HMN FINANCIAL INC - Quarter Report: 2010 March (Form 10-Q)

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

		For the quarterly period ended March 31, 2010
		OR

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

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 þ No o

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 o No o

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 the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

     Yes o No þ

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

Class		Outstanding at April 21, 2010
Common stock, $0.01 par value		4,316,359

 

 

HMN FINANCIAL, INC.
CONTENTS

				Page
PART I — FINANCIAL INFORMATION
Item 1:		Financial Statements (unaudited)
		Consolidated Balance Sheets at March 31, 2010 and December 31, 2009		3
		Consolidated Statements of Loss for the Three Months Ended March 31, 2010 and 2009		4
		Consolidated Statement of Stockholders’ Equity and Comprehensive Loss for the Three Month Period Ended March 31, 2010		5
		Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2010 and 2009		6
		Notes to Consolidated Financial Statements		7
Item 2:		Management’s Discussion and Analysis of Financial Condition and Results of Operations		16
Item 3:		Quantitative and Qualitative Disclosures about Market Risk (Included in Item 2 under Market Risk)		24
Item 4:		Controls and Procedures		26
PART II — OTHER INFORMATION
Item 1:		Legal Proceedings		27
Item 1A:		Risk Factors		27
Item 2:		Unregistered Sales of Equity Securities and Use of Proceeds		28
Item 3:		Defaults Upon Senior Securities		28
Item 4:		[Removed and Reserved]		28
Item 5:		Other Information		28
Item 6:		Exhibits		28
Signatures				29
EX-31.1
EX-31.2
EX-32

PART I – FINANCIAL INFORMATION

Item 1 : Financial Statements

HMN FINANCIAL, INC. AND SUBSIDIARIES

		March 31,				December 31,
(Dollars in thousands)		2010				2009
		(unaudited)
Assets
Cash and cash equivalents		$	34,301				16,418
Securities available for sale:
Mortgage-backed and related securities (amortized cost $46,676 and $51,840)			48,368				53,559
Other marketable securities (amortized cost $113,744 and $105,723)			113,714				106,043
			162,082				159,602
Loans held for sale			2,386				2,965
Loans receivable, net			774,336				799,256
Accrued interest receivable			3,786				4,024
Real estate, net			12,725				16,257
Federal Home Loan Bank stock, at cost			7,286				7,286
Mortgage servicing rights, net			1,356				1,315
Premises and equipment, net			10,403				10,766
Prepaid expenses and other assets			6,284				6,762
Deferred tax asset, net			13,531				11,590
Total assets		$	1,028,476				1,036,241
Liabilities and Stockholders’ Equity
Deposits		$	789,792				796,011
Federal Home Loan Bank advances and Federal Reserve borrowings			132,500				132,500
Accrued interest payable			1,747				2,108
Customer escrows			2,112				1,427
Accrued expenses and other liabilities			4,635				4,257
Total liabilities			930,786				936,303
Commitments and contingencies
Stockholders’ equity:
Serial preferred stock ($.01 par value):
Authorized 500,000 shares; issued shares 26,000			23,901				23,785
Common stock ($.01 par value):
Authorized 11,000,000; issued shares 9,128,662			91				91
Additional paid-in capital			56,326				58,576
Retained earnings, subject to certain restrictions			83,943				86,115
Accumulated other comprehensive income, net of tax			1,003				1,230
Unearned employee stock ownership plan shares			(3,529	)			(3,577	)
Treasury stock, at cost 4,812,303 and 4,965,766 shares			(64,045	)			(66,282	)
Total stockholders’ equity			97,690				99,938
Total liabilities and stockholders’ equity		$	1,028,476				1,036,241

See accompanying notes to consolidated financial statements.

HMN FINANCIAL, INC. AND SUBSIDIARIES

(unaudited)

		Three Months Ended
		March 31,
(Dollars in thousands)		2010				2009
Interest income:
Loans receivable		$	11,759				13,628
Securities available for sale:
Mortgage-backed and related			535				802
Other marketable			572				946
Cash equivalents			1				0
Other			37				(23	)
Total interest income			12,904				15,353
Interest expense:
Deposits			3,421				4,975
Federal Home Loan Bank advances and Federal Reserve borrowings			1,522				1,596
Total interest expense			4,943				6,571
Net interest income			7,961				8,782
Provision for loan losses			6,533				6,569
Net interest income after provision for loan losses			1,428				2,213
Non-interest income:
Fees and service charges			842				1,027
Loan servicing fees			268				252
Gain on sales of loans			314				423
Other			150				131
Total non-interest income			1,574				1,833
Non-interest expense:
Compensation and benefits			3,449				3,849
(Gain) loss on real estate owned			(761	)			1,103
Occupancy			1,031				1,092
Deposit insurance			517				330
Data processing			276				279
Other			1,505				1,775
Total non-interest expense			6,017				8,428
Loss before income tax benefit			(3,015	)			(4,382	)
Income tax benefit			(1,168	)			(1,760	)
Net loss			(1,847	)			(2,622	)
Preferred stock dividends and discount			(440	)			(429	)
Net loss available to common shareholders			(2,287	)			(3,051	)
Basic loss per common share		$	(0.61	)			(0.83	)
Diluted loss per common share		$	(0.61	)			(0.83	)

See accompanying notes to consolidated financial statements.

HMN FINANCIAL, INC. AND SUBSIDIARIES

(unaudited)

																						Unearned
																						Employee
																		Accumulated				Stock								Total
										Additional								Other				Ownership								Stock-
		Preferred				Common				Paid-in				Retained				Comprehensive				Plan				Treasury				Holders’
(Dollars in thousands)		Stock				Stock				Capital				Earnings				Income				Shares				Stock				Equity
Balance, December 31, 2009		$	23,785				91				58,576				86,115				1,230				(3,577	)			(66,282	)			99,938
Net loss															(1,847	)															(1,847	)
Other comprehensive loss, net of tax:
Net unrealized losses on securities available for sale																			(227	)											(227	)
Total comprehensive loss																															(2,074	)
Preferred stock discount amortization			116								(116	)																			0
Stock compensation tax benefits											16																				16
Unearned compensation restricted stock awards											(2,237	)															2,237				0
Amortization of restricted stock awards											97																				97
Preferred stock dividends paid															(325	)															(325	)
Earned employee stock ownership plan shares											(10	)											48								38
Balance, March 31, 2010		$	23,901				91				56,326				83,943				1,003				(3,529	)			(64,045	)			97,690

See accompanying notes to consolidated financial statements.

HMN FINANCIAL, INC. AND SUBSIDIARIES

(unaudited)

		Three Months Ended
		March 31,
(Dollars in thousands)		2010				2009
Cash flows from operating activities:
Net loss		$	(1,847	)			(2,622	)
Adjustments to reconcile net loss to cash provided by operating activities:
Provision for loan losses			6,533				6,569
Provision for real estate losses			0				1,024
Depreciation			397				488
Amortization of premiums, net			186				122
Amortization of deferred loan fees			(73	)			(247	)
Amortization of mortgage servicing rights, net			109				155
Capitalized mortgage servicing rights			(150	)			(193	)
Deferred income tax			(1,792	)			0
Gain(loss) on sales of real estate			(761	)			79
Gain on sales of loans			(314	)			(423	)
Proceeds from sale of loans held for sale			16,361				25,088
Disbursements on loans held for sale			(14,348	)			(25,987	)
Amortization of restricted stock awards			97				76
Amortization of unearned ESOP shares			48				49
Earned employee stock ownership shares priced below original cost			(10	)			(17	)
Stock option compensation			16				7
Decrease in accrued interest receivable			238				810
Decrease in accrued interest payable			(361	)			(1,664	)
Decrease (increase) in other assets			440				(140	)
Increase in other liabilities			368				3,113
Other, net			1				40
Net cash provided by operating activities			5,138				6,327
Cash flows from investing activities:
Principal collected on securities available for sale			5,168				5,035
Proceeds collected on maturities of securities available for sale			17,000				10,000
Purchases of securities available for sale			(25,072	)			0
Proceeds from sales of real estate			5,431				122
Net decrease in loans receivable			16,251				6,838
Purchases of premises and equipment			(34	)			(310	)
Net cash provided by investing activities			18,744				21,685
Cash flows from financing activities:
Decrease in deposits			(6,359	)			(82,322	)
Dividends to preferred stockholders			(325	)			(188	)
Proceeds from borrowings			5,000				592,000
Repayment of borrowings			(5,000	)			(542,000	)
Increase in customer escrows			685				1,310
Net cash used by financing activities			(5,999	)			(31,200	)
Increase (decrease) in cash and cash equivalents			17,883				(3,188	)
Cash and cash equivalents, beginning of period			16,418				15,729
Cash and cash equivalents, end of period		$	34,301				12,541
Supplemental cash flow disclosures:
Cash paid for interest		$	5,304				8,235
Cash paid for income taxes			39				33
Supplemental noncash flow disclosures:
Transfer of loans to real estate			1,138				10,420
Loans transferred to loans held for sale			1,072				0

See accompanying notes to consolidated financial statements.

HMN FINANCIAL, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements
(unaudited)

March 31, 2010 and 2009

(1) HMN Financial, Inc.

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 offices 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 acts as an intermediary for the Bank in completing certain real estate transactions.

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.

(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 loss, consolidated statement of stockholders’ equity and comprehensive loss and consolidated statements of cash flows in conformity with U.S. generally accepted accounting principles. However, all normal recurring adjustments which are, in the opinion of management, necessary for the fair presentation of the interim financial statements have been included. The results of operations for the three-month period ended March 31, 2010 is not necessarily indicative of the results which may be expected for the entire year.

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

(3) New Accounting Standards

In June 2009, the FASB issued SFAS No. 168 (ASU 105), The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles — a replacement of FASB Statement No. 162, The Hierarchy of Generally Accepted Accounting Principles. This Statement establishes the Codification as the source of authoritative GAAP recognized by the FASB to be applied by nongovernmental entities. Rules and interpretive releases of the SEC under federal securities laws are also sources of authoritative GAAP for SEC registrants. All guidance contained in the Codification carries an equal level of authority. Following this Statement, the FASB will not issue new standards in the form of Statements, FASB Staff Positions, or Emerging Issues Task Force Abstracts. Instead, it will issue Accounting Standard Updates (ASUs) that will serve only to update the Codification. This Statement is effective for financial statements issued for interim and annual periods ending after September 15, 2009 and did not have any impact on the Company’s consolidated financial statements except for disclosure changes to the authoritative pronouncement references.

In June 2009, the FASB issued SFAS No. 167 (ASU 810), Amendments to FASB Interpretation No. 46(R). This Statement amends FASB 46(R) to require an enterprise to perform an analysis and ongoing reassessments to determine whether the enterprise’s variable interest or interests give it a controlling financial interest in a variable interest entity and amends certain guidance for determining whether an entity is a variable interest entity. It also requires enhanced disclosures that will provide users of financial statements with more transparent information about an enterprise’s involvement in a variable interest entity. This Statement is effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009 and for all interim reporting periods after that and the adoption of this Statement in 2010 did not have any impact on the Company’s consolidated financial statements as the Company has no interests in any variable interest entities.

In June 2009, the FASB issued SFAS No. 166 (ASU 860), Accounting for Transfers of Financial Assets — an amendment of FASB Statement No. 140. This Statement amends SFAS 140 and removes the concept of a qualifying special-purpose entity from SFAS 140 and eliminates the exception from applying FASB Interpretation No. 46 (revised December 2003), Consolidation of Variable Interest Entities, on qualifying special-purpose entities. This Statement is effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period and for interim and annual reporting periods thereafter. The adoption of this Statement in 2010 did not have any impact on the Company’s consolidated financial statements.

In January 2010, the FASB issued ASU 2010-06, Fair Value Measurements and Disclosures (Topic 820), Improving Disclosures about Fair Value Measurements. This ASU requires new investment fair market disclosures in order to increase the transparency in the financial reporting of investments. The new disclosures and clarifications of existing disclosures are effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. The adoption of this ASU in 2010 did not have a material impact on the Company’s consolidated financial statements.

(4) Derivative Instruments and Hedging Activities

The Company has commitments outstanding to extend credit to future borrowers that had not closed prior to the end of the quarter. The Company intends to sell these commitments, which are referred to as its mortgage pipeline. As commitments to originate or purchase loans enter the mortgage pipeline, the Company generally enters into commitments to sell the mortgage pipeline into the secondary market on a firm commitment or best efforts basis. The commitments to originate, purchase or sell loans on a firm commitment basis are derivatives. As a result of marking to market the mortgage pipeline and the related firm commitments to sell for the period ended March 31, 2010, the Company recorded a decrease in other assets of $14,000, an increase in other liabilities of $11,000 and a loss included in the gain on sales of loans of $25,000.

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 and the related loans held for sale are recorded at the lower of cost or market. The Company recorded a decrease in other assets of $23,000 and an increase in the mark to market adjustment for loans held for sale of $23,000.

(5) Fair Value Measurements

The Company has adopted SFAS No. 157, Fair Value Measurements (ASC 820), 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 March 31, 2010 and March 31, 2009.

		Carrying value at March 31, 2010
(Dollars in thousands)		Total				Level 1				Level 2				Level 3
Securities available for sale		$	162,082				4,970				157,112				0
Mortgage loan commitments			(64	)			0				(64	)			0
Total		$	162,018				4,970				157,048				0

		Carrying value at March 31, 2009
(Dollars in thousands)		Total				Level 1				Level 2				Level 3
Securities available for sale		$	159,869				12,285				147,584				0
Mortgage loan commitments			8				0				8				0
Total		$	159,877				12,285				147,592				0

There were no transfers between Levels 1, 2, or 3 during the three months ended March 31, 2010.

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 the first quarter of 2010 that were still held at March 31, 2010, 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 March 31, 2010.

																		Three months ended
		Carrying value at March 31, 2010																March 31, 2010
(Dollars in thousands)		Total				Level 1				Level 2				Level 3				Total Losses
Loans held for sale		$	2,386				0				2,386				0				(27	)
Mortgage servicing rights			1,356				0				1,356				0				0
Loans (1)			77,998				0				77,998				0				(8,647	)
Real estate, net (2)			12,725				0				12,725				0				0
Total		$	94,465				0				94,465				0				(8,674	)

																		Three months ended
																		March 31, 2009
		Carrying value at March 31, 2009																Total Gains
(Dollars in thousands)		Total				Level 1				Level 2				Level 3				(Losses)
Loans held for sale		$	3,880				0				3,880				0				(42	)
Mortgage servicing rights			765				0				765				0				0
Loans (1)			58,559				0				58,559				0				407
Real estate, net (2)			19,753				0				19,753				0				(1,024	)
Total		$	82,957				0				82,957				0				(659	)

(6) Fair Value of Financial Instruments

Generally accepted accounting principles require interim reporting period disclosure about the fair value of 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 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 estimated fair value of the Company’s financial instruments as of March 31, 2010 is shown below.

		March 31,
		2010												2009
		Carrying				Estimated				Contract				Carrying				Estimated				Contract
(Dollars in thousands)		amount				fair value				amount				amount				fair value				amount
Financial assets:
Cash and cash equivalents		$	34,301				34,301								12,541				12,541
Securities available for sale			162,082				162,082								159,869				159,869
Loans held for sale			2,386				2,386								3,880				3,904
Loans receivable, net			774,336				778,796								877,309				897,342
Federal Home Loan Bank stock			7,286				7,286								7,286				7,286
Accrued interest receivable			3,786				3,786								4,758				4,758
Financial liabilities:
Deposits			789,792				789,792								798,369				798,369
Federal Home Loan Bank advances			132,500				141,499								132,500				141,791
Federal Reserve line of credit			0				0								60,000				59,999
Accrued interest payable			1,747				1,747								4,643				4,643
Off-balance sheet financial instruments:
Commitments to extend credit			(64	)			(64	)			138,784				8				8				167,053
Commitments to sell loans			66				66				9,595				(112	)			(112	)			25,538

(7) Comprehensive Loss

Other comprehensive loss is defined as the change in equity during a period from transactions and other events from nonowner sources. Comprehensive 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. The components of other comprehensive loss and the related tax effects were as follows:

		For the period ended March 31,
		2010												2009
(Dollars in thousands)		Before tax				Tax effect				Net of tax				Before tax				Tax effect				Net of tax
Securities available for sale:
Net unrealized losses arising during the period		$	(376	)			(149	)			(227	)			(306	)			(162	)			(144	)
Other comprehensive loss		$	(376	)			(149	)			(227	)			(306	)			(162	)			(144	)

(8) Securities Available For Sale

The following table shows the gross unrealized losses and fair value 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 March 31, 2010 and March 31, 2009.

		March 31, 2010
		Less than twelve months												Twelve months or more												Total
		# of				Fair				Unrealized				# of				Fair				Unrealized				Fair				Unrealized
(Dollars in thousands)		Investments				Value				Losses				Investments				Value				Losses				Value				Losses
Mortgage backed securities:
FHLMC			1			$	1,102				(59	)			0			$	0				0			$	1,102				(59	)
Other marketable securities:
FNMA Notes			2				9,984				(50	)			0				0				0				9,984				(50	)
FHLMC Notes			2				9,984				(27	)			0				0				0				9,984				(27	)
FHLB Notes			2				10,008				(6	)			0				0				0				10,008				(6	)
Corporate preferred stock			0				0				0				1				175				(525	)			175				(525	)
Total temporarily impaired securities			7			$	31,078				(142	)			1			$	175				(525	)		$	31,253				(667	)

		March 31, 2009
		Less than twelve months												Twelve months or more												Total
		# of				Fair				Unrealized				# of				Fair				Unrealized				Fair				Unrealized
(Dollars in thousands)		Investments				Value				Losses				Investments				Value				Losses				Value				Losses
Mortgage backed securities:
FHLMC			0			$	0				0				1			$	2,782				(63	)		$	2,782				(63	)
FNMA			1				9				0				1				2,128				(5	)			2,137				(5	)
Other marketable securities:
Corporate preferred stock			1				350				(350	)			0				0				0				350				(350	)
Total temporarily impaired securities			2			$	359				(350	)			2			$	4,910				(68	)		$	5,269				(418	)

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 on collateralized mortgage and agency obligations are primarily due to changes in interest rates and were not determined to be other-than-temporary. Mortgage backed securities in the table above had an average life of less than three years and the other marketable securities had an average life of less than one year at March 31, 2010.

The unrealized losses reported for corporate preferred stock at March 31, 2010 related 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 due to increased provisions for loan losses but still meets the regulatory requirements to be considered “well capitalized” based on its most recent regulatory filing. In addition, the owners of the issuing bank appear to have the ability to make additional capital contributions, if needed, to enhance the 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 March 31, 2010. The Company believes it is not probable that they will be required to sell the preferred stock prior to recovery 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.

A summary of securities available for sale at March 31, 2010 is as follows:

						Gross unrealized				Gross unrealized
(Dollars in thousands)		Amortized cost				gains				losses				Fair value
March 31, 2010:
Mortgage-backed securities:
FHLMC		$	24,022				877				0				24,899
FNMA			17,747				753				0				18,500
Collateralized mortgage obligations:
FHLMC			4,522				102				(59	)			4,565
FNMA			385				19				0				404
			46,676				1,751				(59	)			48,368
Other marketable securities:
U.S. Government agency obligations			113,044				578				(83	)			113,539
Corporate preferred stock			700				0				(525	)			175
			113,744				578				(608	)			113,714
		$	160,420				2,329				(667	)			162,082

The following table indicates amortized cost and estimated fair value of securities available for sale at March 31, 2010 based upon contractual maturity adjusted for scheduled repayments of principal and projected prepayments of principal based upon current economic conditions and interest rates.

		Amortized				Fair
(Dollars in thousands)		cost				value
Due less than one year		$	128,506				129,519
Due after one year through five years			27,495				28,522
Due after five years through ten years			3,719				3,866
Due after 10 years			700				175
Total		$	160,420				162,082

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.

(9) Investment in Mortgage Servicing Rights

A summary of mortgage servicing activity is as follows:

		Three months ended				Twelve months ended				Three months ended
(Dollars in thousands)		March 31, 2010				December 31, 2009				March 31, 2009
Mortgage servicing rights:
Balance, beginning of period		$	1,315				728				728
Originations			150				1,143				192
Amortization			(109	)			(556	)			(155	)
Balance, end of period			1,356				1,315				765
Fair value of mortgage servicing rights		$	2,357				2,339				2,004

All of the loans being serviced were single family loans under the FNMA 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 March 31, 2010.

						Weighted				Weighted
		Loan				Average				Average
		Principal				Interest				Remaining				Number
(Dollars in thousands)		Balance				Rate				Term				of Loans
Original term 30 year fixed rate		$	223,406				5.44	%			299				1,943
Original term 15 year fixed rate			98,100				4.95				115				1,571
Adjustable rate			1,254				4.03				303				11

The gross carrying amount of mortgage servicing rights and the associated accumulated amortization at March 31, 2010 is presented in the following table. Amortization expense for mortgage servicing rights was $109,000 and $155,000 for the three months ended March 31, 2010 and 2009, respectively.

		Gross								Unamortized
		Carrying				Accumulated				Intangible
(Dollars in thousands)		Amount				Amortization				Assets
Mortgage servicing rights		$	4,216				(2,860	)			1,356
Total		$	4,216				(2,860	)			1,356

The following table indicates the estimated future amortization expense for mortgage servicing rights:

		Mortgage
		Servicing
(Dollars in thousands)		Rights
Year ending December 31,
2010		$	259
2011			270
2012			231
2013			208
2014			176
Thereafter			212

Projections of amortization are based on existing asset balances and the existing interest rate environment as of March 31, 2010. The Company’s actual experience may be significantly different depending upon changes in mortgage interest rates and other market conditions.

(10) Loss 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 March 31,
		2010				2009
Weighted average number of common shares outstanding used in basic earnings per common share calculation			3,736,852				3,675,984
Net dilutive effect of:
Options			0				0
Restricted stock awards			0				0
Weighted average number of shares outstanding adjusted for effect of dilutive securities			3,736,852				3,675,984
Loss available to common shareholders		$	(2,287,581	)			(3,050,752	)
Basic loss per common share		$	(0.61	)			(0.83	)
Diluted loss per common share		$	(0.61	)			(0.83	)

At March 31, 2010 and March 31, 2009 there were 186,145 and 16,114 common share equivalents outstanding, respectively, that are not included in the calculation of diluted earnings per share as they are anti-dilutive.

(11) Regulatory Capital and Regulatory Oversight

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.

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 March 31, 2010, that the Bank meets all capital adequacy requirements to which it is subject.

Management believes that based upon the Bank’s capital calculations at March 31, 2010 and other conditions consistent with the Prompt Corrective Actions Provisions of the OTS regulations, the Bank would be categorized as well capitalized.

On March 31, 2010, the Bank’s tangible assets and adjusted total assets were $1.01 billion and its risk-weighted assets were $792.8 million. The following table presents the Bank’s capital amounts and ratios at March 31, 2010 for actual capital, required capital and excess capital including ratios required to qualify as a well capitalized institution under the Prompt Corrective Actions regulations.

										Required to be
										Adequately																To Be Well Capitalized Under Prompt
		Actual								Capitalized								Excess Capital								Corrective Action Provisions
						Percent of								Percent of Assets								Percent of								Percent of
(Dollars in thousands)		Amount				Assets(1)				Amount				(1)				Amount				Assets(1)				Amount				Assets(1)
Bank stockholder’s equity		$	94,650
Less:
Net unrealized gains on certain securities available for sale			1,315
Disallowed servicing and tax assets			13,666
Tier I or core capital			79,669
Tier I capital to adjusted total assets							7.88	%		$	40,458				4.00	%		$	39,211				3.88	%		$	50,573				5.00	%
Tier I capital to risk-weighted assets							10.05	%		$	31,712				4.00	%		$	47,957				6.05	%		$	47,568				6.00	%
Plus:
Allowable allowance for loan losses			9,910
Risk-based capital		$	89,579							$	63,424							$	26,155							$	79,280
Risk-based capital to risk- weighted assets							11.30	%							8.00	%							3.30	%							10.00	%

The Bank has an informal written agreement with the OTS that became effective December 9, 2009 and primarily relates to the Bank’s financial performance and credit quality issues. In accordance with the agreement, the Bank has submitted a three year business and capital plan and the OTS has notified the Bank that it does not object to the plan. The Bank is to operate within the parameters of the business and capital plan and is required to monitor and submit periodic reports on its compliance with the plan. The Bank’s operating results for the first quarter of 2010 varied from the plan primarily in that the provision for loan losses recognized in the quarter exceeded the amount included in the business and capital plan. The agreement also requires the Bank to develop plans and take actions to address non-performing assets and watch-list credits. As of March 31, 2010, actual non-performing assets exceeded the amounts reflected in the Bank’s plan submitted to the OTS primarily because more loans were classified as non-performing and fewer non-performing loans were transferred to real estate owned during the first quarter of 2010 than originally anticipated.

HMN also has entered into an informal written agreement with the OTS that became effective December 9, 2009. In accordance with the agreement, the Company submitted a three year capital plan and the OTS has requested additional information regarding the capital plan. The OTS may make comments upon, and require revisions to, the capital plan. The Company is to operate within the parameters of the final capital plan and is required to monitor and submit periodic reports on its compliance with the plan. The Company’s operating results for the first quarter of 2010 varied from the preliminary plan primarily in that the provision for loan losses recognized in the quarter exceeded the amount included in the capital plan. Under the agreement, without the consent of the OTS, 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.

(12) Commitments and Contingencies

The Bank issued standby letters of credit which guarantee the performance of customers to third parties. The standby letters of credit issued and available at March 31, 2010 were approximately $3.6 million, expire over the next two years, and 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.

(13) Business Segments

The Bank has been identified as a reportable operating segment in accordance with the provisions of ASC 280. SFC and HMN did not meet the quantitative thresholds for determining reportable segments 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 equity. Each corporation is managed separately with its own officers and board of directors, some of whom may overlap between the corporations.

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

		Home Federal												Consolidated
(Dollars in thousands)		Savings Bank				Other				Eliminations				Total
At or for the quarter ended March 31, 2010:
Interest income — external customers		$	12,904				0				0				12,904
Non-interest income — external customers			1,582				0				0				1,582
Loss on limited partnerships			(8	)			0				0				(8	)
Intersegment interest income			0				1				(1	)			0
Intersegment non-interest income			43				(1,672	)			1,629				0
Interest expense			4,944				0				(1	)			4,943
Amortization of mortgage servicing rights, net.			109				0				0				109
Other non-interest expense			5,748				203				(43	)			5,908
Income tax benefit			(1,143	)			(25	)			0				(1,168	)
Net loss			(1,670	)			(1,849	)			1,672				(1,847	)
Total assets			1,027,274				98,203				(97,001	)			1,028,476
At or for the quarter ended March 31, 2009:
Interest income — external customers		$	15,353				0				0				15,353
Non-interest income — external customers			1,837				1				0				1,838
Loss on limited partnerships			(5	)			0				0				(5	)
Intersegment interest income			0				4				(4	)			0
Intersegment non-interest income			44				(2,457	)			2,413				0
Interest expense			6,575				0				(4	)			6,571
Amortization of mortgage servicing rights, net.			155				0				0				155
Other non-interest expense			8,118				199				(44	)			8,273
Income tax benefit			(1,732	)			(28	)			0				(1,760	)
Net loss			(2,456	)			(2,623	)			2,457				(2,622	)
Total assets			1,112,271				109,981				(108,893	)			1,113,359

HMN FINANCIAL, INC.

Item 2: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-looking Information

This quarterly report and other reports filed by the Company with the Securities and Exchange Commission 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 of the allowance for loan losses, the adequacy of available liquidity to the Bank, the future outlook for the Company, the Company’s ability to realize the benefit of deferred tax assets, whether the Company will receive all principal and interest payments contractually due on trust preferred securities and whether the Company continues to hold such securities, future expectations regarding dividends, renewals of certificates of deposit and the ability of the Bank to replace deposits that do not renew, 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 and the Company’s compliance with regulatory standards. 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 securing loans to borrowers; possible legislative and regulatory changes; adverse economic, business and competitive developments such as shrinking interest margins; reduced collateral values; 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 or tax laws; international economic developments, changes in credit or other risks posed by the Company’s loan and investment portfolios; technological, computer-related or operational difficulties; adverse changes in securities markets and the availability of, and terms associated with obtaining, additional capital if and when needed; results of litigation; the Company’s participation in the U.S. Treasury Department’s Capital Purchase Program; 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 the Company’s most recent filing on Form 10-K and this 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” section of the Company’s Annual Report on Form 10-K for the year ended December 31, 2009 and Part II, Item 1A of this quarterly report on Form 10-Q.

General

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, Federal Home Loan Bank (FHLB) advances, and Federal Reserve Bank (FRB) borrowings. 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 is also affected by the generation of non-interest income, which consists primarily of gains or losses from the sale of securities, gains from the sale of loans, 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 and amortization of mortgage servicing assets. Over the past several years, the Company has increased the emphasis on commercial and commercial real estate loans, which has increased the credit risk inherent in the loan portfolio. While HMN did not originate or hold subprime mortgages in its loan portfolio, purchase investments backed by subprime mortgages, or incur any write downs directly related to subprime mortgages, subprime credit issues indirectly impacted the Company by making it more difficult for some borrowers with marginal credit to qualify for a mortgage because most of the non-traditional mortgage products were eliminated by the banks and mortgage companies that were previously offering them. This decrease

in available credit reduced the demand for single family homes as there were fewer qualified buyers in the marketplace. The decrease in demand for housing and building lots affected our level of loan charge offs and the risk ratings on many of our residential development loans. Consequently, our provision for loan losses significantly increased relative to periods before the current economic slowdown. The increase in the provision was due primarily to commercial loan charge offs and risk rating downgrades caused by continued weak demand for housing and building and general economic weakness in our markets. In addition, our losses on loans and other real estate owned increased due to the declining value of the real estate.

The earnings of financial institutions, such as the Bank, are significantly affected by prevailing economic and competitive conditions, particularly changes in interest rates, government monetary and fiscal policies, and regulations of various regulatory authorities. Lending activities are influenced by the demand for and supply of 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 levels of personal income and savings.

Critical Accounting Policies

Critical accounting policies are those policies that the Company’s management believes are the most important to understanding the Company’s financial condition and operating results. The Company has identified the following policies as being critical because they require difficult, subjective, and/or complex judgments that are inherently uncertain. Therefore, actual financial results could differ significantly depending upon the estimates, 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 construction permits, development plans, local economic growth rates, 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 components of its overall methodology to determine the adequacy 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 on the homogeneous single-family and consumer loan portfolios is calculated on a pooled basis with individual determination of the allowance of all non-performing loans. 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 specific reserves. 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 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. 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 probable losses in the loan portfolio for which specific reserves are not required. Although management believes that based on current conditions the allowance for loan losses is maintained at an adequate amount to provide for probable loan losses inherent in the portfolio as of the balance sheet date, 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 losses. For income tax purposes, only net charge-offs are deductible, not the 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 judgment concerning management’s evaluation of both positive and negative evidence, the forecasts of future income, applicable 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 realizabilty 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 and the general business and economic trends. At March 31, 2010, the Company did not record a valuation allowance relating to deferred tax assets. This determination was based largely on the Company’s ability to implement tax planning strategies to accelerate taxable income and its ability to generate future taxable income. The Company believes, based on its internal earnings projections, that it will generate sufficient future taxable income that will result in the realization of the Company’s deferred tax assets. This positive evidence was sufficient to overcome the negative evidence of a cumulative loss in the most recent three year period. The recent cumulative loss includes event-specific charges in the form of significant loan loss provisions that have been realized in the past two years, including one specific $12.0 million provision and related charge-offs in 2008 due to the apparently fraudulent activities related to the collateral of one loan, and a $3.8 million non-cash goodwill impairment charge recorded in 2008. Without these event-specific charges, the most recent three year period would not reflect a cumulative loss. 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.

Under current interpretations of the applicable accounting rules, an evaluation is performed each quarter to determine the need for a valuation allowance on the deferred tax asset amount and a valuation allowance may be required if the net income/loss for that period results in a three year cumulative loss, excluding the event-specific charges noted above. The applicable accounting rules would also require that a valuation allowance be established against the entire amount of the net deferred tax asset, which was $13.5 million as of March 31, 2010, since the Company does not currently have the ability to carry back losses to prior periods. If a valuation allowance is required, it will have a limited impact on regulatory capital as the majority of the deferred tax asset amount is already excluded from the current risk based capital calculation.

Accounting for income taxes requires the use of estimates and management’s best judgment to determine the amounts and probabilities of all of the possible outcomes that could be realized upon the ultimate settlement of any tax position using the facts, circumstances, and information available. Because significant estimates and judgments are used in arriving at the amount of tax benefits to be recognized in the financial statements for a given tax position, 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.

Net Loss

The net loss for the first quarter of 2010 was $1.8 million, an improvement of $0.8 million compared to a net loss of $2.6 million for the first quarter of 2009. Net loss available to common shareholders was $2.3 million for the first quarter of 2010, an improvement of $0.8 million, or 25.0%, from the net loss available to common shareholders of $3.1 million for the first quarter of 2009. Diluted loss per common share for the first quarter of 2010 was $0.61, an improvement of $0.22 from diluted loss per common share of $0.83 for the first quarter of 2009. The decrease in the net loss between the periods was due primarily to a $1.9 million improvement in the gains/losses recognized on the sale of real estate owned which was partially offset by an $821,000 decrease in net interest income. The decrease in net interest income was primarily the result of a decrease in interest-earning assets between the periods.

Net Interest Income

Net interest income was $8.0 million for the first quarter of 2010, a decrease of $0.8 million, or 9.3%, compared to $8.8 million for the first quarter of 2009. Interest income was $12.9 million for the first quarter of 2010, a decrease of $2.5 million, or 16.0%, from $15.4 million for the first quarter of 2009. Interest income decreased between the periods primarily because of a $104 million decrease in average interest-earning assets 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 interest rate risk and improving capital ratios. Interest income was also adversely affected by the increase in non-performing assets between the periods. The average yield earned on interest-earning assets was 5.36% for the first quarter of 2010, a decrease of 40 basis points from the 5.76% average yield for the first quarter of 2009.

Interest expense was $4.9 million for the first quarter of 2010, a decrease of $1.7 million, or 24.8%, compared to $6.6 million for the first quarter of 2009. Interest expense decreased primarily because of the lower interest rates paid on money market accounts and certificates of deposits. 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, which is the rate that banks charge other banks for short term loans, 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 deposits, which do not re-price immediately when the federal funds rate changes. Interest expense also decreased because of an $89 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 outstanding borrowings and brokered certificates of 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. The average interest rate paid on interest-bearing liabilities was 2.17% for the first quarter of 2010, a decrease of 46 basis points from the 2.63% average interest rate paid in the first quarter of 2009.

Net interest margin (net interest income divided by average interest earning assets) for the first quarter of 2010 was 3.31%, an increase of 1 basis point, compared to 3.30% for the first quarter of 2009.

A summary of the Company’ net interest margin for the three month period ended March 31, 2010 and March 31, 2009 is as follows:

		For the three month period ended
		March 31, 2010												March 31, 2009
		Average				Interest								Average				Interest
		Outstanding				Earned/				Yield/				Outstanding				Earned/				Yield/
(Dollars in thousands)		Balance				Paid				Rate				Balance				Paid				Rate
Interest-earning assets:
Securities available for sale		$	159,759				1,107				2.81	%		$	165,387				1,748				4.29	%
Loans held for sale			1,785				21				4.77				3,305				41				5.03
Mortgage loans, net			143,667				2,097				5.92				160,762				2,358				5.95
Commercial loans, net			564,322				8,453				6.07				648,210				9,958				6.23
Consumer loans, net			80,991				1,188				5.95				85,407				1,271				6.04
Cash equivalents			18,591				1				0.02				10,468				1				0.04
Federal Home Loan Bank stock			7,286				37				2.06				7,286				(23	)			(1.28	)
Total interest-earning assets			976,401				12,904				5.36				1,080,825				15,354				5.76
Interest-bearing liabilities and noninterest bearing deposits:
NOW accounts			98,474				22				0.09				112,143				40				0.14
Savings accounts			31,821				10				0.13				29,236				9				0.12
Money market accounts			136,800				392				1.16				95,983				356				1.50
Certificates			243,180				1,476				2.46				260,170				2,101				3.28
Brokered deposits			199,257				1,521				3.10				255,210				2,469				3.92
Federal Home Loan Bank advances			132,611				1,522				4.65				192,967				1,596				3.35
Total interest-bearing liabilities			842,143												945,709
Noninterest checking			79,635												65,537
Other noninterest bearing escrow deposits			1,836												1,306
Total interest-bearing liabilities and noninterest bearing deposits		$	923,614				4,943				2.17			$	1,012,552				6,571				2.63
Net interest income						$	7,961											$	8,783
Net interest rate spread											3.19	%											3.13	%
Net interest margin											3.31	%											3.30	%