total
Real estate in judgement subject to redemption	$	49			4,227			4,276			333			0			333
Real estate acquired through foreclosure		2,411			10,754			13,165			4,182			10,536			14,718
Real estate acquired through deed in lieu of foreclosure		45			5,498			5,543			375			5,307			5,682
Real estate acquired in satisfaction of debt		0			106			106			0			106			106
		2,505			20,585			23,090			4,890			15,949			20,839
Allowance for losses		(556	)		(5,918	)		(6,474	)		(979	)		(3,478	)		(4,457	)
	$	1,949			14,667			16,616			3,911			12,471			16,382

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Deposits

12 Months Ended

Dec. 31, 2011

Deposits and Regulatory Matters/Supervisory Agreements and Federal Home Loan Bank Investment [Abstract]

Deposits

NOTE 10 Deposits

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

	2011								2010
(Dollars in thousands)	Weighted Average Rate			Amount		Percent of Total			Weighted Average Rate			Amount		Percent of Total
Noninterest checking		0.00	%	$	113,188		18.3	%		0.00	%	$	96,581		14.1	%
NOW accounts		0.06			64,783		10.4			0.11			94,205		13.8
Savings accounts		0.17			36,071		5.8			0.15			33,973		5.0
Money market accounts		0.46			108,876		17.6			0.75			114,357		16.7
					322,918		52.1						339,116		49.6
Certificates:
0-0.99%					72,768		11.7						41,311		6.1
1-1.99%					134,567		21.8						142,742		20.9
2-2.99%					65,842		10.6						105,126		15.4
3-3.99%					22,583		3.6						50,529		7.4
4-4.99%					1,450		0.2						4,113		0.6
5-5.99%					0		0.0						293		0.0
Total certificates		1.60			297,210		47.9			2.07			344,114		50.4
Total deposits		0.87		$	620,128		100.0	%		1.20		$	683,230		100.0	%

At December 31, 2011 and 2010, the Company had $264.5 million and $256.3 million, respectively, of deposit accounts with balances of $100,000 or more. At December 31, 2011 and 2010, the Company had $67.8 million and $107.5 million of certificate accounts, respectively, that had been acquired through a broker. The Company is currently restricted from renewing existing brokered deposits, or accepting new brokered deposits without the prior consent of the OCC.

Certificates had the following maturities at December 31:

(Dollars in thousands)	2011					2010
Remaining term to maturity	Amount		Weighted Average Rate			Amount		Weighted Average Rate
1-6 months	$	100,513		1.78	%	$	103,567		2.10	%
7-12 months		87,031		1.70			73,470		1.77
13-36 months		103,791		1.33			159,896		2.18
Over 36 months		5,875		2.05			7,181		2.44
	$	297,210		1.60		$	344,114		2.07

At December 31, 2011, mortgage loans and mortgage-backed and related securities with an amortized cost of approximately $28.9 million were pledged as collateral for certain deposits. An additional $1.0 million of letters of credit from the Federal Home Loan Bank (FHLB) were pledged as collateral on Bank deposits.

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

(Dollars in thousands)	2011		2010		2009
NOW accounts	$	57		110		132
Savings accounts		57		45		38
Money market accounts		746		1,341		1,430
Certificates		5,987		9,785		15,979
	$	6,847		11,281		17,579

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Stockholders' Equity

12 Months Ended

Dec. 31, 2011

Other Comprehensive Income (Loss) and Stockholders' Equity [Abstract]

Stockholders' Equity

NOTE 15 Stockholders’ Equity

The Company did not repurchase any shares of its common stock in the open market during 2011, 2010 or 2009. The Company suspended dividend payments on common stock in the fourth quarter of 2008 due to the net operating loss experienced and the challenging economic environment. Because of the unknown duration of the economic slow down, the continued losses experienced in 2010 and 2011, and the limitation on the payment of dividends set forth in the Supervisory Agreements (as described below and in Note 16), it is not known when any future dividends may be paid by the Company.

The Company’s certificate of incorporation authorizes the issuance of up to 500,000 shares of preferred stock, and on December 23, 2008, the Company completed the sale of 26,000 shares of cumulative perpetual preferred stock to the United States Treasury. The preferred stock has a liquidation value of $1,000 per share and a related warrant was also issued to purchase 833,333 shares of HMN common stock at an exercise price of $4.68 per share. The transaction was part of the United States Treasury’s capital purchase program under the Emergency Economic Stabilization Act of 2008. Under the terms of the sale, the preferred shares are entitled to a 5% annual cumulative dividend for each of the first five years of the investment, increasing to 9% thereafter, unless HMN redeems the shares. The Company made all required dividend payments to the Treasury on the outstanding preferred stock in 2009 and 2010 but began deferring the payment of dividends beginning with the February 15, 2011 dividend date. The Company has since deferred payment of the May 15, 2011, August 15, 2011, November 15, 2011 and February 15, 2012 dividends. The amount of accrued but unpaid dividends totaled $1.3 million at December 31, 2011. Under the terms of the certificate of designations for the preferred stock, dividend payments may be deferred without default, but the dividend is cumulative and, if the Company fails to pay dividends for six quarters, whether or not consecutive, the Treasury will have the right to appoint two representatives to the Company’s board of directors. The preferred stock may be redeemed in whole or in part, at par plus accrued and unpaid dividends. The preferred stock is non-voting, other than certain class voting rights. The warrant may be exercised at any time over its ten-year term. The discount on the common stock warrant is being amortized over five years and Treasury has agreed not to vote any shares of common stock acquired upon exercise of the warrant. Both the preferred securities and the warrant qualify as Tier 1 capital.

Under the terms of the written Supervisory Agreements that the Company and the Bank each entered into with the Office of Thrift Supervision (OTS) effective February 22, 2011 as described in Note 16, neither the Company or the Bank may declare or pay any cash dividends, or repurchase or redeem any capital stock, without prior notice to, and consent of, the OCC (as successor to the OTS). The Company does not anticipate requesting consent from the OCC to make any payments of dividends on, or purchase of, its common or preferred stock in 2012.

The OCC has established an individual minimum capital requirement (IMCR) for the Bank as described in Note 16, which required the Bank to establish and maintain core capital at least equal to 8.5% of adjusted total assets at December 31, 2011. This was in excess of the Bank’s 7.14% core capital to adjusted total assets ratio at December 31, 2011.

In order to grant a priority to eligible accountholders in the event of future liquidation, the Bank, at the time of conversion to a stock savings bank, 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 decrease as the balance of eligible accountholders is reduced subsequent to the conversion, based on an annual determination of such balance.

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Fair Value of Financial Instruments

12 Months Ended

Dec. 31, 2011

Fair Value of Financial Instruments [Abstract]

Fair Value of Financial Instruments

NOTE 20 Fair Value of Financial Instruments

ASC 825, Disclosures about Fair Values of Financial Instruments, requires disclosure of estimated fair values of the Company’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, 2011 and 2010 based upon relevant market information, if available, and upon the characteristics of the financial instruments themselves. Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based upon judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. The estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

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

The estimated fair value of the Company’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,
	2011								2010
(Dollars in thousands)	Carrying Amount			Estimated Fair Value			Contract Amount		Carrying Amount			Estimated Fair Value			Contract Amount
Financial assets:
Cash and cash equivalents	$	67,840			67,840					20,981			20,981
Securities available for sale		126,114			126,114					151,564			151,564
Loans held for sale		3,709			3,709					2,728			2,728
Loans receivable, net		555,908			566,266					664,241			655,508
Federal Home Loan Bank stock		4,222			4,222					6,743			6,743
Accrued interest receivable		2,449			2,449					3,311			3,311
Assets held for sale		1,583			1,605					0			0
Financial liabilities:
Deposits		620,128			620,128					683,230			683,230
Deposits held for sale		36,048			36,048					0			0
Federal Home Loan Bank advances		70,000			74,433					122,500			129,893
Accrued interest payable		780			780					1,092			1,092
Off-balance sheet financial instruments:
Commitments to extend credit		29			29			91,113		56			56			92,313
Commitments to sell loans		(94	)		(94	)		7,263		(1	)		(1	)		3,413

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. This method of estimating fair value does not incorporate the exit-price concept of fair value prescribed by ASC 820, Fair Value Measurements and Disclosures.

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    The fair value of demand deposits, savings accounts and certain money market account deposits is the amount payable on demand at the reporting date. The fair value of fixed maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities. If the fair value of the fixed maturity certificates of deposit is calculated at less than the carrying amount, the carrying value of these deposits is reported as the fair value.

The fair value estimate for deposits does not include the benefit that results from the low cost funding provided by the Company’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 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 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 are estimated using the quoted market prices for loans with similar interest rates and terms to maturity.

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Consolidated Statement of Stockholders' Equity and Comprehensive Loss (USD $) In Thousands, unless otherwise specified	Total	Preferred Stock	Common Stock	Additional Paid-in Capital	Retained Earnings	Accumulated Other Comprehensive Income (Loss)	Unearned Employee Stock Ownership Plan Shares	Treasury Stock
Beginning balance at Dec. 31, 2008	$ 112,213	$ 23,384	$ 91	$ 60,687	$ 98,067	$ 2,091	$ (3,771)	$ (68,336)
Net loss	(10,796)				(10,796)
Other comprehensive loss, net of tax:
Net unrealized losses on securities available for sale	(861)					(861)
Total comprehensive loss	(11,657)
Preferred stock discount amortization	0	401		(401)
Stock compensation expense	27			27
Unearned compensation restricted stock awards	0			(2,181)				2,181
Restricted stock awards forfeited	0			127				(127)
Restricted stock awards dividend Forfeited	7				7
Amortization of restricted stock awards	373			373
Earned employee stock ownership plan shares	138			(56)			194
Preferred stock dividends	(1,163)				(1,163)
Ending balance at Dec. 31, 2009	99,938	23,785	91	58,576	86,115	1,230	(3,577)	(66,282)
Net loss	(28,978)				(28,978)
Other comprehensive loss, net of tax:
Net unrealized losses on securities available for sale	(689)					(689)
Total comprehensive loss	(29,667)
Preferred stock discount amortization	0	479		(479)
Stock compensation expense	63			63
Unearned compensation restricted stock awards	0			(2,237)				2,237
Restricted stock awards forfeited	0			178				(178)
Restricted stock awards dividend Forfeited	1				1
Amortization of restricted stock awards	370			370
Earned employee stock ownership plan shares	142			(51)			193
Preferred stock dividends	(1,300)				(1,300)
Ending balance at Dec. 31, 2010	69,547	24,264	91	56,420	55,838	541	(3,384)	(64,223)
Net loss	(11,555)				(11,555)
Other comprehensive loss, net of tax:
Net unrealized losses on securities available for sale	(70)					(70)
Total comprehensive loss	(11,625)
Preferred stock discount amortization	0	516		(516)
Stock compensation expense	29			29
Unearned compensation restricted stock awards	0			(2,700)				2,700
Restricted stock awards forfeited	0			12				(12)
Amortization of restricted stock awards	298			298
Earned employee stock ownership plan shares	112			(81)			193
Preferred stock dividends	(1,300)				(1,300)
Ending balance at Dec. 31, 2011	$ 57,061	$ 24,780	$ 91	$ 53,462	$ 42,983	$ 471	$ (3,191)	$ (61,535)

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Loans Receivable, Net

12 Months Ended

Dec. 31, 2011

Loans Receivable, Net [Abstract]

Loans Receivable, Net

NOTE 4 Loans Receivable, Net

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

(Dollars in thousands)	2011			2010
Residential real estate loans:
1-4 family conventional	$	118,524			128,087
1-4 family FHA		494			399
1-4 family VA		48			49
		119,066			128,535
Commercial real estate:
Lodging		31,905			34,447
Retail/office		80,436			86,768
Nursing home/health care		6,455			5,512
Land developments		45,197			72,810
Golf courses		8,326			8,161
Restaurant/bar/café		3,102			2,684
Alternative fuel plants		18,882			31,123
Warehouse		16,555			17,197
Construction:
1-4 family builder		4,926			10,684
Multi family		1,156			3,874
Commercial real estate		4,840			693
Manufacturing		8,557			8,538
Churches/community service		6,058			6,132
Multi family		35,517			48,266
Other		18,002			19,502
		289,914			356,391
Consumer:
Autos		404			604
Home equity line		41,429			44,933
Home equity		13,426			17,840
Consumer — secured		1,409			1,304
Land/lot loans		2,723			2,510
Savings		576			534
Mobile home		657			764
Consumer — unsecured		1,537			2,114
		62,161			70,603
Commercial business		109,259			153,039
Total loans		580,400			708,568
Less:
Unamortized discounts		93			413
Net deferred loan fees		511			1,086
Allowance for loan losses		23,888			42,828
Total loans receivable, net	$	555,908			664,241
Commitments to originate or purchase loans	$	5,925			629
Commitments to deliver loans to secondary market	$	7,263			3,413
Weighted average contractual rate of loans in portfolio		5.52	%		5.52	%

Included in total commitments to originate or purchase loans are fixed rate loans aggregating $5.9 million and $0.6 million as of December 31, 2011 and 2010, respectively. The interest rates on these loan commitments ranged from 3.00% to 6.79% at December 31, 2011 and from 3.88% to 5.13% at December 31, 2010.

The aggregate amounts of loans to executive officers and directors of the Company was $4.0 million at December 31, 2011 and $4.1 million at December 31, 2010 and December 31, 2009. During 2011, repayments on loans to executive officers and directors were $86,000, new loans to executive officers and directors totaled $665,500 and sales of executive officer and director loans were $415,500. During 2010, the only activity was $12,000 in repayments on loans to executive officers and directors. 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, 2011, 2010 and 2009, the Company was servicing loans for others with aggregate unpaid principal balances of approximately $417.4 million, $508.0 million and $566.0 million, respectively.

The Company originates residential, commercial real estate and other loans primarily in Minnesota and Iowa. At December 31, 2011 and 2010, the Company had in its portfolio single-family and multi-family residential loans located in the following states:

	2011					2010
(Dollars in thousands)	Amount		Percent of Total			Amount		Percent of Total
Iowa	$	4,664		3.9	%	$	4,684		3.6	%
Minnesota		109,632		92.1			118,305		92.0
Wisconsin		2,130		1.8			1,879		1.5
Other states		2,640		2.2			3,667		2.9
Total	$	119,066		100.0	%	$	128,535		100.0	%

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

At December 31, 2011 and 2010, the Company had in its portfolio commercial real estate loans located in the following states:

	2011					2010
(Dollars in thousands)	Amount		Percent of Total			Amount		Percent of Total
California	$	4,943		1.7	%	$	4,916		1.4	%
Florida		2,792		1.0			2,855		0.8
Idaho		4,423		1.5			4,483		1.3
Indiana		7,206		2.5			7,694		2.2
Iowa		6,139		2.1			11,160		3.1
Kansas		1,036		0.4			1,064		0.3
Minnesota		244,798		84.4			303,101		85.0
Nebraska		0		0.0			4,994		1.4
North Carolina		7,075		2.4			7,303		2.0
Tennessee		326		0.1			1,700		0.5
Utah		1,324		0.5			1,414		0.4
Wisconsin		8,413		2.9			5,087		1.4
Other states		1,439		0.5			620		0.2
Total	$	289,914		100.0	%	$	356,391		100.0	%

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

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Assets and Deposits Held for Sale

12 Months Ended

Dec. 31, 2011

Assets and Deposits Held for Sale [Abstract]

Assets and Deposits Held for Sale

NOTE 21 Assets and Deposits Held for Sale

The Bank entered into a definitive purchase and assumption agreement on November 7, 2011 with Pinnacle Bank (Pinnacle) of Marshalltown, Iowa which provides for the sale to Pinnacle of substantially all of the assets associated with the Toledo, Iowa branch (the Branch) of the Bank and the assumption by Pinnacle of substantially all deposit liabilities of the Branch. The Bank will continue to own and operate its other Iowa and Minnesota branches. Regulatory approval for the transaction has been obtained and the transaction is anticipated to be consummated in the first quarter of 2012. The Bank anticipates that the transaction will be funded with available assets, the sale will result in a one time gain on sale in the first quarter of 2012 and a decrease in the Bank’s overall assets of approximately $34 million.

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Loss Per Common Share

12 Months Ended

Dec. 31, 2011

Loss Per Common Share [Abstract]

Loss per Common Share

NOTE 14 Loss per Common Share

The following table reconciles the weighted average shares outstanding and net loss for basic and diluted loss per common share:

	Year ended December 31,
(Dollars in thousands, except per share data)	2011			2010			2009
Weighted average number of common shares outstanding used in basic earnings per common share calculation		3,853,491			3,766,756			3,695,827
Net dilutive effect of:
Options		0			0			0
Restricted stock awards		0			0			0
Weighted average number of common shares outstanding adjusted for effect of dilutive securities		3,853,491			3,766,756			3,695,827
Net loss available to common shareholders	$	(13,376	)		(30,762	)		(12,543	)
Basic loss per common share	$	(3.47	)		(8.17	)		(3.39	)
Diluted loss per common share	$	(3.47	)		(8.17	)		(3.39	)

Options and restricted stock awards are excluded from the loss per share calculation when a net loss is incurred as their inclusion in the calculation would be anti-dilutive and result in a lower loss per common share. Therefore, options and restricted stock awards are zero in all of the above loss per common share calculations.