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HMN FINANCIAL INC - Quarter Report: 2003 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2003

OR

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

For the transition period from _________ to _________

Commission File Number 0-24100

HMN FINANCIAL, INC.

(Exact name of Registrant as specified in its Charter)

Delaware

41-1777397


 

(State or other jurisdiction of incorporation or organization)

(I.R.S. Employer Identification Number)

1016 Civic Center Drive N.W., Rochester, MN

55901


 

(Address of principal executive offices)

(ZIP Code)

Registrant's telephone number, including area code:  

(507) 535-1200

 


 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes (X) No ( )

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes ( ) No (X)

Indicate the number of shares outstanding of each of the issuer's common stock, as of the latest practicable date.

Class

 

Outstanding at October 30, 2003

Common stock, $0.01 par value

 

4,495,830

HMN FINANCIAL, INC.

CONTENTS

PART I - FINANCIAL INFORMATION

   

Page

Item 1:

Financial Statements (unaudited)

 
 

Consolidated Balance Sheets at September 30, 2003 and December 31, 2002

3

 

Consolidated Statements of Income for the Three Months Ended and Nine Months Ended September 30, 2003 and 2002

4

 

Consolidated Statements of Comprehensive Income for the Three Months Ended and Nine Months Ended September 30, 2003 and 2002

5

 

Consolidated Statement of Stockholders' Equity for the Nine Month Period Ended September 30, 2003

6

Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2003 and 2002

7

 

Notes to Consolidated Financial Statements

8-16

Item 2:

Management's Discussion and Analysis of Financial Condition and Results of Operations

17-25

Item 3:

Quantitative and Qualitative Disclosures about Market Risk Discussion included in Item 2 under Market Risk

22

Item 4:

Controls and Procedures

25

     

PART II - OTHER INFORMATION

Item 1:

Legal Proceedings

26

Item 2:

Changes in Securities and Use of Proceeds

26

Item 3:

Defaults Upon Senior Securities

26

Item 4:

Submission of Matters to a Vote of Security Holders

26

Item 5:

Other Information

26

Item 6:

Exhibits and Reports on Form 8-K

26

Signatures

27

PART I - FINANCIAL STATEMENTS

HMN FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

 

   

September 30,

 

December 31,

 
   

2003

 

2002

 
   

(unaudited)

     

Assets

         

Cash and cash equivalents

$

17,854,947

 

27,729,007

 

Securities available for sale:

         

   Mortgage-backed and related securities (amortized cost $16,791,821 and $51,677,294)

 

16,326,907

 

51,895,832

 

    Other marketable securities (amortized cost $71,274,037 and $67,282,379)

 

72,201,371

 

69,501,417

 

     

 
 
 
   

88,528,278

 

121,397,249

 
           

Loans held for sale

 

17,633,615

 

15,126,509

 

Loans receivable, net

 

645,714,604

 

533,905,652

 

Accrued interest receivable

 

3,575,070

 

3,050,636

 

Real estate, net

 

226,239

 

426,691

 

Federal Home Loan Bank stock, at cost

 

11,134,600

 

11,880,500

 

Mortgage servicing rights, net

 

3,341,082

 

2,691,031

 

Premises and equipment, net

 

12,351,770

 

12,875,816

 

Investment in limited partnerships

 

547,421

 

862,666

 

Goodwill

 

3,800,938

 

3,800,938

 

Core deposit intangible

 

476,602

 

561,331

 

Prepaid expenses and other assets

 

1,857,776

 

3,214,792

 
   
 
 

    Total assets

$

807,042,942

 

737,522,818

 
   
 
 
           

Liabilities and Stockholders' Equity

         

Deposits

$

490,087,780

 

432,951,462

 

Federal Home Loan Bank advances

 

229,300,000

 

218,300,000

 

Accrued interest payable

 

428,721

 

849,427

 

Advance payments by borrowers for taxes and insurance

 

992,952

 

707,213

 

Accrued expenses and other liabilities

 

6,315,018

 

7,614,406

 

Deferred tax liabilities

 

758,500

 

1,456,600

 
   
 
 

    Total liabilities

 

727,882,971

 

661,879,108

 
   
 
 

Commitments and contingencies

         

Minority interest

 

(307,234)

 

(420,846)

 

Stockholders' equity:

         

    Serial preferred stock: ($.01 par value)

         

     authorized 500,000 shares; issued and outstanding none

 

0

 

0

 

    Common stock ($.01 par value):

         

     authorized 11,000,000; issued shares 9,128,662

 

91,287

 

91,287

 

Additional paid-in capital

 

57,918,621

 

58,885,279

 

Retained earnings, subject to certain restrictions

 

83,988,066

 

79,660,481

 

Accumulated other comprehensive income

 

298,919

 

1,575,577

 

Unearned employee stock ownership plan shares

 

(4,786,374)

 

(4,931,385)

 

Treasury stock, at cost 4,646,870 and 4,722,856 shares

 

(58,043,314)

 

(59,216,683)

 
   
 
 

    Total stockholders' equity

 

79,467,205

 

76,064,556

 
   
 
 

Total liabilities and stockholders' equity

$

807,042,942

 

737,522,818

 
   
 
 

See accompanying notes to consolidated financial statements.

 

 

HMN FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Statements of Income

(unaudited)


   

Three Months Ended

 

Nine Months Ended

    September 30,  

September 30,

    2003 2002   2003   2002

Interest income:

             

     Loans receivable

$

10,744,663

9,502,274

 

30,628,304

 

28,271,049

     Securities available for sale:

               

         Mortgage-backed and related

 

72,646

 

485,086

 

175,405

 

1,497,251

         Other marketable

 

591,292

 

515,997

 

1,843,359

 

1,952,793

     Cash equivalents

 

12,762

 

38,564

 

98,659

 

297,916

     Other

 

86,196

 

90,603

 

268,880

 

265,305

   
 
 
 

         Total interest income

 

11,507,559

 

10,632,524

 

33,014,607

 

32,284,314

   
 
 
 

Interest expense:

               

     Deposits

 

2,474,680

 

2,556,830

 

7,438,497

 

8,304,055

     Federal Home Loan Bank advances

 

2,590,574

 

2,616,265

 

7,684,876

 

7,788,063

   
 
 
 

        Total interest expense

 

5,065,254

 

5,173,095

 

15,123,373

 

16,092,118

   
 
 
 

   Net interest income

 

6,442,305

 

5,459,429

 

17,891,234

 

16,192,196

Provision for loan losses

 

545,000

 

771,000

 

1,900,000

 

1,801,000

   
 
 
 

        Net interest income after provision

               

         for loan losses

 

5,897,305

 

4,688,429

 

15,991,234

 

14,391,196

   
 
 
 

Non-interest income:

               

     Fees and service charges

 

625,419

 

418,115

 

1,612,595

 

1,212,276

     Mortgage servicing fees

 

261,198

 

184,769

 

716,503

 

521,931

     Securities gains, net

 

417,443

 

376,838

 

1,233,229

 

422,346

     Gain on sales of loans

 

1,601,047

 

432,095

 

4,592,837

 

1,975,124

       Earnings (losses) in limited partnerships

 

10,153

 

(530,943)

 

(313,161)

 

(203,968)

     Other

 

179,112

 

122,539

 

514,906

 

531,519

   
 
 
 

        Total non-interest income

 

3,094,372

 

1,003,413

 

8,356,909

 

4,459,228

   
 
 
 

Non-interest expense:

               

     Compensation and benefits

 

2,085,383

 

1,986,777

 

6,392,457

 

6,006,821

     Occupancy

 

805,890

 

801,026

 

2,399,207

 

2,210,714

     Federal deposit insurance premiums

 

18,047

 

18,173

 

54,838

 

56,280

     Advertising

 

92,161

 

129,254

 

278,013

 

418,336

     Data processing

 

310,614

 

272,696

 

871,660

 

824,080

     Amortization of mortgage servicing

               

       rights, net of valuation adjustments

               

       and servicing costs

 

(193,287)

 

502,282

 

1,705,344

 

884,588

     Other

 

1,211,288

 

844,581

 

3,022,975

 

2,825,635

   
 
 
 

        Total non-interest expense

 

4,330,096

 

4,554,789

 

14,724,494

 

13,226,454

   
 
 
 

        Income before income tax expense

 

4,661,581

 

1,137,053

 

9,623,649

 

5,623,970

Income tax expense

 

1,621,300

 

312,200

 

3,163,600

 

1,637,400

   
 
 
 

        Income before minority interest

 

3,040,281

 

824,853

 

6,460,049

 

3,986,570

Minority interest

 

0

 

(67,012)

 

0

 

(141,306)

   
 
 
 

        Net income

$

3,040,281

 

891,865

 

6,460,049

 

4,127,876

   
 
 
 

Basic earnings per share

$

0.79

 

0.24

 

1.71

 

1.10

   
 
 
 

Diluted earnings per share

$

0.76

 

0.22

 

1.63

 

1.04

   
 
 
 

See accompanying notes to consolidated financial statements.

 

HMN FINANCIAL, INC. AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income
(unaudited)


   

Three Months Ended September 30,

   

2003

 

2002

   
 

Net income

$

       

3,040,281

         

891,865

Other comprehensive income, net of tax:

                       

   Unrealized gains (losses) on securities:

                       

   Unrealized holding gains (losses) arising during period

 

(598,636)

         

1,195,786

       

   Less: reclassification adjustment for gains

                       

     included in net income

 

270,043

         

243,738

       
   
         
       

   Net unrealized gains (losses) on securities

     

(868,679)

         

952,048

   
       
         
   

Other comprehensive income (loss)

         

(868,679)

         

952,048

           
         

Comprehensive income

$

       

2,171,602

         

1,843,913

           
         

 

 

 


   

Nine Months Ended September 30,

   

2003

 

2002

   
 

Net income

$

       

6,460,049

         

4,127,876

Other comprehensive income, net of tax:

                       

   Unrealized losses on hedging valuation

 

0

         

(35,795)

       

      Less: minority interest in hedging valuation

 

0

         

(21,950)

       
   
         
       

      Net unrealized losses on hedging valuation

     

0

         

(13,845)

   

   Unrealized gains (losses) on securities:

                       

   Unrealized holding gains (losses) arising during period

 

(479,029)

         

680,086

       

   Less: reclassification adjustment for gains

                       

     included in net income

 

797,629

         

273,146

       
   
         
       

   Net unrealized gains (losses) on securities

     

(1,276,658)

         

406,940

   
       
         
   

Other comprehensive income (loss)

         

(1,276,658)

         

393,095

           
         

Comprehensive income

$

       

5,183,391

         

4,520,971

           
         

See accompanying notes to consolidated financial statements.

 

 

HMN FINANCIAL, INC. AND SUBSIDIARIES
Consolidated Statement of Stockholders' Equity
For the Nine Month Period Ended September 30, 2003
(unaudited)

 


         

Unearned

   
         

Employee

   
       

Accumulated

Stock

 

Total

   

Additional

 

Other

Ownership

 

Stock-

 

Common

Paid-in

Retained

Comprehensive

Plan

Treasury

Holders'

 

Stock

Capital

Earnings

Income

Shares

Stock

Equity

 

Balance, December 31, 2002

$ 91,287

58,885,279 

79,660,481 

1,575,577

(4,931,385)

(59,216,683)

76,064,556 

  Net income

   

6,460,049 

     

6,460,049 

  Other comprehensive loss

     

(1,276,658)

   

(1,276,658) 

  Treasury stock purchases

         

(1,384,560)

(1,384,560)

  Employee stock options

             

    exercised

 

(1,404,565)

     

2,557,929 

1,153,364 

  Tax benefits of exercised

             

    stock options

 

316,637 

       

316,637 

  Dividends paid

   

(2,132,464)

     

(2,132,464)

  Earned employee stock

             

    ownership plan shares

 

121,270 

   

145,011 

 

266,281 

 

Balance, September 30, 2003

$ 91,287

57,918,621 

83,988,066 

298,919

(4,786,374)

(58,043,314)

79,467,205 

 

See accompanying notes to consolidated financial statements.

 

 

 

HMN FINANCIAL, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(unaudited)


   

Nine Months Ended

September 30,

   
   

2003

 

2002

   
 

Cash flows from operating activities:

       

Net income

$

6,460,049

 

4,127,876

Adjustments to reconcile net income to cash provided by operating activities:

       

Provision for loan losses

 

1,900,000

 

1,801,000

Depreciation

 

1,178,607

 

1,012,082

Amortization of premiums, net

 

572,084

 

239,534

Amortization of deferred loan fees

 

(390,407)

 

(498,149)

Amortization of core deposit intangible

 

84,729

 

93,134

Amortization of mortgage servicing rights and net valuation and servicing costs

 

1,705,344

 

884,588

Capitalized mortgage servicing rights

 

(2,138,477)

 

(1,212,272)

Deferred income taxes

 

0

 

(104,400)

Securities gains, net

 

(1,233,229)

 

(422,346)

Gains on sales of premises

 

(175,883)

 

0

     Losses (gains) on sales of real estate

 

105,418

 

(1,254)

Gains on sales of loans

 

(4,592,837)

 

(1,975,124)

Proceeds from sales of real estate

 

423,295

 

52,435

Proceeds from sales of loans held for sale

 

251,287,444

 

202,650,820

Disbursements on loans held for sale

 

(245,789,157)

 

(141,643,268)

Principal collected on loans held for sale

 

11,521

 

106,603

Amortization of restricted stock awards

 

0

 

7,350

Amortization of unearned ESOP shares

 

145,011

 

145,071

Earned employee stock ownership shares priced above original cost

 

121,270

 

106,789

Decrease (increase) in accrued interest receivable

 

(524,434)

 

338,622

Decrease in accrued interest payable

 

(420,706)

 

(275,432)

Equity losses of limited partnerships

 

313,161

 

203,968

     Equity losses of minority interest

 

0

 

(141,306)

Decrease (Increase) in other assets

 

744,474

 

(94,329)

Decrease in other liabilities

 

(154,792)

 

(1,441,860)

Other, net

 

170,908

 

17,094

   
 

Net cash provided by operating activities

 

9,803,393

 

63,977,226

   
 

Cash flows from investing activities:

       

Proceeds from sales of securities available for sale

 

40,326,825

 

18,036,553

Principal collected on securities available for sale

 

27,772,873

 

14,077,803

Proceeds collected on maturity of securities available for sale

 

10,000,000

 

19,900,000

Purchases of securities available for sale

 

(46,491,697)

 

(40,055,856)

Purchase of Federal Home Loan Bank stock

 

(373,800)

 

0

Redemption of Federal Home Loan Bank stock

 

1,119,700

 

364,500

Net increase in loans receivable

 

(117,617,414)

 

(42,391,910)

Proceeds from sale of premises

 

291,117

 

0

Purchases of premises and equipment

 

(790,012)

 

(3,681,249)

   
 

Net cash used by investing activities

 

(85,762,408)

 

(33,750,159)

   
 

Cash flows from financing activities:

       

Increase in deposits

 

57,162,876

 

321,403

Purchase of treasury stock

 

(1,384,560)

 

(658,611)

Stock options exercised

 

1,153,364

 

635,497

Dividends to stockholders

 

(2,132,464)

 

(1,886,127)

Proceeds from Federal Home Loan Bank advances

 

131,000,000

 

0

Repayment of Federal Home Loan Bank advances

 

(120,000,000)

 

(3,500,000)

Increase (decrease) in advance payments by borrowers for taxes and insurance

 

285,739

 

(138,004)

   
 

Net cash provided (used) by financing activities

 

66,084,955

 

(5,225,842)

   
 

Increase (decrease) in cash and cash equivalents

 

(9,874,060)

 

25,001,225

Cash and cash equivalents, beginning of period

 

27,729,007

 

23,019,553

   
 

Cash and cash equivalents, end of period

$

17,854,947

 

48,020,778

   
 

Supplemental cash flow disclosures:

       

Cash paid for interest

$

15,544,079

 

16,367,550

Cash paid for income taxes

 

2,141,000

 

1,817,500

Supplemental noncash flow disclosures:

       

Loans transferred to loans held for sale

 

3,741,477

 

4,267,484

Transfer of loans to real estate

 

575,606

 

370,625

Transfer of real estate to loans

 

16,533

 

0


See accompanying notes to consolidated financial statements.

 

HMN FINANCIAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(unaudited)

September 30, 2003 and 2002

(1) HMN Financial, Inc.

HMN Financial, Inc. (HMN) is a stock savings bank holding company that owns 100 percent of Home Federal Savings Bank (the Bank or Home Federal). Home Federal has a community banking philosophy and operates retail banking and loan production facilities in Minnesota and Iowa. The Bank has two wholly owned subsidiaries, Osterud Insurance Agency, Inc. (OAI) which offers financial planning products and services and Home Federal Holding, Inc. (HFH) which is the holding company for Home Federal REIT, Inc. (HFREIT) which invests in real estate loans acquired from the Bank. HMN has another wholly owned subsidiary, Security Finance Corporation (SFC) which acts as an intermediary for the Bank in transacting like-kind property exchanges for Bank customers. The Bank has a 51% owned subsidiary, Home Federal Mortgage Services, LLC (HFMS), which was a mortgage banking and mortgage brokerage business located in Brooklyn Park, Minnesota. HFMS's brokerage and production activity stopped during the third quarter of 2002 and the company will be dissolved in the fourth quarter of 2003. The Bank has an 80% owned subsidiary, Federal Title Services, LLC. (FTS), which performs mortgage title services for Bank customers.

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

(2) Basis of Preparation

The accompanying unaudited consolidated financial statements were prepared in accordance with instructions for Form 10-Q and therefore, do not include all disclosures necessary for a complete presentation of the consolidated balance sheets, consolidated statements of income, consolidated statements of comprehensive income, consolidated statements of stockholders' equity and consolidated statements of cash flows in conformity with generally accepted accounting principles. However, normal recurring adjustments which are, in the opinion of management, necessary for the fair presentation of the interim financial statements have been included. The statements of income for the three month and nine month periods ended September 30, 2003 are not necessarily indicative of the results which may be expected for the entire year.

Certain amounts in the consolidated financial statements for prior periods have been reclassified to conform with the current period presentation.

(3) New Accounting Standards

In November 2002, the FASB issued Interpretation No. 45, Guarantor's Accounting and Disclosure Requirements for Guarantees Including Indirect Guarantees of Indebtedness of Others (FIN 45). FIN 45 requires disclosures be made by a guarantor in its interim and annual financial statements about its obligations under certain guarantees that it has issued. It also requires the recognition of a liability by a guarantor at the inception of certain guarantees that it has issued and that a guarantor recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The initial recognition and initial measurement provisions of this Interpretation are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. The disclosure requirements are effective for financial statements of interim or annual periods ending after December 15, 2002. Refer to Note 11 for the related FIN 45 disclosure.

In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure-an amendment of FASB Statement No. 123. This Statement amends SFAS No. 123, Accounting for Stock-Based Compensation, to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this Statement amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both the annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The amendments to SFAS No. 123 are effective for fiscal years ending after December 15, 2002 and for condensed interim financial statements issued after December 15, 2002. HMN has not adopted the voluntary change to the fair value based method of accounting for stock-based employee compensation as of September 30, 2003. Refer to Note 12 for required disclosures relating to stock-based compensation.

In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities (FIN 46). FIN 46 addresses consolidation by business enterprises of variable interest entities (VIEs) that have certain characteristics. It requires a business enterprise that has a controlling interest in a VIE (as defined by FIN 46) to include the assets, liabilities, and results of the activities of the VIE in the consolidated financial statements of the business enterprise. The provisions of FIN No. 46 are applicable to variable interests in VIEs created after January 31, 2003. Variable interests in VIEs created before February 1, 2003, were originally subject to the provisions of FIN No. 46 no later than July 1, 2003, however, the effective date has been delayed under certain conditions to December 31, 2003. The impact of adopting FIN No. 46 on HMN's financial condition and results of operation will not be material.

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

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

(4) Derivative Instruments and Hedging Activities

HMN has commitments outstanding to extend credit to future borrowers that had not closed prior to the end of the quarter, which is referred to as its mortgage pipeline. As commitments to originate loans enter the mortgage pipeline, HMN generally enters into commitments to sell the loans into the secondary market. The commitments to originate and sell loans are derivatives that are recorded at market value. As a result of marking these derivatives to market for the period ended September 30, 2003, HMN recorded a decrease in other assets of $585,446, a decrease in other liabilities of $572,601 and losses on sales of loans of $12,845.

The current commitments to sell loans held for sale are derivatives that do not qualify for hedge accounting. As a result, these derivatives are marked to market. The loans held for sale that are not hedged are recorded at the lower of cost or market. As a result of marking these loans HMN recorded a decrease to loans held for sale of $54,491, a decrease in other liabilities of $249,351, and gains on sales of loans of $194,860.

 

(5) Comprehensive Income

Comprehensive income is defined as the change in equity during a period from transactions and other events from nonowner sources. Comprehensive income is the total of net income and other comprehensive income, which for HMN is comprised of unrealized gains and losses on securities available for sale and unrealized losses on hedging valuations.

There was no hedging valuation in the third quarter of 2003. The gross unrealized holding losses on securities for the third quarter of 2003 was $926,000, the income tax benefit would have been $327,000 and therefore, the net loss was $599,000. The gross reclassification adjustment for the third quarter of 2003 was $417,000, the income tax expense would have been $147,000 and therefore, the net gain was $270,000. The gross unrealized holding gains on securities for the third quarter of 2002 was $1,837,000, the income tax expense would have been $641,000 and therefore, the net gain was $1,196,000. The gross reclassification adjustment in the third quarter of 2002 was $377,000, the income tax expense would have been $133,000 and therefore, the net gain was $244,000.

There was no hedging valuation in the nine-month period ended September 30, 2003. The gross unrealized holding losses on securities for the nine month period ended September 30, 2003 was $742,000, the income tax benefit would have been $263,000 and therefore, the net loss was $479,000. The gross reclassification adjustment in the nine month period ended September 30, 2003 was $1,233,000, the income tax expense would have been $435,000 and therefore, the net reclassification adjustment was $798,000. The gross unrealized losses in hedging valuation for the nine month period ended September 30, 2002 was $45,000, the income tax benefit would have been $9,000 and therefore, the net loss was $36,000. The gross minority interest in hedging valuation for the nine month period ended September 30, 2002 was $22,000. The gross unrealized holding gains on securities for the nine month period ended September 30, 2002 was $1,022,000, the income tax expense would have been $342,000 and therefore, the net gain was $680,000. The gross reclassification adjustment in the nine month period ended September 30, 2002 was $422,000, the income tax expense would have been $149,000 and therefore, the net reclassification adjustment was $273,000.

(6) Investment in Limited Partnerships

Investments in limited partnerships were as follows:


    September 30,   December 31,  

Primary partnership activity

 

2003

 

 2002

 


 
 
 

Mortgage servicing rights

$

0

 

349,577

 

Common stock of financial institutions

 

345,515

 

289,398

 

Low to moderate income housing

 

202,106

 

223,691

 

   
 
 

 

$

547,421

 

862,666

 

   
 
 

 


 

During the third quarter of 2003 HMN's proportionate gains from common stock investments in financial institutions was $16,653 and it recognized $6,500 of losses on low income housing partnerships. During 2003 HMN anticipates receiving low income housing credits totaling $84,000 of which $21,000 will be credited to current income tax benefits. During the third quarter of 2002 HMN's proportionate loss from a mortgage servicing partnership was $504,777, its proportionate share of losses from common stock investments in financial institutions was $19,665 and it recognized $6,500 of losses on low income housing partnerships. During 2002 HMN received low income housing credits totaling $84,000, of which $21,000 were credited to current income tax benefits.

During the nine month period ended September 30, 2003, HMN's proportionate loss from a mortgage servicing partnership was $349,577, its proportionate share of gains from the common stock investments in financial institutions was $55,916 and it recognized $19,500 of losses on the low income housing partnerships. During 2003 HMN anticipates receiving low income housing credits totaling $84,000, of which $63,000 will be credited to current income tax benefits. During the nine month period ended September 30, 2002, HMN's proportionate loss from a mortgage servicing partnership was $173,919, its proportionate share of gains from the common stock investments in financial institutions was $3,907 and it recognized $33,956 of losses on the low income housing partnerships. During 2002 HMN received low income housing credits totaling $84,000, of which $63,000 were credited to current income tax benefits. HMN's investment in a limited partnership that invested in mortgage servicing rights was dissolved in the second quarter of 2003 and the investment was written down to zero.

(7) Investment in Mortgage Servicing Rights

A summary of mortgage servicing activity is as follows:


 

 

 

 

 

Nine Months
ended
Sept. 30, 2003

 

 

Twelve Months
ended
Dec. 31, 2002

 

 

Nine Months
ended
Sept. 30, 2002

   
 
 

Mortgage servicing rights

           

  Balance, beginning of period

$

2,701,031

 

1,922,736

1,922,736

  Originations

 

2,138,477

 

1,956,845

 

1,212,272

  Sales

 

0

 

(41,532)

 

0

  Amortization

 

(1,498,426)

 

(1,137,018)

 

(665,173)




  Balance, end of period

 

3,341,082

 

2,701,031

 

2,469,835




Valuation reserve

  Balance, beginning of period

 

(10,000)

(19,100)

(19,100)

  Additions

(800,000)

(213,000)

(210,000)

  Reductions

810,000

222,100

 

10,600




  Balance, end of period

0

(10,000)

(218,500)

 

 


 


 


  Mortgage servicing rights, net

$

3,341,082

 

2,691,031

2,251,335




  Fair value of mortgage servicing rights

$

4,199,323

 

2,691,031

 

2,262,578

 
 
 

 

Mortgage servicing costs, which include professional services for valuing mortgage servicing rights, were $216,917 at September 30, 2003, and $20,014 and $29,344 for the nine and twelve months ended in September and December of 2002, respectively.

All of the loans being serviced were single family loans serviced for FNMA under the mortgage-backed security program or the individual loan sale program. The following is a summary of the risk characteristics of the loans being serviced at September 30, 2003.


 

 

 

Loan Principal Balance

 

Weighted Average
Interest Rate

 

Weighted Average Remaining Term

 

Number of Loans

 

   
 
 
 
 

Original term 30 year fixed rate

$

170,573,000

 

6.03

%

348

 

1,575

 

Original term 15 year fixed rate

 

239,641,000

 

5.42

%

169

 

2,855

 

Seven year balloon

 

122,000

 

5.75

%

64

 

1

 

Adjustable rate   10,111,000  

4.94

%

347

 

86

 

(8) Intangible Assets

The gross carrying amount of intangible assets and the associated accumulated amortization at September 30, 2003 is presented in the table below. Amortization expense for intangible assets was $645,841 for the quarter ended September 30, 2003 and $1,583,156 for the nine months ended September 30, 2003.


   

Gross

     

Unamortized

   

Carrying

 

Accumulated

 

Intangible

   

Amount

 

Amortization

 

Assets


Amortized intangible assets:

           

Mortgage servicing rights

$

6,117,707

 

(2,776,625)

 

3,341,082

Core deposit intangible

 

1,567,000

 

(1,090,398)

 

476,602

   
 
 

Total

$

7,684,707

 

(3,867,023)

 

3,817,684

   
 
 

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


   

Mortgage

 

Core

   
   

Servicing

 

Deposit

   
   

Rights

 

Intangible

 

Total


Three months ended December 31, 2003

$

118,919

 

29,128

 

148,047

             

Year ended December 31,

           

2004

 

475,678

 

113,857

 

589,535

2005

 

451,440

 

113,857

 

565,297

2006

 

499,915

 

113,857

 

613,772

2007

 

475,678

 

105,903

 

581,581

2008

 

422,825

 

0

 

422,825


Projections of amortization are based on existing asset balances and the existing interest rate environment as of September 30, 2003. HMN's actual experiences may be significantly different depending upon changes in mortgage interest rates and other market conditions.

(9) Earnings per Share

The following table reconciles the weighted average shares outstanding and the income available to common shareholders used for basic and diluted EPS:


   

Three months ended September 30,

 

Nine months ended September 30,

   

2003

 

2002

 

2003

 

2002

   
 
 
 

Weighted average number of common shares outstanding

               

   Used in basic earnings per common share calculation

 

3,846,210

 

3,790,526

 

3,787,494

 

3,757,404

                 

Net dilutive effect of:

               

   Options

 

166,683

 

232,790

 

166,797

 

224,723

   Restricted stock awards

 

0

 

0

 

0

 

49

   
 
 
 

Weighted average number of shares outstanding

               

   Adjusted for effect of dilutive securities

 

4,012,893

 

4,023,316

 

3,954,291

 

3,982,176

   
 
 
 

Income available to common shareholders

$

3,040,281

 

891,865

 

6,460,049

 

4,127,876

Basic earnings per common share

$

0.79

 

0.24

 

1.71

 

1.10

Diluted earnings per common share

$

0.77

 

0.22

 

1.63

 

1.04


(10) Regulatory Capital

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

Quantitative measures established by regulations to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the following table) of Tier I or Core capital and Risk-based capital (as defined in the regulations) to total assets (as defined). Management believes, as of September 30, 2003, that the Bank meets all capital adequacy requirements to which it is subject.

Management believes that based upon the Bank's capital calculations at September 30, 2003 and other conditions consistent with the Prompt Corrective Actions Provisions of the OTS regulations, the Bank would be categorized as well capitalized.

On September 30, 2003 the Bank's tangible assets and adjusted total assets were $800 million and its risk-weighted assets were $634 million. The following table presents the Bank's capital amounts and ratios at September 30, 2003 for actual capital, required capital and excess capital including ratios in order to qualify as being well capitalized under the Prompt Corrective Actions regulations.


                     

To Be Well

 
             

Required To Be

     

Capitalized Under

 
             

Adequately

     

Prompt Corrective

 
   

Actual

   

   Capitalized

     

Excess Capital

   

Actions Provision

 
   
   
   
   
 
       

Percent of

       

Percent of

       

Percent of

       

Percent of

 

(in thousands)

 

Amount

 

Assets (1)

   

Amount

 

Assets (1)

   

Amount

 

Assets (1)

   

Amount

 

Assets (1)

 
   
 
   
 
   
 
   
 
 

Bank stockholder's equity

$

 71,522

                                   

Plus:

                                       

    Net unrealized loss (gain) on certain

                                       

    securities available for sale

                                       

and cash flow hedges

 

(491)

                                   

Less:

                                       

    Goodwill and other intangibles

 

 4,278

                                   
   
                                   

    Tier I or core capital

 

 66,753

                                   
   
                                   

    Tier I capital to adjusted total assets

     

8.35%

 

$

31,982  

 

4.00%

 

$

34,771  

 

4.35%

 

$

  39,978

 

5.00%

 

    Tier I capital to risk-weighted assets

     

10.53%

 

$

25,365  

 

4.00%

 

$

41,388  

 

6.53%

 

$

  38,047

 

6.00%

 

Plus:

                                       

    Allowable allowance for loan losses

 

 5,435

                                   
   
                                   

    Risk-based capital

$

 72,188

     

$

50,729  

     

$

21,459  

     

$

  63,411

     
   
                                   

    Risk-based capital to

                                       

       Risk-weighted assets

     

11.38%

       

8.00%

       

3.38%

       

10.00%

 

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

The tangible capital of the Bank was in excess of the minimum 2% required at September 30, 2003 but is not reflected in the table above.

(11) Commitments and Contingencies

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

The Bank issued standby letters of credit which guarantee the performance of customers to third parties. The outstanding standby letters of credit expire over the next 2 years and totaled approximately $2.5 million at September 30, 2003. The letters of credit were collateralized primarily with commercial real estate mortgages. Since the conditions under which the Bank is required to fund the standby letters of credit may not materialize, the cash requirements are expected to be less than the total outstanding commitments.

(12) Stock-Based Compensation

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


 

 

Quarter Ended
September 30, 2003

 

Quarter Ended
September 30, 2002

 

Nine Months Ended September 30, 2003

 

Nine Months Ended September 30, 2002

 
   
 
 
 
 

Net income:

 

 

 

 

 

 

 

 

 

As reported 9;

$

3,040,281

 

891,865

 

6,460,049

 

4,127,876

 

Deduct: Total stock-based employee

                 

compensation expense determined

                 

under fair value based method for all

                 

awards, net of related tax effects

 

6,788

 

10,524

 

27,043

 

31,572

 
   
 
 
 
 

Pro forma

 

3,033,493

 

881,341

 

6,433,006

 

4,096,304

 

Earnings per common share:

                 

As reported:

                 

Basic 9;

$

0.79

 

0.24

 

1.71

 

1.10

 

Diluted

 

0.76

 

0.22

 

1.63

 

1.04

 

Pro forma:

                 

Basic

 

0.79

 

0.23

 

1.70

 

1.09

 

Diluted

 

0.76

 

0.22

 

1.63

 

1.03

 
                   

 

(13) Business Segments

The Bank has been identified as a reportable operating segment in accordance with the provisions of SFAS No. 131. SFC and HMN, the holding company, did not meet the quantitative thresholds for a reportable segment and therefore are included in the "Other" category.

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

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

 


(Dollars in thousands)

 

Home Federal Savings Bank

 

 

 

Other

 

Eliminations

 

Consolidated Total

 

At or for the quarter ended September 30, 2003:

 

                   

Interest income - external customers

$

11,477

 

 

 

31

 

0

 

11,508

 

Non-interest income - external customers

 

2,949

   

 

134

 

0

 

3,083

 

Earnings (loss) on limited partnerships

 

(6)

 

 

 

16

 

0

 

10

 

Intersegment interest income

 

0

 

 

 

4

 

(4)

 

0

 

Intersegment non-interest income

 

161

 

   

2,967

 

(3,128)

 

0

 

Interest expense

 

5,069

 

   

0

 

(4)

 

5,065

 

Amortization of mortgage servicing rights,

                     

net valuation adjustments, and servicing costs

 

(113)

 

   

0

 

(80)

 

(193)

 

Other non-interest expense

 

4,456

 

   

147

 

(80)

 

4,523

 

Income tax expense (benefit)

 

1,654

(33)

0

1,621

 

Net income

 

2,968

 

   

3,040

 

(2,968)

 

3,040

 

Goodwill  

3,801

     

0

 

0

 

3,801

 

Total assets

 

806,254

     

79,674

 

(78,885)

 

807,043

 

Net interest margin

 

3.41 %

 

 

 

NM

 

NM

 

3.41%

 

Return on average assets

 

1.51 %

 

 

 

NM

 

NM

 

1.53%

 

Return on average realized common equity

 

16.67 %

 

 

 

NM

 

NM

 

15.12%

 

At or for the quarter ended September 30, 2002:

                     

Interest income - external customers

$

10,571

 

 

 

62

 

0

 

10,633

 

Non-interest income - external customers

 

1,455

     

79

 

0

 

1,534

 

Earnings (loss) on limited partnerships

 

(511)

 

   

(20)

 

0

 

(531)

 

Intersegment interest income

 

57

 

   

24

 

(81)

 

0

 

Intersegment non-interest income (expense)

 

46

 

   

901

 

(947)

 

0

 

Interest expense (benefit)

 

5,254

 

   

0

 

(81)

 

5,173

 

Amortization of mortgage servicing rights, net valuation adjustments, and servicing costs

 

553

 

   

1

 

(51)

 

503

 

Other non-interest expense

 

4,045

 

 

 

133

 

(126)

 

4,052

 

Income tax expense (benefit)

 

380

   

 

(68)

 

0

 

312

 

Minority interest

 

(67)

 

 

 

0

 

0

 

(67)

 

Net income

 

718

 

 

 

944

 

(770)

 

892

 

Goodwill

 

3,801

   

 

0

 

0

 

3,801

 

Total assets

 

720,063

 

 

 

75,384

 

(75,978)

 

719,469

 

Net interest margin

 

3.31%

     

NM

 

NM

 

3.29%

 

Return on average assets

 

0.49%

     

NM

 

NM

 

0.51%

 

Return on average realized common equity

 

5.35%

     

NM

 

NM

 

4.58%

                                                  NM - Not meaningful

 


(Dollars in thousands)

 

Home Federal Savings Bank

     

Other

 

Eliminations

 

Consolidated Total

 

At or for the nine months ended September 30, 2003:

 

                 

 

Interest income - external customers

$

32,887

 

 

 

128

 

0

 

33,015

 

Non-interest income - external customers

 

8,369

   

 

301

 

0

 

8,670

 

Earnings (loss) on limited partnerships

 

(369)

 

 

 

56

 

0

 

(313)

 

Intersegment interest income

 

28

 

 

 

26

 

(54)

 

0

 

Intersegment non-interest income

 

669

 

 

 

6,256

 

(6,925)

 

0

 

Intersegment loan loss provision

 

200

 

 

 

0

 

(200)

 

0

 

Interest expense

 

15,177

 

 

 

0

 

(54)

 

15,123

 

Amortization of mortgage servicing rights, net valuation adjustments, and servicing costs

 

1,925

 

 

 

3

 

(223)

 

1,705

 

Other non-interest expense

 

12,853

 

 

 

412

 

(246)

 

13,019

 

Income tax expense (benefit)

 

3,269

 

(105)

 

0

 

3,164

 

Net income

 

6,260

 

 

 

6,457

 

(6,257)

 

6,460

 

Goodwill

3,801

0

0

3,801

Total assets

806,254

 

79,674

 

(78,885)

 

807,043

 

Net interest margin

3.27 %

 

 

NM

 

NM

 

3.29%

 

Return on average assets

1.10 %

 

 

NM

 

NM

 

1.13%

 

Return on average realized common equity

12.05 %

 

 

NM

 

NM

 

10.99%

At or for the nine months ended September 30, 2002:

Interest income - external customers

$

32,021

 

 

263

 

0

 

32,284

Non-interest income - external customers

4,538

 

125

 

0

 

4,663

Earnings (loss) on limited partnerships

(208)

 

 

4

 

0

 

(204)

Intersegment interest income

472

 

 

24

 

(496)

 

0

Intersegment non-interest income

307

 

 

4,030

 

(4,337)

 

0

Interest expense

16,588

 

 

0

 

(496)

 

16,092

Amortization of mortgage servicing rights, net valuation adjustments, and servicing costs

 

1,026

 

 

 

1

 

(142)

 

885

 

Other non-interest expense

 

12,376

 

 

 

419

 

(454)

 

12,341

 

Income tax expense (benefit)

 

1,855

   

 

(218)

 

0

 

1,637

 

Minority interest

(141)

 

 

0

 

0

 

(141)

Net income

3,741

 

 

4,128

 

(3,741)

 

4,128

Goodwill

 

3,801

     

0

 

0

 

3,801

 

Total assets

 

720,063

     

75,384

 

(75,978)

 

719,469

 

Net interest margin

3.26%

NM

NM

3.23%

Return on average assets

 

0.77%

     

NM

 

NM

 

0.78%

 

Return on average realized common equity

8.56%

NM

NM

7.33%

NM - Not meaningful

 

 

Item 2:

HMN FINANCIAL, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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

General
HMN's net income is dependent primarily on its net interest income, which is the difference between interest earned on its loans and investments and the interest paid on deposits and advances. Net interest income is determined by (i) the difference between the yield earned on interest-earning assets and interest rates paid on interest-bearing liabilities (interest rate spread) and (ii) the relative amounts of interest-earning assets and interest-bearing liabilities. HMN's interest rate spread is affected by regulatory, economic and competitive factors that influence interest rates, loan demand and deposit flows. Net interest margin is calculated by dividing net interest income by the average interest-earning assets and is normally expressed as a percentage. Net interest income and net interest margin are affected by changes in interest rates, the volume and the mix of interest-earning assets and interest-bearing liabilities, and the level of non-performing assets. HMN's net income is also affected by the generation of non-interest income, which primarily consists of gains from the sale of securities, gains from the sale of loans, service charges, fees and other income. In addition, net income is affected by the level of operating expenses, provisions made for loan losses and impairment reserve adjustments on mortgage servicing assets.

The operations of financial institutions, including the Bank, are significantly affected by prevailing economic conditions, competition, and the monetary and fiscal policies of governmental agencies. Lending activities are influenced by the demand for and supply of housing and commercial real estate, competition among lenders, the level of interest rates and the availability of funds. Deposit flows and costs of funds are influenced by prevailing market rates of interest primarily on competing investments, the mix of deposit accounts, account maturities and the levels of personal income and savings in the market area of the Bank.

Critical Accounting Policies
Critical accounting policies are those policies that management believes are the most important to the portrayal of the company's financial condition and operating results that require difficult, subjective, or complex judgment. These judgments are often the result of the need to make estimates about the effect of matters that are inherently uncertain and therefore actual results could differ significantly from the estimates used. Management considers the following items to be the critical accounting policies of HMN.

Allowance for Loan Losses and Related Provision
The allowance for loan losses is based on periodic analysis of the loan portfolio by management. In this analysis, management considers factors including, but not limited to, specific occurrences that include loan impairment, changes in the size of the portfolios, general economic conditions, loan portfolio composition, and historical experience. The allowance for loan losses is established for known problem loans, as well as for loans which are not currently known to require specific allowances. Loans are charged off to the extent they are deemed to be uncollectible. The adequacy of the allowance for loan losses is dependent upon management's estimates of variables affecting valuation, appraisals of collateral, evaluations of performance and status, and the amounts and timing of future cash flows expected to be received on impaired loans. Such estimates, appraisals, evaluations and cash flows may be subject to frequent adjustments due to changing economic prospects of borrowers or properties. The estimates are reviewed periodically and adjustments, if any, are recorded in the provision for loan losses in the periods in which the adjustments become known. Although management believes that the allowance for loan losses is maintained at an amount considered adequate to provide for probable loan losses inherent in the portfolio as of the balance sheet dates, future adjustments to the provision for loan losses may be necessary if conditions differ substantially from those in the assumptions used to determine the allowance for loan losses.

Mortgage Servicing Rights
Mortgage servicing rights are capitalized and amortized in proportion to, and over the period of, estimated net servicing income. HMN periodically evaluates its capitalized mortgage servicing rights for impairment. 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. The valuation of the mortgage servicing rights is based on the estimated prepayment speeds and default rates of the stratified portfolio. Changes in the mix of loans, interest rates, prepayment speeds, or default rates from the estimates used in the valuation of the mortgage servicing rights may have a material effect on the amortization and valuation of mortgage servicing rights. Although management believes that the assumptions used and the values determined are reasonable, future adjustments may be necessary if economic conditions differ substantially from the economic conditions in the assumptions used to determine the value of the servicing rights. Refer to the "Mortgage servicing rights, net" line item in the market risk table on page 23 for an indication of how the value of mortgage servicing rights may change in relation to changes in interest rates.

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.

Net Income
HMN's net income for the third quarter of 2003 was $3.0 million, an increase of $2.1 million, or 240.9%, compared to net income of $892,000 for the third quarter of 2002. Basic earnings per share were $0.79 for the quarter ended September 30, 2003, an increase of $0.55 per share, or 229.2%, from $0.24 basic earnings per share for the same quarter of 2002. Diluted earnings per share were $0.76 for the third quarter of 2003, an increase of $0.54, or 245.5%, from $0.22 diluted earnings per share for the third quarter of 2002.

HMN's net income for the nine months ended September 30, 2003 was $6.5 million, an increase of $2.3 million, or 56.5%, compared to net income of $4.1 million for the same nine month period of 2002. Basic earnings per share were $1.71 for the nine months ended September 30, 2003, an increase of $0.61 per share, or 55.5%, from $1.10 basic earnings per share for the same nine month period of 2002. Diluted earnings per share were $1.63 for the nine months ended September 30, 2003, an increase of $0.59, or 56.7%, from $1.04 diluted earnings per share for the same nine month period of 2002.

Net Interest Income
Net interest income was $6.4 million for the third quarter of 2003, an increase of $983,000, or 18.0%, compared to $5.5 million for the third quarter of 2002. Interest income was $11.5 million for the third quarter of 2003, an increase of $875,000, or 8.2%, compared to $10.6 million for the same period of 2002.
Interest income increased primarily due to an increase in interest-earning assets and a change in the mix of assets between the periods. The increase in interest-earning assets was caused primarily by the $141 million increase in commercial loans between the periods. The increase in interest income on the commercial loan portfolio was partially offset by lower income in the investment and single-family loan portfolios caused by a decrease in the outstanding balances and lower interest rates of these assets between the periods. Interest expense was $5.1 million for the third quarter of 2003, a decrease of $108,000 compared to $5.2 million for the third quarter of 2002. Interest expense declined primarily due to a decrease in the interest rates paid on deposits and Federal Home Loan Bank advances and a $49 million increase in the outstanding average balances of checking and money market accounts between the periods, which generally have lower interest rates than other deposit accounts.

Net interest margin (net interest income divided by average interest earning assets) for the third quarter of 2003 was 3.41%, an increase of 12 basis points, compared to 3.29% for the third quarter of 2002.

Net interest income for the nine month period ended September 30, 2003 was $17.9 million, an increase of $1.7 million, or 10.5%, compared to $16.2 million for the same period of 2002. Interest income for the nine month period of 2003 was $33.0 million, an increase of $730,000, or 2.3%, compared to $32.3 million for the same period of 2002. Interest income increased primarily due to an increase in interest-earning assets and a change in the mix of assets between the periods. The increase in interest-earning assets was caused primarily by the $136 million increase in commercial loans between the periods. The increase in interest-earning assets totally offset the decrease in interest income caused by the lower interest rates earned on the assets between the two periods. Interest expense was $15.1 million for the nine-month period of 2003, a decrease of $969,000, or 6.0%, from the $16.1 million for the same period in 2002. Interest expense declined primarily due to a decrease in the interest rates paid on deposits and Federal Home Loan Bank advances and a $42 million increase in the outstanding average balances of checking and money market accounts between the periods, which generally have lower interest rates than other deposit accounts.

Net interest margin (net interest income divided by average interest-earning assets) for the nine months ended September 30, 2003, was 3.29%, an increase of 6 basis points, compared to 3.23% for the same period of 2002.

Provision for Loan Losses
The provision for loan losses for the third quarter ended September 30, 2003 was $545,000, a decrease of $226,000, or 29.3%, compared to $771,000 for the third quarter of 2002. The provision for loan losses decreased primarily due to the slower loan growth that was experienced in the third quarter of 2003 when compared to the third quarter of 2002.
The provision for loan losses for the nine months ended September 30, 2003 was $1.9 million, an increase of $99,000, or 5.5% compared to $1.8 million for the same nine month period in 2002. The provision for loan losses increased primarily due to the slightly higher growth experienced in the commercial and consumer loan portfolios in the first nine months of 2003 compared to the same period of 2002. The provision is the result of management's evaluation of the composition of the loan portfolio, the historical level of non-performing loans, loan charge-off experience, and its assessment of the general economic conditions in the geographic area where properties securing the loan portfolio are located such as national and regional unemployment data, local single family construction permits and local economic growth rates. Management's evaluation of probable losses inherent in the loan portfolio revealed conditions that resulted in increasing the 2003 loan loss provision compared to the provision for 2002. HMN will continue to monitor its allowance for losses and adjust it as conditions dictate. Future economic conditions and other unknown factors will impact the need for future provisions for loan losses. As a result, no assurances can be given that increases in the allowance for loan losses will not be required during future periods.

A reconciliation of HMN's allowance for loan losses is summarized as follows:


2003

 

2002

 
 

Balance at January 1,

$4,824,217

 

$  3,783,112

Provision

1,900,000

 

1,801,000

Commercial loan charge offs

(19,279)

 

(577,125)

Consumer loan charge offs

(134,025)

 

(260,895)

Single family mortgage loan charge offs

(33,750)

 

(44,408)

Recoveries

54,652

 19,177

 
 

Balance at September 30,

$6,591,815

 

$4,720,861

 
 

Non-Interest Income
Non-interest income was $3.1 million for the third quarter of 2003, an increase of $2.1 million, or 208.4%, from $1.0 million for the same period in 2002. Non-interest income increased by $1.2 million due to increased gains recognized on the sale of single family loans during the quarter. The low interest rate environment during the quarter enabled HMN to originate a high number of single-family mortgage loans with the majority of these loans being sold on the secondary mortgage market. Losses in limited partnerships were reduced by $541,000 between the periods as HMN's investment in a limited partnership that invested in mortgage servicing rights was written down to zero and dissolved during the second quarter of 2003. As a result, HMN anticipates less volatility in its investments in limited partnerships in the future. Fees and service charges increased by $207,000 between the periods due to an overdraft protection program that was implemented during the second quarter of 2003 and increases in the fees charged and the number of deposit accounts. Mortgage servicing fees increased by $76,000 as more loans are being serviced in 2003 than in 2002. Non-interest income also improved by $41,000 due to increased gains recognized on the sale of securities as investments were sold to fund a portion of the loan growth during the period.

Non-interest income was $8.4 million for the first nine months of 2003, an increase of $3.9 million, or 87.4%, from $4.5 million for the same period in 2002. Non-interest income increased by $2.6 million due to increased gains on the sale of single-family loans. Low mortgage rates during the first nine-months of 2003 resulted in higher loan originations when compared to the same period of 2002 as consumers took advantage of the low mortgage interest rates to purchase a home or refinance their existing home mortgage. Gains on the sale of securities increased by $811,000 between the periods as investments were sold to fund a portion of the $78 million in loan growth that was experienced during the first nine months of 2003. Fee and service charge income increased by $400,000 between the periods due to an overdraft protection program that was implemented during the second quarter of 2003 and increases in the fees charged and the number of deposit accounts. Mortgage servicing fees increased by $195,000 because more loans are being serviced in 2003 than in 2002. Losses from limited partnerships increased by $109,000 between the periods. The decrease in mortgage interest rates during the first half of 2003 caused the value of HMN's investment in a limited partnership that owned mortgage loan servicing assets to decrease in value due to the anticipated increase in prepayments expected to be received on the partnerships' mortgage servicing assets. The servicing rights were sold and this partnership was dissolved in the second quarter of 2003.

Non-Interest Expense
Non-interest expense was $4.3 million for the third quarter of 2003, a decrease of $225,000, or 4.9%, from $4.6 million for the third quarter of 2002. Amortization of mortgage servicing rights decreased by $696,000, or 138.5%, due primarily to the recapture of $810,000 in previously recognized impairment reserves on the mortgage servicing rights portfolio as a result of rising interest rates at the end of the quarter. Generally, as interest rates increase the value of fixed rate mortgage servicing rights increases and when interest rates decrease the value of the fixed rate mortgage servicing rights decreases due to changes in the anticipated cash flows from payments on the loans being serviced. Other operating expenses increased by $367,000 and compensation costs increased by $99,000 between the periods primarily due to the increased costs associated with the higher loan production in the current quarter compared to the same period in 2002.

Non-interest expense was $14.7 million for the first nine months of 2003, an increase of $1.5 million, or 11.3%, from $13.2 million for the same period in 2002. The increase was primarily the result of an $821,000 increase in the amortization of mortgage servicing rights caused by record loan prepayments during the first nine months of 2003. Compensation and benefit expense increased by $386,000 due to costs associated with a separation agreement with a former executive officer and annual payroll and health insurance cost increases. Occupancy expense increased by $188,000 due to the increased number of facilities maintained during the nine-month period in 2003.

Income Tax Expense
Income tax expense was $1.6 million for the third quarter of 2003, an increase of $1.3 million compared to $312,000 for the same period of 2002. Income tax expense was $3.2 million for the nine-month period ended

September 30, 2003, an increase of $1.5 million compared to $1.6 million for the same nine-month period of 2002. The increase in income tax is primarily due to an increase in taxable income

Non-Performing Assets

The following table sets forth the amounts and categories of non-performing assets in the Bank's portfolio at

September 30, 2003 and December 31, 2002.


 

Sept.30,

   

Dec.31,

 

(Dollars in Thousands)

 

2003

   

2002

 

Non-Accruing Loans:

           

One-to-four family real estate

$

1,073

   

695

 

Commercial real estate

 

2,732

   

1,719

 

Consumer

 

912

   

495

 

Commercial business

 

678

   

427

 
   
   
 

Total

 

5,395

   

3,336

 
   
   
 

Accruing loans delinquent 90 days or more

 

114

   

171

 

Other assets

211

866

Foreclosed and Repossessed Assets

           

One-to-four family real estate

 

180

   

300

 

Consumer

 

71

   

127

 

Commercial

 

50

   

107

 
   
   
 

Total non-performing assets

$

6,021

 

$

4,907

 
   
   
 

Total as a percentage of total assets

 

0.75

%

 

0.67

%

   
   
 

Total non-performing loans

$

5,509

 

$

3,507

 
   
   
 

Total as a percentage of total loans receivable, net

 

0.85

%

 

0.66

%

Allowance for loan loss to non-performing loans

 

119.64

%

 

134.60

%


Total non-performing assets at September 30, 2003 were $6.0 million, an increase of $1.1 million, from $4.9 million at December 31, 2002. The increase in non-performing assets relates primarily to an increase of $1.0 million in non-accruing commercial real estate loans primarily due to one commercial loan in the hospitality industry that became nonaccruing in 2003.

Dividends
On October 28, 2003 HMN declared a cash dividend of $0.20 per share, payable on December 17, 2003 to shareholders of record on November 28, 2003.

During 2003, HMN has declared and paid dividends as follows:

Record date

Payable date

Dividend per share

Dividend Payout Ratio


February 21, 2003

March 7, 2003

$0.18

64.29%

May 22, 2003

June 9, 2003

$0.18

50.00%

August 28, 2003

September 11, 2003

$0.20

38.46%

       

The annualized dividend payout ratio for the past four quarters, ending with the December 17, 2003 payment will be 39.58%.

The declaration of dividends are subject to, among other things, HMN's financial condition and results of operations, the Bank's compliance with its regulatory capital requirements, including the fully phased-in capital requirements, tax considerations, industry standards, economic conditions, regulatory restrictions, general business practices and other factors.

Liquidity
For the nine months ended September 30, 2003, the net cash provided by operating activities was $9.8 million. HMN collected $40.3 million from the sale of securities, $37.8 million from principal repayments and the maturity of securities and $423,000 in proceeds from the sale of real estate. It purchased premises and equipment of $790,000, purchased securities available for sale of $46.5 million and net loans receivable increased by $117.6 million due to loan growth primarily in the commercial and consumer loan areas. HMN had a net increase in deposit balances of $57.2 million for the nine month period. It repaid $120 million of FHLB advances and received $286,000 from borrowers for taxes and insurance. HMN received $1.2 million related to the exercise of stock options, purchased $1.4 million of its own stock, and paid $2.1 million in dividends to its shareholders.

HMN has certificates of deposits with outstanding balances of $163.0 million that come due over the next 12 months. Based upon past experience management anticipates that the majority of the deposits will renew for another term. HMN believes that deposits that do not renew will be replaced with deposits from other customers or brokers, or funded with advances from the FHLB, or will be funded through the sale of securities. Management does not anticipate that it will have a liquidity problem due to maturing deposits.

HMN has $115.9 million of FHLB advances which mature after September 30, 2004 but have call features that can be exercised by the FHLB during the next 12 months. If the call features are exercised HMN has the option of requesting any advance otherwise available to it pursuant to the Credit Policy of the FHLB. HMN also has $15.0 million of FHLB advances which will mature during the next 12 months. Since HMN has the ability to request another advance to replace the advance that is being called or is maturing, management does not anticipate that it will have a liquidity problem due to advances being called by the FHLB during the next 12 months.

Market Risk
Market risk is the risk of loss from adverse changes in market prices and interest rates. HMN's market risk arises primarily from interest rate risk inherent in its investing, lending and deposit taking activities. Management actively monitors and manages its interest rate risk exposure.

HMN's profitability is affected by fluctuations in interest rates. A sudden and substantial change in interest rates may adversely impact HMN's earnings to the extent that the interest rates borne by assets and liabilities do not change at the same speed, to the same extent, or on the same basis. HMN monitors the projected changes in net interest income that occur if interest rates were to suddenly change up or down. The Rate Shock Table located below in the Asset/Liability Management section of this report discloses HMN's projected changes in net interest income based upon immediate interest rate changes called rate shocks.

HMN utilizes a model which uses the discounted cash flows from its interest-earning assets and its interest-bearing liabilities to calculate the current market value of those assets and liabilities. The model also calculates the changes in market value of the interest-earning assets and interest-bearing liabilities due to different interest rate changes. HMN believes that over the next twelve months interest rates could conceivably fluctuate in a range of 200 basis points up or 100 basis points down from where the interest rates were at September 30, 2003. HMN does not have a trading portfolio. The following table discloses the projected changes in market value to HMN's interest-earning assets and interest-bearing liabilities based upon incremental 100 basis point changes in interest rates from interest rates in effect on September 30, 2003.

 

 

 


Other than trading portfolio

Market Value

(Dollars in thousands)
Basis point change in interest rates

 

-100

 

0

 

+100

 

+200

 


Cash equivalents

$

17,868

 

17,855

 

17,842

 

17,829

 

Securities available for sale:

                 

Fixed-rate CMOs

 

14,851

 

14,566

 

14,118

 

12,976

 

Variable-rate CMOs

 

1,678

 

1,685

 

1,699

 

1,707

 

Fixed-rate available for sale mortgage-backed and related securities

 

536

 

531

 

522

 

508

 

Variable-rate available for sale mortgage- Backed and related securities

 

117

 

118

 

118

 

117

 

Fixed-rate available for sale other marketable securities

 

72,561

 

71,263

 

69,990

 

68,745

 

Variable-rate available for sale other marketable securities

 

111

 

107

 

104

 

103

 

Federal Home Loan Bank stock

 

11,783

 

11,228

 

10,708

 

10,222

 

Fixed-rate loans held for sale

 

17,692

 

17,677

 

17,663

 

17,648

 

Loans receivable, net:

                 

Fixed-rate real estate loans

 

157,576

 

155,365

 

151,952

 

147,896

 

Variable-rate real estate loans

 

290,277

 

285,185

 

279,976

 

275,179

 

Fixed-rate other loans

 

83,125

 

82,078

 

80,552

 

79,157

 

Variable-rate other loans

 

144,509

 

139,823

 

137,430

 

135,529

 

Mortgage servicing rights, net

 

2,042

 

3,341

 

3,947

 

4,195

 

Investment in limited partnerships

 

548

 

547

 

547

 

547

 

   
 
 
 
 

Total market risk sensitive assets

 

815,274

 

801,369

 

787,168

 

772,358

 

   
 
 
 
 

NOW deposits

 

75,814

 

75,814

 

75,814

 

75,814

 

Passbook deposits

 

36,005

 

36,005

 

36,005

 

36,005

 

Money market deposits

 

86,088

 

86,088

 

86,088

 

86,088

 

Certificate deposits

 

301,245

 

297,100

 

293,064

 

289,384

 

Fixed-rate Federal Home Loan Bank advances

 

232,019

 

223,492

 

217,386

 

212,240

 

Variable-rate Federal Home Loan Bank advances

 

14,999

 

14,999

 

14,999

 

14,999

 

   
 
 
 
 

Total market risk sensitive liabilities

 

746,170

 

733,498

 

723,356

 

714,530

 





Off-balance sheet financial instruments:

Commitments to extend credit

 

782

 

0

 

(782)

 

(1,117)

 

Commitments to sell or deliver loans

 

(1,162)

 

0

 

1,162

 

1,661

 





Net market risk

$

69,484

67,871

63,432

57,284

   
 
 
 
 

Percentage change from current market value

 

2.38

%

0.00

%

(6.54)

%

(15.60)

%

   
 
 
 
 

 


 

The preceding table was prepared utilizing the following assumptions (Model Assumptions) regarding prepayment and decay ratios which were determined by management based upon their review of historical prepayment speeds and future prepayment projections. Fixed rate loans were assumed to prepay at annual rates of between 7% to 52%, depending on the note rate and the period to maturity. Adjustable rate mortgages (ARMs) were assumed to prepay at annual rates of between 11% and 18%, depending on the note rate and the period to maturity. Growing Equity Mortgage (GEM) loans were assumed to prepay at annual rates of between 7% and 23% depending on the note rate and the period to maturity. Mortgage-backed securities and Collateralized Mortgage Obligations (CMOs) were projected to have prepayments based upon the underlying collateral securing the instrument and the related cash flow priority of the CMO tranche owned. Certificate accounts were assumed not to be withdrawn until maturity. Passbook and money market accounts were assumed to decay at an annual rate of 20%. FHLB advances were projected to be called at the first call date where the projected interest rate on similar remaining term advances exceeded the interest rate on HMN's callable advance.

Certain shortcomings are inherent in the method of analysis presented in the foregoing table. 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 (Interest Spread) will remain constant over the interest changes disclosed in the table. Changes in Interest Spread could impact projected market value changes. Certain assets, such as ARMs, have features which restrict changes in interest rates on a short-term basis and over the life of the assets. The market value of the interest-bearing assets which are approaching their lifetime interest rate caps could be different from the values disclosed in the table. In the event of a change in interest rates, prepayment and early withdrawal levels may deviate significantly from those assumed in calculating the foregoing table. The ability of many borrowers to service their debt may decrease in the event of an interest rate increase.

Asset/Liability Management
HMN's management reviews the impact that changing interest rates will have on its net interest income projected for the twelve months following September 30, 2003 to determine if its current level of interest rate risk is acceptable. The following table projects the estimated annual impact on net interest income of immediate interest rate changes called rate shocks.


Rate Shock

 

Net Interest

 

Percentage

in Basis Points

 

Income

 

Change


+200

 

26,475,000

 

10.60 %

+100

 

25,760,000

 

7.61 %

0

 

23,938,000

 

0.00 %

-100

 

21,781,000

 

-9.01 %


The preceding table was prepared utilizing the Model Assumptions regarding prepayment and decay ratios which were determined by management based upon their review of historical prepayment speeds and future prepayment projections.

Certain shortcomings are inherent in the method of analysis presented in the foregoing table. In the event of a change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed in calculating the foregoing table. The ability of many borrowers to service their debt may decrease in the event of a substantial increase in interest rates and could impact net interest income.

In an attempt to manage its exposure to changes in interest rates, management closely monitors interest rate risk. The Bank has an Asset/Liability Committee consisting of executive officers which meets at least quarterly to review the interest rate risk position and projected profitability. The committee makes adjustments to the asset/liability position of the Bank which are reported to the Board of Directors of the Bank. This Committee also reviews the Bank's portfolio, formulates investment strategies and oversees the timing and implementation of transactions to assure attainment of the Board's objectives in the most effective manner. In addition, the Board reviews on a quarterly basis the Bank's asset/liability position, including simulations of the effect on the Bank's capital of various interest rate scenarios.

In managing its asset/liability mix, the Bank, at times, depending on the relationship between long- and short-term interest rates, market conditions and consumer preference, may place more emphasis on managing net interest

margin than on better matching the interest rate sensitivity of its assets and liabilities in an effort to enhance net

interest income. Management believes that the increased net interest income resulting from a mismatch in the maturity of its asset and liability portfolios can, during periods of declining or stable interest rates, provide high enough returns to justify the increased exposure to sudden and unexpected increases in interest rates.

To the extent consistent with its interest rate spread objectives, the Bank attempts to reduce its interest rate risk and has taken a number of steps to restructure its assets and liabilities. The Bank has primarily focused its fixed rate one-to-four family residential lending program on loans with contractual terms of 10 years or less. The Bank generally follows the practice of selling all of its fixed rate single family loans with contractual terms greater than 10 years which conform to the secondary market guidelines. HMN continues to focus its portfolio lending on the origination of commercial and consumer loans which generally have shorter weighted average terms to maturity and/or interest rates which adjust at least every three years. At times, depending on its interest rate sensitivity, the Bank may sell fixed rate single family loans in order to reduce interest rate risk and record a gain on the sale of loans.

Item 4: Controls and Procedures
Evaluation of disclosure controls and procedures.
As of the end of the period covered by this report, the Company conducted an evaluation, under the supervision and with the participation of the principal executive officer and principal financial officer, of the Company's disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (Exchange Act)). Based on this evaluation, the principal executive officer and principal financial officer 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 Securities and Exchange Commission rules and forms. There was no change in the Company's internal control over financial reporting during the Company's most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.

 

HMN FINANCIAL, INC.

PART II - OTHER INFORMATION

ITEM 1. Legal Proceedings.

None.

ITEM 2. Changes in Securities and Use of Proceeds.

Not applicable.

ITEM 3. Defaults Upon Senior Securities.

Not applicable.

ITEM 4. Submission of Matters to a Vote of Security Holders.

None.

ITEM 5. Other Information.

None.

ITEM 6. Exhibits and Reports on Form 8-K.

    1. Exhibits. See Index to Exhibits on page 28 of this report.
    2. Reports furnished on Form 8-K.

(1) On July 25, 2003, HMN reported its financial results for its second fiscal quarter ended June 30, 2003.

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

SIGNATURES

Pursuant to the requirement of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

HMN FINANCIAL, INC.

 

Registrant

   
   

Date: November 10, 2003

/s/ Michael McNeil

 

Michael McNeil,

 

President/Chief Executive Officer

 

(Principal Executive Officer)
(Duly Authorized Representative)

   

Date: November 10, 2003

/s/ Jon Eberle
 

Jon Eberle,

 

Chief Financial Officer

 

(Principal Financial Officer)

 

 

HMN FINANCIAL, INC.
INDEX TO EXHIBITS
FOR FORM 10-Q

 

         

Sequential

       

Reference

Page Numbering

Regulation

   

to Prior

Where Attached

S-K

   

Filing or

Exhibits Are

Exhibit

   

Exhibit

Located in This

Number

 

Document Attached Hereto

Number

Form 10-Q Report


3.1

 

Amended and Restated Articles of Incorporation

*1

N/A

           

3.2

 

Amended and Restated By-laws

*2

N/A

           

4

 

Form of Common Stock

*3

N/A

     

Including indentures

 

 

31.1

 

Rule 13a-14(a)/15d-14(a) Certification of CEO

31.1

Filed Electronically

         

31.2

 

Rule 13a-14(a)/15d-14(a) Certification of CFO

31.2

Filed Electronically

         

32

 

Section 1350 Certification of CEO and CFO

32

Filed Electronically


*1

Incorporated by reference to the same numbered exhibit to the Company's Quarterly Report on Form 10-Q for the period ended March 31, 1998 (File No. 0-24100).

           

*2

Incorporated by reference to the same numbered exhibit to the Company's Quarterly Report on Form 10-Q for the period ended September 30, 1997 (File 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).


 

EXHIBIT 31.1

CERTIFICATIONS

I, Michael McNeil, certify that:

1. I have reviewed this quarterly report on Form 10-Q 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)) for the registrant and we 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) evaluated the effectiveness of the registrant's disclosure controls and procedures 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

c) disclosed in this report any change in the registrant's internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal 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: November 10, 2003                     By /s/ Michael McNeil
                                                             President/Chief Executive Officer

 

 

 

 

 

 

 

EXHIBIT 31.2

CERTIFICATIONS

I, Jon Eberle, certify that:

1. I have reviewed this quarterly report on Form 10-Q 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)) for the registrant and we 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) evaluated the effectiveness of the registrant's disclosure controls and procedures 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

c) disclosed in this report any change in the registrant's internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal 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: November 10, 2003                         By /s/ Jon Eberle
                                                                Senior Vice President/CFO