-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, HvCmcB41HGCaJGz+pw1qcKFd1F8W7SZoyT4qp7j07j0rhEKkfl5ESbVBEKbQmmt5 RVnJMiyfe2lEIwp3k5m8MA== 0001047469-08-010336.txt : 20080926 0001047469-08-010336.hdr.sgml : 20080926 20080926152126 ACCESSION NUMBER: 0001047469-08-010336 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 12 CONFORMED PERIOD OF REPORT: 20080630 FILED AS OF DATE: 20080926 DATE AS OF CHANGE: 20080926 FILER: COMPANY DATA: COMPANY CONFORMED NAME: HF FINANCIAL CORP CENTRAL INDEX KEY: 0000881790 STANDARD INDUSTRIAL CLASSIFICATION: SAVINGS INSTITUTION, FEDERALLY CHARTERED [6035] IRS NUMBER: 460418532 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 033-44383 FILM NUMBER: 081091115 BUSINESS ADDRESS: STREET 1: 225 SOUTH MAIN AVE CITY: SIOUX FALLS STATE: SD ZIP: 57102 BUSINESS PHONE: 6053337556 10-K 1 a2188088z10-k.htm 10-K
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549


FORM 10-K

(Mark One)    

ý

 

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

For the fiscal year ended June 30, 2008

OR

o

 

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

For the transition period from                                   to                                    .

Commission file number 0-19972

HF FINANCIAL CORP.
(Exact name of registrant as specified in its charter)

Delaware
(State or other jurisdiction of
incorporation or organization)
  46-0418532
(I.R.S. Employer
Identification No.)

225 South Main Avenue,
Sioux Falls, SD

(Address of principal executive offices)

 


57104

(ZIP Code)

Registrant's telephone number, including area code: (605) 333-7556

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, par value $.01 per share

        Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes o    No ý

        Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

Yes o    No ý

        Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or Section 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 ý    No o

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

        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 o
(Do not check if a smaller
reporting company)
  Smaller reporting company ý

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

Yes o    No ý

        The aggregate market value of the common stock held by non-affiliates of the Registrant, computed by reference to the closing price as of the last business day of the Registrant's most recently completed second fiscal quarter, December 31, 2007, was approximately $60.1 million.

        As of September 16, 2008, there were 3,982,068 shares of the Registrant's common stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

        Portions of the Registrant's definitive proxy statement to be delivered to stockholders in connection with the 2008 annual meeting of stockholders to be held on November 19, 2008, are incorporated by reference in response to Part III of this report.


Annual Report on Form 10-K

Table of Contents

 
   
  Page
Number
 


PART I


 

Item 1.

 

Business

   
1
 

Item 1A.

 

Risk Factors

   
32
 

Item 1B.

 

Unresolved Staff Comments

   
38
 

Item 2.

 

Properties

   
38
 

Item 3.

 

Legal Proceedings

   
38
 

Item 4.

 

Submission of Matters to a Vote of Security Holders

   
38
 

PART II

 

Item 5.

 

Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

   
39
 

Item 6.

 

Selected Financial Data

   
42
 

Item 7.

 

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

   
45
 

Item 7A.

 

Quantitative and Qualitative Disclosures About Market Risk

   
67
 

Item 8.

 

Financial Statements and Supplementary Data

   
68
 

Item 9.

 

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

   
114
 

Item 9A.

 

Controls and Procedures

   
114
 

Item 9B.

 

Other Information

   
114
 

PART III

 

Item 10.

 

Directors, Executive Officers and Corporate Governance

   
114
 

Item 11.

 

Executive Compensation

   
115
 

Item 12.

 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

   
115
 

Item 13.

 

Certain Relationships and Related Transactions, and Director Independence

   
115
 

Item 14.

 

Principal Accounting Fees and Services

   
116
 

PART IV

 

Item 15.

 

Exhibits and Financial Statement Schedules

   
116
 

i


Forward-Looking Statements

        This Annual Report on Form 10-K ("Form 10-K") and other reports issued by HF Financial Corp. (the "Company"), including reports filed with the Securities and Exchange Commission (the "SEC"), contain "forward-looking statements" that deal with future results, expectations, plans and performance. In addition, the Company's management may make forward-looking statements orally to the media, securities analysts, investors or others. These forward-looking statements might include one or more of the following:

    Projections of income, loss, revenues, earnings or losses per share, dividends, capital expenditures, capital structure, tax benefit or other financial items.

    Descriptions of plans or objectives of management for future operations, products or services, transactions, investments and use of subordinated debentures payable to trusts.

    Forecasts of future economic performance.

    Use and descriptions of assumptions and estimates underlying or relating to such matters.

        Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. They often include words such as "optimism," "look-forward," "bright," "believe," "expect," "anticipate," "intend," "plan," "estimate" or words of similar meaning, or future or conditional verbs such as "will," "would," "should," "could" or "may."

        Forward-looking statements about the Company's expected financial results and other plans are subject to certain risks, uncertainties and assumptions. These include, but are not limited to, the risks discussed in Part I, Item 1A "Risk Factors" in this Form 10-K and the following: possible legislative changes and adverse economic, business and competitive conditions and developments (such as shrinking interest margins and continued short-term rate environments); deposit outflows; reduced demand for financial services and loan products; changes in accounting policies or guidelines, or in monetary and fiscal policies of the federal government; changes in credit and other risks posed by the Company's loan and lease portfolios; the ability or inability of the Company to manage interest rate and other risks; unexpected or continuing claims against the Company's self-insured health plan; the Company's use of trust preferred securities; the ability or inability of the Company to successfully enter into a definitive agreement for and close anticipated transactions; technological, computer-related or operational difficulties; adverse changes in securities markets; results of litigation; or other significant uncertainties.

        Forward-looking statements speak only as of the date they are made. The Company does not undertake to update forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements are made. Although the Company believes that its expectations are reasonable, it can give no assurance that such expectations will prove to be correct. Based upon changing conditions, should any one or more of these risks or uncertainties materialize, or should any underlying assumptions prove incorrect, actual results may vary materially from those described in any forward-looking statements.

        References in this Form 10-K to "we," "our," "us" and other similar references are to the Company, unless otherwise expressly stated or the context requires otherwise.


PART I

Item 1.    Business

        This section should be read in conjunction with the following parts of this Form 10-K: Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," Part II, Item 7A, "Quantitative and Qualitative Disclosures About Market Risk" and Part II, Item 8, "Financial Statements and Supplementary Data."

1


The Company

        HF Financial Corp., a unitary thrift holding company, was formed in November 1991 for the purpose of owning all of the outstanding stock of Home Federal Bank (the "Bank") issued in the mutual to stock conversion of the Bank. The Company acquired all of the outstanding stock of the Bank on April 8, 1992. The Company is incorporated under the laws of the State of Delaware and generally is authorized to engage in any activity that is permitted by the Delaware General Corporation Law. Unless otherwise indicated, all matters discussed in this Form 10-K relate to the Company, and its direct and indirect subsidiaries, including without limitation, the Bank. See "Subsidiary Activities" below for further information regarding the subsidiary operations of the Company and the Bank.

        The executive offices of the Company and its direct and indirect subsidiaries are located at 225 South Main Avenue, Sioux Falls, South Dakota, 57104. The Company's telephone number is (605) 333-7556.

Website and Available Information

        The website for the Company and the Bank is located at www.homefederal.com. Information on this website does not constitute part of this Form 10-K.

        The Company makes available, free of charge, its Form 10-K, its quarterly reports on Form 10-Q, its current reports on Form 8-K and amendments to such reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), as soon as reasonably practicable after such forms are filed with or furnished to the SEC. Copies of these documents are available to stockholders upon request addressed to the Secretary of the Company at 225 South Main Avenue, Sioux Falls, South Dakota, 57104.

The Bank

        The Bank was founded in 1929 and is a federally chartered stock savings bank headquartered in Sioux Falls, South Dakota. The Bank provides full-service consumer and commercial business banking, including an array of financial products, to meet the needs of its market place. The Bank attracts deposits from the general public and uses such deposits, together with borrowings and other funds, to originate one- to four-family residential, commercial business, consumer, multi-family, commercial real estate, construction and agricultural loans. The Bank's consumer loan portfolio includes, among other things, automobile loans, home equity loans, loans secured by deposit accounts and student loans. The Bank also purchases mortgage-backed securities and invests in U.S. Government and agency obligations and other permissible investments. The Bank does not hold any non-investment grade bonds (i.e., "junk bonds"). The Bank receives loan servicing income on loans serviced for others and commission income from credit life insurance on consumer loans. The Bank, through its wholly-owned subsidiaries, offers annuities, mutual funds, life insurance and other financial products and equipment leasing services.

        The Bank's deposits are insured up to applicable limits by the Deposit Insurance Fund ("DIF"), which is administered by the Federal Deposit Insurance Corporation ("FDIC"), and the Bank is subject to primary regulation and examination by the Office of Thrift Supervision ("OTS").

Segments

        Operating segments are defined as components of an enterprise for which separate financial information is available that is evaluated regularly by the chief operating decision makers in deciding how to allocate resources and in assessing performance. The Company's reportable segments are "banking" (including leasing activities) and "other." The "banking" segment is conducted through the Bank and Mid America Capital Services, Inc. ("Mid America Capital") and the "other" segment is composed of smaller non-reportable segments, the Company and inter-segment eliminations. For

2



financial information by segment see Note 1 of "Notes to Consolidated Financial Statements," which is included in Part II, Item 8, "Financial Statements and Supplementary Data" of this Form 10-K.

Subsidiary Activities

        In addition to the Bank, the Company had six other wholly-owned subsidiaries as of June 30, 2008: HF Financial Group, Inc. ("HF Group"), HF Financial Capital Trust III ("Trust III"), HF Financial Capital Trust IV ("Trust IV"), HF Financial Capital Trust V ("Trust V"), HF Financial Capital Trust VI ("Trust VI") and HomeFirst Mortgage Corp. (the "Mortgage Corp.").

        In August 2002, the Company formed HF Group, a South Dakota corporation, to market software to facilitate employee benefits administration, payroll processing and management and governmental reporting. HF Group has an approved line of credit with the Company of $100,000, with no funds advanced as of June 30, 2008. Intercompany interest income and interest expense are eliminated in the preparation of consolidated financial statements.

        In December 2002, the Company formed Trust III, a Delaware corporation, for the sole purpose of issuing trust preferred securities and investing the proceeds in subordinated debentures of the Company. These subordinated debentures constitute the sole asset of Trust III.

        In September 2003, the Company formed Trust IV, a Delaware corporation, for the sole purpose of issuing trust preferred securities and investing the proceeds in subordinated debentures of the Company. These subordinated debentures constitute the sole asset of Trust IV.

        In December 2006, the Company formed Trust V, a Delaware corporation, for the sole purpose of issuing trust preferred securities and investing the proceeds in subordinated debentures of the Company. These subordinated debentures constitute the sole asset of Trust V.

        In July 2007, the Company formed Trust VI, a Delaware corporation, for the sole purpose of issuing trust preferred securities and investing the proceeds in subordinated debentures of the Company. These subordinated debentures constitute the sole asset of Trust VI.

        The Mortgage Corp., a South Dakota corporation, was previously engaged in the business of originating one- to four-family residential mortgage loans, which were sold into the secondary market. The Mortgage Corp. had no activity during fiscal 2008.

        As a federally chartered thrift institution, the Bank is permitted by OTS regulations to invest up to 2.00% of its assets in the stock of, or loans to, service corporation subsidiaries. The Bank may invest an additional 1.00% of its assets in service corporations where such additional funds are used for inner-city or community development purposes. The Bank currently has less than 1.00% of its assets in investments in its subsidiary service corporations as defined by the OTS. In addition to investments in service corporations, the Bank is permitted to invest an unlimited amount in operating subsidiaries engaged solely in activities in which the Bank may engage directly.

        The Bank has five wholly-owned subsidiaries, Hometown Insurors, Inc. ("Hometown"), Mid America Capital, Home Federal Securitization Corp. ("HFSC"), Mid-America Service Corporation ("Mid-America") and PMD, Inc. ("PMD").

        Hometown, a South Dakota corporation, provides financial and insurance products to customers of the Bank and members of the general public in the Bank's market area. Insurance products offered by Hometown primarily include annuities and life insurance products. Hometown obtains its funding via a line of credit from the Bank. Banking regulations do not limit the amount of funding provided to an operating subsidiary. As of June 30, 2008, the Bank had advanced no funds on an approved line of credit of $100,000. Intercompany interest income and interest expense are eliminated in the preparation of consolidated financial statements.

3


        Mid America Capital, a South Dakota corporation, specializes in equipment finance leasing. Mid America Capital obtains its funding through a line of credit from the Bank. Banking regulations do not limit the amount of funding provided to an operating subsidiary. As of June 30, 2008, Mid America Capital had advanced $16.2 million on an approved line of credit of $35.0 million with the Bank. Intercompany interest income and interest expense are eliminated in the preparation of consolidated financial statements.

        HFSC, a Delaware corporation, existed for the sole purpose of buying motor vehicle installment loans from the Bank to be securitized. HFSC had no activity during fiscal 2008. See "Off-Balance Sheet Financing Arrangements" of this Form 10-K for more information on the automobile securitization.

        Mid-America, a South Dakota corporation, in the past provided residential appraisal services to the Bank and other lenders in the Bank's market. Mid-America had no activity during fiscal 2008.

        PMD, a South Dakota corporation, in the past was engaged in the business of buying, selling and managing repossessed real estate properties. PMD had no activity during fiscal 2008.

Market Area

        Based on total assets at June 30, 2008, the Bank is the largest savings association headquartered in South Dakota. The Bank has a total of 33 banking centers in its market area and one internet branch located at www.homefederal.com. The Bank's primary market area includes communities located in eastern and central South Dakota, including the Sioux Falls metropolitan statistical area (MSA), Pierre, Mitchell, Aberdeen, Brookings, Dakota Dunes, Watertown, and Yankton. The Bank also has a branch in Marshall, Minnesota, which serves customers located in southwestern Minnesota, and its banking center located in Dakota Dunes, South Dakota serves customers located in northwestern Iowa. The Bank's primary market area features a variety of agri-business, banking, financial services, health care and light manufacturing firms. The internet branch allows access to customers beyond traditional geographical areas.

        Mid America Capital provides services to customers primarily in a five-state area in the upper Midwest, but originations can and have expanded nationwide based on relationships developed with existing Bank customers and other vendor relationships.

        HF Group provided services to customers in the three-state region of South Dakota, Minnesota and Iowa.

Lending Activities

        The Bank originates a variety of loans including business banking loans, commercial and agricultural loans; mortgage lending, including one- to four-family residential mortgages; and consumer loans, including loans for automobile purchases, home equity and home improvement loans and student loans.

Business Banking

         Commercial Business Lending.    In order to serve the needs of the local business community and improve the interest rate sensitivity and yield of its assets, the Bank originates adjustable- and fixed-rate commercial loans. Interest rates on commercial business loans generally adjust or float with a designated national index plus a specified margin. The Bank's commercial business lending activities encompass loans with a variety of purposes and security, including loans to finance accounts receivable, inventory and equipment and business expansion within the Bank's market area. The Bank originates commercial business loans directly and through programs sponsored by the Small Business Administration ("SBA") of which a portion of such loans are also guaranteed in part by the SBA. The Bank generally originates commercial business loans for its portfolio and retains the servicing with

4


respect to such loans. The Bank anticipates continued expansion and emphasis of its commercial business lending, subject to market conditions and the Home Owners' Loan Act ("HOLA") restrictions. See "Regulation—Business Activities" below for HOLA restrictions.

        Commercial business loans typically are made on the basis of the borrower's ability to make repayment from the cash flow of the borrower's business. As a result, the availability of funds for the repayment of commercial business loans may be substantially dependent on the success of the business itself (which, in turn, may be dependent upon the general economic environment). The Bank's commercial business loans are occasionally secured by the assets of the business, such as accounts receivable, equipment and inventory. However, the collateral securing the loans may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business. Whenever possible, the Bank's commercial business loans include personal guarantees of the borrowers. In addition, the loan officer may perform on-site visits, obtain financial statements and perform a financial review of the loan.

         Multi-Family and Commercial Real Estate Lending.    The Bank engages in multi-family and commercial real estate lending primarily in South Dakota and the adjoining Midwestern states. These lending activities may include existing property or new construction development or purchased loans.

        Loans secured by multi-family and commercial real estate properties are generally larger and involve a greater degree of credit risk than one- to four-family residential mortgage loans. Because payments on loans secured by multi-family and commercial real estate properties are often dependent on the successful operation or management of the properties, repayment of such loans may be subject to adverse conditions in the real estate market or the economy. If the cash flow from the project is reduced (for example, if leases are not obtained or renewed), the borrower's ability to repay the loan may be impaired. In addition, loans secured by property outside of the Bank's primary market area may contain a higher degree of risk due to the fact that the Bank may not be as familiar with market conditions where such property is located. The Bank does not have a material concentration of multi-family or commercial real estate loans outside of South Dakota and the adjoining Midwestern states.

        The Bank presently originates adjustable-rate, short-term balloon payment, fixed-rate multi-family and commercial real estate loans. The Bank's multi- family and commercial real estate loan portfolio is secured primarily by apartment buildings and owner occupied and non-owner occupied commercial real estate. The terms of such loans are negotiated on a case-by-case basis. Commercial real estate loans generally have terms that do not exceed 25 years. The Bank has a variety of rate adjustment features, call provisions and other terms in its multi-family and commercial real estate loan portfolio. Generally, the loans are made in amounts up to 80.00% of the appraised value of the collateral property and with debt service coverage ratios of 115.00% or higher. The debt service coverage is the ratio of net cash from operations before payment of debt service. However, these percentages may vary depending on the type of security and the guarantor. Such loans provide for a negotiated margin over a designated national index. The Bank analyzes the financial condition of the borrower, the borrower's credit history, the borrower's prior record for producing sufficient income from similar loans, references and the reliability and predictability of the net income generated by the property securing the loan. The Bank generally requires personal guarantees of borrowers.

        Depending on the circumstances of the security of the loan or the relationship with the borrower, the Bank may decide to sell participations in the loan. The sale of participation interests in a loan are necessitated by the amount of the loan or the limitation of loans-to-one borrower. See "Regulation—Loans-to-One Borrower" for a discussion of the loans-to-one borrower regulations. In return for servicing these loans for the participants, the Bank generally receives a fee of 0.25% to 0.38%. Also, income is received at loan closing from loan fees and discount points. Appraisals on properties securing multi-family and commercial real estate loans originated by the Bank are performed by appraisers approved pursuant to the Bank's appraisal policy.

5


        The HOLA includes a provision that limits the Bank's non-residential real estate lending to no more than four times its total capital. This maximum limitation, which at June 30, 2008 was $350.6 million, has not materially limited the Bank's lending practices.

        Under HOLA, the maximum amount which the Bank may lend to any one borrower is 15.00% of the Bank's unimpaired capital and surplus, or $13.3 million at June 30, 2008. Loans in an amount equal to an additional 10.00% of unimpaired capital and surplus may be made to the same borrower if such loans are fully secured by readily marketable collateral. The Bank may request a waiver from the OTS to exceed the 15.00% loans-to-one borrower limitation on a case-by-case basis. See "Regulation—Loans-to-One Borrower" for more information and a discussion of the loans-to-one borrower regulations.

         Construction and Development Lending.    The Bank makes construction loans to individuals for the construction of their residences as well as to builders and, to a lesser extent, developers, for the construction of one- to four-family residences and condominiums and the development of one- to four-family lots in the Bank's primary market area.

        Construction loans to individuals for their residences are structured to be converted to mortgage loans at the end of the construction phase, which typically runs six to 12 months. These construction loans have rates and terms which match the one- to four-family residential mortgage loans offered by the Bank. Residential construction loans are generally underwritten pursuant to the same guidelines used for originating residential mortgage loans.

        The Bank also makes loans to developers for the purpose of developing one- to four-family lots. These loans typically have terms of one year and carry floating interest rates based on a national designated index. Loan commitment and partial release fees are charged. These loans generally provide for the payment of interest and loan fees from loan proceeds. The principal balance of these loans is typically paid down as lots are sold. Builder construction and development loans are obtained principally through continued business from developers and builders who have previously borrowed from the Bank, as well as broker referrals and direct solicitations of developers and builders. The application process includes a submission to the Bank of plans, specifications and costs of the project to be constructed or developed. These items are used as a basis to determine the appraised value of the subject property. Loans are based on the lesser of current appraised value and/or the cost of construction (land plus building).

        The Bank makes loans for the construction of multi-family residential properties. Such loans are generally made at adjustable rates, which adjust periodically based on the appropriate Treasury Note maturity.

        Construction loans are generally originated with a maximum loan-to-value ratio of 80.00% and land development loans are generally originated with a maximum loan-to-value ratio of 60.00%, based upon an independent appraisal. Because of the uncertainties inherent in estimating development and construction costs and the market for the project upon completion, it is relatively difficult to evaluate accurately the total loan funds required to complete a project, the related loan-to-value ratios and the likelihood of ultimate success of the project. Construction and development loans to borrowers other than owner occupants also involve many of the same risks discussed above regarding multi-family and commercial real estate loans and tend to be more sensitive to general economic conditions than many other types of loans.

        Prior to making a commitment to fund a construction loan, the Bank requires an appraisal of the property, or, for larger projects, both an appraisal and a study of the feasibility of the proposed project. The Bank's construction loan policy provides for the inspection of properties by independent in-house and outside inspectors at the commencement of construction and prior to disbursement of funds during the term of the construction loan.

6


         Agricultural Loans.    In order to serve the needs of the local agricultural community and improve the interest rate sensitivity and yield of its assets, the Bank originates agricultural loans through its agricultural division. The agricultural division offers loans to its customers such as: (1) operating loans which are used to fund operating expenses, which typically have a one year term and are indexed to the national prime rate; (2) term loans on machinery, equipment and breeding stock that may have a term up to seven years and require annual payments; (3) agricultural farmland term loans which are used to fund land purchases or refinances; (4) specialized livestock loans to fund facilities and equipment for confinement enterprises; and (5) loans to fund ethanol plant development. Agriculture real estate loans typically will have personal guarantees of the borrowers, a first lien on the real estate, interest rates adjustable to the national prime rate or Treasury Note rates, and annual, quarterly or monthly payments. Operating and term loans are secured by farm chattels (crops, livestock, machinery, etc.), which are the operating assets of the borrower. The Bank also originates agricultural loans directly and through programs sponsored by the Farmers Service Agency ("FSA") of which a portion of such loans are also guaranteed in part by the FSA.

        Loan customers are required to supply current financial statements, tax returns and cash flow projections which are updated on an annual basis. In addition, on major loans, the loan officer will perform an annual farm visit, obtain financial statements and perform a financial review of the loan.

Mortgage Lending

         One- to Four-Family Residential Mortgage Lending.    One- to four-family residential mortgage loan originations are primarily generated by the Bank's marketing efforts, its present customers, walk-in customers and referrals from real estate agents and builders. The Bank has focused its lending efforts primarily on the origination of loans secured by first mortgages on owner-occupied, one- to four-family residences.

        The Bank currently makes 10-, 15-, 20- and 30-year fixed- and adjustable-rate ("ARM") one- to four-family residential mortgage loans in amounts up to 95.00% of the appraised value of the collateral property provided that private mortgage insurance is obtained in an amount sufficient to reduce the Bank's exposure at or below the 80.00% level. The Bank generally offers an ARM loan having a fixed rate for the initial three to five years, which then converts to a one-year ARM loan for the remainder of the life of the loan. These loans provide for an annual cap and a lifetime cap at a set percent over the fully-indexed rate.

        The Bank also offers balloon loans, which are sold on the secondary market and have a fixed-rate for the first five or seven years of the loan. At the end of the five- or seven-year period, the loan converts to a 23- or 25-year fixed-rate loan at the then current market rate provided that the borrower qualifies at the new rate. If the borrower fails to qualify at the new rate, the loan becomes payable in full. The Bank also offers a portfolio loan product that is a five- or seven-year balloon loan that is underwritten to secondary market standards but if fully payable at the end of the balloon term.

        To meet the needs of the Bank's borrowers and financial needs of the communities it serves, the Bank has developed two distinct types of loan programs. The Integrity Mortgage Program is a limited documentation program that is generally available to the upper credit profile customer. The Olympic Plus Program is a program for individuals that do not meet secondary market standards but are eligible for private mortgage insurance. The program underwriting guidelines match those as established by the private mortgage insurance company. Borrowers may choose from either an ARM or balloon product as a financing option.

        The Bank also offers fixed-rate 10- to 30-year mortgage loans that conform to secondary market standards. Interest rates charged on these fixed-rate loans are competitively priced on a daily basis according to market conditions. Residential loans generally do not include prepayment penalties.

7


        The Bank also originates fixed-rate one- to four-family residential mortgage loans through the South Dakota Housing Development Authority ("SDHDA") program. These loans generally have terms not to exceed 30 years and are insured by the Federal Housing Administration ("FHA"), Veterans Administration ("VA"), Rural Development or private mortgage insurance. The Bank receives an origination fee of 1.00% of the loan amount from the borrower and a servicing fee of generally 0.38% from the SDHDA for these services. The Bank is the largest servicer of loans for the SDHDA. At June 30, 2008, the Bank serviced $932.9 million of mortgage loans for the SDHDA. See Note 4 of "Notes to Consolidated Financial Statements," which is included in Part II, Item 8, "Financial Statements and Supplementary Data" in this Form 10-K for information on loan servicing.

        In underwriting one- to four-family residential mortgage loans, the Bank evaluates both the borrower's ability to make monthly payments and the value of the property securing the loan. The property that secures the real estate loans made by the Bank is appraised by an appraiser approved under the Bank's appraisal policy. The Bank requires borrowers to obtain title, fire and casualty insurance in an amount not less than the amount of the loan. Real estate loans originated by the Bank contain a "due-on-sale" clause allowing the Bank to declare the unpaid principal balance due and payable upon the sale of the collateral property.

        The Bank offers on-line mortgage capabilities through QuickClick™ Online Mortgage Solutions, a service that allows customers to check rates, research loan options and complete mortgage applications via the Bank's website. This service is currently available to branch locations in South Dakota and Minnesota.

Consumer Lending

         Other Consumer Lending.    The Bank's management considers its consumer loan products to be an important component of its lending strategy. Specifically, consumer loans generally have shorter terms to maturity and carry higher rates of interest than one- to four-family residential mortgage loans. In addition, the Bank's management believes that the offering of consumer loan products helps to expand and create stronger ties to its existing customer base by increasing the number of customer relationships and providing cross-marketing opportunities.

        Loans secured by second mortgages, together with loans secured by all prior liens, are generally limited to 100.00% or less of the appraised or assessed value of the property securing the loan and generally have maximum terms that do not exceed 10 to 15 years.

        The student loans originated by the Bank are guaranteed as to principal and interest by the South Dakota Education Assistance Corporation. The Bank typically sells such student loans with servicing rights released approximately 120 days after funds have been disbursed to the student.

        Consumer loan terms vary according to the type of collateral, length of contract and creditworthiness of the borrower. The Bank offers both open- and closed-end credit. Overdraft lending is extended through lines of credit that are tied to a checking account. The credit lines generally bear interest at 18.00% and are generally limited to no more than $2,000. Loans secured by deposit accounts at the Bank are currently originated for up to 90.00% of the account balance (although historically the Bank has loaned up to 100.00% of the account balance), with a hold placed on the account restricting the withdrawal of the account balance. The interest rate on such loans is typically equal to 2.00% above the contract rate.

        The underwriting standards employed by the Bank for consumer loans include an application, a determination of the applicant's payment history on other debts, and an assessment of the ability to meet existing obligations and payments on the proposed loan. Although creditworthiness of the applicant is a primary consideration, the underwriting process also includes a comparison of the value of the security, if any, in relation to the proposed loan amount.

8


        Consumer loans may entail greater credit risk than residential mortgage loans, particularly in the case of consumer loans which are unsecured or are secured by rapidly depreciable assets, such as automobiles or boats. In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation. In addition, consumer loan collections are dependent on the borrower's continuing financial stability, thus are more likely to be affected by adverse personal circumstances. Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans.

Leasing Activities

         General.    Through its wholly-owned subsidiary, Mid America Capital, the Bank originates commercial and municipal leases. These products have a fixed interest rate for the duration of the lease with terms typically ranging from 24 - 60 months. The leases generally are 100.00% financed with only the first or first and last months' payments due at lease inception. As a result of the 100.00% financing and fixed interest rate, the yield on leases is higher than similar type lending products.

        Leases are originated generally in a five-state area in the upper Midwest. All leases are secured by the equipment leased, with personal guarantees of the borrowers normally obtained on commercial leases.

         Commercial Leases.    In order to support the Bank and its customers and to improve the yield of its assets, Mid America Capital originates commercial leases to customers primarily in the upper Midwest. Mid America Capital offers three types of commercial leases: capital, tax and Terminal Rental Adjustment Clause ("TRAC") leases. TRAC leases are generally for medium- to heavy-duty titled equipment, such as semi-tractors and trailers and medium- to heavy-duty trucks. Leases may be structured with a contracted residual of as little as $1.00 up to 20.00-25.00% of the equipment cost. Leases encompass a wide variety of equipment for a variety of commercial uses. The customer base tends to be small- to medium-sized businesses that view leasing as another financing option that augments their overall operation. Repayment terms tend to be monthly in nature.

        As with commercial loans, commercial leases typically are made on the basis of the borrower's ability to make repayment from the cash flow of their business. As a result, the availability of funds for the repayment of commercial leases may be substantially dependent on the success of the business itself. The collateral securing the leases will generally depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business.

         Municipal Leases.    The Bank and Mid America Capital also originate leases to municipal entities such as cities, counties, and public schools. The lessee must be a political subdivision of the state in order to qualify as a municipal lease. Because the interest income earned on this type of lease is exempt from federal income taxes, the rate offered to the municipality is usually substantially lower than a comparable commercial lease. Repayment terms generally are on a monthly, semi-annual or annual basis. Residuals are $1.00 for municipal leases.

        Repayment is based on the municipality's ability to levy and collect taxes. Assuming the municipality has a bond rating, that bond rating, together with audited financial statements, are the basis for the lease. On larger leases, bond ratings and financial statements will be reviewed annually.

9


         Loan and Lease Portfolio Composition.    The following table sets forth information concerning the composition of the Company's loan and lease portfolio from continuing operations in dollar amounts and in percentages (before deductions for the undisbursed portion of loans in process, deferred fees and discounts and allowance for losses) as of the dates indicated.

 
  At June 30,  
 
  2008   2007   2006   2005   2004  
 
  Amount   Percent
of Total
  Amount   Percent
of Total
  Amount   Percent
of Total
  Amount   Percent
of Total
  Amount   Percent
of Total
 
 
  (Dollars in Thousands)
 

One- to four-family(1)

  $ 108,548     13.36 % $ 125,525     15.97 % $ 108,342     14.57 % $ 106,832     15.46 % $ 104,492     15.80 %

Multi-family

    46,118     5.68     34,126     4.34     34,161     4.59     34,241     4.95     42,721     6.46  

Commercial business and real estate(2)(3)

    310,379     38.20     281,357     35.79     248,060     33.35     223,812     32.39     213,696     32.32  

Agricultural real estate

    78,043     9.60     48,030     6.11     31,484     4.23     23,954     3.47     20,449     3.09  

Construction and development

    8,286     1.02     18,674     2.38     33,596     4.52     15,454     2.24     15,044     2.28  

Equipment finance leases(2)

    19,250     2.37     22,267     2.83     29,343     3.95     33,090     4.79     26,942     4.07  

Agricultural business

    91,934     11.31     69,608     8.86     57,985     7.80     50,088     7.25     42,953     6.50  

Consumer Loans:

                                                             
 

Automobile

    58,807     7.24     98,238     12.50     106,900     14.37     108,621     15.72     101,669     15.38  
 

Deposit account

    1,580     0.19     1,772     0.23     1,553     0.21     1,253     0.18     1,489     0.22  
 

Student(4)

    614     0.08     263     0.03     420     0.06     400     0.06     324     0.05  
 

Junior liens on mortgages

    81,250     10.00     79,113     10.06     84,898     11.42     87,243     12.63     85,684     12.96  
 

Other

    7,724     0.95     7,079     0.90     6,932     0.93     5,968     0.86     5,748     0.87  
                                           
 

Total consumer loans

    149,975     18.46     186,465     23.72     200,703     26.99     203,485     29.45     194,914     29.48  
                                           
   

Total gross loans and leases

    812,533     100.00 %   786,052     100.00 %   743,674     100.00 %   690,956     100.00 %   661,211     100.00 %
                                           

Less:

                                                             
 

Undisbursed portion of loans in process

    (19,834 )         (10,387 )         (9,674 )         (6,350 )         (7,338 )      
 

Deferred fees and discounts

    (193 )         582           883           1,289           1,029        
 

Allowance for losses

    (5,933 )         (5,872 )         (5,657 )         (5,076 )         (3,605 )      
                                                     
   

Total loans and leases receivable, net

  $ 786,573         $ 770,375         $ 729,226         $ 680,819         $ 651,297        
                                                     

(1)
Includes one- to four-family loans held for sale.

(2)
Includes tax-exempt loans and leases.

(3)
Includes commercial loans held for sale.

(4)
Includes student loans held for sale.

10


        The following table sets forth the composition of the Company's loan and lease portfolio from continuing operations by fixed- and adjustable-rate in dollar amounts and in percentages (before deductions for the undisbursed portion of loans in process, deferred fees and discounts and allowance for losses) as of the dates indicated. Variable loans are tied to various indices including prime rate and the treasury yield curve and have reset dates ranging from daily to several years.

 
  At June 30,  
 
  2008   2007   2006   2005   2004  
 
  Amount   Percent
of Total
  Amount   Percent
of Total
  Amount   Percent
of Total
  Amount   Percent
of Total
  Amount   Percent
of Total
 
 
  (Dollars in Thousands)
 

Fixed-Rate Loans and Leases:

                                                             

One- to four-family(1)

    76,392     9.40 % $ 89,086     11.33 % $ 70,341     9.46 % $ 65,605     9.49 % $ 70,895     10.72 %

Multi-family, commercial & construction(2)(3)

    107,511     13.23     121,046     15.40     115,939     15.59     70,121     10.14     70,696     10.69  

Agricultural real estate

    23,842     2.93     13,591     1.73     9,495     1.28     4,096     0.59     2,609     0.39  

Consumer(4)

    110,699     13.63     146,686     18.66     151,354     20.35     141,942     20.54     133,012     20.12  

Agricultural business

    17,022     2.09     14,007     1.78     6,673     0.90     6,759     0.98     3,905     0.59  

Equipment finance leases(2)

    19,250     2.37     22,267     2.83     29,343     3.95     33,090     4.79     26,942     4.07  
                                           
 

Total fixed-rate loans and leases

    354,716     43.65     406,683     51.73     383,145     51.53     321,613     46.53     308,059     46.58  
                                           

Adjustable-Rate Loans:

                                                             

One- to four-family(1)

    32,156     3.96     36,439     4.64     38,001     5.11     41,227     5.97     33,597     5.08  

Multi-family, commercial & construction

    257,271     31.67     213,111     27.12     199,878     26.87     203,386     29.44     200,765     30.36  

Agricultural real estate

    54,201     6.67     34,439     4.38     47,770     6.42     19,858     2.87     17,840     2.70  

Consumer(4)

    39,277     4.83     39,779     5.06     49,349     6.64     61,543     8.92     61,902     9.37  

Agricultural business

    74,912     9.22     55,601     7.07     25,531     3.43     43,329     6.27     39,048     5.91  
                                           
 

Total adjustable-rate loans

    457,817     56.35     379,369     48.27     360,529     48.47     369,343     53.47     353,152     53.42  
                                           
   

Total loans and leases

    812,533     100.00 %   786,052     100.00 %   743,674     100.00 %   690,956     100.00 %   661,211     100.00 %
                                           

Less:

                                                             
 

Undisbursed portion of loans in process

    (19,834 )         (10,387 )         (9,674 )         (6,350 )         (7,338 )      
 

Deferred fees and discounts

    (193 )         582           883           1,289           1,029        
 

Allowance for loan and lease losses

    (5,933 )         (5,872 )         (5,657 )         (5,076 )         (3,605 )      
                                                     
   

Total loans and leases receivable, net

  $ 786,573         $ 770,375         $ 729,226         $ 680,819         $ 651,297        
                                                     

(1)
Includes one- to four-family loans held for sale.

(2)
Includes tax-exempt loans and leases.

(3)
Includes commercial loans held for sale.

(4)
Includes student loans held for sale.

11


        The following schedule illustrates the scheduled principal contractual repayments of the Company's loan and lease portfolio at June 30, 2008. Mortgages which have adjustable or renegotiable interest rates are shown as maturing at the contractual maturity date. The schedule does not reflect the effects of possible prepayments or enforcement of due-on-sale clauses.

 
  Real Estate   Non-Real Estate  
 
  One- to Four-
Family(1)
  Multi-
Family
  Commerical   Agricultural   Construction &
Development
  Consumer(2)   Commercial
Business(3)
  Agricultural   Total  
 
  (Dollars in Thousands)
 

Due in less than 1 year

  $ 4,082   $ 3,487   $ 34,348   $ 9,404   $ 4,351   $ 38,495   $ 73,134   $ 76,746   $ 244,046  

Due in 1 to 5 years

    27,130     15,626     52,718     19,336     601     93,499     57,316     13,113     279,339  

Due 5 years or greater

    77,336     27,005     97,972     49,303     3,334     17,982     14,141     2,075     289,148  
                                       

Total

  $ 108,548   $ 46,118   $ 185,038   $ 78,043   $ 8,286   $ 149,976   $ 144,591   $ 91,934   $ 812,533  
                                       

(1)
Includes one- to four-family loans held for sale.

(2)
Includes demand loans, loans having no stated maturity, student loans held for sale and overdraft loans.

(3)
Includes equipment finance leases, tax-exempt leases and commercial loans held for sale.

        Scheduled contractual principal repayments of loans do not reflect the actual life of such assets. The average life of loans is substantially less than their average contractual terms because of prepayments. In addition, due-on-sale clauses on loans generally give the Bank the right to declare a conventional loan immediately due and payable in the event, among other things, that the borrower sells the real property subject to the mortgage and the loan is not repaid. The average life of mortgage loans tends to increase when current mortgage loan rates are substantially higher than rates on existing mortgage loans and decrease when rates on existing mortgages are substantially higher than current mortgage loan rates.

        The following table sets forth the composition of the Company's deferred fees and discounts on loans as of the dates indicated.

 
  At June 30,  
 
  2008   2007   2006   2005   2004  
 
  (Dollars in Thousands)
 

One-to four-family

  $ (599 ) $ (691 ) $ (616 ) $ (576 ) $ (561 )

Multi-family, commercial real estate & construction

    (232 )   (276 )   (348 )   (278 )   (334 )

Consumer

    44     103     113     122     113  

Agricultural

    (70 )   (44 )   (32 )   (32 )   (32 )

Equipment finance leases

    39     40     63     80     77  

Commercial business

    21     14     5     (15 )   (125 )

Dealer reserve

    604     1,436     1,698     1,988     1,891  
                       
 

Total deferred fees and discounts

  $ (193 ) $ 582   $ 883   $ 1,289   $ 1,029  
                       

        Deferred fees and discounts on loans and leases have trended to a net deferred cost position. In fiscal 2008, the net deferred fees and discounts on loans and leases decreased by $775,000. This decrease was primarily due to a $832,000 decrease in dealer reserve, as a result of lower dollar volume of originated indirect automobile loans as the Company ceased originations in the first quarter of fiscal 2008.

Potential Problem Loans

         Nonperforming Assets.    See "Asset Quality" under Part II, Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" of this Form 10-K for discussion.

12


         Classified Assets.    Federal regulations provide for the classification of loans, leases and other assets, such as debt and equity securities considered by the OTS to be of lesser quality, as "substandard," "doubtful" or "loss." An asset is considered "substandard" if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. "Substandard" assets include those characterized by the "distinct possibility" that the Company will sustain "some loss" if the deficiencies are not corrected. Assets classified as "doubtful" have all of the weaknesses inherent in those classified "substandard," with the added characteristic that the weaknesses present make "collection or liquidation in full," on the basis of currently existing facts, conditions, and values, "highly questionable and improbable." Assets classified as "loss" are those considered "uncollectible" and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted. Assets which do not currently expose the Company to sufficient risk to warrant classification in one of the aforementioned categories, but possess weaknesses, are required to be designated "criticized" or "special mention" by management.

        When the Company classifies problem assets as "loss," it is required either to establish a specific allowance for losses equal to 100.00% of that portion of the asset so classified or to charge-off such amount. The Company's determination as to the classification of its assets and the amount of its valuation allowances is subject to review by the Bank's Regional Director at the regional OTS office, who may order the establishment of additional general or specific loss allowances.

        In connection with the filing of its periodic reports with the OTS and in accordance with its classification of assets policy, the Company regularly reviews problem loans and leases in its portfolio to determine whether any loans or leases require classification in accordance with applicable regulations. On the basis of management's monthly review of its assets, at June 30, 2008, the Company had designated $22.2 million of its assets as special mention and $11.5 million of its assets as classified. Other potential problem loans are included in criticized and classified assets. See "Asset Quality" under Part II, Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" of this Form 10-K for further discussion.

         Allowance for Loan and Lease Losses.    See "Application of Critical Accounting Policies" and "Asset Quality" under Part II, Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" of this Form 10-K for discussion.

Investment Activities

        The Bank is required under OTS regulation to maintain a sufficient amount of liquid assets. Liquidity may increase or decrease depending upon the availability of funds and comparative yields on investments in relation to the return on loans.

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

        Generally, the investment policy of the Bank is to invest funds among various categories of investments and maturities based upon the Bank's asset/liability management policies, investment quality and marketability, liquidity needs and performance objectives.

        At June 30, 2008, the Company's investments in mortgage-backed securities totaled $189.6 million, or 17.2% of its total assets. As of such date, the Bank also had a $11.2 million investment in the stock

13



of the Federal Home Loan Bank of Des Moines ("FHLB" or "FHLB of Des Moines") in order to satisfy the FHLB of Des Moines' requirement for membership.

        The composition and maturities of the investment securities portfolio, excluding equity securities, are indicated in the following table.

 
  At June 30, 2008  
 
  Less Than 1 Year   1 to 5 Years   5 to 10 Years   Over 10 Years   Total Investment
Securities
 
 
  Amortized
Cost
  Weighted
Average
Yield
  Amortized
Cost
  Weighted
Average
Yield
  Amortized
Cost
  Weighted
Average
Yield
  Amortized
Cost
  Weighted
Average
Yield
  Amortized
Cost
  Fair Value  
 
  (Dollars in Thousands)
 

U.S. government agencies & corporations

        % $ 6,174     5.07 % $ 2,316     5.41 %       % $ 8,490   $ 8,663  

Federal Home Loan Bank

            2,999     5.23     945     5.50             3,944     4,031  

Municipal bonds

    230     2.63     3,376     3.71     4,723     3.81     3,990     3.96     12,319     12,181  

Trust preferred securities

                            12,372     4.64     12,372     10,292  

Mortgage-backed securities

            1,777     5.25     52,054     5.05     137,116     5.29     190,947     189,567  
                                                   

Total investment securities

  $ 230         $ 14,326         $ 60,038         $ 153,478         $ 228,072   $ 224,734  
                                                   

        The effective maturities for the Bank's mortgage-backed securities are much shorter due to the combination of prepayments and the variable nature of $63.1 million of mortgage-backed securities. The variable or hybrid (fixed for a period of time and then variable thereafter) structure gives the Bank flexibility in risk management of the balance sheet.

        The Company's investment securities portfolio did not contain non-investment grade bonds (i.e., "junk bonds") or other corporate debt securities.

        No other-than-temporary impairments were recorded against earnings during fiscal years 2008, 2007 or 2006. See Note 1, "Summary of Significant Accounting Policies," and Note 2, "Investment Securities," of "Notes to Consolidated Financial Statements," which is included in Part II, Item 8 of this Form 10-K for additional information.

        The Bank's investment security portfolio is managed in accordance with a written investment policy adopted by the Board of Directors. Investments may be made by the Bank's officers within specified limits and approved in advance by the Board of Directors for transactions over these limits. At the present time, the Bank does not have any investments that are held for trading purposes. At June 30, 2008, the Company had $225.0 million of securities available for sale, including mortgage-backed securities of $189.6 million. See Note 2 of "Notes to Consolidated Financial Statements," which is included in Part II, Item 8 "Financial Statements and Supplementary Data" of this Form 10-K for further information on the Company's investment portfolio.

Sources of Funds

         General.    The Company's primary sources of funds are earnings, in-market deposits, FHLB advances and other borrowings, amortization and repayments of loan principal, mortgage-backed securities and callable agency securities. Secondary sources include sales of mortgage loans, sales and/or maturities of securities, out-of-market deposits and short-term investments.

        Borrowings of the Bank are primarily from the FHLB of Des Moines, and may be used on a short-term basis to compensate for seasonal reductions in deposits or deposit inflows at less than projected levels, and may be used on a longer-term basis to support expanded lending activities. The Bank has established collateral at the Federal Reserve Bank ("FRB") as a contingent source of funding. See Note 7 of the "Notes to Consolidated Financial Statements," which is included in Part II, Item 8 "Financial Statements and Supplementary Data" of this Form 10-K for further detail of the Company's borrowings.

14


         Deposits.    The Bank offers a variety of deposit accounts having a wide range of interest rates and terms. The Bank's deposits consist of statement savings accounts, checking accounts, money market and certificate of deposit accounts ranging in terms from 30 days to five years. The Bank primarily solicits deposits from its market area. The Bank relies primarily on customer service, competitive pricing policies and advertising to attract and retain these deposits. Based on liquidity needs, the Bank may, from time to time, acquire out-of-market deposits.

        The flow of deposits is influenced by general economic conditions, changes in money market and prevailing interest rates and competition.

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

15


        The following table sets forth the dollar amount of deposits in the various types of deposit accounts offered by the Bank as of the dates indicated.

 
  At June 30,  
 
  2008   2007   2006  
 
  Amount   Percent of
Total
  Amount   Percent of
Total
  Amount   Percent of
Total
 
 
  (Dollars in Thousands)
 

Transaction Accounts:

                                     

Noninterest bearing accounts

  $ 90,598     11.55 % $ 86,679     10.62 % $ 84,757     11.02 %

Interest bearing accounts weighted average rates of .64%, 1.97% and 0.95% at June 30, 2008, 2007 and 2006

    90,125     11.49     87,030     10.67     54,862     7.14  

Savings accounts weighted average rates of 1.46%, 3.26% and 3.40% at June 30, 2008, 2007 and 2006

    78,575     10.02     66,235     8.12     76,695     9.97  

Money market accounts weighted average rates of 1.53%, 3.84% and 3.89% at June 30, 2008, 2007 and 2006

    171,689     21.89     212,546     26.05     232,471     30.23  
                           

Total transaction accounts

   
430,987
   
54.95
   
452,490
   
55.46
   
448,785
   
58.36
 
                           

In-Market Certificates of Deposit:

                                     

0.00 - 3.99%

   
124,448
   
15.87
   
45,387
   
5.56
   
124,302
   
16.16
 

4.00 - 4.99%

    106,627     13.60     78,457     9.62     104,320     13.57  

5.00 - 5.99%

    94,727     12.08     167,710     20.56     34,135     4.44  

6.00 - 6.99%

    193     0.02     304     0.04     7     0.00  

7.00 - 7.99%

                         
                           

Total in-market certificates of deposit

    325,995     41.57     291,858     35.78     262,764     34.17  

Out-of-market certificates of deposit weighted average rate of 2.98%, 5.10% and 4.69% at June 30, 2008, 2007 and 2006

   
27,255
   
3.48
   
71,516
   
8.76
   
57,453
   
7.47
 
                           

Total certificates of deposit

   
353,250
   
45.05
   
363,374
   
44.54
   
320,217
   
41.64
 
                           

Total deposits

  $ 784,237     100.00 % $ 815,864     100.00 % $ 769,002     100.00 %
                           

16


        The following table sets forth the amount of the Company's certificates of deposit and other deposits by time remaining until maturity as of June 30, 2008.

 
  Maturity    
 
 
  Less Than 3 Months   3 to 6 Months   6 to 12 Months   Over 12 Months   Total  

Certificates of deposit less than $100,000(1)

  $ 44,961   $ 22,811   $ 47,577   $ 76,268   $ 191,617  

Certificates of deposit of $100,000 or more

   
32,783
   
12,725
   
13,553
   
54,898
   
113,959
 

Out-of-market certificates of deposit(2)

   
17,179
   
8,982
   
1,094
   
0
   
27,255
 

Public funds(3)(4)

   
9,369
   
7,231
   
2,707
   
1,112
   
20,419
 
                       

Total certificates of deposit

 
$

104,292
 
$

51,749
 
$

64,931
 
$

132,278
 
$

353,250
 
                       

(1)
Includes funds from the Certificate of Deposit Account Registry Service ("CDARS") certificate of deposit program of $9.3 million.

(2)
Includes certificates of deposit of $100,000 or greater of $18.8 million.

(3)
Includes certificates of deposit from governmental and other public entities, excluding out-of-market certificates of deposit.

(4)
Includes certificates of deposit of $100,000 or greater of $9.3 million.

        The Bank solicits certificates of deposit of $100,000 or greater from various state, county and local government units which carry rates which are negotiated at the time of deposit. See Note 6 of "Notes to Consolidated Financial Statements," which is included in Part II, Item 8 "Financial Statements and Supplementary Data" of this Form 10-K. Deposits at June 30, 2008, and 2007 included $76.5 million and $73.3 million, respectively, of deposits from one local governmental entity, the majority of which are savings account balances.

         Borrowings.    Although deposits are the Bank's primary source of funds, the Bank's policy has been to utilize borrowings when they are a less costly source of funds or can be invested at a positive rate of return.

        The Bank's borrowings consist primarily of advances from the FHLB of Des Moines upon the security of its capital stock of the FHLB of Des Moines and certain pledgeable loans, including but not limited to, its mortgage related loans, mortgage-backed securities and U.S. Government and other agency securities. Such advances can be made pursuant to several different credit programs, each of which has its own interest rate and range of maturities. At June 30, 2008, the Bank's FHLB advances totaled $198.3 million, representing 19.1% of total Company liabilities. See Note 7 of "Notes to Consolidated Financial Statements," which is included in Part II, Item 8 "Financial Statements and Supplementary Data" of this Form 10-K for further detail of the Company's borrowings.

17


        The following table sets forth the maximum month-end balances and average balances of FHLB and FRB advances and other borrowings at the dates indicated.

 
  Years Ended June 30,  
 
  2008   2007   2006  
 
  (Dollars in Thousands)
 

Maximum Month-End Balance:

                   

FHLB and FRB advances

  $ 244,040   $ 131,975   $ 152,369  

Other borrowings

    180     100     700  

Average Balance:

                   

FHLB and FRB advances

  $ 152,140   $ 106,150   $ 119,408  

Other borrowings

    149     2     287  

        The following table sets forth certain information as to the Bank's FHLB and FRB advances and other borrowings of the Company at the dates indicated.

 
  June 30,  
 
  2008   2007   2006  
 
  (Dollars in Thousands)
 

Overnight federal funds purchased

  $ 29,920   $   $ 1,120  

Fixed-rate FHLB advances

    168,355     68,500     90,500  

Other borrowings

    179     100      
               

Total borrowings

  $ 198,454   $ 68,600   $ 91,620  
               

Weighted average interest rate of borrowings

    3.88 %   4.78 %   4.51 %

Competition

        The banking business is highly competitive and the Bank experiences competition in each of its markets from many other financial institutions, many of which are larger and may have significantly greater financial and other resources. Specifically, the Bank competes with commercial banks, credit unions, savings and loan associations, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market funds and other mutual funds, as well as super-regional, national and international financial institutions, that operate offices in our primary market areas and elsewhere. Many of these competitors are also well-established financial institutions.

        Competitors that are not depository institutions are generally not subject to the extensive regulations that apply to the Bank. The Bank competes with these institutions both in attracting deposits and in making loans. The Bank competes for deposits by offering a variety of deposit accounts at competitive rates, convenient business hours and convenient branch locations with inter-branch deposit and withdrawal privileges at each. The Bank competes for loans on the basis of quality of service, interest rates, loan fees and loan type. In addition, the Bank must attract its customer base from other existing financial institutions and from new residents. In new markets that the Bank may enter, the Bank will also compete against well-established community banks that have developed relationships within the community.

Employees

        At June 30, 2008, the Bank had a total of 307 full-time equivalent employees ("FTEs") including 5 FTEs of the Bank's subsidiary corporations. The Bank's employees are not represented by any collective bargaining group. Management considers its relations with its employees to be good.

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Regulation

         General.    The Bank is a federally chartered thrift institution, the deposits of which are federally insured by the DIF. Accordingly, the Bank is subject to broad federal regulation and oversight extending to all its operations, by its primary federal regulator, the OTS, and by its deposit insurer, the FDIC. The Bank is a member of the FHLB of Des Moines and is subject to certain limited regulation by the Federal Reserve Board. As the unitary thrift holding company of the Bank, the Company is also subject to federal regulation and oversight by the OTS. The purpose of the regulation of the Company, like other depository institution holding companies, is to protect subsidiary institutions where deposits are federally insured.

        Certain of these regulatory requirements and restrictions are discussed below or elsewhere in this Form 10-K. The following discussion is intended to be a summary of the material statutes, regulations and policies applicable to savings associations and their holding companies, and it does not purport to be a complete discussion of all such statutes, regulations and policies.

         Regulation of Federal Savings Associations.    The OTS has extensive authority over the operations of federal savings associations, such as the Bank. This regulation and supervision establishes a comprehensive framework of activities in which a federal savings association can engage and is intended primarily for the protection of the DIF and depositors. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. Any change in such laws and regulations or interpretations thereof, whether by the OTS, the FDIC or through legislation, could have a material adverse impact on the Company and the Bank and their operations and stockholders.

        The Bank is required to file periodic reports with the OTS and is subject to periodic examinations primarily by the OTS and to a lesser extent by the FDIC. The last examination of the Bank by the OTS concluded on June 28, 2008.

         Assessments.    The OTS has established a schedule for the assessment of fees upon all savings associations to fund the operations of the OTS. The general assessment, paid on a semiannual basis, is computed by totaling three components: the Bank's total assets, supervisory condition, and complexity of operations. The Bank's OTS assessment (standard assessment) for the fiscal year ended June 30, 2008, was approximately $219,206.

         Enforcement.    The OTS has primary enforcement responsibility over savings associations, including the Bank. This enforcement authority includes, among other things, the ability to assess civil money penalties, to issue cease and desist orders and to remove directors and officers. In general, these enforcement actions may be initiated in response to violations of laws and regulations and to unsafe or unsound practices. Under the Federal Deposit Insurance Act, the FDIC has the authority to recommend to the Director of the OTS that enforcement action be taken with respect to a particular savings association. If action is not taken by the OTS, the FDIC may take action under certain circumstances.

         Safety and Soundness Standards.    Under federal law, the OTS has adopted a set of guidelines prescribing safety and soundness standards. The guidelines establish general standards relating to internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, asset quality, earnings and compensation, fees and benefits. In general, the guidelines require, among other things, appropriate systems and practices to identify and manage the risks and exposures specified in the guidelines. The guidelines prohibit excessive compensation as an unsafe and unsound practice and describe compensation as excessive when the amounts paid are unreasonable or disproportionate to the services performed by an executive officer, employee, director or principal stockholder.

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        In addition, the OTS adopted regulations that authorize, but do not require, the OTS to order an institution that has been given notice by the OTS that it is not satisfying any of such safety and soundness standards to submit a compliance plan. If, after being so notified, an institution fails to submit an acceptable compliance plan or fails in any material respect to implement an accepted compliance plan, the OTS must issue an order directing action to correct the deficiency and may issue an order directing corrective actions and other actions of the types to which an undercapitalized association is subject under the "prompt corrective action" provisions of federal law. If an institution fails to comply with such an order, the OTS may seek to enforce such order in judicial proceedings and to impose civil money penalties.

         Prompt Corrective Regulatory Action.    Under the OTS prompt corrective action regulations, the OTS is required to take certain, and is authorized to take other, supervisory actions against undercapitalized savings banks. For this purpose, a savings bank is placed in one of the following five categories based on the association's capital:

    well-capitalized;

    adequately capitalized;

    undercapitalized;

    significantly undercapitalized; or

    critically undercapitalized.

        The severity of the action authorized or required to be taken under the prompt corrective action regulations increases as a bank's capital decreases within the three undercapitalized categories. All banks are prohibited from paying dividends or other capital distributions or paying management fees to any controlling person if, following such distribution, the bank would be undercapitalized. The OTS is required to monitor closely the condition of an undercapitalized bank and to restrict the growth of its assets.

        An undercapitalized bank is required to file a capital restoration plan within 45 days of the date the bank receives notices that it is within any of the three undercapitalized categories, and the plan must be guaranteed by any parent holding company. The aggregate liability of a parent holding company is limited to the lesser of:

    an amount equal to five percent of the bank's total assets at the time it became "undercapitalized;" and

    the amount that is necessary (or would have been necessary) to bring the bank into compliance with all capital standards applicable with respect to such bank as of the time it fails to comply with the plan.

        If a bank fails to submit an acceptable plan, it is treated as if it were "significantly undercapitalized." Banks that are "significantly" or "critically undercapitalized" are subject to a wider range of regulatory requirements and restrictions. Under the OTS regulations, generally, a federally chartered savings bank is treated as "well-capitalized" if its total risk-based capital ratio is 10% or greater, its Tier 1 risk-based capital ratio is 6% or greater, its leverage ratio is 5% or greater, and it is not subject to any order or directive by the OTS to meet a specific capital level.

        At June 30, 2008, the Bank met the criteria for being considered "well-capitalized."

         Business Activities.    The activities of federal savings banks are governed by federal laws and regulations. These laws and regulations delineate the nature and extent of the activities in which federal savings associations may engage. In particular, many types of lending authority for federal savings associations are limited to a specified percentage of the institution's capital or assets.

20


         Loan and Investment Powers.    The Bank derives its lending and investment powers from the HOLA, and the regulations of the OTS thereunder. Under these laws and regulations, the Bank may invest in mortgage loans secured by residential and commercial real estate, commercial and consumer loans, certain types of debt securities and certain other assets. The Bank may also establish service corporations that may engage in activities not otherwise permissible for the Bank, including certain real estate equity investments and securities and insurance brokerage activities. These investment powers are subject to various limitations, including (a) a prohibition against the acquisition of any corporate debt security that is not rated in one of the four highest rating categories; (b) a limit of 400.00% of an association's capital on the aggregate amount of loans secured by non-residential real estate property; (c) a limit of 20.00% of an association's assets on the aggregate amount of commercial and agricultural loans and leases with the amount of commercial loans in excess of 10.00% of assets being limited to small business loans; (d) a limit of 35.00% of an association's assets on the aggregate amount of secured consumer loans and acquisitions of certain debt securities, with amounts in excess of 30.00% of assets being limited to loans made directly to the original obligor and where no third-party finder or referral fees were paid; (e) a limit of 5.00% of assets on non-conforming loans (loans in excess of the specific limitations of the HOLA); and (f) a limit of the greater of 5.00% of assets or an association's capital on certain construction loans made for the purpose of financing what is or is expected to become residential property. In addition, the HOLA and the OTS regulations provide that a federal savings association may invest up to 10.00% of its assets in tangible personal property for leasing purposes. At June 30, 2008, the Bank met the 10.00% leasing limitation with 1.74% of total Bank assets. Such general leases, however, do not have to be aggregated with the institution's loans for purposes of the HOLA's investment and lending limitations. At June 30, 2008, the Bank met the 20.00% limitation with 18.85% of total Bank assets.

         Loans-To-One Borrower.    Under the HOLA, the Bank is generally subject to the same limits on loans-to-one borrower as are imposed on national banks. With specified exceptions, the Bank may not make a loan or extend credit to a single or related group of borrowers in excess of 15.00% of the association's unimpaired capital and surplus. Additional amounts may be loaned, not in excess of 10.00% of unimpaired capital and surplus, if such loans or extensions of credit are fully secured by readily-marketable collateral. At June 30, 2008, the Bank's lending limit under this restriction was $13.3 million.

         Insurance of Accounts and Regulation by the FDIC.    The Bank is a member of, and pays deposit insurance assessments to, the DIF, which is administered by the FDIC. Savings deposits are generally insured up to $100,000 per insured member (as defined by law and regulation) by the FDIC and such insurance is backed by the full faith and credit of the United States Government. Effective April 1, 2006, through the Federal Deposit Insurance Reform Act of 2005, the maximum insurance coverage for self-directed retirement plan deposits only, increased from $100,000 to $250,000. All other deposit coverage remains at $100,000. As insurer, the FDIC imposes deposit insurance premiums and is authorized to conduct examinations of and to require reporting by FDIC-insured institutions. It also may prohibit any FDIC-insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious risk to the DIF. The FDIC also has the authority to initiate enforcement actions against savings associations, after giving the OTS an opportunity to take such action, and may terminate the deposit insurance if it determines that the institution has engaged or is engaging in unsafe or unsound practices, or is in an unsafe or unsound condition.

        The DIF was formed on March 31, 2006, following the merger of the Bank Insurance Fund and the Savings Association Insurance Fund in accordance with the Federal Deposit Insurance Reform Act of 2005 (the "Deposit Insurance Fund Act"). In addition to merging the insurance funds, the Deposit Insurance Fund Act established a statutory minimum and maximum designated reserve ratio for the DIF and granted the FDIC greater flexibility in establishing the required reserve ratio. In its

21



regulations implementing the Deposit Insurance Fund Act, the FDIC has set the current annual designated reserve ratio for the DIF at 1.25%.

        In order to maintain the DIF, member institutions are assessed an insurance premium. The amount of each institution's premium is currently based on the balance of insured deposits and the degree of risk the institution poses to the DIF. Under the assessment system, the FDIC assigns an institution to one of nine risk categories using a two-step process based first on capital ratios (the capital group assignment) and then on other relevant information (the supervisory subgroup assignment). Each risk category is assigned an assessment rate. Assessment rates currently range from 0.00% of deposits for an institution in the highest category (i.e., well-capitalized and financially sound, with no more than a few minor weaknesses) to 0.43% of deposits for an institution in the lowest category (i.e., undercapitalized and substantial supervisory concerns). The FDIC is authorized to raise the assessment rates as necessary to maintain the DIF. The Bank's assessment rate at June 30, 2008 was 0.056%. Any increase in insurance assessments could have an adverse effect on the earnings of insured institutions, including the Bank.

        The Federal Deposit Insurance Reform Act of 2005 allows "eligible insured depository institutions" to share a one-time assessment credit pool of approximately $4.7 billion. To be eligible, an institution must have been in existence on December 31, 1996 and have paid a deposit insurance assessment prior to that date, or be a "successor" to such an institution. The Bank's remaining assessment credit is $111,219, which will be applied to reduce future deposit insurance assessments.

        In addition, all FDIC-insured institutions are required to pay assessments to the FDIC at an annual rate of approximately 0.0124% of insured deposits to fund interest payments on bonds issued by the Financing Corporation ("FICO"), an agency of the federal government established in 1987 to recapitalize the predecessor to the DIF. These assessments, which are adjusted quarterly, will continue until the FICO bonds mature in 2017 through 2019.

        The Bank's assessment rate for the fiscal year ending June 30, 2008, was 0.056% and the premium paid for this period was $91,872. The FDIC has authority to increase insurance assessments. A significant increase in DIF insurance premiums would have an adverse effect on the operating expenses and results of operations of the Bank. Management cannot predict what the insurance assessment rate will be in the future.

        Under federal law, insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC or the OTS. The management of the Bank does not know of any practice, condition or violation that might lead to termination of deposit insurance.

         Regulatory Capital Requirements.    OTS regulations require the Bank to meet three minimum capital standards:

    A tangible capital ratio requirement of 1.50%;

    A leverage (core capital) ratio requirement of 4.00% (3.00% if a savings association has been assigned the highest composite rating); and

    A risk-based capital ratio requirement of 8.00%.

        In assessing an institution's capital adequacy, the OTS takes into consideration not only these numeric factors but also qualitative factors as well, and has the authority to establish higher capital requirements for individual institutions where necessary. The Bank, as a matter of prudent management, targets as its goal the maintenance of capital ratios which exceed these minimum

22



requirements and that are consistent with the Bank's risk profile. At June 30, 2008, the Bank exceeded each of its capital requirements as shown in the following table:

 
  Amount(2)   Percent of
Applicable
Assets(1)
 
 
  (Dollars in Thousands)
 

GAAP Capital

  $ 87,653     7.94 %
           

Tier 1 (core) capital

  $ 85,623     7.78 %

Required

    55,034     4.00  
           

Excess over requirement

  $ 30,589     3.78 %
           

Risk-based capital

  $ 91,417     10.83 %

Required

    84,398     8.00  
           

Excess over requirement

  $ 7,019     2.83 %
           

      (1)
      Tier I (core) capital figures are determined as a percentage of total adjusted assets; risk based capital figures are determined as a percentage of risk-weighted assets.

      (2)
      The Bank's investment in its subsidiaries is included for purposes of calculating regulatory capital.

        The Federal Deposit Insurance Corporation Improvement Act (the "FDICIA") requires that the OTS and other federal banking agencies revise their risk-based capital standards, with appropriate transition rules, to ensure that they take into account interest rate risk, concentration of risk and the risks of non-traditional activities. The OTS monitors the interest rate risk of individual institutions through the OTS requirements for interest rate risk management, the ability of the OTS to impose individual minimum capital requirements on institutions that exhibit a high degree of interest rate risk, and the requirements of Thrift Bulletin 13a, which provides guidance on the management of interest rate risk and the responsibility of boards of directors in that area.

        The OTS continues to monitor the interest rate risk of individual institutions through analysis of the change in net portfolio value ("NPV"). NPV is defined as the net present value of the expected future cash flows of an entity's assets and liabilities and, therefore, hypothetically represents the value of an institution's net worth. The OTS has also used this NPV analysis as part of its evaluation of certain applications or notices submitted by savings banks. The OTS, through its general oversight of the safety and soundness of savings associations, retains the right to impose minimum capital requirements on individual institutions to the extent the institution is not in compliance with certain written guidelines established by the OTS regarding NPV analysis. The OTS has not imposed any such requirements on the Bank.

         Limitations on Dividends and Other Capital Distributions.    The OTS imposes various restrictions or requirements on the Bank's ability to make capital distributions, including cash dividends. A savings institution that is the subsidiary of a savings and loan holding company must file a notice with the OTS at least 30 days before making a capital distribution. The Bank must file an application for prior approval if the total amount of its capital distributions, including the proposed distribution, for the applicable calendar year would exceed an amount equal to the Bank's net income for that year plus retained net income for the previous two years.

        The OTS may disapprove of a notice or application if:

    the Bank would be undercapitalized following the distribution;

23


    the proposed capital distribution raises safety and soundness concerns; or

    the capital distribution would violate a prohibition contained in any statute, regulation or agreement between the Bank and the OTS or the FDIC, or a condition imposed on the Bank in an OTS-approved application or notice.

        During the fiscal year ended June 30, 2008, the Bank paid cash dividends to the Company totaling $5.2 million.

         Liquidity.    All savings associations, including the Bank, are required to maintain a sufficient amount of liquid assets to ensure its safe and sound operation. For a discussion of what the Bank includes in liquid assets, see Part II, Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" of this Form 10-K.

         Branching.    Subject to certain limitations, the HOLA and the OTS regulations permit federally chartered savings associations to establish branches in any state of the United States. The authority to establish such branches is available (a) in states that expressly authorize branches of savings associations located in another state or (b) to an association that qualifies as a "domestic building and loan association" under the Internal Revenue Code of 1986, as amended, which imposes qualification requirements similar to those for a "qualified thrift lender" under the HOLA. See the section below entitled "Qualified Thrift Lender Test." This authority under the HOLA and the OTS regulations preempts any state law purporting to regulate branching by federal savings associations.

         Community Reinvestment.    Under the Community Reinvestment Act (the "CRA"), as implemented by the OTS regulations, the Bank has a continuing and affirmative obligation consistent with its safe and sound operation to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution's discretion to develop the types of products and services that it believes are best suited to its particular community. The CRA requires the OTS, in connection with its examination of a savings association, to assess the Bank's record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications by the Bank. The CRA also requires all institutions to make public disclosure of their CRA ratings. The Bank received an "Outstanding" CRA rating in the OTS evaluation, which was last completed on May 29, 2008.

        The CRA regulations rate an institution based on its actual performance in meeting community needs. In particular, the rating system focuses on three tests: (a) a lending test, to evaluate the institution's record of making loans in its assessment areas; (b) an investment test, to evaluate the institution's record of investing in community development projects, affordable housing, and programs benefiting low or moderate income individuals and businesses; and (c) a service test, to evaluate the institution's delivery of services through its branches, ATMs and other offices.

         Qualified Thrift Lender ("QTL") Test.    Under the HOLA, the Bank must comply with the qualified thrift lender, or "QTL" test. Under the QTL test, the Bank is required to maintain at least 65.00% of its "portfolio assets" (total assets less (a) specified liquid assets up to 20.00% of total assets, (b) intangibles, including goodwill, and (c) the value of property used to conduct business) in certain "qualified thrift investments" (primarily residential mortgages and related investments, including certain mortgage-backed securities, credit card loans, student loans and small business loans) in at least nine months of the most recent 12 month period. The Bank may also satisfy the QTL test by qualifying as a "domestic building and loan association" as defined in the Internal Revenue Code of 1986, as amended.

        At June 30, 2008, the Bank held 74.82% of its portfolio assets in qualified thrift investments and had more than 65.00% of its portfolio assets in qualified thrift investments in 12 of the 12 months

24



during the fiscal year ended June 30, 2008, and thus qualified under the QTL test. The Bank has met the QTL test since its inception.

        A savings bank that fails the QTL test and is unable to demonstrate a reasonable likelihood of meeting it in the future may be required to convert to a bank charter and will generally be prohibited from: (1) engaging in any new activity not permissible for a national bank, (2) paying dividends not permissible under national bank regulations, and (3) establishing any new branch office in a location not permissible for a national bank. In addition, if the institution does not re-qualify under the QTL test within three years after failing the test, the institution would be prohibited from engaging in any activity not permissible for a national bank and may have to repay any outstanding advances from the Federal Home Loan Bank as promptly as possible.

         Transactions with Affiliates.    The Bank's authority to engage in transactions with its "affiliates" is limited by the OTS regulations, Sections 22(g), 22(h) 23A and 23B of the Federal Reserve Act (the "FRA") and Regulation W issued by the Federal Reserve Board, Section 11 of the HOLA as well as any additional limitations adopted by the OTS. OTS regulations regarding transactions with affiliates conform to Regulation W. These provisions, among other things, prohibit or limit a savings bank from extending credit to, or entering into certain transactions with, its affiliates and principal stockholders, directors and executive officers.

        In addition, the OTS regulations include additional restrictions on savings banks under Section 11 of the HOLA, including provisions prohibiting a savings bank from making a loan to an affiliate that is engaged in non-bank holding company activities and provisions prohibiting a savings association from purchasing or investing in securities issued by an affiliate that is not a subsidiary. OTS regulations also include certain specific exemptions from these prohibitions. The FRB and the OTS require each depository institution that is subject to Sections 23A and 23B to implement policies and procedures to ensure compliance with Regulation W and the OTS regulations regarding transactions with affiliates.

        Section 402 of the Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley") prohibits the extension of personal loans to directors and executive officers of issuers (as defined in Sarbanes-Oxley). The prohibition, however, does not apply to mortgages advanced by an insured depository institution, such as the Bank, that are subject to the insider lending restrictions of Section 22(h) of the FRA.

         Real Estate Lending Standards.    The OTS and the other federal banking agencies adopted regulations to prescribe standards for extensions of credit that (a) are secured by real estate or (b) are made for the purpose of financing the construction of improvements on real estate. The OTS regulations require the Bank to establish and maintain written internal real estate lending standards that are consistent with safe and sound banking practices and appropriate to the size of the association and the nature and scope of its real estate lending activities. The standards also must be consistent with accompanying OTS guidelines, which include loan-to-value ratios for the different types of real estate loans. The Bank is also permitted to make a limited amount of loans that do not conform to the proposed loan-to-value limitations so long as such exceptions are reviewed and justified appropriately. The guidelines also list a number of lending situations in which exceptions to the loan-to-value standards are justified.

         Nontraditional Mortgage Products.    The federal banking agencies recently published final guidance for institutions that originate or service nontraditional or alternative mortgage products, defined to include all residential mortgage loan products that allow borrowers to defer repayment on principal or interest, such as interest-only mortgages and payment option adjustable-rate mortgages. No portion of the Bank's adjustable rate residential mortgage loans consist of interest-only or payment option mortgage loans.

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        Recognizing that alternative mortgage products expose institutions to increased risks as compared to traditional loans where payments amortize or reduce the principal amount, the guidance required increased scrutiny for alternative mortgage products. Institutions that originate or service alternative mortgages should have (a) strong risk management practices that include maintenance of capital levels and allowance for loan losses commensurate with the risk; (b) prudent lending policies and underwriting standards that address a borrower's repayment capacity; and (c) programs and practices designed to ensure that consumers receive clear and balanced information to assist in making informed decisions about mortgage products. The guidance also recommends heightened controls and safeguards when an institution combines an alternative mortgage product with features that compound risk, such as a simultaneous second-lien or the use of reduced documentation to evaluate a loan application.

        The Bank is required to comply with the guidance as it is interpreted and applied by the OTS.

         Privacy Regulations.    Under the OTS regulations adopted pursuant to the Gramm-Leach-Bliley Act of 1999, the Bank is required to adopt procedures to protect customers' "nonpublic personal information." The regulations generally require that the Bank disclose its privacy policy, including identifying with whom it shares a customer's "nonpublic personal information," to customers at the time of establishing the customer relationship and annually thereafter. In addition, the Bank is required to provide its customers with the ability to "opt-out" of having it share their personal information with unaffiliated third parties and not to disclose account numbers or access codes to nonaffiliated third parties for marketing purposes. The Bank currently has a privacy protection policy in place, which has been reviewed, for compliance with the regulations.

         Protection of Customer Information.    In addition to certain state laws governing protection of customer information, the Bank is subject to federal regulatory guidelines establishing standards for safeguarding customer information. These regulations implement certain provisions of the Gramm-Leach-Bliley Act. The guidelines describe the agencies' expectations for the creation, implementation and maintenance of an information security program, which would include administrative, technical and physical safeguards appropriate to the size and complexity of the institution and the nature and scope of its activities. The standards set forth in the guidelines are intended to ensure the security and confidentiality of customer records and information, protect against any anticipated threats or hazards to the security or integrity of such records and protect against unauthorized access to or use of such records or information that could result in substantial harm or inconvenience to any customer. Federal guidelines also impose certain customer disclosures and other actions in the event of unauthorized access to customer information.

         Trust Activities Regulation.    The Bank derives its trust powers from Section 5(n) of the HOLA and the regulations and policies of the OTS. Under these laws, regulations and policies, the trust activities of federal savings banks are governed by both federal and state laws. Generally, the scope of trust activities that the Bank can provide will be governed by the laws of the states in which the Bank is "located" (as such term is defined under the regulations of the OTS), while other aspects of the trust operations of the Bank are governed by federal laws and regulations. If the trust activities of a federal savings bank are located in more than one state, however, then the scope of fiduciary services the federal savings bank can provide will vary depending on the laws of each state.

        The Bank, through its trust department, acts as trustee, personal representative, administrator, guardian, custodian, record keeper, agent, registrar, advisor and manager for various accounts. As of June 30, 2008, the trust department of the Bank maintained approximately $95.0 million in assets under management.

         Federal Reserve System.    Under FRB regulations, the Bank is required to maintain noninterest-earning reserves against its transaction accounts. FRB regulations generally require that (a) reserves of 3.00% must be maintained against aggregate transaction account balances of $48.3 million or less,

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subject to adjustment by the FRB, and (b) a reserve of 10% must be maintained against that portion of total transaction accounts in excess of $48.3 million. The first $7.8 million of otherwise reservable balances are exempted from the reserve requirements. The Bank is in compliance with these reserve requirements at June 30, 2008. Because required reserves must be maintained in the form of either vault cash, a noninterest bearing account at a FRB, or a pass-through account as defined by the FRB, the effect of this reserve requirement is to reduce the Bank's interest-earning assets to the extent that the requirement exceeds vault cash.

         Federal Home Loan Bank System.    The Bank is a member of the FHLB of Des Moines, which is one of 12 regional FHLBs that administers the home financing credit function of savings associations. Each FHLB serves as a reserve or central bank for its members within its assigned region. It is funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB System. It makes loans to members (i.e., advances) in accordance with policies and procedures established by the board of directors of the FHLB. These policies and procedures are subject to the regulation and oversight of the Federal Housing Finance Board. All advances from the FHLB are required to be fully secured by sufficient collateral as determined by the FHLB. The Bank, as a member of the FHLB of Des Moines, is required to acquire and hold shares of capital stock in the FHLB of Des Moines equal to 0.12% of the total assets of the Bank at December 31 annually. The Bank is also required to own activity-based stock, which is based on 4.45% of the Bank's outstanding advances. These percentages are subject to change at the discretion of the FHLB Board of Directors.

        At June 30, 2008, the Bank had $11.2 million in FHLB stock, which was in compliance with this requirement. The Bank receives dividends on its FHLB stock, subject to approval by the FHLB. For the fiscal year ended June 30, 2008, dividends paid by the FHLB of Des Moines to the Bank totaled approximately $304,000, which constitutes a $17,000 decrease in the amount of dividends received in fiscal 2007.

         USA Patriot Act.    The Bank is subject to the OTS and Financial Crimes Enforcement Network regulations implementing the Bank Secrecy Act, as amended by the USA Patriot Act, which gives the federal government expanded powers to address terrorist threats through enhanced domestic security measures, expanded surveillance powers, increased information sharing, and broadened anti-money laundering requirements. By way of amendments to the Bank Secrecy Act, Title III of the USA Patriot Act takes measures intended to encourage information-sharing among bank regulatory agencies and law enforcement bodies. Further, certain provisions of Title III of the USA Patriot Act impose affirmative obligations on a broad range of financial institutions, including banks, thrifts, brokers, dealers, credit unions, money transfer agents and parties registered under the Commodity Exchange Act.

        Among other requirements, Title III of the USA Patriot Act imposes the following requirements with respect to financial institutions:

    Pursuant to Section 352, all financial institutions must establish anti-money laundering programs that include, at minimum: (a) internal policies, procedures, and controls, (b) specific designation of an anti-money laundering compliance officer, (c) ongoing employee training programs, and (d) an independent audit function to test the anti-money laundering program.

    Pursuant to Section 326, on May 9, 2003, the OTS, in conjunction with other bank regulators, issued Joint Final Rules that provide for minimum standards with respect to customer identification and verification. These rules require each financial institution to implement a written customer identification program appropriate for its size, location and type of business that includes certain minimum requirements.

    Section 312 requires financial institutions that establish, maintain, administer or manage private banking accounts or correspondent accounts in the United States for non-United States persons or their representatives (including foreign individuals visiting the United States) to establish

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      appropriate, specific and, where necessary, enhanced due diligence policies, procedures and controls designed to detect and report money laundering.

    Financial institutions are prohibited from establishing, maintaining, administering or managing correspondent accounts for foreign shell banks (foreign banks that do not have a physical presence in any country), and will be subject to certain recordkeeping obligations with respect to correspondent accounts of foreign banks.

    Bank regulators are directed to consider a holding company's effectiveness in combating money laundering when ruling on FRA and Bank Merger Act applications.

         The Sarbanes-Oxley Act.    As a public company, we are subject to the Sarbanes-Oxley Act, which implements a broad range of corporate governance and accounting measures for public companies designed to promote honesty and transparency in corporate America and to better protect investors from corporate wrongdoing.

        The Sarbanes-Oxley Act's principal legislation and the derivative rulemaking promulgated by the SEC include:

    the creation of an independent accounting oversight board;

    auditor independence provisions which restrict non-audit services that accountants may provide to their audit clients;

    additional corporate governance and responsibility measures, including the requirement that the chief executive officer and chief financial officer certify financial statements;

    a requirement that companies establish and maintain a system of internal control over financial reporting and that a company's management provide an annual report regarding its assessment of the effectiveness of such internal control over financial reporting to the company's independent accountants and that such accountants provide an attestation report with respect to management's assessment of the effectiveness of the company's internal control over financial reporting;

    forfeiture of bonuses or other incentive-based compensation and profits from the sale of an issuer's securities by directors and senior officers in the twelve month period following initial publication of any financial statements that later require restatement;

    an increase in the oversight of, and enhancement of certain requirements relating to audit committees of public companies and how they interact with the company's independent auditors;

    a requirement that audit committee members must be independent and are absolutely barred from accepting consulting, advisory or other compensatory fees from the issuer;

    a requirement that companies disclose whether at least one member of the audit committee is an "audit committee financial expert" (as such term is defined by the SEC) and if not, why not;

    expanded disclosure requirements for corporate insiders, including accelerated reporting of stock transactions by insiders and a prohibition on insider trading during pension blackout periods;

    a prohibition on personal loans to directors and officers, except certain loans made by insured financial institutions;

    disclosure of a code of ethics and filing a Current Report on Form 8-K for a change or waiver of such code;

    mandatory disclosure by analysts of potential conflicts of interest; and

    a range of enhanced penalties for fraud and other violations.

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        Furthermore, the NASDAQ Stock Market (the "NASDAQ") has also implemented corporate governance rules which implement the mandates of the Sarbanes-Oxley Act. The material NASDAQ rules include, among other things, ensuring that a majority of the board of directors are independent of management, establishing and publishing a code of conduct for directors, officers and employees, and requiring stockholder approval of all new stock option plans and all material modifications. These rules affect the Company because its common stock is listed on the NASDAQ Stock Market under the symbol "HFFC."

        The Company anticipates additional expenses in complying with the provisions of the Sarbanes-Oxley Act and the resulting regulation. Management presently anticipates that the associated internal costs and third party expenses may be significant.

         Holding Company Regulation.    The Company is a unitary savings and loan holding company within the meaning of the HOLA. As such, the Company is required to register with and be subject to OTS examination and supervision as well as certain reporting requirements. In addition, the OTS has enforcement authority over the Company and any of its non-savings institution subsidiaries. Among other things, this authority permits the OTS to restrict or prohibit activities that are determined to be a serious risk to the financial safety, soundness or stability of a subsidiary savings bank. Unlike bank holding companies, a savings and loan holding company is not subject to any regulatory capital requirements or to supervision by the Federal Reserve System.

         "Grandfathered" Savings and Loan Holding Company Status.    Because the Company acquired the Bank prior to May 4, 1999, the Company is a "grandfathered" unitary savings and loan holding company under the Gramm-Leach-Bliley Act. As such, the Company has restrictions on its business activities, provided the Bank continues to be a "qualified thrift lender." If, however, the Company is acquired by a non-financial company, or if it acquires another savings association subsidiary (and becomes a multiple savings and loan holding company), the Company will terminate its "grandfathered" unitary savings and loan holding company status, and become subject to certain additional limitations on the types of business activities in which the Company could engage. All "non-grandfathered" unitary savings and loan holding companies are limited to financially related activities permissible for bank holding companies, as defined under the Gramm-Leach-Bliley Act.

         Restrictions Applicable to All Savings and Loan Holding Companies.    Federal law prohibits a savings and loan holding company, including the Company, directly or indirectly, from acquiring:

    control (as defined under the HOLA) of another savings institution (or a holding company parent) without prior OTS approval;

    through merger, consolidation, or purchase of assets, another savings institution or a holding company thereof, or acquiring all or substantially all of the assets of such institution (or a holding company) without prior OTS approval; or

    control of any depository institution not insured by the FDIC (except through a merger with and into the holding company's savings institution subsidiary that is approved by the OTS).

        A savings and loan holding company may not acquire as a separate subsidiary an insured institution that has a principal office outside of the state where the principal office of its subsidiary institution is located, except:

    in the case of certain emergency acquisitions approved by the FDIC;

    if such holding company controls a savings institution subsidiary that operated a home or branch office in such additional state as of March 5, 1987; or

    if the laws of the state in which the savings institution to be acquired is located specifically authorize a savings institution chartered by that state to be acquired by a savings institution

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      chartered by the state where the acquiring savings institution or savings and loan holding company is located, or by a holding company that controls such a state chartered association.

        In addition, if the Bank fails the QTL test (discussed above), the Company must register with the FRB as a bank holding company under the Bank Holding Company Act within one year of the Bank's failure to so qualify.

        The HOLA prohibits a savings and loan holding company (directly or indirectly, or through one or more subsidiaries) from acquiring another savings association or holding company thereof without prior written approval of the OTS; acquiring or retaining, with certain exceptions, more than 5% of a non-subsidiary savings association, a non-subsidiary holding company, or a non-subsidiary company engaged in activities other than those permitted by the HOLA; or acquiring or retaining control of a depository institution that is not federally insured. In evaluating applications by holding companies to acquire savings associations, the OTS must consider the financial and managerial resources and future prospects of the company and institution involved, the effect of the acquisition on the risk to the insurance funds, the convenience and needs of the community and competitive factors.

         Federal Securities Law.    The common stock of the Company is registered with the SEC under the Exchange Act. The Company is subject to the information, proxy solicitation, insider trading restrictions and other requirements of the SEC under the Exchange Act.

        Company stock held by persons who are affiliates (generally officers, directors and principal stockholders) of the Company may not be resold without registration or unless sold in accordance with certain resale restrictions. If the Company meets specified current public information requirements, each affiliate of the Company is able to sell in the public market, without registration, a limited number of shares in any three-month period.

         Delaware General Corporation Law.    The Company is incorporated under the laws of the State of Delaware. Thus, the Company is subject to regulation by the State of Delaware and the rights of the Company's stockholders are governed by the Delaware General Corporation Law.

Federal and State Taxation

        The Company and its direct and indirect subsidiaries file a consolidated federal income tax return on a fiscal year basis. In addition, each of Trust III, Trust IV, Trust V and Trust VI are required to file individual trust returns on a calendar year basis.

        In addition to the regular income tax, corporations, including savings associations such as the Bank, generally are subject to a minimum tax. An alternative minimum tax is imposed at a minimum tax rate of 20.00% on alternative minimum taxable income, which is the sum of a corporation's regular taxable income (with certain adjustments) and tax preference items, less any available exemption. The alternative minimum tax is imposed to the extent it exceeds the corporation's regular income tax and net operating losses can offset no more than 90.00% of alternative minimum taxable income.

        To the extent earnings appropriated to a savings association's bad debt reserves for "qualifying real property loans" and deducted for federal income tax purposes exceed the allowable amount of such reserves computed under the experience method and to the extent of the association's supplemental reserves for losses on loans ("Excess"), such Excess may not, without adverse tax consequences, be utilized for the payment of cash dividends or other distributions to a shareholder (including distributions on redemption, dissolution or liquidation) or for any other purpose (except to absorb bad debt losses). As of June 30, 2008, the Bank's Excess for tax purposes totaled approximately $4.8 million.

         South Dakota Taxation.    The Bank is subject to the South Dakota Franchise tax to the extent that such corporations are engaged in business in the state of South Dakota. South Dakota does not have a

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corporate income tax. The franchise tax will be imposed at a rate of 6.00% on franchise taxable income which is computed in the same manner as federal taxable income with some minor variations to comply with South Dakota law, other than the carryover of net operating losses which is not permitted under South Dakota law. A South Dakota return of franchise tax must be filed annually.

         Minnesota Taxation.    The Bank is subject to the Minnesota Corporate Income tax to the extent that such corporations are engaged in business in the state of Minnesota. The Corporate Income tax is imposed at a rate of 9.8% on corporate taxable income, which is computed in the same manner as federal taxable income with some minor variations to comply with Minnesota law. A Minnesota return of Corporate Income tax must be filed annually.

         Delaware Taxation.    As a Delaware holding company, the Company is exempted from Delaware corporate income tax but is required to file an annual report with and pay an annual fee to the State of Delaware. The Company is also subject to an annual franchise tax imposed by the State of Delaware, which is made in quarterly payments.

         Taxation in Other States.    Mid America Capital is required to file state income tax returns in those states which lessees have operations. The total taxes paid in the year ended June 30, 2008 were not material to the operation of the Company.

Executive Officers of the Company

        Information regarding the executive officers of the Company and the Bank is set forth below.

        Curtis L. Hage—Mr. Hage, age 62, is Chairman, President and Chief Executive Officer of the Company. He was elected to the position of Chairman of the Board of Directors of the Company in September 1996 and has held the positions of President and Chief Executive Officer since February 1991. Prior to such time, Mr. Hage served as Executive Vice President of the Bank since 1986. Since joining the Bank in 1968, he served in various capacities prior to being elected Executive Vice President. Mr. Hage received his M.B.A. from the University of South Dakota and attended the Graduate School of Savings Institution Management at the University of Texas.

        Darrel L. Posegate—Mr. Posegate, age 50, has served as Executive Vice President, Chief Financial Officer and Treasurer of the Company since January 2002. He has served as President of the Bank since October 2006 and as Executive Vice President, Chief Financial Officer and Treasurer of the Bank from January 2002 until October 2006. Prior to such time, he was employed in senior leadership roles in the banking industry since 1983. Mr. Posegate received his B.A. degree from Luther College, Decorah, Iowa, and is a Certified Public Accountant.

        David A. Brown—Mr. Brown, age 47, has served as the Senior Vice President/Business Banking of the Bank from November 1999 until May 2008 at which time he was promoted to the position of Senior Vice President/Community Banking. Prior to joining the Bank, Mr. Brown served as Vice President/Manager Commercial Banking of Firstar Bank, Sioux City, Iowa, a national banking institution, a position he held since December 1998. Mr. Brown received his M.B.A. and a B.S. in Business Administration from the University of South Dakota.

        Jon M. Gadberry—Mr. Gadberry, age 46, has served as Senior Vice President/Wealth Management of the Bank since December 2007. Prior to joining the Bank, Mr. Gadberry was employed by Bank of the West as Vice President/Trust Manager from November 2004 to December 2007. Mr. Gadberry received his B.S. in Business Administration from Concordia College in Moorhead, Minnesota.

        Mary F. Hitzemann—Ms. Hitzemann, age 55, has served as the Senior Vice President/Human Resources of the Bank since October 1993. Ms. Hitzemann joined the Bank in January 1993. Prior to that time, she was employed as Vice President of Human Resources for Rapid City Regional Hospital from May 1989 to May 1992. Ms. Hitzemann received her B.A. degree from Augustana College.

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        Brent R. Olthoff—Mr. Olthoff, age 37, has served as Senior Vice President, Chief Financial Officer and Treasurer of the Bank since April 2007. Mr. Olthoff joined the Bank in July 2001, and was promoted to Vice President/Finance in July 2004. Prior to serving in his current role, Mr. Olthoff was employed by FTN Financial, a capital markets firm in Memphis, Tennessee, where he was Vice President/Asset Strategies from February 2006 to April 2007. Mr. Olthoff received his B.B.A degree in Finance from Iowa State University.

        Natalie A. Sundvold, formerly Natalie A. Solberg—Ms. Sundvold, age 45, has served as the Senior Vice President/Service & Support of the Bank since October 2002. She joined the Bank in February 1994 as manager of the phone banking center and was promoted to Vice President/In-Touch Banking in October 1995. Prior to joining the Bank, she was employed by the Bank of New York from October 1989 to October 1993. Ms. Sundvold received her B.S. from Northern State University.

        Michael Westberg—Mr. Westberg, age 41, has served as the Senior Vice President/Retail Banking of the Bank from July 2006 to May 2008 at which time he was promoted to the position of Senior Vice President/Corporate Strategy. Mr. Westberg joined the Bank in February 1996 as a branch manager. Prior to joining the Bank, he was employed with First Savings Bank, Beresford (South Dakota) from 1992 to 1996; and The Associates, Dallas, Texas, from 1989 to 1992. Mr. Westberg attended Illinois State University majoring in business and is a graduate of the American Bankers Association National School of Banking.

Item 1A.    Risk Factors

        The following are certain material risks that our management believes are specific to us and our business. You should understand that it is not possible to predict or identify all such potential risks and, as such, this list of risk factors should not be viewed as all-inclusive or in any particular order. An investment in shares of our common stock involves various risks. Before deciding to make an investment decision regarding our common stock, you should carefully consider the risks described below in conjunction with the other information in this Form 10-K and information incorporated by reference into this Form 10-K, including our consolidated financial statements and related notes which are set forth in Part II, Item 8 "Financial Statements and Supplementary Data" of this Form 10-K. Our business, financial condition and results of operations could be harmed by any of the following risks or by other risks that have not been identified or that the Company may believe are immaterial or unlikely. The value or market price of our common stock could decline due to any of these risks, and you may lose all or part of your investment. The risks discussed below also include forward-looking statements and our actual results may differ substantially from those discussed in these forward-looking statements.

Risks Related to Our Business

         We face strong competition for customers, which could prevent us from obtaining customers and may cause us to pay higher interest rates to attract deposits and charge lower rates to obtain the loan volume we need to grow, any of which may reduce our profitability.    The banking business is highly competitive and we experience competition in each of our markets from many other financial institutions, many of which are larger and may have significantly greater financial and other resources than we have. Specifically, we compete with commercial banks, credit unions, savings and loan associations, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market funds and other mutual funds, as well as super-regional, national and international financial institutions, that operate offices in our primary market areas and elsewhere. Many of these competitors are also well-established financial institutions.

        Competitors that are not depository institutions are generally not subject to the extensive regulations that apply to us. We compete with these institutions both in attracting deposits and in

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making loans. In addition, we must attract our customer base from other existing financial institutions and from new residents. There is a risk that we will not be able to compete successfully with these other financial institutions in our markets, and that we may have to pay higher interest rates to attract deposits or charge lower interest rates to obtain loan volume, resulting in reduced profitability. In new markets that we may enter, we will also compete against well-established community banks that have developed relationships within the community.

         Changes in interest rates may reduce our profitability.    Our profitability depends in large part on our net interest income, which is the difference between interest earned from interest-earning assets, such as loans and mortgage-backed securities, and interest paid on interest-bearing liabilities, such as deposits and borrowings. Our net interest income will be adversely affected if market interest rates change such that the interest we pay on deposits and borrowings increases faster than the interest we earn on loans and investments. Many factors cause changes in interest rates, including governmental monetary policies and domestic and international economic and political conditions. While we intend to manage the effects of changes in interest rates by adjusting the terms, maturities, and pricing of our assets and liabilities, our efforts may not be effective in a changing rate environment and our financial condition and results of operations may suffer.

        Interest rates were at historically low levels until June 2004 at which time the Federal Reserve began increasing short-term interest rates 17 times or 425 basis points through June 29, 2006. Beginning September 18, 2007, the Federal Reserve began an interest rate easing of 325 basis points through April 30, 2008. During this period, a flattening and slight inversion of the treasury yield curve caused by increasing short-term rates and lagging long-term rates had a negative impact on our net interest margin. In fiscal 2008, as short-term interest rates decreased, the Company experienced a positive effect to its net interest margin If short-term interest rates rise, and if rates on our deposits and borrowings re-price upwards faster than the rates on our long-term loans and investments, the Company may experience compression of our net interest margin, which will have a negative effect on our profitability.

         Our growth may require us to raise additional capital that may not be available when it is needed or may not be available on terms acceptable to us.    We are required by regulatory authorities to maintain adequate levels of capital to support our operations. To support our future continued growth, we may need to raise additional capital. Our ability to raise additional capital, if needed, will depend in part on conditions in the capital markets at that time, which are outside our control. Accordingly, we cannot assure you of our ability to raise additional capital, if needed, on terms acceptable to us. If we cannot raise additional capital when needed, our ability to further expand our operations through internal growth could be materially impaired.

        In the event that we are able to raise capital through the issuance of additional shares of common stock or other securities, the ownership interests of current investors would be diluted and the per share book value of our common stock may be diluted. New investors may also have rights, preferences and privileges senior to the holders of our common stock, which may adversely affect the holders of our common stock.

        We may look to sell production assets, such as mortgage loans, into the secondary market as a means to manage the size of the balance sheet and manage the use of capital. The demand for these products in the capital markets is not driven by us and may not benefit us at the time we look to sell the loans.

         We are subject to extensive regulations that may limit or restrict our activities and the cost of compliance is high.    We operate in a highly regulated industry and are subject to examination, supervision and comprehensive regulation by various regulatory agencies. Banking regulations are primarily intended to protect the federal deposit insurance funds and depositors, not stockholders. Our compliance with these

33



regulations is costly and restricts certain of our activities, including payment of dividends, mergers and acquisitions, investments, loans and interest rates charged, interest rates paid on deposits and locations of offices. We are also subject to regulatory capital requirements, which require us to maintain adequate capital to support our growth. If we fail to meet these capital and other regulatory requirements, our ability to grow, our cost of funds and FDIC insurance, our ability to pay dividends on common stock, and our ability to make acquisitions could be materially and adversely affected.

        Congress and federal agencies continually review laws, regulations and policies applicable to the banking industry for possible changes, and we cannot predict the effects of these changes on our business and profitability. Because, like all banks and bank holding companies, government regulation greatly affects our business and financial results, our cost of compliance could adversely affect our ability to operate profitably. See "Regulation" under Part I, Item 1 "Business" of this Form 10-K for a detailed discussion of regulation requirements.

         Changes in or interpretations of accounting standards may materially impact our financial statements.    Accounting principles generally accepted in the United States of America and accompanying accounting pronouncements, implementation guidelines, interpretations and practices for many aspects of our business are complex and involve subjective judgments, including, but not limited to accounting for the allowance for loan and lease losses and pending and incurred but not reported health claims. Changes in these estimates or changes in other accounting rules and principles, or their interpretation, could significantly change our reported earnings and operating results, and could add significant volatility to those measures, without a comparable underlying change in cash flow from operations.

         Our success is influenced by growth in South Dakota and lack of growth or changes in national and South Dakota economic and political conditions could adversely affect our earnings, as our borrowers' ability to repay loans and the value of the collateral securing our loans decline and as loans and deposits decline.    Our success and growth is significantly influenced by the growth in population and income levels and deposits in our primary market areas, which are mainly in South Dakota. If the communities in which we operate do not grow or if prevailing economic conditions locally or nationally are unfavorable, our business may be negatively affected.

        Additionally, there are inherent risks associated with our lending activities, including credit risk, which is the risk that borrowers may not repay outstanding loans or the value of the collateral securing loans will decrease. Conditions such as inflation, recessions, unemployment, changes in interest rates and money supply and other factors beyond our control may adversely affect the ability of our borrowers to repay their loans and the value of collateral securing the loans, which could adversely affect our earnings. Because our business operations and activities are concentrated in the State of South Dakota and most of our credit exposure is in that state, we are specifically at risk from adverse economic, political and business conditions that affect South Dakota.

         Our allowance for loan losses may prove to be insufficient to absorb losses in our loan portfolios, which could adversely affect our operating results.    Like all financial institutions, we maintain an allowance for loan losses to provide for loans in our portfolio that may not be repaid in their entirety. Although we believe that our allowance for loan losses is maintained at a level adequate to absorb probable losses inherent in our loan portfolio as of the corresponding balance sheet date, the determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and requires us to make significant estimates of current credit risks and future trends, all of which may undergo material changes. Accordingly, our allowance for loan losses may not be sufficient to cover actual loan losses, and future provisions for loan losses could materially adversely affect our operating results by decreasing our net income.

        In evaluating the adequacy of our allowance for loan losses, we consider numerous quantitative factors, including our historical charge-off experience, growth of our loan portfolio, changes in the

34



composition of our loan portfolio and the volume of delinquent and criticized loans. In addition, we use information about specific borrower situations, including their financial position and estimated collateral values, to estimate the risk and amount of loss for those borrowers. Finally, we also consider many qualitative factors, including general and economic business conditions, duration of the current business cycle, current general market collateral valuations, trends apparent in any of the factors we take into account and other matters, which are by nature more subjective and fluid. Our estimates of the risk of loss and amount of loss on any loan are complicated by the significant uncertainties surrounding our borrowers' abilities to successfully execute their business models through changing economic environments, competitive challenges and other factors. In considering information about specific borrower situations our analysis is subject to the risk that we are provided inaccurate or incomplete information. Because of the degree of uncertainty and susceptibility of these factors to change, our actual losses may vary from our current estimates.

        Additionally, bank regulators periodically review our allowance for loan losses and may require an increase in the provision for loan losses or recognize loan charge-offs based upon their judgments, which may be different from ours. Any increase in our allowance for loan losses or loan charge-offs required by these regulatory authorities may adversely affect our operating results.

         The net realizable value of our investment securities could be lower than the fair value assigned under generally accepted accounting principles.    We determine the fair value of our investment securities based on the most recent quoted market price for such securities as of the applicable balance sheet date. We use quoted market prices to determine the amount of any unrealized losses that may be reflected in our other comprehensive income and the net book value of our investment securities. The price at which a security could be sold in a market transaction could be significantly lower than the quoted market price for the security, particularly if the quoted market price is based on infrequent trading history, the market for the security is illiquid, or could be dependent on the size of the trade. The risk that there will be a material difference between the fair value that we assign to a security and its net realizable value is particularly significant for certain securities that we hold in our investment portfolio, including our "private label" collateralized mortgage obligation and our rated pooled trust preferred securities. If the net realizable value is lower than the fair value that we assign to a security, impairment losses could be required in the future.

         Our ability to secure wholesale funding to supplement core deposits may prove insufficient.    We must maintain sufficient funds to respond to the obligations of our depositors and borrowers. As part of our liquidity management, we use a number of funding sources to supplement our core deposit growth. These sources include brokered certificates of deposit, federal funds purchased, Federal Reserve Bank and FHLB advances. Adverse operating results or changes in industry conditions could lead to an inability to replace these additional funding sources at maturity. Our financial flexibility will be severely constrained if we are unable to maintain our access to funding or if adequate financing is not available to accommodate future growth at acceptable interest rates. If we are required to rely more heavily on more expensive funding sources to support future growth, our revenues may not increase proportionately to cover our costs, and our profitability would be adversely affected.

         Our ability to retain and attract qualified employees is critical to the success of our business and the failure to do so may materially adversely affect our performance.    Our people are our most important resource and competition for qualified employees is intense. In order to retain and attract qualified employees, we must compensate such employees at market levels. Typically, those levels have caused employee compensation to be our greatest noninterest expense. In addition, because certain information concerning our employee compensation is included in our filings with the SEC and is, therefore, available to our competitors, we believe that our employees may be more highly recruited by our competitors. If we are unable to continue to retain and attract qualified employees, or if

35



compensation costs required to retain and attract qualified employees becomes more expensive, our performance, including our competitive position, could be affected.

         Our ability to maintain our reputation is critical to the success of our business and the failure to do so may materially adversely affect our performance.    Our reputation is one of the most valuable components of our business. As such, we strive to conduct our business in a manner that enhances our reputation. This is done, in part, by recruiting, hiring and retaining employees who share our core values of being an integral part of the communities we serve, delivering superior service to our customers and caring about our customers and associates. If our reputation is negatively affected, by the actions of our employees or otherwise, our business and, therefore, our operating results may be materially adversely affected.

         Revenues from our Trust and Asset Management business are significant to our earnings.    We believe that the revenues which are derived from our Trust and Asset Management business are significant to our business. The success of our Trust and Asset Management business is dependent on our ability to produce investment returns which meet the expectations of our clients. Administering or managing assets in accordance with the terms of governing documents and applicable laws is also important to client satisfaction. Our inability to succeed in either of the foregoing areas could negatively affect our revenues we receive from our Trust and Asset Management business.

         Natural disasters, acts of war or terrorism, and other external events could significantly impact our business.    Severe weather, natural disasters, acts of war or terrorism, and other adverse external events could have a significant impact on our ability to conduct business. Such events could affect the stability of our deposit base, impair the ability of borrowers to repay outstanding loans, impair the value of collateral securing loans, cause significant property damage, result in loss of revenue and/or cause us to incur additional expenses. Although management has established disaster recovery policies and procedures, the occurrence of any such event could have a material adverse effect on our business, which, in turn, could have a material adverse effect on our financial condition and results of operations.

Risks Related to Our Common Shares

         The trading volume in our common stock has been low, and the sale of a substantial number of shares of our common stock in the public market could depress the price of our common stock and make it difficult for you to sell your shares.    Our common stock is listed to trade on the NASDAQ Stock Market, but is thinly traded. As a result, you may not be able to sell your shares of common stock on short notice. Additionally, thinly traded stock can be more volatile than stock trading in an active public market. The sale of a substantial number of shares of our common stock at one time could temporarily depress the market price of our common stock, making it difficult for you to sell your shares and impairing our ability to raise capital.

         Our ability to pay dividends depends primarily on dividends from our banking subsidiary, Home Federal Bank, which is subject to regulatory limits.    We are a unitary thrift holding company and our operations are conducted primarily by our banking subsidiary, Home Federal Bank. Since we receive substantially all of our revenue from dividends from Home Federal Bank, our ability to pay dividends on our common stock depends on our receipt of dividends from Home Federal Bank. Dividend payments from Home Federal Bank are subject to legal and regulatory limitations, generally based on net income and retained earnings. The ability of Home Federal Bank to pay dividends to us is also subject to its profitability, financial condition, capital expenditures and other cash flow requirements. There is no assurance that Home Federal Bank will be able to pay dividends to us in the future or that we will generate adequate cash flow to pay dividends in the future. The inability to receive dividends from Home Federal Bank could have an adverse affect on our business and financial conditions. Additionally, we may elect in the future to defer interest payments on our subordinated debentures payable to trusts. The indenture agreements prohibit dividend payments on common stock following the

36



deferral of interest payments on the subordinated debentures underlying trust preferred securities. Similarly, our failure to pay dividends on our common stock could have a material adverse effect on the market price of our common stock.

         We are subject to security and operational risks relating to our use of technology that could damage our reputation and our business.    Security breaches in our internet banking activities or other communication and information systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our financial condition and results of operations. We rely on standard internet and other security systems to provide the security and authentication necessary to effect secure transmission of data. These precautions may not protect our systems from compromises or breaches of our security measures.

         Certain provisions of our certificate of incorporation and bylaws, as well as Delaware and federal law, may discourage, delay or prevent an acquisition of control of us.    Certain provisions included in our certificate of incorporation and bylaws, as well as certain provisions of the Delaware General Corporation Law and federal law, may discourage, delay or prevent potential acquisitions of control of us, particularly when attempted in a transaction that is not negotiated directly with, and approved by, our Board of Directors, despite possible benefits to our stockholders.

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

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

    require that certain business combinations between us and a stockholder beneficially owning in excess of 10% of the then-outstanding shares of our common stock (i) be approved by at least 662/3% of the total number of our outstanding voting shares, voting as a single class, (ii) be approved by a majority of the Board of Directors serving prior to the 10% stockholder becoming such, or (iii) involve consideration per share generally equal to that paid by such 10% stockholder when such stockholder acquired his, her or its stock;

    divide our Board of Directors into three classes serving staggered three-year terms and provide that a director may only be removed prior to the expiration of a term for cause by the affirmative vote of the holders of at least 80% of the voting power of all of the then-outstanding shares of capital stock entitled to vote in an election of directors;

    require that a special meeting of stockholders be called pursuant to a resolution adopted by a majority of our Board of Directors;

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

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

        Furthermore, federal law requires OTS approval prior to any direct or indirect acquisition of "control" (as defined in OTS regulations) of the Bank, including any acquisition of control of us.

37


Item 1B.    Unresolved Staff Comments

        None.

Item 2.    Properties

        The Company and its direct and indirect subsidiaries conduct their business at the main office located at 225 South Main Avenue, Sioux Falls, South Dakota, 57104. Currently, the Bank also conducts business from 32 other offices located in its primary market area. Of such 33 total business offices, the Company owns 15, including the main office, and leases 18 others.

        The total net book value of the Company's premises and equipment (including land, building, leasehold improvements and furniture, fixtures and equipment) at June 30, 2008 was $14.8 million. The Company previously announced a new facility in Watertown, South Dakota to be constructed in fiscal 2009 which will replace an existing branch office. Management believes there is a continuing need to keep facilities and equipment up-to-date and continued investment will be necessary in the future.

Item 3.    Legal Proceedings

        On June 26, 2006, the Company filed a $3.8 million lawsuit against MetaBank and two individuals, J. Tyler Haahr and Daniel A. Nelson, for their role in a participation loan, alleging fraud, breach of fiduciary duty, conspiracy and negligent misrepresentation. These damages were the result of a failure by the lead bank to make disclosures regarding an investigation of the commercial customer by the Iowa Attorney General at the time the Bank agreed to an extension of loan participation agreements. Legal proceedings are currently pending in the Second Judicial Circuit Court, Minnehaha County, South Dakota. Summary judgment motions have been denied, which management believes are favorable to the Company, and the lawsuit is scheduled for trial during the Company's second fiscal quarter.

        In addition, the Company, the Bank and each of their subsidiaries are, from time to time, involved as plaintiff or defendant in various legal actions arising in the normal course of their businesses. While the ultimate outcome of any such proceedings cannot be predicted with certainty, it is generally the opinion of management, after consultation with counsel representing the Bank and the Company in any such proceedings, that the resolution of any such proceedings should not have a material effect on the Company's consolidated financial position or results of operations. The Company, the Bank and each of their subsidiaries are not aware of any legal actions or other proceedings contemplated by governmental authorities outside of the normal course of business.

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

        No matter was submitted to a vote of stockholders, through the solicitation of proxies or otherwise, during the quarterly period ended June 30, 2008.

38



PART II

Item 5.    Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Stock Listing

        The Company's common stock is traded under the symbol "HFFC" on the NASDAQ Stock Market.

        The following table sets forth the range of high and low sale prices for the Company's common stock for each of the fiscal quarters of the two years ended June 30, 2008 and 2007. Quotations for such periods are as reported by the NASDAQ Stock Market.

FISCAL 2008
  HIGH   LOW  

1st Quarter

  $ 18.15   $ 15.72  

2nd Quarter

  $ 16.75   $ 14.14  

3rd Quarter

  $ 16.55   $ 14.92  

4th Quarter

  $ 18.03   $ 16.00  

 

FISCAL 2007
  HIGH   LOW  

1st Quarter

  $ 17.50   $ 15.75  

2nd Quarter

  $ 17.73   $ 16.10  

3rd Quarter

  $ 18.50   $ 17.11  

4th Quarter

  $ 18.44   $ 17.17  

        As of September 16, 2008, the Company had 486 holders of record of its common stock.

        The transfer agent for the Company's common stock is Mellon Investor Services, PO Box 3315, South Hackensack, New Jersey, 07606-1915.

Dividends

        The Company paid cash dividends on a quarterly basis of $0.1050, $0.1075, $0.1075 and $0.1075 per share throughout fiscal 2008. The Company paid cash dividends on a quarterly basis of $0.1025, $0.1050, $0.1050 and $0.1050 per share in fiscal 2007. The Board of Directors intends to continue the payment of quarterly cash dividends, dependent on the results of operations and financial condition of the Company, tax considerations, industry standards, economic conditions, general business practices and other factors the Board of Directors deems relevant. On July 28, 2008, the Board of Directors announced the approval of a cash dividend of $0.1125 per share and the Company paid the respective cash dividends on August 15, 2008 to shareholders of record on August 8, 2008. The Company's ability to pay dividends is dependent on the dividend payments it receives from its subsidiary, the Bank, which are subject to OTS regulations. See Item 1, "Business—Regulation" of this Form 10-K. The ability of the Company to pay dividends is also subject to the terms of the agreements on subordinated debentures payable to trusts, should the Company elect to defer interest payments. In addition, the Company's ability to pay dividends is subject to the terms of its line of credit with First Tennessee Bank, NA. See Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources" of this Form 10-K.

39


Stockholder Return Performance

        The following line graph compares the cumulative total stockholder return on the Company's common stock to the comparable cumulative total return of the NASDAQ Market Index and the NASDAQ Bank Index for the last five years.

        The performance graph assumes that on July 1, 2003, $100 was invested in the Company's common stock (at the closing price of the previous trading day) and in each of the indexes. The comparison assumes the reinvestment of all dividends. Cumulative total stockholder returns for the Company's common stock, NASDAQ Market Index and the NASDAQ Bank Index are based on the Company's fiscal year ending June 30.


COMPARISON OF 5-YEAR CUMULATIVE TOTAL RETURN
AMONG HF FINANCIAL CORP.
NASDAQ MARKET INDEX AND NASDAQ BANK INDEX

GRAPHIC

ASSUMES $100 INVESTED ON JULY 1, 2003
ASSUMES DIVIDEND REINVESTED
FISCAL YEAR ENDING JUNE 30, 2008

Equity Compensation Plan

        The following table sets forth certain information about the common stock that may be issued upon exercise of options, warrants and rights under all of the Company's existing equity compensation plans, including the 2002 Stock Option and Incentive Plan, the 1996 Director Restricted Stock Plan, and the 1991 Stock Option Plan (collectively, the "Incentive Plans"). The 1996 Director Restricted Stock Plan expired on January 1, 2007, and the 1991 Stock Option Plan expired on October 27, 2002. Although the column below entitled "Number of Shares to be Issued Upon Exercise of Outstanding Options, Warrants and Rights" includes common stock to be issued upon unexpired options issued under the 1991 Stock Option Plan, no common stock remains available for future awards under the

40



1991 Stock Option Plan. Additionally, no common stock remains available for future awards under the 1996 Director Restricted Stock Plan.

Plan Category
  Number of Shares to be
Issued Upon Exercise of
Outstanding Options,
Warrants and Rights
  Weighted-Average
Exercise Price of
Outstanding Options,
Warrants and Rights
  Number of Shares
Remaining Available for
Future Issuance Under
Equity Compensation Plans
(Excluding Shares Reflected
in the First Column)(1)
 

Equity plan compensation plans approved by stockholders

    248,176   $ 13.12     547,629  

Equity plan compensation plans not approved by stockholders

   
N/A
   
N/A
   
N/A
 

Total

   
248,176
 
$

13.12
   
547,629
 

(1)
All 547,629 shares may be issued under the 2002 Stock Option and Incentive Plan in the form of nonvested stock.

Sales of Unregistered Stock

        The Company had no sales of unregistered stock during the fiscal year ended June 30, 2008.

Issuer Purchases of Equity Securities

        The following table sets forth the purchases by the Company of its common stock during the quarterly period ended June 30, 2008:

Period
  Total Number
of Shares
Purchased(1)
  Average
Price Paid
per Share
  Total Number of
Shares Purchased
as Part of Publicly
Announced
Programs(2)(3)
  Maximum Number of
Shares that May Yet
Be Purchased Under
the Current Program
 

April 1 - 30, 2008

      $ 0.00         300,049  

May 1 - 31, 2008

    6,527   $ 17.09     6,527     388,794  

June 1 - 30, 2008

      $ 0.00         388,794  
                     
 

4th Quarter Total

    6,527   $ 17.09     6,527        
                     

(1)
Excludes 1,877 shares of the Company's common stock that the Company repurchased pursuant to one or more of its Incentive Plans. Under the Incentive Plans, participants may exercise stock options by surrendering shares of common stock that the participants already own as payment of the exercise price. Participants in the Incentive Plans may also surrender shares as payment of applicable tax withholding on the vesting of nonvested stock. Shares so surrendered by participants in the Incentive Plans are repurchased pursuant to the terms of the Incentive Plans and applicable award agreements and not pursuant to publicly announced stock buy back programs.

(2)
The Company had in effect a stock buy back program which was publicly announced on April 30, 2007, in which the Company was permitted to repurchase up to 10% of the common stock of the Company that was outstanding on May 1, 2007, which equaled 399,141 shares. This stock buy back program expired on April 30, 2008. A total of 99,092 shares were purchased under this program during the fiscal year ended June 30, 2008.

(3)
The Company approved a new stock buy back program commencing on May 1, 2008, which was publicly announced on April 28, 2008. Under this program, the Company may repurchase up to 10% of the common stock of the Company outstanding on May 1, 2008, which equals 395,321 shares, through April 30, 2009. A total of 6,527 shares have been purchased pursuant to this program during the fiscal year ended June 30, 2008.

41


Item 6.    Selected Financial Data

        The following table sets forth selected consolidated financial statement and operations data with respect to the Company for the periods indicated. This information should be read in conjunction with the Financial Statements and related notes appearing in Part II, Item 8 "Financial Statements and Supplementary Data" of this Form 10-K and with Part II, Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" of this Form 10-K. The Company's selected financial statement and operations data for fiscal year 2004 have been derived from audited consolidated financial statements, which have been audited by McGladrey & Pullen, LLP, independent public accountants. The Company's selected financial statement and operations data for each of the fiscal years 2005 through 2008 have been derived from audited consolidated financial statements, which have been audited by Eide Bailly, LLP, independent public accountants.

 
  At June 30,  
 
  2008   2007   2006   2005   2004  
 
  (Dollars in Thousands)
 

Selected Statement of Financial Condition Data:

                               

Total assets

  $ 1,103,494   $ 1,001,454   $ 961,294   $ 897,874   $ 847,070  

Securities available for sale

    225,004     142,223     145,518     142,429     122,715  

FHLB stock

    11,245     5,058     5,647     7,699     5,469  

Loans and leases receivable

    777,777     761,599     721,603     670,581     640,946  

Loans held for sale

    8,796     8,776     7,623     10,238     10,351  

Deposits

    784,237     815,864     769,002     681,216     658,719  

Advances from FHLB and other borrowings

    198,454     68,600     91,620     119,664     93,750  

Subordinated debentures payable to trusts

    27,837     27,837     27,837     27,837     27,837  

Stockholders' equity

    64,203     62,270     56,058     53,635     51,649  

42


 

 
  Years Ended June 30,  
 
  2008   2007   2006   2005   2004  
 
  (Dollars in Thousands, Except Per Share Data)
 

Selected Statement of Income Data:

                               

Interest and dividend income

  $ 63,174   $ 61,874   $ 53,411   $ 44,946   $ 40,260  

Interest expense

    33,298     36,240     27,762     18,747     15,188  
                       
 

Net interest income

    29,876     25,634     25,649     26,199     25,072  

Provision for losses on loans and leases

    1,994     1,198     5,279     2,681     2,020  
                       
 

Net interest income after provision for losses
on loans and leases

    27,882     24,436     20,370     23,518     23,052  

Loan servicing income

    2,211     1,803     1,123     1,248     1,334  

Gain on sale of land, net

            3557          

Gain on sale of branches, net

        2,763              

Gain on sale of loans, net

    1,197     923     969     924     1,555  

Gain on sale of securities, net

    3         3     20     43  

Other noninterest income

    7,922     7,707     7,199     6,822     6,896  

Noninterest expense

    (30,606 )   (29,605 )   (26,499 )   (24,936 )   (24,773 )
                       
 

Income from continuing operations before income taxes

    8,609     8,027     6,722     7,596     8,107  

Income tax expense

    2,766     2,644     2,214     2,431     2,891  
                       
 

Income from continuing operations

    5,843     5,383     4,508     5,165     5,216  
                       

Discontinued Operations:

                               
 

Income (loss) from operations of discontinued
segment (net of income taxes)

                     
 

(Loss) on discontinued segment (net of income taxes)

                     
                       
 

Income (loss) from discontinued operations

                     
 

Net income

  $ 5,843   $ 5,383   $ 4,508   $ 5,165   $ 5,216  
                       

43


 

 
  Years Ended June 30,  
 
  2008   2007   2006   2005   2004  
 
  (Dollars in Thousands, Except Per Share Data)
 

Basic earnings (loss) per share:(1)

                               
 

Net income

  $ 1.47   $ 1.35   $ 1.15   $ 1.33   $ 1.34  

Diluted earnings (loss) per share:(1)

                               
 

Net income

    1.45     1.33     1.13     1.29     1.30  

Dividends declared per share(1)

   
0.43
   
0.42
   
0.41
   
0.40
   
0.39
 

Dividend payout ratio(2)

    29.25 %   30.93 %   35.20 %   30.03 %   29.33 %

Interest rate spread (average during period)

   
2.70
   
2.36
   
2.60
   
3.02
   
3.18
 

Net interest margin(3)

    3.11     2.80     2.98     3.29     3.41  

Net interest margin, TE(4)

    3.16     2.85     3.01     3.32     3.45  

Average interest-earning assets to average interest-
bearing liabilities

   
1.12
   
1.11
   
1.12
   
1.12
   
1.11
 

Equity to total assets (end of period)

   
5.82
   
6.22
   
5.83
   
5.97
   
6.10
 

Equity-to-assets ratio (ratio of average equity to
average total assets)

    6.21     6.06     5.94     6.25     6.36  

Nonperforming assets to total assets (end of period)

   
0.34
   
0.40
   
0.40
   
0.78
   
0.27
 

Allowance for loan and lease losses to nonperforming
loans and leases (end of period)(5)

   
191.08
   
167.87
   
168.11
   
73.24
   
174.75
 

Allowance for loan and lease losses to total loans and
leases (end of period)

   
0.75
   
0.76
   
0.77
   
0.74
   
0.55
 

Nonperforming loans and leases to total loans and
leases (end of period)(5)

   
0.39
   
0.45
   
0.46
   
1.01
   
0.32
 

Noninterest expense to average total assets

   
2.97
   
3.00
   
2.87
   
2.91
   
3.11
 

Net interest income after provision for losses for loans
and leases to noninterest expense (end of period)

   
91.10
   
82.54
   
76.87
   
94.31
   
93.05
 

Return on assets (ratio of net income to average total assets)

   
0.57
   
0.55
   
0.49
   
0.60
   
0.66
 

Return on equity (ratio of net income to average equity)

   
9.12
   
9.01
   
8.23
   
9.66
   
10.30
 

Operating Efficiency Ratio(6)

   
70.75
   
76.56
   
71.41
   
67.68
   
68.57
 

Efficiency Ratio(7)

    74.27     76.24     68.83     70.81     70.98  

Number of full-service offices

    33     33     35     34     34  

(1)
All per share data has been retroactively adjusted for the 10% stock dividend paid on April 24, 2006.

(2)
Dividends declared per share divided by net income per share.

(3)
Net interest income divided by average interest-earning assets.

(4)
Net interest margin expressed on a fully taxable equivalent basis.

(5)
Nonperforming loans and leases include nonaccruing loans and leases and accruing loans delinquent more than 90 days.

44


(6)
Total noninterest expense divided by the sum of net interest income plus total noninterest income excluding net interest expense on trust preferred securities and gain on sale of branches and gain on sale of land.

(7)
Total noninterest expense divided by the sum of net interest income plus total noninterest income.

Item 7.    Management's Discussion and Analysis of Financial Condition and Results of Operations

        This section should be read in conjunction with the following parts of this Form 10-K: Part II, Item 8 "Financial Statements and Supplementary Data," Part II, Item 7A, "Quantitative and Qualitative Disclosures About Market Risk," and Part I, Item 1 "Business."

Executive Summary

        The Company's net income for fiscal 2008 was $5.8 million, or $1.45 per diluted share, compared to $5.4 million, or $1.33 per diluted share for fiscal 2007. Return on average equity was 9.12% at June 30, 2008, compared to 9.01% at June 30, 2007.

        Net interest income for fiscal 2008 was $29.9 million, an increase of $4.2 million or 16.5% over the same period a year ago. The net interest margin was 3.11%, compared to 2.80% for the same period a year ago, an increase of 31 basis points. On a fully taxable equivalent basis, the net interest margin for fiscal 2008 was 3.16%, compared to 2.85% in fiscal 2007. The cost of funds rate on interest-bearing liabilities decreased from 4.39% in fiscal 2007 to 3.87% in fiscal 2008, a change of 52 basis points. For the same period, yields on earning assets decreased from 6.75% to 6.58%, a decrease of 17 basis points. Increases in volume from fiscal 2007 to fiscal 2008 of average earning assets and interest-bearing liabilities were 4.8% and 4.2% respectively. The Company was positioned to benefit from a steeper, more positive yield curve slope, and as such the net interest margin ratio benefitted as the Federal Funds Rate decreased 325 basis points in fiscal 2008.

        Variability of the net interest margin ratio may be affected by many aspects, including Federal Reserve policies for short-term interest rates, competitive and global economic factors and customer preferences for various products and services.

        The Company held $12.4 million in trust preferred securities at June 30, 2008. These are comprised of rated, pooled securities issued primarily by banks throughout the United States. The cash flows of the securities are derived from interest spreads between the issuer and the investor. These cash flows are used primarily to pay contractual interest. Principal payments are received primarily by the issuer paying off the securities at redeemable dates. In general, if certain ratios within the investment structure are reduced below established levels, excess interest cash flows are redirected to pay down principal in various tranches established by the investment structure.

        The allowance for loan and lease losses remained at $5.9 million at June 30, 2008, compared to $5.9 million at June 30, 2007, an increase of $61,000 or 1.0%. The ratio of allowance for loan and lease losses to total loans and leases was 0.75% as of June 30, 2008 compared to 0.76% at June 30, 2007. Total nonperforming assets at June 30, 2008 were $3.7 million as compared to $4.0 million at June 30, 2007. The ratio of nonperforming assets to total assets improved to 0.34% for June 30, 2008, compared to 0.40% at June 30, 2007. The allowance for loan and lease losses is calculated based on loan and lease levels, loan and lease loss history, credit quality of the loan and lease portfolio, and environmental factors such as economic health of the region and management experience. This risk rating analysis is designed to give the Company a consistent and systematic methodology to determine proper levels for the allowance at a given time.

        As of June 30, 2008, the Company continued to record a receivable in the amount of $223,000 from the sale of certain loan participation interests in December 2005. The balance of this receivable represents the remaining amount the Company expects to be paid on the receivable and the Company

45



has requested such payment from the lead bank. In addition, on June 26, 2006, the Company filed a $3.8 million lawsuit against this lead bank for their role in this participation loan, alleging fraud, breach of fiduciary duty, conspiracy, and negligent misrepresentation. See Part 1, Item 3 "Legal Proceedings" of this Form 10-K.

        Total deposits at June 30, 2008, were $784.2 million, a decrease of $31.6 million, or 3.9%, from June 30, 2007. Out-of-market certificates of deposit declined $44.3 million to $27.3 million at June 30, 2008, as the Company pursued other sources of wholesale funding. Interest expense on deposits was $24.7 million for fiscal 2008, a decrease of $3.8 million, or 13.4%, over the same period a year ago. A primary factor affecting interest expense was the decrease in money market rates and other non-maturity deposit product rates.

        The total risk-based capital ratio was 10.83% at June 30, 2008, compared to 11.05% at June 30, 2007. This continues to place the Bank in the "well-capitalized" category within OTS regulation at June 30, 2008, and is consistent within the "well-capitalized" OTS category in which the Company plans to operate. The Company historically has been able to manage the size of its assets through secondary market loan sales of single-family mortgages, student loans and a loan securitization.

        Noninterest expense for fiscal 2008 was $30.6 million, compared to $29.6 million a year ago, an increase of $1.0 million or 3.4%. Compensation and employee benefits for fiscal 2008 accounted for an increase of $1.2 million, or 6.7%, from the same period a year ago. Net healthcare costs, inclusive of self-funded health claims, administration fees and fully-insured dental premiums offset by stop loss insurance receivable and employee reimbursements for fiscal 2008 were $1.5 million, compared to $2.1 million for the same period a year ago, a decrease of $667,000 or 31.0%. This change is primarily due to lower health claims expense and recognition of stop loss insurance receipts.

        Noninterest income for fiscal 2008 was $11.3 million, compared to $13.2 million for the same period a year ago, a decrease of $1.9 million or 14.1%. Excluding the one-time $2.8 million gain on sale of branches during fiscal 2007, the increase was $900,000 or 8.6%. This core increase was driven primarily by increases in loan servicing income and fees on deposits. Loan servicing income increased in fiscal 2008 by $408,000 or 22.6% from fiscal 2007. Fees on deposits increased in fiscal 2008 by $256,000 or 5.0% from fiscal 2007.

        The Company focuses on balancing operating costs with operating revenue levels in order to provide better efficiency ratios over time and continues to review its operations for ways to reduce its cost structure while continuing to support long-term revenue enhancements. The operating efficiency ratio for fiscal 2008 was 70.75%, compared to 76.56% for the same period a year ago, a decrease of 581 basis points. The operating efficiency ratio excludes the impact of net interest expense on the variable priced trust preferred securities and the one-time gain on sale of branches. The Company has issued trust preferred securities primarily to provide funding for stock repurchases and to repay other borrowings. Net interest expense on the $27.8 million of trust preferred securities outstanding decreased to $2.1 million for fiscal 2008, compared to $2.7 million for the same period a year ago, a decrease of $563,000 or 20.9%. The average rate paid on these securities decreased 203 basis points, from 9.61% in fiscal 2007 to 7.58% in fiscal 2008. The total efficiency ratio was 74.27% at June 30, 2008, compared to 76.24% for the same period a year ago, a decrease of 197 basis points. Contributing to this improvement in the efficiency ratio from a year ago include an increase in Company revenue to $41.2 million for fiscal 2008, or a 14.3% increase compared to the same period a year ago excluding the one-time gain on sale of branches of $2.8 million. It is the Company's continuing goal to move the operating efficiency ratio towards the 50% level over the long term. Management believes that this can be accomplished through steady growth of the balance sheet and the containment of incremental operating expenses.

        Recent events in the financial markets produce uncertainties to management about future operating results and the future financial condition of the Company. The interdependencies of the

46



national economy and financial markets do affect the macro economics reviewed by management and may produce outcomes in the future which have not impacted the Company previously.

General

        The Company is a financial services provider and, as such, has inherent risks that must be managed in order to achieve net income. Primary risks that affect net income include credit risk, liquidity risk, operational risk, regulatory compliance risk and reputation risk. The Company's net income is derived by management of the net interest margin, the ability to collect fees from services provided, by controlling the costs of delivering services and the management of loan and lease losses. The primary source of revenues comes from the net interest margin, which represents the difference between income on interest-earning assets (i.e. loans and investment securities) and expense on interest-bearing liabilities (i.e. deposits and borrowed funding). The net interest margin is affected by regulatory, economic and competitive factors that influence interest rates, loan demand and deposit flows. Fees earned include charges for deposit services, trust services and loan services. Personnel costs are the primary expenses required to deliver the services to customers. Other costs include occupancy and equipment and general and administrative expenses.

Financial Condition Data

        At June 30, 2008 the Company had total assets of $1,103.5 million, an increase of $102.0 million from the level at June 30, 2007. The increase in assets was due primarily to increases in securities of $82.8 million, FHLB stock of $6.2 million, and net loans and leases receivable of $16.2 million offset by a decrease in cash and cash equivalents of $1.3 million. The increase in liabilities of $100.1 million was due to increases in advances from the FHLB and other borrowing of $129.9 million, offset by a decrease in deposits of $31.6 million from the levels at June 30, 2007. In addition, stockholders' equity increased to $64.2 million at June 30, 2008, from $62.3 million at June 30, 2007, primarily due to net income of $5.8 million offset by cash dividends paid of $1.7 million.

        The increase in securities of $82.8 million was due primarily to an increase in purchases of U.S. agency mortgage-backed securities, over sales, amortization and repayments of principal. The increase in FHLB stock of $6.2 million was the result of increased stock requirement by FHLB based upon an increase in outstanding advances.

        The increase in net loans and leases receivable of $16.2 million was due primarily to an increase in purchases and originations over sales, amortization and repayments of principal. During the first quarter of fiscal 2008, the Company announced that it had ceased origination of indirect auto loans. Indirect auto loan outstanding balances declined $38.8 million during the fiscal year to $44.3 million at June 30, 2008. In addition, deferred fees and discounts decreased by $775,000 primarily due to a decrease of $832,000 for deferred fees and discounts on indirect automobile loans that include prepaid dealer reserves.

        The decrease in cash and cash equivalents of $1.3 million was primarily due to the timing of items in clearing.

        Advances from the FHLB and other borrowings increased $129.9 million for the year ended June 30, 2008, primarily due to the Company increasing its short- and long-term advances by a net of $99.9 million, while increasing overnight Federal Funds advances by $29.9 million during the fiscal year ended June 30, 2008.

        The $31.6 million decrease in deposits was primarily due to decreases in out-of-market certificates of deposit of $44.3 million, and money market accounts of $40.9 million, offset by increases in in-market certificates of deposit of $34.1 million and savings accounts of $12.3 million.

47


Analysis of Net Interest Income

        Net interest income represents the difference between income on interest-earning assets and expense on interest-bearing liabilities. Net interest income depends upon the volume of interest-earning assets and interest-bearing liabilities and the interest rates earned or paid on them.

         Average Balances, Interest Rates and Yields.    The following table presents for the periods indicated, the total dollar amount of interest income from average interest-earning assets and the resulting yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and rates, and the net interest margin. The table does not reflect any effect of income taxes. Average balances consist of daily average balances for the Bank with simple average balances for all other companies. The average balances include nonaccruing loans and leases. The yields on loans and leases include origination fees, net of costs, which are considered adjustments to yield.

 
  Years Ended June 30,  
 
  2008   2007   2006  
 
  Average
Outstanding
Balance
  Interest
Earned/
Paid
  Yield/
Rate
  Average
Outstanding
Balance
  Interest
Earned/
Paid
  Yield/
Rate
  Average
Outstanding
Balance
  Interest
Earned/
Paid
  Yield/
Rate
 
 
  (Dollars in Thousands)
 

Interest-earning assets:

                                                       
 

Loans and leases receivable(1)(3)

  $ 775,558   $ 53,972     6.96 % $ 758,455   $ 54,344     7.17 % $ 703,787   $ 47,096     6.69 %
 

Investment securities(2)(3)

    176,652     8,844     5.01 %   152,132     7,209     4.74 %   151,139     6,133     4.06 %
 

FHLB stock

    8,511     358     4.21 %   6,406     321     5.01 %   6,871     182     2.65 %
                                       

Total interest-earning assets

    960,721   $ 63,174     6.58 %   916,993   $ 61,874     6.75 %   861,797   $ 53,411     6.20 %
                                             
 

Noninterest-earning assets

    70,371                 68,832                 61,491              
                                                   

Total assets

  $ 1,031,092               $ 985,825               $ 923,288              
                                                   

Interest-bearing liabilities:

                                                       

Deposits:

                                                       
 

Checking and money market

  $ 268,264   $ 6,979     2.60 % $ 282,312   $ 10,436     3.70 % $ 274,093   $ 8,281     3.02 %
 

Savings

    56,005     1,152     2.06 %   46,207     1,240     2.68 %   51,356     1,150     2.24 %
 

Certificates of deposit

    355,401     16,562     4.66 %   362,321     16,829     4.64 %   298,940     10,744     3.59 %
                                       
   

Total interest-bearing deposits

    679,670     24,693     3.63 %   690,840     28,505     4.13 %   624,389     20,175     3.23 %
 

FHLB advances and other borrowings

    152,289     6,494     4.26 %   106,151     5,061     4.77 %   119,727     5,357     4.47 %
 

Subordinated debentures payable to trusts(4)

    27,837     2,111     7.58 %   27,837     2,674     9.61 %   27,837     2,230     8.01 %
                                       

Total interest-bearing liabilities

    859,796   $ 33,298     3.87 %   824,828   $ 36,240     4.39 %   771,953   $ 27,762     3.60 %
                                             
 

Noninterest-bearing deposits

    79,313                 76,698                 77,419              
 

Other liabilities

    27,914                 24,558                 19,109              
                                                   

Total liabilities

    967,023                 926,084                 868,481              
 

Equity

    64,069                 59,741                 54,807              
                                                   

Total liabilities and equity

  $ 1,031,092               $ 985,825               $ 923,288              
                                                   

Net interest income; interest rate spread

        $ 29,876     2.70 %       $ 25,634     2.36 %       $ 25,649     2.60 %
                                             

Net interest margin(5)

                3.11 %               2.80 %               2.98 %
                                                   

Net interest margin, TE(6)

                3.16 %               2.85 %               3.01 %
                                                   

(1)
Includes loan fees and interest on accruing loans and leases past due 90 days or more.

(2)
Includes federal funds sold.

(3)
Yields do not reflect the tax-exempt nature of loans, equipment leases and municipal securities.

(4)
Includes $125 and $290 expense in July 2007 and December 2006, respectively, for unamortized debt issuance costs.

(5)
Net interest margin is net interest income divided by average interest-earning assets.

(6)
Net interest margin expressed on a fully taxable equivalent basis.

48


Rate/Volume Analysis of Net Interest Income

        The following schedule presents the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities. It distinguishes between the increases and decreases due to fluctuating outstanding balances that are due to the levels and volatility of interest rates. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in volume (i.e., changes in volume multiplied by old rate) and (ii) changes in rate (i.e., changes in rate multiplied by old volume). For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately to the change due to volume and the change due to rate.

 
  Years Ended June 30,   Years Ended June 30,  
 
  2008 vs. 2007   2007 vs. 2006  
 
  Increase
(Decrease)
Due to
Volume
  Increase
(Decrease)
Due to
Rate
  Total
Increase
(Decrease)
  Increase
Due to
Volume
  Increase
(Decrease)
Due to
Rate
  Total
Increase
(Decrease)
 
 
  (Dollars in Thousands)
 

Interest-earning assets:

                                     
 

Loans and leases receivable(1)

  $ 1,226   $ (1,598 ) $ (372 ) $ 3,658   $ 3,590   $ 7,248  
 

Investment securities(2)

    1,162     473     1,635     40     1,036     1,076  
 

FHLB stock

    97     (60 )   37     (18 )   157     139  
                           

Total interest-earning assets

  $ 2,485   $ (1,185 ) $ 1,300   $ 3,680   $ 4,783   $ 8,463  
                           

Interest-bearing liabilities:

                                     

Deposits:

                                     
 

Checking and money market

  $ (520 ) $ (2,938 ) $ (3,458 ) $ 248   $ 1,907   $ 2,155  
 

Savings

    263     (351 )   (88 )   (115 )   205     90  
 

Certificates of deposit

    (322 )   55     (267 )   2,278     3,807     6,085  
                           
   

Total interest-bearing deposits

    (579 )   (3,234 )   (3,813 )   2,411     5,919     8,330  

FHLB advances and other borrowings

    2,200     (766 )   1,434     (607 )   311     (296 )

Subordinated debentures payable to trusts

        (563 )   (563 )       444     444  
                           

Total interest-bearing liabilities

  $ 1,621   $ (4,563 ) $ (2,942 ) $ 1,804   $ 6,674   $ 8,478  
                           

Net interest income increase (decrease)

              $ 4,242               $ (15 )
                                   

(1)
Includes loan fees and interest on accruing loans and leases past due 90 days or more.

(2)
Includes federal funds sold.

Application of Critical Accounting Policies

        GAAP requires management to utilize estimates when reporting financial results. The Company has identified the policies discussed below as Critical Accounting Policies because the accounting estimates require management to make certain assumptions about matters that may be uncertain at the time the estimate was made and a different method of estimating could have been reasonably made that could have a material impact on the presentation of the Company's financial condition, changes in financial condition or results of operations.

        Allowance for Loan and Lease Losses—GAAP requires the Company to set aside reserves or maintain an allowance against probable loan and lease losses in the loan and lease portfolio. Management must develop a consistent and systematic approach to estimate the appropriate balances that will cover the probable losses. Due to the uncertainty of future events, the approach includes a process that may differ significantly from other methodologies and still produce an estimate that is in accordance with GAAP.

49


        The allowance is compiled by utilizing the Company's loan and lease risk rating system, which is structured to identify weaknesses in the loan and lease portfolio. The risk rating system has evolved to a process whereby management believes the system will properly identify the credit risk associated with the loan and lease portfolio. Due to the stratification of loans and leases for the allowance calculation, the estimate of the allowance for loan and lease losses could change materially if the loan and lease risk rating system would not properly identify the strength of a large or a few large loan and lease customers. Although management believes that it uses the best information available to determine the allowance, unforeseen market or borrower conditions could result in adjustments and net earnings being significantly affected if circumstances differ substantially from the assumptions used in making the final determinations.

        Mortgage Servicing Rights ("MSR")—The Company records a servicing asset for contractually separated servicing from the underlying mortgage loans. The asset is initially recorded at fair value and represents an intangible asset backed by an income stream from the serviced assets. The asset is amortized in proportion to and over the period of estimated net servicing income.

        At each balance sheet date, the MSRs are analyzed for impairment, which occurs when the fair value of the MSRs is lower than the amortized book value. The Company's MSRs are primarily servicing rights acquired on South Dakota Housing Development Authority first time homebuyers program. Due to the lack of quoted markets for the Company's servicing portfolio, the Company estimates the fair value of the MSRs using present value of future cash flow analysis. If the analysis produces a fair value that is greater than or equal to the amortized book value of the MSRs, no impairment is recognized. If the fair value is less than the book value, an expense for the difference is charged to earnings by initiating a MSR valuation account. If the Company determines this impairment is temporary, any future changes in fair value are recorded as a change in earnings and the valuation. If the Company determines the impairment to be permanent, the valuation is written off against the MSRs which results in a new amortized balance.

        The Company has included MSRs as a critical accounting policy because the use of estimates for determining fair value using present value concepts may produce results which may significantly differ from other fair value analysis perhaps even to the point of recording impairment. The risk to earnings is when the underlying mortgages payoff significantly faster than the assumptions used in the previously recorded amortization. Estimating future cash flows on the underlying mortgages is a difficult analysis and requires judgment based on the best information available. The Company looks at alternative assumptions and projections when preparing a reasonable and supportable analysis. Based on the Company's quarterly analysis of MSRs, there was no impairment to the MSRs at June 30, 2008.

        Self-Insurance—The Company has a self-insured healthcare plan for its employees up to certain limits. To mitigate a portion of these risks, the Company has a stop-loss insurance policy through a commercial insurance carrier for coverage in excess of $65,000 per individual occurrence. The estimate of self-insurance liability is based upon known claims and an estimate of incurred, but not reported ("IBNR") claims. IBNR claims are estimated using historical claims lag information received by a third party claims administrator. Due to the uncertainty of health claims, the approach includes a process that may differ significantly from other methodologies and still produce an estimate that is in accordance with GAAP. Although management believes that it uses the best information available to determine the accrual, unforeseen health claims could result in adjustments to the accrual. These adjustments could significantly affect net earnings if circumstances differ substantially from the assumptions used in estimating the accrual.

Asset Quality

        When a borrower fails to make a required payment on a loan within 10 to 15 days after the payment is due, the Bank generally institutes collection procedures by issuing a late notice. The

50



customer is contacted again when the payment is between 17 and 40 days past due. In most cases, delinquencies are cured promptly; however, if a loan has been delinquent for more than 40 days, the Bank attempts additional written as well as verbal contacts and, if necessary, personal contact with the borrower in order to determine the reason for the delinquency and to effect a cure, and, where appropriate, reviews the condition of the property and the financial circumstances of the borrower. Based upon the results of any such investigation, the Bank may: (i) accept a repayment program which under appropriate circumstances could involve an extension in the case of consumer loans for the arrearage from the borrower, (ii) seek evidence, in the form of a listing contract, of efforts by the borrower to sell the property if the borrower has stated that he is attempting to sell, or (iii) initiate foreclosure proceedings. When a loan payment is delinquent for 90 days, the Bank generally will initiate foreclosure proceedings unless management is satisfied the credit problem is correctable.

        Loans are generally classified as nonaccrual when there are reasonable doubts as to the collectability of principal and/or interest and/or when payment becomes 90 days past due, except loans which are well secured and in the process of collection. Interest collections on nonaccrual loans, for which the ultimate collectability of principal is uncertain, are applied as principal reductions.

        Leases are generally classified as nonaccrual when there are reasonable doubts as to the collectability of principal and/or interest. Leases may be placed on nonaccrual when the lease has experienced either four consecutive months with no payments or once the account is five months in arrears. Interest collections on nonaccrual leases, for which the ultimate collectability of principal is uncertain, are applied as principal reductions.

        When a lessee fails to make a required lease payment within 10 days after the payment is due, Mid America Capital generally institutes collection procedures. The lessee may be contacted by telephone on the 10th, but no later than the 30th day of delinquency. A late notice is automatically issued by the system on the 11th day of delinquency and is sent to the lessee. The lease may be referred to legal counsel when the lease is past due beyond four payments and no positive response has been received or when other considerations are present.

        Nonperforming assets (nonaccrual loans and leases, accruing loans and leases delinquent more than 90 days and foreclosed assets) decreased to $3.7 million at June 30, 2008 from $4.0 million at June 30, 2007, a decrease of $258,000. In addition, the ratio of nonperforming assets to total assets, which is one indicator of credit risk exposure, improved to 0.34% at June 30, 2008, from 0.40% at June 30, 2007.

        Nonaccruing loans and leases increased $134,000 to $2.3 million at June 30, 2008 compared to $2.2 million at June 30, 2007. Included in nonaccruing loans and leases at June 30, 2008 were eight loans totaling $503,000 secured by one- to four-family real estate, two commercial real estate loans totaling $429,000, one agricultural real estate loan totaling $42,000, eleven commercial business loans totaling $555,000, two agricultural business loans totaling $201,000, one equipment finance lease totaling $27,000 and 37 consumer loans totaling $566,000.

        The Company's nonperforming loans and leases, which represent nonaccrual and past due 90 days and still accruing, have decreased $393,000 from the levels at June 30, 2007. The risk rating system in place is designed to identify and manage the nonperforming loans and leases. Commercial and agricultural loans and equipment finance leases will have specific reserve allocations based on collateral values or based on the present value of expected cash flows if the loans or leases are deemed impaired. Loans and leases that are not performing do not necessarily result in a loss.

        As of June 30, 2008, the Company had $643,000 of foreclosed assets. The balance of foreclosed assets at June 30, 2008 consisted of $443,000 in equipment finance leases, $124,000 in consumer collateral and $76,000 in single-family residences.

51


        At June 30, 2008, the Company had designated $22.2 million of its assets as special mention and classified $11.5 million of its assets that management has determined need to be closely monitored because of possible credit problems of the borrowers or the cash flows of the secured properties. At June 30, 2008, the Company had $21.8 million in multi-family, commercial real estate and agricultural participation loans purchased, of which $3.9 million were classified at June 30, 2008. These loans and leases were considered in determining the adequacy of the allowance for loan and lease losses. The allowance for loan and lease losses is established based on management's evaluation of the risks probable in the loan and lease portfolio and changes in the nature and volume of loan and lease activity. Such evaluation, which includes a review of all loans and leases for which full collectability may not be reasonably assured, considers the estimated fair market value of the underlying collateral, present value of expected principal and interest payments, economic conditions, historical loss experience and other factors that warrant recognition in providing for an adequate loan and lease loss allowance.

        Although the Company's management believes that the June 30, 2008 recorded allowance for loan and lease losses was adequate to provide for probable losses on the related loans and leases, there can be no assurance that the allowance existing at June 30, 2008 will be adequate in the future.

        In accordance with the Company's internal classification of assets policy, management evaluates the loan and lease portfolio on a monthly basis to identify loss potential and determines the adequacy of the allowance for loan and lease losses quarterly. Loans are placed on nonaccrual status when the collection of principal and/or interest becomes doubtful. Foreclosed assets include assets acquired in settlement of loans.

52


        The following table sets forth the amounts and categories of the Company's nonperforming assets from continuing operations for the periods indicated.

 
  At June 30,  
 
  2008   2007   2006   2005   2004  
 
  (Dollars in Thousands)
 

Nonaccruing loans and leases:

                               
 

One- to four-family

  $ 503   $ 228   $ 371   $ 263   $ 86  
 

Commercial real estate

    429     25         70     75  
 

Commercial business

    555     1441     341     4518     795  
 

Equipment finance leases

    27     118     36     130     21  
 

Consumer

    566     378     287     341     564  
 

Agricultural

    244                 20  
                       
   

Total

    2,324     2,190     1,035     5,322     1,561  
                       

Accruing loans and leases delinquent more than 90 days:

                               
 

One- to four-family

    306     470     358     98      
 

Commercial real estate

    24     178     308     292      
 

Commercial business

    71     213     814     1,052     221  
 

Equipment finance leases

    9     88     302     71     281  
 

Consumer

    119     1     7          
 

Agricultural

    252     358     541     96      
                       
   

Total

    781     1,308     2,330     1609     502  
                       

Foreclosed assets:

                               
 

One- to four-family

    76     158     96     39     100  
 

Equipment finance leases

    443     180     254          
 

Consumer

    124     170     177     50     112  
                       
   

Total(1)

    643     508     527     89     212  
                       

Total nonperforming assets(2)

  $ 3,748   $ 4,006   $ 3,892   $ 7,020   $ 2,275  
                       

Ratio of nonperforming assets to total assets(3)

    0.34 %   0.40 %   0.40 %   0.78 %   0.27 %
                       

Ratio of nonperforming loans and leases to total loans and leases(4)

    0.39 %   0.45 %   0.46 %   1.01 %   0.32 %
                       

(1)
Total foreclosed assets do not include land or other real estate owned held for sale.

(2)
Nonperforming assets include nonaccruing loans and leases, accruing loans and leases delinquent more than 90 days and foreclosed assets.

(3)
Percentage is calculated based upon total assets of the Company and its direct and indirect subsidiaries on a consolidated basis.

(4)
Nonperforming loans and leases include both nonaccruing and accruing loans and leases delinquent more than 90 days.

53


        The following table sets forth information with respect to activity in the Company's allowance for loan and lease losses from continuing operations during the periods indicated.

 
  Years Ended June 30,  
 
  2008   2007   2006   2005   2004  
 
  (Dollars in Thousands)
 

Balance at beginning of period

  $ 5,872   $ 5,657   $ 5,076   $ 3,605   $ 3,842  

Charge-offs:

                               
 

One- to four-family

    (3 )   (12 )   (1 )       (7 )
 

Commercial real estate

                (31 )   (92 )
 

Commercial business

    (894 )   (386 )   (3,389 )   (187 )   (457 )
 

Equipment finance leases

    (475 )   (162 )   (165 )   (269 )   (30 )
 

Consumer

    (853 )   (701 )   (1,066 )   (1,044 )   (1,143 )
 

Agricultural

    (20 )   (31 )   (502 )   (14 )   (835 )
                       
 

Total charge-offs

    (2,245 )   (1,292 )   (5,123 )   (1,545 )   (2,564 )
                       

Recoveries:

                               
 

One- to four-family

    2     3     1     9     4  
 

Commercial real estate

        1     6         1  
 

Commercial business

    8     9     15     31     3  
 

Equipment finance leases

    34     0     40     2     64  
 

Consumer(1)

    263     216     237     215     232  
 

Agricultural

    5     80     126     78     3  
                       
 

Total recoveries

    312     309     425     335     307  
                       
   

Net (charge-offs)

    (1,933 )   (983 )   (4,698 )   (1,210 )   (2,257 )
                       

Additions charged to operations

    1,994     1,198     5,279     2,681     2,020  

Allowance related to assets acquired (sold), net

                     
                       

Balance at end of period

  $ 5,933   $ 5,872   $ 5,657   $ 5,076   $ 3,605  
                       

Ratio of net (charge-offs) during the period to average loans and leases outstanding during the period

    (0.25 )%   (0.13 )%   (0.67 )%   (0.18 )%   (0.36 )%
                       

Ratio of allowance for loan and lease losses to total loans and leases at end of period

    0.75 %   0.76 %   0.77 %   0.74 %   0.55 %
                       

Ratio of allowance for loan and lease losses to nonperforming loans and leases at end of period

    191.08 %   167.87 %   168.11 %   73.24 %   174.75 %
                       

54


        The distribution of the Company's allowance for loan and lease losses and impaired loss summary are summarized in the following tables.

 
  At June 30,  
 
  2008   2007   2006   2005   2004  
 
  Amount   Percent of Loans in
Each Category to
Total Loans
  Amount   Percent of Loans in
Each Category to
Total Loans
  Amount   Percent of Loans in
Each Category to
Total Loans
  Amount   Percent of Loans in
Each Category to
Total Loans
  Amount   Percent of Loans in
Each Category to
Total Loans
 
 
  (Dollars in Thousands)
 

One- to four-family(1)

  $ 294     4.95 % $ 342     5.82 % $ 193     17.02 % $ 186     17.21 % $ 15     17.51 %

Commercial and multi-family real estate(1)

    875     14.75     647     11.02     396     26.54     261     19.66     220     20.57  

Commercial business(2)

    2,174     36.64     2,795     47.60     3,133     17.42     2,953     22.96     1,270     22.85  

Consumer

    1,190     20.06     1,178     20.06     1,432     26.99     1,343     29.45     1,736     29.48  

Agricultural

    1,400     23.60     910     15.50     503     12.03     333     10.72     364     9.59  
                                           
 

Total

  $ 5,933     100.00 % $ 5,872     100.00 % $ 5,657     100.00 % $ 5,076     100.00 % $ 3,605     100.00 %
                                           

(1)
Includes construction and development loans.

(2)
Includes equipment finance leases.

55


 
  FAS 5
Allowance
for Loan and
Lease Losses
  FAS 114
Impaired Loan
Valuation Allowance
  FAS 5
Allowance
for Loan and
Lease Losses
  FAS 114
Impaired Loan
Valuation Allowance
 
Loan Type
  At June 30, 2008   At June 30, 2007  
 
  (Dollars in Thousands)
 

One- to four-family

  $ 294       $ 342      

Commercial real estate

    740         524      

Multi-family real estate

    135         123      

Commercial business

    1,678         1,974     335  

Equipment finance leases

    496         486      

Consumer

    1,190         1,178      

Agricultural

    1,270     130     860     50  
                   
 

Total

  $ 5,803   $ 130   $ 5,487   $ 385  
                   


FAS 114 Impaired Loan Summary

 
  Number
of Loan
Customers
  Loan
Balance
  Impaired
Loan
Valuation
Allowance
  Number
of Loan
Customers
  Loan
Balance
  Impaired
Loan
Valuation
Allowance
 
Loan Type
  At June 30, 2008   At June 30, 2007  
 
  (Dollars in Thousands)
 

Commercial business

    0   $ 0   $ 0     7   $ 1,360   $ 335  

Agricultural

    2     316     130     1     121     50  
                           
 

Total

    2   $ 316   $ 130     8   $ 1,481   $ 385  
                           

        The allowance for loan and lease losses was $5.9 million at June 30, 2008, as compared to $5.9 million at June 30, 2007. The ratio of the allowance for loan and lease losses to total loans and leases was 0.75% at June 30, 2008, compared to 0.76% at June 30, 2007. The Company's management has considered nonperforming assets and other assets of concern in establishing the allowance for loan and lease losses. The Company continues to monitor its allowance for possible loan and lease losses and make future additions or reductions in light of the level of loans and leases in its portfolio and as economic conditions dictate. The current level of the allowance for loan and lease losses is a result of management's assessment of the risks within the portfolio based on the information revealed in credit reporting processes. The Company utilizes a risk-rating system on commercial business, agricultural, construction, multi-family and commercial real estate loans, including purchased loans. A periodic credit review is performed on all types of loans and leases to establish the necessary reserve based on the estimated risk within the portfolio. This assessment of risk takes into account the composition of the loan and lease portfolio, historical loss experience for each loan and lease category, previous loan and lease experience, concentrations of credit, current economic conditions and other factors that in management's judgment deserve recognition. OTS regulators have reviewed the Company's methodology for determining allowance requirements on the Company's loan and lease portfolio and have made no required recommendations for changes in methodology in the allowances during the three year period ended June 30, 2008.

        Real estate properties acquired through foreclosure are recorded at the lower of cost or fair value (less a deduction for disposition costs). Valuations are periodically updated by management and a specific provision for losses on such properties is established by a charge to operations if the carrying values of the properties exceed their estimated net realizable values.

        Although management believes that it uses the best information available to determine the allowances, unforeseen market conditions could result in adjustments and net earnings being significantly affected if circumstances differ substantially from the assumptions used in making the final

56



determinations. Future additions to the Company's allowances result from periodic loan, property and collateral reviews and thus cannot be predicted in advance. See Note 1 of "Notes to Consolidated Financial Statements," which is included in Part II, Item 8 "Financial Statements and Supplementary Data" of this Form 10-K for a description of the Company's policy regarding the provision for losses on loans and leases.

Comparison of the Years Ended June 30, 2008 and June 30, 2007

         General.    The Company's income was $5.8 million or $1.47 and $1.45 for basic and diluted earnings per share, respectively, for the year ended June 30, 2008, a $460,000 increase in earnings compared to $5.4 million or $1.35 and $1.33 for basic and diluted earnings per share, respectively, for the prior year. Fiscal year 2007 second quarter net income included a non-recurring after-tax gain on sale of branches of $1.7 million or $0.42 diluted earnings per share. For the year ended June 30, 2008, the return on average equity was 9.12%, a 1.2% increase compared to 9.01% in the prior year. For the year ended June 30, 2008, the return on average assets was 0.57%, a 3.6% increase compared to 0.55% in the prior year. As discussed in more detail below, the increases were due to a variety of key factors, including increases in net interest income of $4.2 million, offset by increases in provision for losses on loans and leases of $796,000 and increases in noninterest expense of $1.0 million.

         Interest and Dividend Income.    Interest and dividend income was $63.2 million for the year ended June 30, 2008, as compared to $61.9 million for the prior year, an increase of $1.3 million or 2.1%. A $1.2 million decrease in interest and dividend income was the result of a 2.5% decrease in the average yield on interest-earning assets and a $2.5 million increase in interest and dividend income was the result of a 4.8% increase in the average volume of total interest-earning assets. The average yield on interest-earning assets was 6.58% for the year ended June 30, 2008, as compared to 6.75% for the prior year. The average volume of loans and leases receivable increased from $758.5 million for the year ended June 30, 2007, to $775.6 million for the year ended June 30, 2008. For the year ended June 30, 2008, the average yield on loans and leases receivable was 6.96%, a decrease of 2.9% from 7.17% in the prior year. The overall increase in interest and dividend income was due in part to the repricing of loans and investments that generally reflected national interest rates.

         Interest Expense.    Interest expense was $33.3 million for the year ended June 30, 2008, as compared to $36.2 million for the prior year, a decrease of $2.9 million or 8.12%. A $3.2 million decrease was the result of an 11.9% decrease in the average rate paid on interest-bearing deposits. The average rate on interest-bearing deposits was 3.63% for the year ended June 30, 2008, as compared to 4.13% for the prior year. A $766,000 decrease in interest expense was the result of a 10.6% decrease in the average yield on FHLB advances and other borrowings to 4.26% for the year ended June 30, 2008, compared to 4.77% for the prior fiscal year, and a $2.2 million increase in interest expense was the result of a 43.5% increase in the average balance of FHLB advances and other borrowings. In addition, interest expense decreased $563,000 due to the average yield on subordinated debentures payable to trust decreasing to 7.58% for the year ended June 30, 2008, compared to 9.61% for the prior fiscal year.

         Net Interest Income.    The Company's net interest income for the year ended June 30, 2008, increased $4.2 million or 16.55%, to $29.8 million compared to $25.6 million for the prior year. The Company's net interest margin increased to 3.11% for the year ended June 30, 2008, as compared to 2.80% for the prior year. The Company continues to have a diversified loan portfolio comprised of a mix of consumer and business type lending. This mix helps the Company manage the net interest margin and interest rate risk by retaining loan and lease production on the balance sheet or looking at alternatives through secondary markets.

         Provision for Losses on Loans and Leases.    The allowance for loan and lease losses is maintained at a level which is considered by management to be adequate to absorb probable losses on existing

57



loans and leases that may become uncollectible, based on an evaluation of the collectability of the loans and leases and prior loan and lease loss experience. The evaluation takes into consideration such factors as changes in the nature and volume of the loan and lease portfolio, overall portfolio quality, review of specific problem loans and leases, and current economic conditions that may affect the borrower's ability to pay. The allowance for loan and lease losses is established through a provision for losses on loans and leases charged to expense. See "Asset Quality" above for further discussion.

        Provision for losses on loans and leases increased $796,000 or 66.4%, to $2.0 million for the year ended June 30, 2008, as compared to $1.2 million in the prior year. Net charge-offs increased from $1.0 million during fiscal 2007 to $1.9 million during fiscal 2008. Nonperforming assets decreased $258,000 for the year ended June 30, 2008.

        The allowance for losses on loans and leases at June 30, 2008 was $5.9 million. The allowance remained from the June 30, 2007, balance of $5.9 million primarily as a result of charge-offs exceeding recoveries by $1.9 million offset by the provision for losses on loans and leases of $2.0 million. The ratio of allowance for loan and lease losses to nonperforming loans and leases at June 30, 2008, was 191.08% compared to 167.87% at June 30, 2007. The allowance for loan and lease losses to total loans and leases at June 30, 2008, was 0.75% compared to 0.76% at June 30, 2007. The Bank's management believes that the June 30, 2008, recorded allowance for loan and lease losses is adequate to provide for probable losses on the related loans and leases, based on its evaluation of the collectability of loans and leases and prior loss experience.

         Noninterest Income.    Noninterest income was $11.3 million for the year ended June 30, 2008, as compared to $13.2 million for the year ended June 30, 2007, a decrease of $1.9 million or 14.12%. The decrease in noninterest income was due primarily to a one-time gain on sale of branches of $2.8 million in fiscal 2007. During fiscal 2008 the Company experienced increases in loan servicing income of $408,000, gain on sale of loans of $274,000, fees on deposits of $256,000, and trust income of $30,000, offset by decreases in other noninterest income of $71,000.

        The net gain on sale of branches of $2.8 million in fiscal 2007 was due to the sale of three branches and their associated book of business, as well as one physical location. The sale was completed during the second quarter of fiscal 2007 and produced the one-time gain on sale. The proceeds of the sale were invested in new market locations and new marketing initiatives.

        Loan servicing income increased by $408,000 to $2.2 million for the year ended June 30, 2008, as compared to $1.8 million for the prior year, primarily due to increased originated and purchased servicing rights for SDHDA mortgage loans. At June 30, 2008, the Bank serviced $932.9 million of mortgage loans for the SDHDA.

        Fees on deposits increased by $256,000 to $5.4 million during the year ended June 30, 2008, as compared to $5.1 million for the prior year, primarily due to a $278,000 net increase in income from point-of-sale purchases by customers and ATM service fees, and a $21,000 increase in net NSF/OD fees.

        Trust income increased by $30,000 to $966,000 during the year ended June 30, 2008, as compared to the prior year primarily due to further diversification of trust activities. Assets under management decreased from $126.4 million to $95.0 million.

        Other noninterest income for the year ended June 30, 2008, was $1.6 million as compared to $1.6 million for the prior year, a decrease of $71,000.

         Noninterest Expense.    Noninterest expense was $30.6 million for the year ended June 30, 2008, as compared to $29.6 million for the prior year, an increase of $1.0 million. The increase in noninterest expense was due primarily to increases in compensation and employee benefits of $1.2 million, and occupancy and equipment of $35,000, offset by a decrease in advertising costs of $464,000.

58


        Compensation and employee benefits increased $1.2 million during the year ended June 30, 2008, as compared to the prior fiscal year primarily due to increases in employee variable pay compensation of $1.2 million related to performance incentives and offset by a decrease in net healthcare costs of $667,000. Net healthcare costs, inclusive of health claims and administration fees offset by stop loss and employee reimbursement under the Company's self-insured health plan, was $1.5 million for the fiscal year ended June 30, 2007, a decrease of 31.0% compared to the prior fiscal year. The Company has had a self-insured health plan since January 1994. Management continues to believe the current structure is a reasonable alternative to traditional healthcare plans over the long term. The level of healthcare costs which the Company incurs may vary from year to year. The reduction in net healthcare costs for the fiscal year ending June 30, 2008, does not necessarily indicate a trend. This is a challenging area for all companies and the Company continues to review its healthcare plans in an effort to provide its employees with affordable health care.

        Advertising costs decreased $464,000 to $1.1 million for the year ended June 30, 2008 as compared to $1.5 million for the prior year, primarily due to new deposit package programs marketed during the prior year.

        Occupancy and equipment costs increased $35,000 during the year ended June 30, 2008, as compared to the prior fiscal year. This increase was primarily the result of $20,000 of increased rent expense, and $11,000 of increased furniture and fixture depreciation expense.

         Income Tax Expense.    The Company's income tax expense increased $122,000, or 4.63%, for the year ended June 30, 2008 to $2.8 million compared to $2.6 million for the prior year. The increase was due primarily to the increase in income before taxes. The effective tax rate for the years ended June 30, 2008, and June 30, 2007, was 32.13% and 32.94%, respectively.

Comparison of the Years Ended June 30, 2007 and June 30, 2006

         General.    The Company's income was $5.4 million or $1.35 and $1.33 for basic and diluted earnings per share, respectively, for the year ended June 30, 2007, an $875,000 increase in earnings compared to $4.5 million or $1.15 and $1.13 for basic and diluted earnings per share, respectively, for the prior year. For the year ended June 30, 2007, the return on average equity was 9.01%, a 9.5% increase compared to 8.23% in the prior year. For the year ended June 30, 2007, the return on average assets was 0.55%, a 12.2% increase compared to 0.49% in the prior year. As discussed in more detail below, the increases were due to a variety of key factors, including decreases in provision for losses on loans and leases of $4.1 million and increases in noninterest income of $345,000 offset by increases in noninterest expense of $3.1 million.

         Interest and Dividend Income.    Interest and dividend income was $61.9 million for the year ended June 30, 2007 as compared to $53.4 million for the prior year, an increase of $8.5 million or 15.8%. A $4.8 million increase in interest and dividend income was the result of an 8.9% increase in the average yield on interest-earning assets and a $3.7 million increase in interest and dividend income was the result of a 6.4% increase in the average volume of total interest-earning assets. The average yield on interest- earning assets was 6.75% for the year ended June 30, 2007 as compared to 6.20% for the prior year. The average volume of loans and leases receivable increased from $703.8 million for the year ended June 30, 2006 to $758.5 million for the year ended June 30, 2007. For the year ended June 30, 2007 the average yield on loans and leases receivable was 7.17%, an increase of 7.2% from 6.69% in the prior year. The overall increase in interest and dividend income was due in part to the repricing of loans and investments that generally reflected national interest rates.

         Interest Expense.    Interest expense was $36.2 million for the year ended June 30, 2007 as compared to $27.7 million for the prior year, an increase of $8.5 million or 30.5%. A $5.9 million increase was the result of a 27.9% increase in the average rate paid on interest-bearing deposits. The average rate on interest-bearing deposits was 4.13% for the year ended June 30, 2007 as compared to 3.23% for the

59



prior year. A $311,000 increase in interest expense was the result of a 6.7% increase in the average yield on FHLB advances and other borrowings to 4.77% for the year ended June 30, 2007 compared to 4.47% for the prior fiscal year and a $607,000 decrease in interest expense was the result of an 11.3% decrease in the average balance of FHLB advances and other borrowings. In addition, interest expense increased $444,000 due to the average yield on subordinated debentures payable to trust increasing to 9.61% for the year ended June 30, 2007 compared to 8.01% for the prior fiscal year.

         Net Interest Income.    The Company's net interest income for the year ended June 30, 2007 decreased $15,000, or 0.1%, to $25.6 million compared to $25.6 million for the prior year. The Company's net interest margin decreased to 2.80% for the year ended June 30, 2007 as compared to 2.98% for the prior year. The Company continues to have a diversified loan portfolio comprised of a mix of consumer and business type lending. This mix helps the Company manage the net interest margin and interest rate risk by retaining loan and lease production on the balance sheet or looking at alternatives through secondary markets.

         Provision for Losses on Loans and Leases.    The allowance for loan and lease losses is maintained at a level which is considered by management to be adequate to absorb probable losses on existing loans and leases that may become uncollectible, based on an evaluation of the collectability of the loans and leases and prior loan and lease loss experience. The evaluation takes into consideration such factors as changes in the nature and volume of the loan and lease portfolio, overall portfolio quality, review of specific problem loans and leases, and current economic conditions that may affect the borrower's ability to pay. The allowance for loan and lease losses is established through a provision for losses on loans and leases charged to expense. See "Asset Quality" above for further discussion.

        Provision for losses on loans and leases decreased $4.1 million, or 77.3%, to $1.2 million for the year ended June 30, 2007 as compared to $5.3 million in the prior year. Net charge-offs decreased from $4.7 million during fiscal 2006 to $1.0 million during fiscal 2007. Nonperforming assets increased $114,000 for the year ended June 30, 2007.

        The allowance for losses on loans and leases at June 30, 2007 was $5.9 million. The allowance increased from the June 30, 2006 balance of $5.7 million primarily as a result of charge-offs exceeding recoveries by $1.0 million offset by the provision for losses on loans and leases of $1.2 million. The ratio of allowance for loan and lease losses to nonperforming loans and leases at June 30, 2007 was 167.87% compared to 168.11% at June 30, 2006. The allowance for loan and lease losses to total loans and leases at June 30, 2007 was 0.76% compared to 0.77% at June 30, 2006. The Bank's management believes that the June 30, 2007 recorded allowance for loan and lease losses was adequate to provide for probable losses on the related loans and leases, based on its evaluation of the collectability of loans and leases and prior loss experience.

         Noninterest Income.    Noninterest income was $13.2 million for the year ended June 30, 2007 as compared to $12.9 million for the year ended June 30, 2006, an increase of $345,000, or 2.7%. The increase in noninterest income was due primarily to increases in loan servicing income of $680,000, fees on deposits of $595,000, trust income of $87,000 and a one-time gain on sale of branches of $2.8 million, offset by decreases in other noninterest income of $174,000 and the one-time gain on sale of land of $3.6 million completed in fiscal 2006.

        The net gain on sale of branches of $2.8 million was due to the sale of three branches and their associated book of business, as well as one physical location. The sale was completed during the second quarter of fiscal 2007 and produced the one-time gain on sale. The proceeds of the sale were invested in new market locations and new marketing initiatives.

        The net gain on sale of land of $3.6 million was due to the completion of the sale of a parcel of land purchased for expansion several years ago. The sale was completed during the second quarter of

60



fiscal 2006 and produced the one-time gain on sale. The Company has acquired other locations in the interim and determined that it no longer needed this parcel for the expansion planned.

        Loan servicing income increased by $680,000 to $1.8 million for the year ended June 30, 2007 as compared to $1.1 for the prior year, primarily due to the purchase of servicing rights during the first quarter of fiscal 2007.

        Fees on deposits increased by $595,000 to $5.1 million during the year ended June 30, 2007 as compared to $4.5 million for the prior year, primarily due to a $357,000 increase in net NSF/OD fees and a $142,000 net increase in income from point-of-sale purchases by customers and ATM service fees.

        Trust income increased by $87,000 to $936,000 during the year ended June 30, 2007 as compared to the prior year primarily due to assets under management increasing from $114.6 million to $126.4 million.

        Other noninterest income for the year ended June 30, 2007 was $1.6 million as compared to $1.8 million for the prior year, a decrease of $174,000. This decrease was primarily due to $137,000 of securitization income recorded in fiscal 2006. There was no securitization income recorded in fiscal 2007. See "Consumer Lending – Other Consumer Lending" and "Off-Balance Sheet Financing Arrangements" of this Form 10-K for more information on the automobile securitization.

         Noninterest Expense.    Noninterest expense was $29.6 million for the year ended June 30, 2007 as compared to $26.5 million for the prior year, an increase of $3.1 million. The increase in noninterest expense was due primarily to increases in compensation and employee benefits of $1.7 million, advertising of $685,000 and occupancy and equipment of $459,000.

        Compensation and employee benefits increased $1.7 million during the year ended June 30, 2007 as compared to the prior fiscal year primarily due to increases in employee variable pay compensation of $819,000 related to performance incentives and net healthcare costs of $654,000. Net healthcare costs, inclusive of health claims and administration fees offset by stop loss and employee reimbursement under the Company's self-insured health plan, was $2.1 million for the fiscal year ended June 30, 2007, an increase of 43.7% compared to the prior fiscal year. The Company has had a self-insured health plan since January 1994. Management continues to believe the current structure is a reasonable alternative to traditional healthcare plans over the long term. This is a challenging area for all companies and the Company continues to review its healthcare plans in an effort to provide its employees with affordable health care.

        Advertising costs increased $685,000 to $1.5 million for the year ended June 30, 2007 as compared to $856,000 for the prior year, primarily due to new deposit package programs marketed during the year.

        Occupancy and equipment costs increased $459,000 during the year ended June 30, 2007 as compared to the prior fiscal year. This increase was primarily the result of $195,000 of increased rent expense, $128,000 of increased furniture and fixture depreciation expense and $61,000 of increased building and property maintenance expense.

         Income Tax Expense.    The Company's income tax expense increased $430,000, or 19.4%, for the year ended June 30, 2007 to $2.6 million compared to $2.2 million for the prior year. The increase was due primarily to the increase in income before taxes. The effective tax rate for the years ended June 30, 2007 and June 30, 2006 was 32.94%.

Liquidity and Capital Resources

        The Company's liquidity is comprised of three primary classifications: cash flows from operating activities, cash flows from investing activities and cash flows from financing activities. Net cash provided

61



by operating activities was $14.3 million for the fiscal year ended June 30, 2008. For the fiscal year ended June 30, 2007, net cash provided by operating activities was $10.3 million. Net cash used in investing activities was $111.5 million for the fiscal year ended June 30, 2008. For the fiscal year ended June 30, 2007, net cash used in investing activities was $44.1 million. Net cash provided by financing activities for the fiscal year ended June 30, 2008, was $95.9 million primarily due to an increase in FHLB borrowing. This compares to net cash provided by financing activities in the prior fiscal year of $29.2 million primarily due to a net increase in deposit accounts of $80.4 million offset by a $33.6 million sale of deposits related to branch sales completed in the second quarter of fiscal 2007.

        The Bank's primary sources of funds are earnings, in-market deposits, FHLB advances and other borrowings, repayments of loan principal, mortgage-backed securities and callable agency securities and, to a lesser extent, sales of mortgage loans, sales and maturities of securities, out-of-market deposits and short-term investments. While scheduled loan payments and maturing securities are relatively predictable, deposit flows and loan and security prepayments are more influenced by interest rates, general economic conditions and competition. The Bank attempts to price its deposits to meet its asset/liability objectives consistent with local market conditions. Excess balances are invested in overnight funds.

        Liquidity management is both a daily and long-term responsibility of management. The Bank adjusts its investments in liquid assets based upon management's assessment of (i) expected loan demand, (ii) projected loan sales, (iii) expected deposit flows, (iv) yields available on interest-bearing deposits, and (v) the objectives of its asset/liability management program. Excess liquidity is invested generally in interest-bearing overnight deposits and other short-term government and agency obligations. During the year ended June 30, 2008, the Bank increased its borrowings with the FHLB and other borrowings by $129.8 million.

        The Bank anticipates that it will have sufficient funds available to meet current loan commitments. At June 30, 2008, the Bank had outstanding commitments to originate and purchase mortgage and commercial loans of $40.4 million and to sell mortgage loans of $11.9 million. Commitments by the Bank to originate loans are not necessarily executed by the customer. The Bank monitors the ratio of commitments to funding for use in liquidity management. At June 30, 2008, the Bank had no outstanding commitments to purchase investment securities available for sale and no commitments to sell investment securities available for sale.

        Although in-market deposits are the Bank's primary source of funds, the Bank's policy has been to utilize borrowings where the funds can be invested in either loans or securities at a positive rate of return or to use the funds for short-term liquidity purposes. The Bank currently has $15.0 million in an unsecured line of federal funds with First Tennessee Bank, NA. The Bank currently has a $10.0 million federal funds accommodation from Northern Trust. There were no funds drawn on any line of credit at June 30, 2008. Also, the Bank has implemented arrangements to acquire out-of-market certificates of deposit as an additional source of funding. As of June 30, 2008, the Bank had $27.3 million in out-of-market certificates of deposit. The Bank may also seek other sources of contingent liquidity including additional federal funds purchased lines with correspondent banks and lines of credit with the FRB.

        The Company has a line of credit for $6.0 million with First Tennessee Bank, NA for liquidity needs in the Company. The note is short-term in duration and is subject to annual review. In case of default on the notes, the Company's ability to pay cash dividends may be restricted. At June 30, 2008, no funds were advanced on the line of credit. See Note 7 of "Notes to Consolidated Financial Statements," which is included in Part II, Item 8 "Financial Statements and Supplementary Data" of this Form 10-K, Part II, Item 7 "Financial Condition Data" of this Form 10-K and Exhibit 10.10 of this Form 10-K for additional information.

62


        The Company uses its capital resources to pay dividends to its stockholders, to repurchase Company stock in the market pursuant to Board of Directors' approved plans, to support organic growth, to make acquisitions, to service its debt obligations and to provide funding for investment into the Bank of Tier 1 (core) capital.

        During the year ended June 30, 2008, the Company had in effect a stock buy back program which was publicly announced on April 30, 2007 in which the Company was permitted to repurchase up to 10% of the common stock of the Company that was outstanding on May 1, 2007. This stock buy back program expired on April 30, 2008. There were 99,092 shares purchased under the program during the fiscal years ended June 30, 2007, and June 30, 2008.

        The Company approved a new stock buy back program, which began on May 1, 2008, and was publicly announced on April 28, 2008. Under this program, the Company may repurchase up to 10% of the common stock of the Company outstanding on May 1, 2008, which equals 395,321 shares, through April 30, 2009. There were 6,527 shares purchased under the program during the fiscal year ended June 30, 2008.

        Savings institutions insured by the FDIC are required to meet three regulatory capital requirements. If a requirement is not met, regulatory authorities may take legal or administrative actions, including restrictions on growth or operations or, in extreme cases, seizure. Institutions not in compliance may apply for an exemption from the requirements and submit a recapitalization plan. Under these capital requirements, at June 30, 2008, the Bank met all current capital requirements.

        The OTS has adopted capital requirements for savings institutions comparable to the requirement for national banks. The minimum OTS core capital requirement for well-capitalized institutions is 5.00% of total adjusted assets. The Bank had Tier 1 (core) capital of 7.78% at June 30, 2008. The minimum OTS risk-based capital requirement for well-capitalized institutions is 10.00% of risk-weighted assets. The Bank had risk-based capital of 10.83% at June 30, 2008.

Off-Balance Sheet Financing Arrangements

        During fiscal 2003, the Bank securitized and sold consumer automobile loans in the amount of $50.0 million through HFSC and Home Federal Automobile Securitization Trust 2003-A. As a result of this securitization transaction, the Bank had off-balance sheet automobile loans in the amount of $35.5 million at June 30, 2003. At June 30, 2005, the outstanding balance was $6.6 million. As part of the sales transaction, the Bank retained servicing responsibilities and a retained interest in the interest payments from the receivables, which was subordinated to third party investors' interests. The receivables were sold without legal recourse to third party conduits. The sale provided the Bank with an additional source of liquidity at interest rates more favorable than it could receive through other forms of financing. It also assisted in reducing capital requirements and credit risk to the Bank, in addition to giving the Bank access to the national capital markets. The Bank had the option to execute a clean-up call when the remaining balance of the loans outstanding was at 10% of the original balance. On November 9, 2005, the Bank exercised its option to execute the cleanup call by purchasing the outstanding principal balances of the securitized motor vehicle installment loans.

Impact of Inflation and Changing Prices

        The Consolidated Financial Statements and Notes thereto presented in Part II, Item 8 "Financial Statements and Supplementary Data" of this Form 10-K have been prepared in accordance with GAAP, which require the measurement of financial position and operating results in terms of historical dollars without considering the change in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of the Bank's operations. Unlike most industrial companies, nearly all the assets and liabilities of the Bank are monetary in nature. As a result, interest rates have a greater impact on the Bank's performance than do the effects of general

63



levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.

Effect of New Accounting Standards

        Note 1, "Summary of Significant Accounting Policies," of the notes to consolidated financial statements of this Form 10-K discusses new accounting policies adopted by the Company during fiscal 2008. The expected impact of accounting policies recently issued or proposed but not yet required to be adopted are discussed below. To the extent the adoption of new accounting standards materially affects the Company's financial condition, results of operations, or liquidity, the impacts are discussed in the applicable sections of this financial review and the notes to consolidated financial statements.

        In September 2006, FASB issued Statement of Financial Accounting Standards No. 157 (SFAS 157), "Fair Value Measurements." SFAS 157 provides a common definition of fair value and a framework for measuring assets and liabilities at fair values when a particular standard prescribes it. In addition, the Statement expands disclosures about fair value measurements. As required by SFAS 157, the Company will adopt this new accounting standard effective July 1, 2008. Management does not expect that adoption of SFAS 157 will have a material impact on our financial statements.

        In February 2007, FASB issued Statement of Financial Accounting Standards No. 159 (SFAS 159), "The Fair Value Option for Financial Assets and Financial Liabilities—Including an Amendment of FASB Statement No. 115." SFAS 159 allows companies the choice to measure many financial instruments and certain other items at fair value. This gives a company the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. The Statement is effective July 1, 2008. Management does not expect that adoption of SFAS 159 will have a material impact on our financial statements.

        In December 2007, FASB issued Statement of Financial Accounting Standards No. 141R (SFAS 141R), "Business Combinations." SFAS 141R improves reporting by creating greater consistency in the accounting and financial reporting of business combinations, resulting in more complete, comparable, and relevant information for investors and other users of financial statements. SFAS 141R is effective July 1, 2009. Management has reviewed SFAS 141R and does not expect the adoption of this statement to have a material impact on the Company's consolidated financial condition, results of operations or cash flow.

        In December 2007, FASB issued Statement of Financial Accounting Standards No. 160 (SFAS 160), "Noncontrolling Interests in Consolidated Financial Statements—an amendment of ARB No. 51." SFAS 160 is effective for the Company beginning July 1, 2009. SFAS 160 improves the relevance, comparability, and transparency of financial information provided to investors by requiring all entities to report noncontrolling (minority) interest in subsidiaries in the same way—as equity in the consolidated financial statements. The Company does not currently have any noncontrolling interest in the consolidated financial statements.

        In March 2008, FASB issued Statement of Financial Accounting Standards No. 161 (SFAS 161), "Disclosures about Derivative Instruments and Hedging Activities." SFAS 161 is intended to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand their effects on an entity's financial position, financial performance, and cash flows. The Company will adopt SFAS 161 effective January 1, 2009. Management has reviewed SFAS 161 and does not expect the adoption of this statement to have a material impact on the Company's consolidated financial condition, results of operations or cash flow.

        In May 2008, the FASB issued SFAS No. 162, "The Hierarchy of Generally Accepted Accounting Principles" ("SFAS 162"). This statement makes the hierarchy explicitly and directly applicable to

64



preparers of financial statements, a step that recognizes preparers' responsibilities for selecting the accounting principles for their financial statements. SFAS 162 provides for slight modifications to the current hierarchy in place by adding FASB Staff Positions, Statement 133 Implementation Issues, and EITF D-Topics to it. The Company will adopt SFAS 162 effective November 15, 2008.

        In May 2008, the FASB issued SFAS No. 163, "Accounting for Financial Guarantee Insurance Contracts—An Interpretation of FASB Statement No. 60" ("SFAS 163"). This statement requires that an insurance enterprise recognize a claim liability prior to an event of default when there is evidence that credit deterioration has occurred in an insured financial obligation. SFAS 163 also clarifies how Statement 60 applies to financial guarantee insurance contracts, including the recognition and measurement to be used to account for premium revenue and claim liabilities. Expanded disclosures about financial guarantee insurance contracts are also required by this statement. SFAS 163 is effective July 1, 2009. The Company is in the process of assessing the impact on its results of operations, financial position, and cash flow.

Asset/Liability and Risk Management

        Interest rate risk is the most significant market risk affecting the Company. Other types of market risk, such as foreign currency exchange rate risk and commodity price risk, do not arise in the normal course of the Company's business activities. The Bank, like other financial institutions, is subject to interest rate risk to the extent that its interest-bearing liabilities with short- and medium-term maturities mature or reprice more rapidly than its interest-earning assets. The Company does not currently engage in trading activities to control interest rate risk although it may in the future, if necessary, to manage interest rate risk. Interest rate swaps may be entered into to modify interest rate risk. See Note 9 of "Notes to Consolidated Financial Statements" of this Form 10-K for additional information.

        As a continuing part of its financial strategy, the Bank considers methods of managing this asset/liability mismatch consistent with maintaining acceptable levels of net interest income. In order to properly monitor interest rate risk, the Board of Directors has created an Asset/Liability Committee whose principal responsibilities are to assess the Bank's asset/liability mix and recommend strategies to the Board that will enhance income while managing the Bank's vulnerability to changes in interest rates.

        In managing market risk and the asset/liability mix, the Bank has placed its emphasis on developing a portfolio in which, to the extent practicable, assets and liabilities reprice within similar periods. The goal of this policy is to provide a relatively consistent level of net interest income in varying interest rate cycles and to minimize the potential for significant fluctuations from period to period.

        One approach used to quantify interest rate risk is the net portfolio value ("NPV") analysis. In essence, this analysis calculates the difference between the present value of the liabilities and the present value of expected cash flows from assets and off-balance sheet contracts. The following table sets forth, at June 30, 2008 and June 30, 2007, an analysis of the Company's interest rate risk as measured by the estimated changes in NPV resulting from instantaneous and sustained parallel shifts in the yield curve (+ 300 or -100 basis points, measured in 100 basis point increments). Due to the low prevailing interest rate environment, -200 and -300 NPV was not estimated by the Bank at June 30, 2008.

        Even if interest rates change in the designated amounts, there can be no assurance that the Company's assets and liabilities would perform as set forth below. In addition, a change in U.S.

65



Treasury rates in the designated amounts accompanied by a change in the shape of the Treasury yield curve would cause significantly different changes to the NPV than indicated below.

June 30, 2008  
 
   
  Estimated Increase
(Decrease) in NPV
 
Change in
Interest Rates
  Estimated
NPV
Amount
 
  Amount   Percent  
 
  (Dollars in Thousands)
 
  Basis Points                    
  +300   $ 110,881   $ (1,943 )   (2 )%
  +200     113,956     1,132     1  
  +100     115,324     2,500     2  
  —      112,824          
  -100     105,084     (7,740 )   (7 )
June 30, 2007  
 
   
  Estimated Increase
(Decrease) in NPV
 
Change in
Interest Rates
  Estimated
NPV
Amount
 
  Amount   Percent  
 
  (Dollars in Thousands)
 
  Basis Points                    
  +300   $ 99,706   $ (7,529 )   (7 )%
  +200     102,142     (5,093 )   (5 )
  +100     106,941     (293 )   (0 )
  —      107,234          
  -100     103,321     (3,913 )   (4 )
  -200     93,723     (13,511 )   (13 )

Contractual Obligations

        The following table sets forth information with respect to the Company's contractual obligations as of June 30, 2008. Operating lease obligations are primarily related to the lease of certain branch offices, which the Company has committed to as of June 30, 2008.

 
  Payments due by period  
 
  Less Than
1 Year
  1 to 3 Years   3 to 5 Years   Greater Than
5 Years
  Total  

Deposits without a stated maturity

  $ 430,987               $ 430,987  

Certificates of Deposit

    220,972     118,479     13,762     37     353,250  

FHLB and Federal Funds

    41,420     59,855     46,500     50,500     198,275  

Long-Term Debt Obligations

                27,837     27,837  

Operating Lease Obligations

    801     1,287     654     2,393     5,135  
                       

Total Contractual Obligations

  $ 694,180   $ 179,621   $ 60,916   $ 80,767   $ 1,015,484  
                       

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Item 7A. Quantitative and Qualitative Disclosures About Market Risk

Interest Rate Risk Management

        The Company's net income is largely dependent on its net interest income. Net interest income is susceptible to interest rate risk to the degree that interest-bearing liabilities with short- and medium-term maturities mature or reprice more rapidly than its interest-earning assets. When interest-bearing liabilities mature or reprice more quickly than interest-earning assets in a given period, a significant increase in market rates of interest could adversely affect net interest income. Similarly, when interest-earning assets mature or reprice more quickly than interest-bearing liabilities, falling interest rates could result in a decrease in net income.

        In an attempt to manage its exposure to change in interest rates, management monitors the Company's interest rate risk. The Asset/Liability Committee meets periodically to review the Company's interest rate risk position and profitability, and to recommend adjustments for consideration by executive management. Management also reviews the Bank's securities 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 managing market risk and the asset/liability mix, the Bank has placed its emphasis on developing a portfolio in which, to the extent practicable, assets and liabilities reprice within similar periods. Notwithstanding the Company's interest rate risk management activities, the potential for changing interest rates is an uncertainty that can have an adverse effect on net income. The Company does not currently engage in trading activities or use derivative instruments to control interest rate risk although it may in the future, if necessary, to manage interest rate risk.

        In adjusting the Company's asset/liability position, management attempts to manage the Company's interest rate risk while enhancing net interest margins. At times, depending on the level of general interest rates, the relationship between long and short-term interest rates, market conditions and competitive factors, management may determine to increase the Company's interest rate risk position somewhat in order to increase its net interest margin. The Company's results of operations and net portfolio values remain vulnerable to increases in interest rates and to fluctuations in the difference between long- and short-term interest rates.

        Consistent with the asset/liability management philosophy described above, the Company has taken several steps to manage its interest rate risk. The Company has structured its security portfolio to shorten the repricing of its interest-earning assets. The Company's mortgage-backed securities and securities available for sale typically have either short or medium terms to maturity or adjustable interest rates. At June 30, 2008, the Company had investment securities available for sale of $17.8 million with contractual maturities of five years or less. Variable-rate mortgage-backed securities totaled $63.1 million at June 30, 2008. Mortgage-backed securities amortize and experience prepayments of principal. The Company has received average cash flows from principal paydowns, maturities, sales and calls of all securities available for sale of $52.0 million annually over the past three fiscal years. The Company also manages interest rate risk reduction by utilizing non-certificate depositor accounts for certain liquidity purposes. The Board and management believe that such accounts carry a lower cost than certificate accounts, and that a material portion of such accounts may be more resistant to changes in interest rates than are certificate accounts. At June 30, 2008, the Company had $78.6 million of savings accounts, $171.7 million of money market accounts and $180.7 million of checking accounts, representing 55.0% of total depositor account balances.

        One approach used to quantify interest rate risk is the NPV analysis. In essence, this analysis calculates the difference between the present value of liabilities and the present value of expected cash flows from assets and off-balance sheet contracts. See Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations—Asset/Liability and Risk Management" of this Form 10-K for further discussion regarding the NPV analysis and an analysis of the Company's interest rate risk as measured by the estimated changes in NPV resulting from instantaneous and sustained parallel shifts in the yield curve.

67


Item 8.    Financial Statements and Supplementary Data

Management's Report on
Internal Control over Financial Reporting

        HF Financial Corp.'s (the "Company") management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Securities Exchange Act of 1934, as amended). Under the supervision and with the participation of the Company's management, including its Chairman, President and Chief Executive Officer and its Executive Vice President, Chief Financial Officer and Treasurer, the Company conducted an evaluation of the effectiveness of its internal control over financial reporting as of June 30, 2008 based on the framework in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this evaluation, management concluded that the Company's internal control over financial reporting was effective as of June 30, 2008 in providing reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.

        Pursuant to temporary rules of the Securities and Exchange Commission, the Company's Annual Report on Form 10-K for the year ended June 30, 2008 does not contain an attestation report of the Company's registered public accounting firm regarding the Company's internal control over financial reporting.

/s/ CURTIS L. HAGE

Curtis L. Hage
Chairman, President and
Chief Executive Officer
  /s/ DARREL L. POSEGATE

Darrel L. Posegate
Executive Vice President,
Chief Financial Officer and Treasurer

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TABLE OF CONTENTS

INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM'S REPORT ON THE FINANCIAL STATEMENTS

    70  

CONSOLIDATED FINANCIAL STATEMENTS

       
 

Statements of Financial Condition

    71  
 

Statements of Income

    72  
 

Statements of Stockholders' Equity

    73  
 

Statements of Cash Flows

    74  
 

Notes to Consolidated Financial Statements

    76  

69


LOGO

Report of Independent Registered Public Accounting Firm

To the Board of Directors and Stockholders
HF Financial Corp.
Sioux Falls, South Dakota

        We have audited the accompanying consolidated statements of financial condition of HF Financial Corp. as of June 30, 2008 and 2007, and the related consolidated statements of income, stockholders' equity and cash flows for each of the years in the three-year period ended June 30, 2008. HF Financial Corp.'s management is responsible for these consolidated financial statements. Our responsibility is to express an opinion on these financial statements based on our audits.

        We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such an opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe our audits provide a reasonable basis for our opinion.

        In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of HF Financial Corp. as of June 30, 2008 and 2007, and the results of its operations and its cash flows for each of the years in the three-year period ended June 30, 2008, in conformity with accounting principles generally accepted in the United States of America.

LOGO

Sioux Falls, South Dakota
September 26, 2008

70


HF FINANCIAL CORP.

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

JUNE 30, 2008 AND 2007

(DOLLARS IN THOUSANDS, except share data)

 
  2008   2007  

ASSETS

             

Cash and cash equivalents

 
$

21,170
 
$

22,476
 

Securities available for sale (Note 2)

    225,004     142,223  

Federal Home Loan Bank stock (Note 7)

    11,245     5,058  

Loans held for sale (Note 3)

    8,796     8,776  

Loans and leases receivable (Note 3)

    777,777     761,599  

Accrued interest receivable

    7,540     8,495  

Office properties and equipment, net of accumulated depreciation (Note 5)

    14,849     15,830  

Foreclosed real estate and other properties

    643     508  

Cash value of life insurance

    14,050     13,519  

Servicing rights (Note 4)

    11,189     10,871  

Goodwill, net

    4,951     4,951  

Other assets (Note 10)

    6,280     7,148  
           

  $ 1,103,494   $ 1,001,454  
           

LIABILITIES AND STOCKHOLDERS' EQUITY

             

Liabilities

             
 

Deposits (Note 6)

  $ 784,237   $ 815,864  
 

Advances from Federal Home Loan Bank and other borrowings (Note 7)

    198,454     68,600  
 

Subordinated debentures payable to trusts (Note 8)

    27,837     27,837  
 

Advances by borrowers for taxes and insurance

    10,795     10,337  
 

Accrued expenses and other liabilities (Note 14)

    17,968     16,546  
           
   

Total liabilities

    1,039,291     939,184  
           

Stockholders' equity (Notes 12, 13 and 14)

             
 

Preferred stock, $.01 par value, 500,000 shares authorized, none outstanding

         
 

Series A Junior Participating Preferred Stock, $1.00 stated value, 50,000 shares authorized, none outstanding

         
 

Common stock, $.01 par value, 10,000,000 shares authorized, 6,035,447 and 5,991,200 shares issued at June 30, 2008 and June 30, 2007, respectively

    60     60  
 

Common stock subscribed for but not issued

    95     81  
 

Additional paid-in capital

    21,905     20,898  
 

Retained earnings, substantially restricted

    76,041     71,900  
 

Accumulated other comprehensive (loss), net of related deferred tax effect (Note 17)

    (3,001 )   (1,502 )
 

Less cost of treasury stock, 2,083,455 and 1,977,836 shares at June 30, 2008 and June 30, 2007, respectively

    (30,897 )   (29,167 )
           

    64,203     62,270  
           

  $ 1,103,494   $ 1,001,454  
           

See Notes to Consolidated Financial Statements

71


HF FINANCIAL CORP.

CONSOLIDATED STATEMENTS OF INCOME

YEARS ENDED JUNE 30, 2008, 2007 AND 2006

(DOLLARS IN THOUSANDS, except share data)

 
  2008   2007   2006  

Interest, dividend and loan fee income:

                   
 

Loans and leases receivable

  $ 53,972   $ 54,344   $ 47,096  
 

Investment securities and interest-bearing deposits

    9,202     7,530     6,315  
               

    63,174     61,874     53,411  
               

Interest expense:

                   
 

Deposits

    24,693     28,505     20,175  
 

Advances from Federal Home Loan Bank and other borrowings

    8,605     7,735     7,587  
               

    33,298     36,240     27,762  
               
 

Net interest income

   
29,876
   
25,634
   
25,649
 

Provision for losses on loans and leases

    1,994     1,198     5,279  
               
 

Net interest income after provision for losses on loans and leases

    27,882     24,436     20,370  
               

Noninterest income:

                   
 

Gain on sale of branches, net

        2,763      
 

Gain on sale of land, net

            3,557  
 

Fees on deposits

    5,389     5,133     4,538  
 

Loan servicing income

    2,211     1,803     1,123  
 

Gain on sale of loans, net

    1,197     923     969  
 

Earnings on cash value of life insurance

    626     597     570  
 

Trust income

    966     936     849  
 

Commission and insurance income

    447     500     531  
 

Gain on sale of securities, net

    3         3  
 

Other

    494     541     711  
               

    11,333     13,196     12,851  
               

Noninterest expense:

                   
 

Compensation and employee benefits

    19,616     18,379     16,691  
 

Occupancy and equipment

    3,832     3,797     3,338  
 

Check and data processing expense

    2,416     2,299     2,165  
 

Marketing

    1,077     1,541     856  
 

Foreclosed real estate and other properties, net

    181     101     184  
 

Other

    3,484     3,488     3,265  
               

    30,606     29,605     26,499  
               
 

Income before income taxes

   
8,609
   
8,027
   
6,722
 

Income tax expense (Note 10)

    2,766     2,644     2,214  
               
 

Net income

  $ 5,843   $ 5,383   $ 4,508  
               

Basic earnings per share (Note 13):

 
$

1.47
 
$

1.35
 
$

1.15
 

Diluted earnings per share (Note 13):

    1.45     1.33     1.13  

Dividend declared per share

    0.43     0.42     0.41  

See Notes to Consolidated Financial Statements

72


HF FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED JUNE 30, 2008, 2007 AND 2006
(DOLLARS IN THOUSANDS, except share data)

 
  Common
Stock
  Common
Stock
Subscribed
  Additional
Paid-in
Capital
  Retained
Earnings
  Deferred
Compensation
  Accumulated
Other
Comprehensive
(Loss)
  Treasury
Stock
  Total  

Balance, June 30, 2005

  $ 55   $ 1,266   $ 19,190   $ 65,267   $ (2,140 ) $ (836 ) $ (29,167 ) $ 53,635  
 

Comprehensive income

                                                 
   

Net income

                4,508                 4,508  
   

Net changes in unrealized gain (loss) on securities available for sale, net of deferred taxes

                        (1,624 )       (1,624 )
   

Net change in retained interest, net of deferred taxes

                        (2 )       (2 )
                                                 
 

Comprehensive income

                                              2,882  
 

Issuance of stock and exercise of stock options (Note 16)

    4     (1,266 )   1,878                     616  
 

Common stock subscribed for but not issued

        65     (65 )                    
 

Cash dividends paid on common stock

                (1,596 )               (1,596 )
 

Reclassify stock-based compensation to additional paid-in capital

            (2,140 )       2,140              
 

Amortization of stock-based compensation

            521                     521  
                                   

Balance, June 30, 2006

    59     65     19,384     68,179         (2,462 )   (29,167 )   56,058  
 

Comprehensive income

                                                 
   

Net income

                5,383                 5,383  
   

Net changes in unrealized gain (loss) on securities available for sale, net of deferred taxes

                        1,058         1,058  
                                                 
 

Comprehensive income

                                6,441  
 

Adjustment to initially apply FASB Statement No. 158, net of tax

                        (98 )       (98 )
 

Issuance of stock and exercise of stock options (Note 16)

    1     (65 )   1,079                     1,015  
 

Common stock subscribed for but not issued

        81     (81 )                    
 

Cash dividends paid on common stock

                (1,662 )               (1,662 )
 

Amortization of stock-based compensation

            516                     516  
                                   

Balance, June 30, 2007

    60     81     20,898     71,900         (1,502 )   (29,167 )   62,270  
 

Comprehensive income

                                                 
   

Net income

                5,843                 5,843  
   

Net changes in unrealized gain (loss) on securities

                        (664 )       (664 )
   

Net unrealized losses on defined benefit plan, net of deferred taxes

                          (755 )       (755 )
   

Net unrealized losses on derivatives and hedging activities, net of deferred taxes

                        (80 )       (80 )
                                                 
 

Comprehensive income

                                              4,344  
 

Issuance of stock and exercise of stock options (Note 16)

        (81 )   630                     549  
 

Common stock subscribed for but not issued

        95     (95 )                    
 

Cash dividends paid on common stock

                (1,702 )               (1,702 )
 

Purchase of treasury stock

                            (1,730 )   (1,730 )
 

Amortization of stock-based compensation

            472                     472  
                                   

Balance, June 30, 2008

  $ 60   $ 95   $ 21,905   $ 76,041   $   $ (3,001 ) $ (30,897 ) $ 64,203  
                                   

See Notes to Consolidated Financial Statements

73


HF FINANCIAL CORP.

CONSOLIDATED STATEMENTS OF CASH FLOWS

YEARS ENDED JUNE 30, 2008, 2007 AND 2006

(DOLLARS IN THOUSANDS, except share data)

 
  2008   2007   2006  

Cash Flows From Operating Activities

                   
 

Net income

  $ 5,843   $ 5,383   $ 4,508  
 

Adjustments to reconcile net income to net cash provided by (used in) operating activities

                   
   

Provision for losses on loans and leases

    1,994     1,198     5,279  
   

Depreciation

    1,633     1,623     1,504  
   

Amortization of discounts and premiums on securities and other

    1,710     1,817     1,781  
   

Stock based compensation

    472     628     709  
   

Deferred income taxes (credits)

    11     (485 )   (557 )
   

Net change in loans held for resale

    1,177     (230 )   3,584  
   

(Gain) on sale of loans, net

    (1,197 )   (923 )   (969 )
   

Realized (gain) on sale of securities, net

    (3 )       (3 )
   

(Gain) on sale of land

            (3,557 )
   

(Gain) on sale of branches

        (2,763 )    
   

Losses and provision-for-losses on sales of foreclosed real estate and other properties, net

    58     52     30  
   

(Gain) Loss on disposal of office properties and equipment, net

    (1 )   (9 )   29  
   

Change in other assets and liabilities (Note 20)

    2,588     4,017     (660 )
               

Net cash provided by operating activities

    14,285     10,308     11,678  
               

Cash Flows From Investing Activities

                   
 

Net change in loans outstanding

    (19,842 )   (46,699 )   (57,548 )
 

Proceeds from sale of land

            4,863  
 

Purchase of land held for sale

            (1,209 )
 

Proceeds from sale of loans associated with branch sales

        4,256      
 

Securities available for sale

                   
   

Sales, maturities and repayments

    67,302     35,666     53,085  
   

Purchases

    (151,405 )   (31,048 )   (59,781 )
 

Purchase of Federal Home Loan Bank stock

    (9,846 )   (4,172 )   (4,522 )
 

Redemption of Federal Home Loan Bank stock

    3,659     4,762     6,574  
 

Proceeds from sale of office properties and equipment

    1,283     17     3  
 

Proceeds from sale of office properties and equipment associated with branch sales

        340      
 

Purchase of office properties and equipment

    (1,934 )   (3,342 )   (3,170 )
 

Purchase of servicing rights

    (1,392 )   (6,140 )   (989 )
 

Proceeds from sale of foreclosed real estate and other properties

    701     2,277     715  
               

Net cash (used in) investment activities

    (111,474 )   (44,083 )   (61,979 )
               

See Notes to Consolidated Financial Statements

74


HF FINANCIAL CORP.

CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)

YEARS ENDED JUNE 30, 2008, 2007 AND 2006

(DOLLARS IN THOUSANDS, except share data)

 
  2008   2007   2006  

Cash Flows From Financing Activities

                   
 

Net increase (decrease) in deposit accounts

  $ (31,627 ) $ 80,425   $ 87,786  
 

Proceeds of advances from Federal Home Loan Bank and other borrowings

    1,926,299     722,111     807,905  
 

Payments on advances from Federal Home Loan Bank and other borrowings

    (1,796,445 )   (745,131 )   (835,949 )
 

Payment of debt issue costs

            (7 )
 

Proceeds from issuance of subordinated debentures

    5,000     10,000      
 

Deposit account disbursements associated with branch sales

        (33,563 )    
 

Proceeds on core deposit premium

        2,763      
 

Redemption of subordinated debentures

    (5,000 )   (10,000 )    
 

Increase (decrease) in advances by borrowers

    458     3,368     523  
 

Purchases of treasury stock

    (1,730 )        
 

Proceeds from issuance of common stock

    630     903     428  
 

Cash dividends paid

    (1,702 )   (1,662 )   (1,596 )
               

Net cash provided by financing activities

    95,883     29,214     59,090  
               

Increase (decrease) in cash and cash equivalents

    (1,306 )   (4,561 )   8,789  

Cash and Cash Equivalents

                   
 

Beginning

    22,476     27,037     18,248  
               
 

Ending

  $ 21,170   $ 22,476   $ 27,037  
               

See Notes to Consolidated Financial Statements

75


HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2008 AND 2007

(DOLLARS IN THOUSANDS, Except share data)

NOTE 1—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

        The accounting and reporting policies of HF Financial Corp. and subsidiaries ("the Company") conform to accounting principles generally accepted in the United States of America and to general practice within the industry. The following is a description of the more significant of those policies that the Company follows in preparing and presenting its consolidated financial statements.

Nature of Operations

        The Company, a unitary thrift holding company, was formed in November 1991, for the purpose of owning all of the outstanding stock of Home Federal Bank ("the Bank"). The Company is incorporated under the laws of the State of Delaware and generally is authorized to engage in any activity that is permitted by the Delaware General Corporation Law. The executive offices of the Company and its direct and indirect subsidiaries are located in Sioux Falls, South Dakota.

        The Bank was founded in 1929 and is a federally chartered stock savings bank headquartered in Sioux Falls, South Dakota. The Bank provides full-service consumer and commercial business banking, including an array of financial products, to meet the needs of its market place. The Bank attracts deposits from the general public and uses such deposits, together with borrowings and other funds, to originate one-to-four family residential, commercial business, consumer, multi-family, commercial real estate, construction and agricultural loans. The Bank's consumer loan portfolio includes, among other things, automobile loans, home equity loans, loans secured by deposit accounts and student loans. The Bank also purchases mortgage-backed securities and invests in U.S. Government and agency obligations and other permissible investments. The Bank receives loan servicing income on loans serviced for others and commission income from credit-life insurance on consumer loans. The Bank, through its wholly-owned subsidiaries, offers annuities, mutual funds, life insurance and other financial products and equipment leasing services.

Principles of Consolidation

        The accompanying consolidated financial statements include the accounts of the Company, the Company's wholly-owned subsidiaries, HomeFirst Mortgage Corp. (the Mortgage Corp.), HF Financial Group, Inc. (HF Group), and Home Federal Bank (the Bank) and the Bank's wholly-owned subsidiaries, Hometown Insurors, Inc. (Hometown), Mid America Capital Services, Inc. (Mid America Capital), Home Federal Securitization Corp. (HFSC), Mid-America Service Corporation and PMD, Inc. All intercompany balances and transactions have been eliminated in consolidation.

Basis of Financial Statement Presentation and Use of Estimates

        In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the statement of financial condition and revenues and expenses for the fiscal year. Actual results could differ significantly from those estimates. Material estimates that are particularly susceptible to significant change in the near-term related to the determination of the allowance for loan and lease losses, self-insurance and servicing rights.

76


HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2008 AND 2007

(DOLLARS IN THOUSANDS, Except share data)

NOTE 1—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Cash and Cash Equivalents

        For purposes of reporting the statements of cash flows, the Company includes as cash equivalents all cash accounts which are not subject to withdrawal restrictions or penalties and time deposits with original maturities of 90 days or less.

Trust Assets

        Assets of the trust department, other than trust cash on deposit at the Bank, are not included in these consolidated financial statements because they are not assets of the Bank.

Securities

        Management determines the appropriate classification of securities at the date individual securities are acquired and evaluates the appropriateness of such classifications at each statement of financial condition date.

        Securities available for sale are those debt securities that the Company intends to hold for an indefinite period of time, but may not hold necessarily to maturity, and all equity securities. Any decision to sell a security classified as available for sale would be based on various factors, including significant movements in interest rates, changes in the maturity mix of the Company's assets and liabilities, liquidity needs, regulatory capital considerations, and other similar factors. Securities available for sale are carried at fair value and unrealized gains or losses are reported as increases or decreases in other comprehensive income net of the related deferred tax effect.

        Declines in the fair value of securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses. In estimating other-than-temporary impairment losses, management considers many factors including (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) applicable rating(s) by an independent rating agency, and (4) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.

        Premiums and discounts on securities are amortized over the contractual lives of those securities, except for mortgage-backed securities, for which prepayments are probable and predictable, which are amortized over the estimated expected repayment terms of the underlying mortgages. The method of amortization results in a constant effective yield on those securities (the interest method). Interest on debt securities is recognized in income as accrued. Realized gains and losses on the sale of securities are determined using the specific identification method.

Loans Held for Sale

        Loans receivable, which the Bank may sell or intends to sell prior to maturity, are carried at the lower of net book value or fair value on an aggregate basis. Such loans held for sale include loans receivable that management intends to use as part of its asset/liability strategy, or that may be sold in response to changes in interest rates, changes in prepayment risk or other similar factors.

77


HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2008 AND 2007

(DOLLARS IN THOUSANDS, Except share data)

NOTE 1—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Loans and Leases Receivable

        Loans receivable are stated at unpaid principal balances, less the allowance for loan losses, and net of deferred loan origination fees, costs and discounts.

        Interest income on loans is accrued over the term of the loan based upon the outstanding principal amount. Discounts and premiums on loans are amortized to income using the interest method over the remaining period to contractual maturity, adjusted for prepayments.

        Loans and leases are generally classified as nonaccrual when there are reasonable doubts as to the collectability of principal and/or interest and/or when payment becomes 90 days past due, except loans which are well secured and in the process of collection. Uncollectible interest on loans and leases that are impaired or contractually past due is charged off based on management's periodic evaluation. The charge to interest income is equal to all interest previously accrued, and income is subsequently recognized only to the extent cash payments are received until, in management's judgment, the borrower's ability to make periodic interest and principal payments is no longer in doubt, in which case the loan is returned to accrual status.

        The Company's leases receivable are classified as direct finance leases. Under the direct financing method of accounting for leases, the total net payments receivable under the lease contracts and the residual value of the leased equipment, net of unearned income, are recorded as a net investment in direct financing leases and the unearned income is recognized each month on a basis which approximates the interest method.

        The allowance for loan and lease losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed.

        The allowance for loan losses is evaluated on a regular basis by management and is based upon management's periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower's ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

        A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and insignificant payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower's prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial and construction loans by either the present value of expected future cash flows

78


HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2008 AND 2007

(DOLLARS IN THOUSANDS, Except share data)

NOTE 1—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)


discounted at the loan's effective interest rate, the loan's obtainable market price, or the fair value of the collateral if the loan is collateral dependent.

        Large groups of similar balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer and residential loans for impairment disclosures.

Loan Origination Fees and Related Discounts

        Loan fees and certain direct loan origination costs are deferred, and the net fee or cost is recognized as an adjustment to interest income using the interest method over the contractual life of the loans, adjusted for prepayments.

        Commitment fees and costs relating to commitments, the likelihood of exercise of which is remote, are recognized during the commitment period. If the commitment is subsequently exercised during the commitment period, the remaining unamortized commitment fee at the time of exercise is recognized over the life of the loan as an adjustment of yield.

Loan Servicing

        The cost allocated to servicing rights purchased or retained has been recognized as a separate asset. Servicing rights are initially measured at fair value and are being amortized in proportion to and over the period of estimated net servicing income. Servicing rights are periodically evaluated for impairment based on the fair value of those rights. Fair values are estimated using discounted cash flows based on current market rates of interest. For purposes of measuring impairment, the rights are stratified by one or more predominant risk characteristics of the underlying loans. The Bank stratifies its capitalized servicing rights based on loan type. The Company performs quarterly testing to determine if loan servicing rights purchased and retained servicing rights are impaired. As of June 30, 2008, and 2007, there was no impairment to loan servicing rights purchased and retained servicing rights.

Goodwill

        Goodwill is the difference between the purchase price and the amounts assigned to the net assets acquired and accounted for under the purchase method of accounting. Prior to July 2002, goodwill was amortized over 10 years. Subsequent to the provisions of the Financial Accounting Standards Board (FASB) Statement No. 142, Goodwill and Other Intangible Assets, which requires that goodwill no longer be amortized to earnings, but instead be reviewed at least annually for impairment and the FASB issued Statement No. 147, Acquisitions of Certain Financial Institutions, which provides guidance on the accounting for the acquisition of a financial institution, the Company no longer amortizes goodwill assets after October 1, 2002.

        At June 30, 2008, and 2007, the Company had $4,951 of goodwill that is not being amortized. The Company performs annual testing to determine if goodwill is impaired. As of June 30, 2008, and 2007, there is no impairment with respect to goodwill.

79


HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2008 AND 2007

(DOLLARS IN THOUSANDS, Except share data)

NOTE 1—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Foreclosed Real Estate and Other Properties

        Real estate and other properties acquired through, or in lieu of, loan foreclosure are initially recorded at lower of cost or fair value less estimated costs to sell at the date of foreclosure. Costs relating to improvement of property are capitalized, whereas costs relating to the holding of property are expensed. Valuations are periodically performed by management and charge-offs to operations are made if the carrying value of a property exceeds its estimated fair value less estimated costs to sell.

        Land held for sale is carried at the lower of cost, including cost of improvements and amenities incurred subsequent to acquisition, or fair value less cost to sell. Costs relating to the development and improvement of property are capitalized, whereas costs relating to holding property are expensed. The carrying amount of land held for sale was $1,362 at June 30, 2006, $0 at June 30, 2007, and $0 at June 30, 2008, as the property was sold in June 2007.

Office Properties and Equipment

        Land is carried at cost. All other properties and equipment are carried at cost, less accumulated depreciation and amortization. Buildings and improvements and leasehold improvements are depreciated primarily on the straight-line method over the estimated useful lives of the assets, which are five to fifty years. Furniture, fixtures, equipment and automobiles are depreciated using both the straight-line and declining balance methods over the estimated useful lives of the assets, which are three to twelve years.

Income Taxes

        Deferred taxes are provided on an asset and liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carryforwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. The impact of a tax position will be recognized in the financial statements if that position is more-likely-than-not of being sustained upon examination, based on the technical merits of the position. A tax position meeting the more-likely-than-not threshold is measured at the largest amount of benefit that is greater than 50 percent likely of being realized upon settlement. The Company classifies interest and penalties on the underpayment of income taxes, if any, as a component of income tax expense.

Earnings Per Share (EPS)

        Basic EPS represents income available to common stockholders divided by the weighted-average number of common shares outstanding during the period, inclusive of nonvested stock awards. Diluted EPS reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued.

80


HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2008 AND 2007

(DOLLARS IN THOUSANDS, Except share data)

NOTE 1—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

        During the third quarter of fiscal 2006, the Company declared a 11/10-for-1 stock split of all of the common stock of the Company outstanding, payable in the form of a 1/10-for-1 stock dividend. The 10% stock dividend was paid on April 24, 2006, to shareholders of record as of April 10, 2006. All per share data and number of common shares outstanding have been retroactively adjusted for all periods presented as a result of the stock split.

Segment Reporting

        Operating segments are defined as components of an enterprise for which separate financial information is available that is evaluated regularly by the chief operating decision makers in deciding how to allocate resources and in assessing performance. The Company's reportable segments are "banking" (including leasing activities) and "other." The "banking" segment is conducted through the Bank and Mid America Capital and the "other" segment is composed of smaller nonreportable segments, the Company and intersegment eliminations.

        The management approach is used as the conceptual basis for identifying reportable segments and is based on the way that management organizes the segments within the enterprise for making operating decisions, allocating resources, and monitoring performance, which is primarily based on products.

 
  Banking   Other   Total  

2008

                   

Net interest income

  $ 31,907   $ (2,031 ) $ 29,876  

Provision for losses on loans and leases

    (1,994 )       (1,994 )

Noninterest income

    10,980     353     11,333  

Intersegment noninterest income

    (105 )   (71 )   (176 )

Noninterest expense

    (29,703 )   (903 )   (30,606 )

Intersegment noninterest expense

        176     176  
               
 

Income (loss) before income taxes

  $ 11,085   $ (2,476 ) $ 8,609  
               
 

Total assets

  $ 1,098,592   $ 4,902   $ 1,103,494  
               

2007

                   

Net interest income

  $ 29,057   $ (3,423 ) $ 25,634  

Intersegment interest income

    (878 )   878      

Provision for losses on loans and leases

    (1,198 )       (1,198 )

Noninterest income

    13,355     (159 )   13,196  

Intersegment noninterest income

    (348 )   348      

Noninterest expense

    (28,828 )   (777 )   (29,605 )

Intersegment noninterest expense

    8     (8 )    
               
 

Income (loss) before income taxes

  $ 11,168   $ (3,141 ) $ 8,027  
               
 

Total assets

  $ 999,871   $ 1,583   $ 1,001,454  
               

81


HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2008 AND 2007

(DOLLARS IN THOUSANDS, Except share data)

NOTE 1—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

 
  Banking   Other   Total  

2006

                   

Net interest income

  $ 28,905   $ (3,256 ) $ 25,649  

Intersegment interest income

    (1,144 )   1,144      

Provision for losses on loans and leases

    (5,279 )       (5,279 )

Noninterest income

    9,584     3,267     12,851  

Intersegment noninterest income

    (183 )   183      

Noninterest expense

    (25,857 )   (642 )   (26,499 )

Intersegment noninterest expense

    6     (6 )    
               
 

Income (loss) before income taxes

  $ 6,032   $ 690   $ 6,722  
               
 

Total assets

  $ 958,352   $ 2,942   $ 961,294  
               

Stock-based compensation

        The Company adopted SFAS No. 123R Share-Based Payment effective as of July 1, 2005 using the Black-Scholes option-pricing model and the modified prospective method in which compensation cost is recognized for all awards granted subsequent to the Company's adoption of this statement as well as for the unvested portion of awards outstanding as of the Company's adoption of this statement. See Note 16 for more information on stock option and incentive plans.

Self-insurance

        The Company has had a self-insured health plan for its employees, subject to certain limits, since January 1994. The Bank is named the plan administrator for this plan and has retained the services of an independent third party administrator to process claims and handle other duties for this plan. The third party administrator does not assume liability for benefits payable under this plan.

        The Company assumes the responsibility for funding the plan benefits out of general assets; however, employees cover some of the costs of covered benefits through contributions, deductibles, co-pays and participation amounts. An employee is eligible for coverage upon completion of 30 calendar days of regular employment. The plan, which is on a calendar year basis, is intended to comply with, and be governed by, the Employee Retirement Income Security Act of 1974, as amended.

        The accrual estimate for pending and incurred but not reported health claims is based upon a pending claims lag report provided by a third party provider. Although management believes that it uses the best information available to determine the accrual, unforeseen health claims could result in adjustments and net earnings being significantly affected if circumstances differ substantially from the assumptions used in estimating the accrual. Net healthcare costs are inclusive of health claims expenses

82


HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2008 AND 2007

(DOLLARS IN THOUSANDS, Except share data)

NOTE 1—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

and administration fees offset by stop loss and employee reimbursement. The following table is a summary of net healthcare costs by quarter during fiscal years 2008, 2007 and 2006.

 
  2008   2007   2006  

Quarter ended September 30

  $ 221   $ 436   $ 419  

Quarter ended December 31

    409     357     409  

Quarter ended March 31

    328     760     382  

Quarter ended June 30

    524     596     285  
               
 

Net healthcare costs

  $ 1,482   $ 2,149   $ 1,495  
               

Interest Rate Contracts and Hedging Activities

        The Company uses derivative financial instruments to modify exposures to changes in interest rates and market prices for other financial instruments. To qualify for and maintain hedge accounting, the Company must meet formal documentation and effectiveness evaluation requirements both at the hedge's inception and on an ongoing basis. The application of the hedge accounting policy requires strict adherence to documentation and effectiveness testing requirements, judgment in the assessment of hedge effectiveness, identification of similar hedged item groupings, and measurement of changes in the fair value of hedged items. If in the future derivative financial instruments used by the Company no longer qualify for hedge accounting, the impact on the consolidated results of operations and reported earnings could be significant, as discussed below.

        The Company discontinues hedge accounting prospectively when (1) it is determined that the derivative is no longer effective in offsetting changes in the cash flows of a hedged item (including forecasted transactions); (2) the derivative expires or is sold, terminated, or exercised; (3) the derivative is de-designated as a hedge instrument, because it is unlikely that a forecasted transaction will occur; or (4) management determines that designation of the derivative as a hedge instrument is no longer appropriate.

        When hedge accounting is discontinued because it is probable that a forecasted transaction will not occur, the derivative will continue to be carried on the balance sheet at its fair value, and gains and losses that were accumulated in other comprehensive income will be recognized immediately in earnings. In all other situations in which hedge accounting is discontinued, the derivative will be carried at its fair value on the balance sheet, with subsequent changes in its fair value recognized in current-period earnings.

        Interest rate swaps utilized by the Company are each accounted for as a cash flow hedge, which hedge the interest rate risk in the cash flows of long-term, variable-rate subordinated debentures. The cumulative change in fair value of the hedging derivatives, to the extent that it is expected to be offset by the cumulative change in anticipated interest cash flows from the hedged exposures, will be deferred and reported as a component of other comprehensive income (OCI). Any hedge ineffectiveness will be charged to current-period earnings.

83


HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2008 AND 2007

(DOLLARS IN THOUSANDS, Except share data)

NOTE 1—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Recent Accounting Pronouncements

        In March 2006, FASB issued SFAS No. 156, Accounting for Servicing of Financial Asset, which amends SFAS No. 140. SFAS No. 156 requires the recognition of all separately recognized servicing assets and servicing liabilities to be initially measured at fair value utilizing the amortization method or fair market value method. SFAS 156 is effective the beginning of the first fiscal year that begins after September 15, 2006. Under the amortization method, an entity shall amortize the value of servicing assets or liabilities in proportion to and over the period of estimated net servicing income or net servicing loss and assess servicing assets or liabilities for impairment or increased obligation based on fair value at each reporting date. Under the fair value method, an entity shall measure servicing assets or liabilities at fair value at each reporting date and report changes in fair value in earnings in the period in which the changes occur. The Company adopted SFAS 156 effective July 1, 2007, and the adoption did not have a material impact on its results of operations, financial position, and liquidity.

        In June 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109, ("FIN 48"). FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The Interpretation requires the impact of a tax position to be recognized in the financial statements if that position is more-likely-than-not of being sustained upon examination, based on the technical merits of the position. A tax position meeting the more-likely-than-not threshold is then to be measured at the largest amount of benefit that is greater than 50 percent likely of being realized upon settlement. FIN 48 also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 was effective for fiscal years beginning after December 15, 2006. The Company adopted the provisions of FIN 48 effective July 1, 2007, resulting in no cumulative effect adjustment to retained earnings as of the date of adoption and determined that the adoption did not have a material impact on its results of operations, financial position, and liquidity.

        In September 2006, FASB issued Statement of Financial Accounting Standards No. 158 (SFAS 158), Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans—an amendment of FASB Statements No. 87, 88, 106 and 132R. SFAS 158 requires recognition of the overfunded or underfunded status of pension and other postretirement benefit plans on the balance sheet. Under SFAS 158, gains and losses, prior service costs and credits and any remaining transition amounts under SFAS 87 and SFAS 106 that have not yet been recognized through net periodic benefit cost will be recognized in accumulated other comprehensive income, net of tax effects, until they are amortized as a component of net periodic cost. Also, the measurement date—the date at which the benefit obligation and plan assets are measured—is required to be the company's fiscal year-end. As required by SFAS 158, the Company adopted the balance sheet recognition provisions at June 30, 2007, and adopted the year-end measurement date at June 30, 2008.

84


HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2008 AND 2007

(DOLLARS IN THOUSANDS, Except share data)

NOTE 2—INVESTMENTS IN SECURITIES

        The amortized cost and fair value of investments in securities, all of which are classified as available for sale according to management's intent, are as follows:

 
  June 30, 2008  
 
  Amortized
Cost
  Gross
Unrealized
Gains
  Gross
Unrealized
(Losses)
  Fair
Value
 
 
  (Dollars in Thousands)
 

Debt securities:

                         
 

U.S. government agencies

  $ 8,490   $ 173   $   $ 8,663  
 

Federal Home Loan Bank

    3,944     87         4,031  
 

Municipal bonds

    12,319     51     (189 )   12,181  
 

Trust preferred securities

    12,372         (2,080 )   10,292  
                   

    37,125     311     (2,269 )   35,167  
                   

Equity securities:

                         
 

FNMA

    8             8  
 

Federal Ag Mortgage

    7     2         9  
 

Other Investments

    253             253  
                   

    268     2         270  
                   

Mortgage-backed securities

    190,947     558     (1,938 )   189,567  
                   

  $ 228,340   $ 871   $ (4,207 ) $ 225,004  
                   

 

 
  June 30, 2007  
 
  Amortized
Cost
  Gross
Unrealized
Gains
  Gross
Unrealized
(Losses)
  Fair
Value
 
 
  (Dollars in Thousands)
 

Debt securities:

                         
 

U.S. government agencies

  $ 12,092   $ 21   $ (102 ) $ 12,011  
 

Federal Home Loan Bank

    17,433     12     (122 )   17,323  
 

Municipal bonds

    8,088         (183 )   7,905  
 

Trust preferred securities

    11,018     16     (126 )   10,908  
                   

    48,631     49     (533 )   48,147  
                   

Equity securities:

                         
 

FNMA

    8     18         26  
 

Federal Ag Mortgage

    7     6         13  
 

Other Investments

    184             184  
                   

    199     24         223  
                   

Mortgage-backed securities

    95,657     5     (1,809 )   93,853  
                   

  $ 144,487   $ 78   $ (2,342 ) $ 142,223  
                   

85


HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2008 AND 2007

(DOLLARS IN THOUSANDS, Except share data)

NOTE 2—INVESTMENTS IN SECURITIES (Continued)

        The following tables present the age of gross unrealized losses and fair value by investment category in accordance with FASB Staff Position (FSP) No. FAS 115-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.

 
  June 30, 2008  
 
  Less than 12 Months   12 Months or More   Total  
 
  Fair
Value
  Gross
Unrealized
(Losses)
  Fair
Value
  Gross
Unrealized
(Losses)
  Fair
Value
  Gross
Unrealized
(Losses)
 
 
  (Dollars in Thousands)
 

Debt securities:

                                     
 

Municipal bonds

  $ 5,195   $ (127 ) $ 1,250   $ (62 ) $ 6,445   $ (189 )
 

Trust preferred securities

    8,627     (1,727 )   1,665     (353 )   10,292     (2,080 )
                           

    13,822     (1,854 )   2,915     (415 )   16,737     (2,269 )
                           

Mortgage-backed securities

    112,929     (1,208 )   24,758     (730 )   137,687     (1,938 )
                           

  $ 126,751   $ (3,062 ) $ 27,673   $ (1,145 ) $ 154,424   $ (4,207 )
                           

 

 
  June 30, 2007  
 
  Less than 12 Months   12 Months or More   Total  
 
  Fair
Value
  Gross
Unrealized
(Losses)
  Fair
Value
  Gross
Unrealized
(Losses)
  Fair
Value
  Gross
Unrealized
(Losses)
 
 
  (Dollars in Thousands)
 

Debt securities:

                                     
 

U.S. government agencies

  $ 1,535   $ (23 ) $ 7,954   $ (79 ) $ 9,489   $ (102 )
 

Federal Home Loan Bank

    7,927     (40 )   5,989     (82 )   13,916     (122 )
 

Municipal bonds

    4,878     (73 )   2,816     (110 )   7,694     (183 )
 

Trust preferred securities

            1,893     (126 )   1,893     (126 )
                           

    14,340     (136 )   18,652     (397 )   32,992     (533 )
                           

Mortgage-backed securities

    28,809     (250 )   59,048     (1,559 )   87,857     (1,809 )
                           

  $ 43,149   $ (386 ) $ 77,700   $ (1,956 ) $ 120,849   $ (2,342 )
                           

        Management does not believe that any individual unrealized loss as of June 30, 2008, represents an other-than-temporary impairment. The Company has the ability and intent to hold those investments until a recovery of fair value.

        The unrealized losses reported for mortgage-backed securities relate primarily to securities issued by government agencies such as Federal National Mortgage Association ("FNMA"), Government National Mortgage Association ("GNMA") and Federal Home Loan Mortgage Corporation ("FHLMC"). These unrealized losses in total are primarily attributable to changes in interest rates and the contractual cash flows of those investments which are guaranteed by an agency of the U.S. government.

86


HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2008 AND 2007

(DOLLARS IN THOUSANDS, Except share data)

NOTE 2—INVESTMENTS IN SECURITIES (Continued)

        The unrealized losses reported for trust preferred securities are attributable to rated pooled securities. There have been no rating changes regarding any of these investments during the fiscal year. Based upon information available at financial statement date, management believes that it is probable that all amounts due according to contractual terms will be collected.

        The amortized cost and fair value of debt securities as of June 30, 2008, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because the borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 
  Amortized
Cost
  Fair
Value
 

Due in one year or less

  $ 230   $ 230  

Due after one year through five years

    12,549     12,740  

Due after five years through ten years

    7,984     8,058  

Due after ten years

    16,362     14,139  
           

    37,125     35,167  

Mortgage-backed securities

    190,947     189,567  
           

  $ 228,072   $ 224,734  
           

        Equity securities have been excluded from the maturity table above because they do not have contractual maturities associated with debt securities.

        Proceeds from the sale of securities available for sale in fiscal 2008 were $5,511 and resulted in gross gains of $3. Proceeds from the sale of securities available for sale in fiscal 2007 were $3,542 and resulted in gross gains of $0. Proceeds from the sale of securities available for sale in fiscal 2006 were $14,061 and resulted in gross gains of $3.

        At June 30, 2008, and 2007, securities with a fair value of $208,715 and $128,099, respectively, were pledged as collateral for public deposits, borrowings and other purposes.

87


HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2008 AND 2007

(DOLLARS IN THOUSANDS, Except share data)

NOTE 3—LOANS AND LEASES RECEIVABLE

        Loans and leases receivable at June 30, 2008, and 2007, consist of the following:

 
  2008   2007  

Loans secured by real estate

             
 

Residential

             
   

One-to-four family

  $ 100,589   $ 117,235  
   

Multi-family

    46,118     34,126  
 

Commercial

    185,038     181,121  
 

Agriculture

    78,043     48,030  
 

Construction and development

    8,286     18,674  

Business, consumer and other

             
 

Commercial business

    125,118     100,013  
 

Automobile

    58,807     98,238  
 

Junior liens on real estate

    81,250     79,113  
 

Agriculture

    91,934     69,608  
 

Equipment financing leases

    19,250     22,267  
 

Other loans

    7,724     7,079  
 

Loans on savings accounts

    1,580     1,772  
           

    803,737     777,276  

Add (less)

             
 

Undisbursed portion of loans in process

    (19,834 )   (10,387 )
 

Deferred loan fees and unamortized discounts and premiums, net

    (193 )   582  
 

Allowance for loan and lease losses

    (5,933 )   (5,872 )
           

  $ 777,777   $ 761,599  
           

        Loans held for sale totaling $8,796 at June 30, 2008, consist of $7,959 of one-to-four family fixed-rate loans, $223 of commercial loans and $614 of student loans. Loans held for sale totaling $8,776 at June 30, 2007, consist of $8,290 of one-to-four family fixed-rate loans, $223 of commercial loans and $263 of student loans.

        Activity in the allowance for loan losses included in continuing operations is summarized as follows for the fiscal years ended June 30:

 
  2008   2007   2006  

Balance, beginning

  $ 5,872   $ 5,657   $ 5,076  
 

Provision charged to income

    1,994     1,198     5,279  
 

Charge-offs

    (2,245 )   (1,292 )   (5,123 )
 

Recoveries

    312     309     425  
               

Balance, ending

  $ 5,933   $ 5,872   $ 5,657  
               

88


HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2008 AND 2007

(DOLLARS IN THOUSANDS, Except share data)

NOTE 3—LOANS AND LEASES RECEIVABLE (Continued)

        The following is a summary of information pertaining to impaired loans and nonaccrual loans as of and for the fiscal years ended June 30, 2008, 2007 and 2006:

 
  2008   2007   2006  

Impaired loans without a valuation allowance

  $ 514   $ 962   $ 325  

Impaired loans with a valuation allowance

    316     519      
               
 

Total impaired loans

  $ 830   $ 1,481   $ 325  
               

Valuation allowance related to impaired loans

  $ 130   $ 385   $  
               

Nonaccruing loans and leases

  $ 2,324   $ 2,190   $ 1,035  

Accruing loans and leases delinquent more than 90 days

    781     1,308     2,330  

Average investment in impaired loans

    885     966     2,604  

Interest income recognized on impaired loans

    17     6     7  

        No additional funds are committed to be advanced in connection with impaired loans.

        The Company has granted loans to directors, executive officers or related interests. These loans were made on substantially the same terms, including rates and collateral, as those prevailing at the time for comparable transactions with other unrelated customers, and do not involve more than a normal risk of collection. The aggregate amount of loans to such related parties was approximately $4,765 and $3,442 at June 30, 2008 and 2007.

NOTE 4—LOAN SERVICING

        Mortgage loans serviced for others (primarily the South Dakota Housing Development Authority) are not included in the accompanying consolidated statements of financial condition. The unpaid principal balances of mortgage loans serviced for others were $1,024,984 and $970,188 at June 30, 2008, and 2007, respectively.

        Custodial balances maintained in connection with mortgage loan servicing, and included in advances by borrowers for taxes and insurance, were approximately $9,758 and $9,210, at June 30, 2008, and 2007, respectively.

        The carrying values of mortgage and consumer servicing rights were $11,189 and $10,871 at June 30, 2008, and 2007, respectively. The fair values of these rights were $16,629 and $15,740 at June 30, 2008, and 2007, respectively. The fair values of the servicing rights were estimated as the present value of the expected future cash flows using a discount rate of 10%. During fiscal years 2008 and 2007, servicing rights approximating $1,634 and $6,341, respectively, were capitalized. Fiscal 2007 servicing rights include the purchase of $4,956 rights. The Company recognized expense for amortization of the cost of servicing rights in the amount of $1,317, $1,117 and $757 for the fiscal years ended June 30, 2008, 2007 and 2006, respectively.

        No valuation allowances were provided for servicing rights capitalized during the fiscal years ended June 30, 2008, and 2007.

89


HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2008 AND 2007

(DOLLARS IN THOUSANDS, Except share data)

NOTE 5—OFFICE PROPERTIES AND EQUIPMENT

 
  2008   2007  

Land

  $ 1,734   $ 1,920  

Buildings and improvements

    18,304     19,025  

Leasehold improvements

    2,201     2,199  

Furniture, fixtures, equipment and automobile

    16,887     15,374  
           

    39,126     38,518  

Less accumulated depreciation and amortization

    (24,277 )   (22,688 )
           

  $ 14,849   $ 15,830  
           

        The Company leases numerous telephone and office equipment, which require minimum rentals totaling $299 through the year ending June 30, 2012. In addition, the Company has leased property under various operating lease agreements, which expire at various times. The total rental commitments at June 30, 2008, under the leases are as follows:

2009

  $ 801  

2010

    726  

2011

    561  

2012

    374  

2013

    280  

Thereafter

    2,393  
       

  $ 5,135  
       

NOTE 6—DEPOSITS

        Deposits at June 30, 2008, and 2007 consist of the following:

 
  2008   2007  

Noninterest bearing checking accounts

  $ 90,598   $ 86,679  

Interest bearing accounts

    90,125     87,030  

Money market accounts

    171,689     212,546  

Savings accounts

    78,575     66,235  

In-market certificates of deposit

    325,995     291,858  

Out-of-market certificates of deposit

    27,255     71,516  
           

  $ 784,237   $ 815,864  
           

90


HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2008 AND 2007

(DOLLARS IN THOUSANDS, Except share data)

NOTE 6—DEPOSITS (Continued)

        Scheduled maturities of certificates of deposit are as follows:

        Maturing in fiscal year:

2009

  $ 220,972  

2010

    101,143  

2011

    17,336  

2012

    7,198  

2013

    6,564  

Thereafter

    37  
       

  $ 353,250  
       

        Non-IRA deposit accounts are insured up to $100 by the Deposit Insurance Fund (DIF) under management of the Federal Deposit Insurance Corporation (FDIC). The DIF was formed on March 31, 2006, following the merger of the Bank Insurance Fund and the Savings Association Insurance Fund. IRA deposit accounts are insured up to $250 by the DIF under management of the FDIC. The aggregate amount of jumbo certificates of deposit with a minimum denomination of $100 was approximately $151,517 and $162,953 at June 30, 2008, and 2007, respectively. Deposits at June 30, 2008, and 2007 include $76,507 and $73,286, respectively, of deposits from one local governmental entity, the majority of which are savings accounts.

NOTE 7—ADVANCES FROM FEDERAL HOME LOAN BANK AND OTHER BORROWINGS

        Advances from the Federal Home Loan Bank of Des Moines (FHLB) and other borrowings at June 30, 2008, and 2007, are summarized as follows:

 
  2008   2007  

Overnight federal funds purchased (with rates ranging from 2.60% to 3.26%)

  $ 29,920   $  

Fixed-rate advances (with rates ranging from 2.02% to 6.36%)

    168,355     68,500  

Other borrowings(1)

    179     100  
           

  $ 198,454   $ 68,600  
           

(1)
The Bank is a participating lender in the South Dakota Housing Development Authority program for flood victims in the north-eastern part of the state of South Dakota, as of May 2007. The money is provided to the Bank at a zero percent interest rate to be used in making loans to such flood victims. This is a revolving line of credit, in which the participating lender may borrow, prepay and re-borrow for a term of 10 years.

91


HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2008 AND 2007

(DOLLARS IN THOUSANDS, Except share data)

NOTE 7—ADVANCES FROM FEDERAL HOME LOAN BANK AND OTHER BORROWINGS (Continued)

        Aggregate maturities of term FHLB advances and other borrowings, computed based upon contractual maturity date, are as follows:

        Maturing in fiscal year:

2009

  $ 11,500  

2010

    34,855  

2011

    25,000  

2012

    10,000  

2013

    36,500  

Thereafter

    50,679  
       

  $ 168,534  
       

        Prepayment of convertible, or callable, advances results in a prepayment fee as negotiated between the Bank and the FHLB. Convertible advances without a strike rate are subject to be called at the FHLB's discretion. Convertible advances tied to LIBOR strike rates may only be called if the three-month LIBOR rate is equal to or greater than the indicated strike rate.

        Advances with the FHLB are secured by stock in the FHLB, which is comprised of membership stock and activity-based stock. The membership stock requirement is based as a percentage of total assets as of the preceding December 31. At June 30, 2008, and 2007 the Bank held $1,223 and $1,212 in membership stock. The activity-based stock minimum requirement is based on 4.45% of advances outstanding. At June 30, 2008, and 2007 the Bank held $10,022 and $3,846 in activity-based stock.

        In addition, advances with the FHLB are secured by one-to-four family first mortgage loans, multi-family first mortgage loans and investment securities. In order to provide additional borrowing collateral, commercial real estate first mortgage loans, agricultural real estate first mortgage loans, home equity line of credit loans and home equity second mortgage loans have also been pledged with the FHLB. At June 30, 2008, the Bank had total collateral with the FHLB of $260,765 of which $62,490 was available for additional borrowing. At June 30, 2007, the Bank had total collateral with the FHLB of $136,877 of which $31,377 was available for additional borrowing.

        Advances with the Federal Reserve Bank are secured by commercial business loans. At June 30, 2008, the Bank had total collateral with the Federal Reserve Bank of $35,233 of which $35,233 was available for borrowing.

        The Bank currently has a $15,000 unsecured line of federal funds with First Tennessee Bank, NA. On October 22, 2007, the Bank also reaffirmed a $10,000 federal funds accommodation from Northern Trust. In addition, the Company has a line of credit for $6,000 with First Tennessee Bank, NA for liquidity needs of the Company. There were no funds drawn on any line of credit at June 30, 2008.

92


HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2008 AND 2007

(DOLLARS IN THOUSANDS, Except share data)

NOTE 8—SUBORDINATED DEBENTURES PAYABLE TO TRUSTS

        On November 28, 2001, the Company issued 10,000 shares totaling $10,000 of Company Obligated Mandatorily Redeemable Preferred Securities of Trust I. Trust I was established and exists for the sole purpose of issuing trust preferred securities and investing the proceeds in subordinated debentures of the Company. These subordinated debentures constitute the sole asset of Trust I. The securities provide for cumulative cash distributions calculated at a rate based on six-month LIBOR plus 3.75% adjusted semi-annually. The Company may, at one or more times, defer interest payments on the capital securities for up to 10 consecutive semi-annual periods, but not beyond December 8, 2031. At the end of the deferral period, all accumulated and unpaid distributions must be paid. The capital securities must be redeemed on December 8, 2031; however, the Company has the option to shorten the maturity date to a date not earlier than December 8, 2006. The capital securities have no voting rights, are unsecured, and rank junior in priority of the payment to all of the Company's indebtedness and senior to the Company's capital stock.

        On December 8, 2006, the Company exercised its option to redeem the 10,000 shares totaling $10,000 of Trust I. Proceeds from Trust V were used to fund this redemption.

        On July 11, 2002, the Company issued 5,000 shares totaling $5,000 of Company Obligated Mandatorily Redeemable Preferred Securities of Trust II. Trust II was established and exists for the sole purpose of issuing trust preferred securities and investing the proceeds in subordinated debentures of the Company. These subordinated debentures constitute the sole asset of Trust II. The securities provide for cumulative cash distributions calculated at a rate based on three-month LIBOR plus 3.65% adjusted quarterly. The Company may, at one or more times, defer interest payments on the capital securities for up to 20 consecutive quarterly periods, but not beyond October 7, 2032. The capital securities must be redeemed on October 7, 2032; however, the Company has the option to shorten the maturity date to a date not earlier than July 7, 2007. Holders of the capital securities have no voting rights, are unsecured, and rank junior in priority of the payment to all of the Company's indebtedness and senior to the Company's capital stock.

        On July 7, 2007, the Company exercised its option to redeem the 5,000 shares totaling $5,000 of Trust II. Proceeds from Trust VI were used to fund this redemption.

        On December 19, 2002, the Company issued 5,000 shares totaling $5,000 of Company Obligated Mandatorily Redeemable Preferred Securities of Trust III. Trust III was established and exists for the sole purpose of issuing trust preferred securities and investing the proceeds in subordinated debentures of the Company. These subordinated debentures constitute the sole asset of Trust III. The securities provide for cumulative cash distributions calculated at a rate based on three-month LIBOR plus 3.35% adjusted quarterly. The Company may, at one or more times, defer interest payments on the capital securities for up to 20 consecutive quarterly periods, but not beyond January 7, 2033. At the end of the deferral period, all accumulated and unpaid distributions must be paid. The capital securities must be redeemed on January 7, 2033; however, the Company has the option to shorten the maturity date to a date not earlier than January 7, 2008. Holders of the capital securities have no voting rights, are unsecured, and rank junior in priority of the payment to all of the Company's indebtedness and senior to the Company's capital stock.

93


HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2008 AND 2007

(DOLLARS IN THOUSANDS, Except share data)

NOTE 8—SUBORDINATED DEBENTURES PAYABLE TO TRUSTS (Continued)

        On September 25, 2003, the Company issued 7,000 shares totaling $7,000 of Company Obligated Mandatorily Redeemable Preferred Securities of Trust IV. Trust IV was established and exists for the sole purpose of issuing trust preferred securities and investing the proceeds in subordinated debentures of the Company. These subordinated debentures constitute the sole asset of Trust IV. The securities provide for cumulative cash distributions calculated at a rate based on three-month LIBOR plus 3.10% adjusted quarterly. The Company may, at one or more times, defer interest payments on the capital securities for up to 20 consecutive quarterly periods, but not beyond October 8, 2033. At the end of the deferral period, all accumulated and unpaid distributions must be paid. The capital securities must be redeemed on October 8, 2033; however, the Company has the option to shorten the maturity date to a date not earlier than October 8, 2008. Holders of the capital securities have no voting rights, are unsecured, and rank junior in priority of the payment to all of the Company's indebtedness and senior to the Company's capital stock.

        On December 7, 2006, the Company issued 10,000 shares totaling $10,000 of Company Obligated Mandatorily Redeemable Preferred Securities of Trust V. Trust V was established and exists for the sole purpose of issuing trust preferred securities and investing the proceeds in subordinated debentures of the Company. These subordinated debentures constitute the sole asset of Trust V. The securities provide for cumulative cash distributions calculated at a rate based on three-month LIBOR plus 1.83%, fixed for five years at 6.61%; thereafter, adjusted quarterly. The Company may, at one or more times, defer interest payments on the capital securities for up to 20 consecutive quarterly periods, but not beyond March 1, 2037. At the end of the deferral period, all accumulated and unpaid distributions must be paid. The capital securities must be redeemed on March 1, 2037; however, the Company has the option to shorten the maturity date to a date not earlier than March 1, 2012. Holders of the capital securities have no voting rights, are unsecured, and rank junior in priority of the payment to all of the Company's indebtedness and senior to the Company's capital stock.

        On July 5, 2007, the Company issued 5,000 shares totaling $5,000 of Company Obligated Mandatorily Redeemable Preferred Securities of Trust VI. Trust VI was established and exists for the sole purpose of issuing trust preferred securities and investing the proceeds in subordinated debentures of the Company. These subordinated debentures constitute the sole asset of Trust VI. The securities provide for cumulative cash distributions calculated at a rate based on three-month LIBOR plus 1.65% adjusted quarterly. The Company may, at one or more times, defer interest payments on the capital securities for up to 20 consecutive quarterly periods, but not beyond October 1, 2037. At the end of the deferral period, all accumulated and unpaid distributions must be paid. The capital securities must be redeemed on October 1, 2037; however, the Company has the option to shorten the maturity date to a date not earlier than October 1, 2012. Holders of the capital securities have no voting rights, are unsecured, and rank junior in priority of the payment to all of the Company's indebtedness and senior to the Company's capital stock.

NOTE 9—INTEREST RATE CONTRACTS

        Interest rate swap contracts are entered into primarily as an asset/liability management strategy of the Company to modify interest rate risk. The primary risk associated with all swaps is the exposure to movements in interest rates and the ability of the counterparties to meet the terms of the contract. The

94


HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2008 AND 2007

(DOLLARS IN THOUSANDS, Except share data)

NOTE 9—INTEREST RATE CONTRACTS (Continued)


Company is exposed to losses if the counterparty fails to make its payments under a contract in which the Company is in a receiving status. The Company minimizes its risk by monitoring the credit standing of the counterparty. The Company anticipates the counterparty will be able to fully satisfy its obligations under the remaining agreements.

        During the first quarter of fiscal 2008, the Company entered into an interest rate swap agreement with a $5,000 notional amount to convert the variable-rate Trust Preferred VI security into a fixed-rate instrument for a term of five years at a fixed rate of 6.69%. This rate swap is designated as a cash flow hedge. The fair value of the derivative was a $218 loss at June 30, 2008.

        During the fourth quarter of fiscal 2008, the Company entered into an interest rate swap agreement with a $7,000 notional amount to convert the variable-rate Trust Preferred IV security into a fixed-rate instrument for a term of three years at a fixed rate of 6.19%. This rate swap is designated as a cash flow hedge. The fair value of the derivative was a $97 gain at June 30, 2008.

        No gain or loss was recognized in earnings in fiscal 2008 related to these interest rate swaps. No deferred net losses on interest rate swaps in other comprehensive loss as of June 30, 2008 are expected to be reclassified into earnings during the next twelve months.

NOTE 10—INCOME TAX MATTERS

        The Company and subsidiaries file a consolidated federal income tax return on a fiscal year basis in the U.S. federal jurisdiction and various states. The Company is no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations by tax authorities for years before 2004. The Bank is allowed bad debt deductions based on actual charge-offs.

        The consolidated provision for income taxes from continuing operations consists of the following for the years ended June 30, 2008, 2007 and 2006:

 
  2008   2007   2006  

Current

                   
 

Federal

  $ 2,163   $ 2,516   $ 2,475  
 

State

    592     613     296  

Deferred expense

    11     (485 )   (557 )
               

  $ 2,766   $ 2,644   $ 2,214  
               

95


HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2008 AND 2007

(DOLLARS IN THOUSANDS, Except share data)

NOTE 10—INCOME TAX MATTERS (Continued)

        Income tax expense is different from that calculated at the statutory federal income tax rate. The reasons for this difference in tax expense are as follows:

 
  2008   2007   2006  

Computed "expected" tax expense

  $ 3,013   $ 2,810   $ 2,352  

Increase (decrease) in income taxes resulting from

                   
 

Tax exempt income

    (385 )   (353 )   (237 )
 

State taxes, net of federal benefit

    369     392     165  
 

Increase in cash surrender value of life insurance

    (186 )   (177 )   (169 )
 

Stock options

    8     32     (19 )
 

Benefit of income taxed at lower rates

    (64 )   (58 )   (52 )
 

Change in valuation allowance

        (1 )   (3 )
 

Other, net

    11     (1 )   177  
               

  $ 2,766   $ 2,644   $ 2,214  
               

        The components of the net deferred tax asset (liability) as of June 30, 2008, and 2007 are as follows:

 
  2008   2007  

Deferred tax assets

             
 

Allowance for loan and lease losses

  $ 2,008   $ 1,986  
 

Accrued expenses

    253     360  
 

Net unrealized loss on securities available for sale

    1,268     860  
 

Pension cost

    523     60  
 

Other

    193     412  
           

    4,245     3,678  
 

Less valuation allowance

    (1 )   (1 )
           

    4,244     3,677  
           

Deferred tax liabilities

             
 

Property and equipment

    718     1,155  
 

Mortgage servicing rights

    501     388  
 

Other assets

    176     208  
 

Other

    51     29  
           

    1,446     1,780  
           

  $ 2,798   $ 1,897  
           

        Retained earnings at June 30, 2008, and 2007, include approximately $4,805 related to the pre-1987 allowance for loan losses for which no deferred federal income tax liability has been recognized. These amounts represent an allocation of income to bad debt deductions for tax purposes only. If the Bank no longer qualifies as a bank, or in the event of a liquidation of the Bank, income would be created for

96


HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2008 AND 2007

(DOLLARS IN THOUSANDS, Except share data)

NOTE 10—INCOME TAX MATTERS (Continued)


tax purposes only, which would be subject to the then current corporate income tax rate. The unrecorded deferred income tax liability on the above amount for financial statement purposes was approximately $1,634.

        The Company adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes ("FIN 48") effective July 1, 2007. Implementation resulted in no cumulative effect adjustment to retained earnings as of the date of adoption. The Company had no unrecognized tax benefits as of June 30, 2008. The Company recognized no interest and penalties on the underpayment of income taxes during the year ended June 30, 2008 and had no accrued interest and penalties on the balance sheet as of June 30, 2008. The Company has no tax positions for which it is reasonably possible that the total amounts of unrecognized tax benefits will significantly increase with the next twelve months.

NOTE 11—REGULATORY CAPITAL

        The Bank is subject to various regulatory capital requirements administered by 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 Bank'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 regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the following table) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined) and of Tier I capital (as defined) to adjusted total assets (as defined). Management believes, as of June 30, 2008, and 2007, that the Bank meets all capital adequacy requirements to which it is subject.

        As of June 30, 2008, the Office of Thrift Supervision (OTS) categorized the Bank as "well capitalized" under the regulatory framework. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier I risk-based, and Tier I (core) capital ratios as set forth in the table. There are no conditions or events since that notification that management believes have unfavorably changed the Bank's category.

97


HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2008 AND 2007

(DOLLARS IN THOUSANDS, Except share data)

NOTE 11—REGULATORY CAPITAL (Continued)

        The following table summarizes the Bank's compliance with its regulatory capital requirements at June 30, 2008, and 2007:

 
  Actual   Requirement   To Be Well
Capitalized Under
Prompt Corrective
Action Provisions
 
 
  Amount   Percent   Amount   Percent   Amount   Percent  

As of June 30, 2008

                                     
 

Tier I (core) capital (to adjusted total assets)

  $ 85,623     7.78 % $ 44,027     4.00 % $ 55,034     5.00 %
 

Total risk-based capital (to risk-weighted assets)

    91,417     10.83 %   67,519     8.00 %   84,398     10.00 %
 

Tangible capital (to tangible assets)

    85,623     7.78 %   16,510     1.50 %   N/A     N/A  
 

Tier I (core) capital (to risk-weighted assets)

    85,623     10.15 %   N/A     N/A     50,639     6.00 %

As of June 30, 2007

                                     
 

Tier I (core) capital (to adjusted total assets)

  $ 82,824     8.31 % $ 39,895     4.00 % $ 49,869     5.00 %
 

Total risk-based capital (to risk-weighted assets)

    88,252     11.05 %   63,933     8.00 %   79,916     10.00 %
 

Tangible capital (to tangible assets)

    82,824     8.31 %   14,961     1.50 %   N/A     N/A  
 

Tier I (core) capital (to risk-weighted assets)

    82,824     10.37 %   N/A     N/A     47,950     6.00 %

NOTE 12—STOCKHOLDERS' EQUITY

        The Company currently has in effect a publicly announced stock buy-back program in which up to 10% of the common stock of the Company outstanding on May 1, 2008, may be acquired through April 30, 2009. As of June 30, 2008, the Company has repurchased 6,527 shares of common stock pursuant to this current program. Pursuant to a series of stock buy-back programs initiated by the Company since 1996, the Company has purchased an aggregate of 2,083,455 shares of common stock through June 30, 2008. As of June 30, 2008, the maximum number of shares that may yet be purchased under the current program was 388,794 shares.

        The Company has authorized 50,000 shares of Preferred Stock, designated as "Series A Junior Participating Preferred Stock" with a stated value of $1.00 per share. Outstanding shares of the Junior Preferred Stock are entitled to cumulative dividends. Such shares have voting rights of 100 votes per share and a preference in liquidation. The shares are not redeemable after issuance.

        The Company also has preferred share purchase rights (Rights). Each Right entitles the registered holder to purchase from the Company one one-hundredth of a share of Series A Junior Participating Preferred Stock at a price of $65 per one-hundredth of a preferred share, subject to the complete terms as stated in the Rights Agreement. The Rights become exercisable immediately after the earlier of (i) ten business days following a public announcement that a person or group has acquired beneficial

98


HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2008 AND 2007

(DOLLARS IN THOUSANDS, Except share data)

NOTE 12—STOCKHOLDERS' EQUITY (Continued)


ownership of 20% or more of the outstanding common shares of the Company (subject to certain exclusions), (ii) ten business days following the commencement or announcement of an intention to make a tender offer or exchange offer, the consummation of which would result in the beneficial ownership by a person or group of 20% or more of such outstanding common shares. The Rights expired on October 22, 2006, and were not renewed by the Company.

        Under current regulations, the Bank is not permitted to pay dividends on its stock if its regulatory capital would reduce below (i) the amount required for the liquidation account established to provide a limited priority claim to the assets of the Bank to qualifying depositors (Eligible Account Holders) at March 31, 1992, who continue to maintain deposits at the Bank after its conversion from a federal mutual savings and loan association to a federal stock savings bank pursuant to its Plan of Conversion adopted August 21, 1991, or (ii) the Bank's regulatory capital requirements. Capital distributions are limited to the greater of 100% of net income for the year to date plus 50% of the amount of which the lesser of the institution's tangible core or risk-based capital exceeds its capital requirement for such capital commitment, as measured at the beginning of the calendar year or up to 75% of net income over the most recent four quarter period. Subsequent to June 30, 2008, the Bank sent written notification to the OTS of its intention to pay dividends for each quarter in the year ending June 30, 2009, to the Company, while maintaining its capital requirements.

        On July 28, 2008, the Board of Directors declared a $0.1125 per share dividend payable on August 15, 2008, to shareholders of record as of August 8, 2008. This cash dividend has not been reflected in the consolidated financial statements.

NOTE 13—EARNINGS PER SHARE

        A reconciliation of the income and common stock share amounts used in the calculation of basic and diluted EPS for the fiscal years ended June 30, 2008, 2007 and 2006, follow:

 
  2008   2007   2006  

Net income

  $ 5,843   $ 5,383   $ 4,508  

Basic EPS:

                   
 

Weighted average number of common shares outstanding

    3,969,988     3,978,571     3,914,952  
 

Earnings per common share

  $ 1.47   $ 1.35   $ 1.15  

Diluted EPS:

                   
 

Weighted average number of common shares outstanding

    3,969,988     3,978,571     3,914,952  
 

Common share equivalents—stock options/Stock Appreciation Rights (SARs) under employee compensation plans

    53,486     78,155     85,126  
               
 

Weighted average number of common shares and common share equivalents

    4,023,474     4,056,726     4,000,078  
               
 

Earnings per common share

 
$

1.45
 
$

1.33
 
$

1.13
 

99


HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2008 AND 2007

(DOLLARS IN THOUSANDS, Except share data)

NOTE 13—EARNINGS PER SHARE (Continued)

        During the third quarter of fiscal 2006, the Company declared a 11/10-for-1 stock split of all of the common stock of the Company outstanding, payable in the form of a 1/10-for-1 stock dividend. The 10% stock dividend was paid on April 24, 2006, to shareholders of record as of April 10, 2006. All per share data and number of common shares outstanding have been retroactively adjusted for all periods presented as a result of the stock split.

        Options outstanding of approximately 16,100 shares of common stock at a weighted average share price of $17.27 during the fiscal year ended June 30, 2008, were not included in the computation of diluted earnings per share because the exercise price of those instruments exceeded the average market price of the common shares during the year. All options outstanding were included in the computation for the year ended June 30, 2007. Options outstanding of approximately 30,800 shares of common stock at a weighted average share price of $17.27 during the fiscal year ended June 30, 2006, were not included in the computation of diluted earnings per share because the exercise price of those instruments exceeded the average market price of the common shares during the year.

NOTE 14—DEFINED BENEFIT PLAN

        The Company has a noncontributory (cash balance) defined benefit pension plan covering all employees of the Company and its wholly-owned subsidiaries who have attained the age of 21 and have completed 1,000 hours in a plan year. The benefits are based on 6% of each eligible participant's annual compensation, plus income earned in the accounts at a rate determined annually based on 30-year treasury note rates. The Company's funding policy is to make the minimum annual required contribution plus such amounts as the Company may determine to be appropriate from time to time. One hundred percent vesting occurs after five years with a retirement age of the later of age 65 or 5 years of participation.

        Statement of Financial Accounting Standards No. 158 (SFAS 158) was issued in September 2006 entitled Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans—an amendment of FASB Statements No. 87, 88, 106 and 132R. SFAS 158 requires recognition of the overfunded or underfunded status of pension and other postretirement benefit plans on the balance sheet. Under SFAS 158, gains and losses, prior service costs and credits and any remaining transition amounts under SFAS 87 and SFAS 106 that have not yet been recognized through net periodic benefit cost will be recognized in accumulated other comprehensive income, net of tax effects, until they are amortized as a component of net periodic cost. Also, the measurement date—the date at which the benefit obligation and plan assets are measured—is required to be the company's fiscal year-end. As required by SFAS 158, the Company adopted the balance sheet recognition provisions at June 30, 2007. Effective July 1, 2007, the Company adopted the requirement to recognize changes in the plan's funded status in the year in which the changes occur in other comprehensive income.

100


HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2008 AND 2007

(DOLLARS IN THOUSANDS, Except share data)

NOTE 14—DEFINED BENEFIT PLAN (Continued)

        The incremental effect of applying the balance sheet recognition provisions of SFAS 158 at June30, 2007, on the following balance sheet items is as follows:

 
  Before   SFAS 158
Adjustment
  After  

Prepaid Expenses and Other Assets

  $ 4,453   $ (158 ) $ 4,295  

Deferred Income Taxes

    1,955     60     2,015  

Total Assets

    1,001,552     (98 )   1,001,454  

Accumulated Other Comprehensive Income (Loss)

    (1,404 )   (98 )   (1,502 )

Total Stockholder's Equity

    62,368     (98 )   62,270  

        Information relative to the components of net periodic benefit cost measured as of June 30, 2008 and April 30, 2007 for the Company's defined benefit plan is presented below.

 
  2008   2007  

Changes in benefit obligations

             
 

Benefit obligations, beginning

  $ 5,606   $ 5,353  
   

Service cost

    447     466  
   

Interest cost

    437     391  
   

Benefits paid

    (504 )   (579 )
   

Assumption changes

    365      
   

Actuarial (gain) loss

    (57 )   (25 )
           
 

Benefit obligations, ending

  $ 6,294   $ 5,606  
           

Changes in plan assets

             
 

Fair value of plan assets, beginning

  $ 5,899   $ 5,387  
   

Actual return (loss) on plan assets

    (423 )   470  
   

Company contributions

    532     621  
   

Benefits paid

    (504 )   (579 )
           
 

Fair value of plan assets, ending

  $ 5,504   $ 5,899  
           

Funded status at end of year

  $ (790 ) $ 293  
           

Accumulated benefit obligation

 
$

5,295
 
$

4,714
 
           

101


HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2008 AND 2007

(DOLLARS IN THOUSANDS, Except share data)

NOTE 14—DEFINED BENEFIT PLAN (Continued)

        Amounts recognized in accumulated other comprehensive income (pre tax) for the years ended June 30, 2008 and 2007, consist of the following:

Projected benefit obligation

  $ (6,294 ) $ (5,606 )

Fair value of assets

    5,504     5,899  

Unrecognized transitional asset

         

Unrecognized prior service cost

         

Prepaid pension cost

    (586 )   (451 )
           

Acuumulated other comprehensive income (loss)

  $ (1,376 ) $ (158 )
           

        The net actuarial loss and net prior service cost for the defined benefit plan that will be amortized from accumulated other comprehensive income into net periodic benefit cost in 2009 is $62.

        The components of net periodic benefit cost for the fiscal years ended June 30, consist of the following:

 
  2008   2007   2006  

Service cost

  $ 447   $ 466   $ 466  

Interest cost

    437     391     365  

Expected return on plan assets

    (487 )   (436 )   (373 )

Amortization of prior losses

             

Amortization of transition asset

            11  
               
 

Total costs recognized in expense

  $ 397   $ 421   $ 469  
               

        The weighted-average assumptions used to determine benefit obligations at June 30, are as follows:

 
  2008   2007  

Discount rate—pre-retirement

    7.50 %   7.50 %

Discount rate—post-retirement

    4.52 %   4.82 %

Rate of compensation increase

    4.00 %   4.00 %

        The weighted-average assumptions used to determine net periodic benefit cost for fiscal years ended June 30, are as follows:

 
  2008   2007  

Discount rate—pre-retirement

    7.50 %   7.50 %

Discount rate—post-retirement

    4.82 %   4.58 %

Rate of compensation increase

    4.00 %   4.00 %

Expected long-term return on plan assets

    8.00 %   8.00 %

        The overall expected long-term rate of return on assets is based on economic forecasts and projected asset allocation.

102


HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2008 AND 2007

(DOLLARS IN THOUSANDS, Except share data)

NOTE 14—DEFINED BENEFIT PLAN (Continued)

        The Company's pension plan weighted-average asset allocations by asset category are as follows:

 
  2008  
Investment Category
  Market
Value
  Unrealized
Gain/(Loss)
  Actual Asset
Mix as a % of
Market Value
  Target Asset
Mix as a % of
Market Value
 

Equities

  $ 3,512   $ 90     63.8 %   65.0 %

Fixed

    1,991     7     36.2 %   30.0 %

Cash and cash equivalents

    1         0.0 %   5.0 %
                   
 

Total pension plan assets

  $ 5,504   $ 97     100.0 %   100.0 %
                   

 

 
  2007  
Investment Category
  Market
Value
  Unrealized
Gain/(Loss)
  Actual Asset
Mix as a % of
Market Value
  Target Asset
Mix as a % of
Market Value
 

Equities

  $ 4,131   $ 851     70.0 %   65.0 %

Fixed

    1,746     246     29.6 %   30.0 %

Cash and cash equivalents

    22     (248 )   0.4 %   5.0 %
                   
 

Total pension plan assets

  $ 5,899   $ 849     100.0 %   100.0 %
                   

        The objective of the pension plan investment policy for equities is to pursue a growth strategy that results in capital appreciation. The objective of the pension plan investment policy for fixed rate instruments and cash equivalents is to ensure safety of principal and interest.

        The Company expects to contribute $600 to its pension plan in fiscal 2009. The minimum required contribution is $0.

        Estimated Future Benefit Payments: The following benefit payments which reflect expected future service, as appropriate, are expected to be paid during the years ended June 30:

2009

  $ 465  

2010

    1,089  

2011

    381  

2012

    619  

2013

    327  

Years 2014 - 2018

    2,881  

NOTE 15—RETIREMENT SAVINGS PLAN

        The Company has a retirement savings plan covering all employees of the Company who have attained age 21 and completed one expected year of service during which they worked at least 1,000 hours. The plan is intended to be a qualified profit sharing plan with a cash or deferred arrangement pursuant to IRS Code Section 401(k) and regulations issued there under. The plan allows voluntary contributions by eligible employees, and also allows discretionary contributions by the

103


HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2008 AND 2007

(DOLLARS IN THOUSANDS, Except share data)

NOTE 15—RETIREMENT SAVINGS PLAN (Continued)


Company as determined annually by the Board of Directors. The total compensation cost charged to expense related to the plan was $335, $286 and $265, for 2008, 2007 and 2006, respectively.

NOTE 16—STOCK-BASED COMPENSATION PLANS

        During fiscal 2003, the Company established the 2002 Stock Option and Incentive Plan (2002 Option Plan). Under the 2002 Option Plan, awards for an aggregate amount of 907,500 common shares may be granted to directors and employees of the Bank. Options granted under the Option Plan may be either options that qualify as Incentive Stock Options, as defined in the Code, or options that do not qualify. Options granted may have a maximum term of 10 years. The 2002 Option Plan also provides for the award of stock appreciation rights, limited stock appreciation rights and nonvested stock.

        The Company has a long-term incentive plan, which provides for the grant of nonvested stock awards and for stock appreciation rights ("SARs") settled in stock under the 2002 Option Plan if the Company achieves certain performance levels. For fiscal years 2008, 2007 and 2006, the Company met a performance level in the plan and, accordingly, for fiscal 2008 nonvested stock with a value of $97 and SARs with a value of $97 will be issued in fiscal 2009. During fiscal years 2008 and 2007, 5,146 and 4,078 shares, respectively of nonvested stock were issued and 29,204 and 20,953 SARs were issued in fiscal 2008 and 2007 respectively, under the 2002 Option Plan. The nonvested shares and SARs vest 25% in each of the first through fourth anniversaries of the date of grant. The issuance value of the nonvested shares was $83 and $65 for 2008 and 2007, respectively, and is being amortized over the vesting period of four years with the unamortized balance included in additional paid in capital in the consolidated statements of financial condition. During fiscal years 2008, 2007 and 2006, $391, $388 and $388 respectively, were recorded as amortization expense. The issuance value of the 2008 and 2007 SARs was $83 and $65 and each issuance is being amortized over the vesting period of four years. During fiscal year 2008 and 2007, $30 and $11 was recorded as amortization expense.

        In connection with meeting a performance level of the long-term incentive plan, 6,584 shares of nonvested stock and 47,051 SARs will be issued in fiscal 2009 under the plan. Both the nonvested shares and SARs issued in fiscal 2009 will have a four-year vesting period in which 25% of the stock vests in each of the first through fourth anniversaries of the date of grant.

        During fiscal 2004, the Company created a pool of 12,100 nonvested shares for grants under the 2002 Option Plan (2002 Pool). The key provisions of the 2002 Pool include: outright grant of shares with restrictions as to sale, transfer, and pledging; during the restriction period, the grantee receives dividends and has voting rights related to the shares awarded; and all nonvested shares are forfeited upon termination. During fiscal years 2008 and 2007, 2,718 and 1,747 nonvested shares, respectively, were awarded under the Pool. The issuance value of these nonvested shares was $42 and $31 in 2008 and 2007, respectively, and is being amortized over their vesting periods with the unamortized balance included in additional paid in capital in the consolidated balance sheet. During fiscal years 2008, 2007 and 2006, $28, $30 and $37, respectively, were recorded as amortization expense.

        In association with the 2002 Option Plan, awards of nonvested shares of the Company's common stock are made to outside directors of the Company. Each outside director is entitled to all voting,

104


HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2008 AND 2007

(DOLLARS IN THOUSANDS, Except share data)

NOTE 16—STOCK-BASED COMPENSATION PLANS (Continued)


dividend and distribution rights during the vesting period. During fiscal year 2008, 11,301 shares of nonvested stock were awarded. The nonvested shares vest on the first anniversary of the date of grant. During fiscal year 2008, $138 was recorded as amortization expense.

        The fair value of each incentive stock option and each stock appreciation right grant is estimated at the grant date using the Black-Scholes option pricing model. The following assumptions were used for grants in fiscal years 2008, 2007 and 2006:

 
  2008   2007   2006  

Expected volatility

    22.00 %   23.00 %   24.00 %

Expected dividend yield

    2.61 %   2.63 %   2.75 %

Risk-free interest rate

    3.94 %   4.61 %   4.09 %

Expected term (in years)

    4     4     7  

        Stock option activity for the fiscal year ended June 30, are as follows:

 
  2008  
 
  Shares   Weighted
Average
Exercise
Price
  Weighted
Average
Remaining
Contractual
Term
  Aggregate
Intrinsic
Value
 

Beginning Balance

    245,129   $ 12.49              

Granted

                     

Forfeited

    (5,608 )   17.27              

Exercised

    (35,967 )   11.82              
                       

Ending Balance

    203,554   $ 12.48     4.26   $ 793  
                   

Vested and exercisable at June 30

    203,554   $ 12.48     4.26   $ 793  
                   

        Stock appreciation rights activity for the fiscal year ended June 30, are as follows:

 
  2008  
 
  SARs   Weighted
Average
Exercise
Price
  Weighted
Average
Remaining
Contractual
Term
  Aggregate
Intrinsic
Value
 

Beginning Balance

    19,372   $ 16.00              

Granted

    29,204     16.10              

Forfeited

    (3,534 )   16.06              

Exercised

    (420 )   16.00              
                       

Ending Balance

    44,622   $ 16.06     8.82   $ 11  
                   

Vested and exercisable at June 30

    4,414   $ 16.00     8.03   $ 1  
                   

105


HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2008 AND 2007

(DOLLARS IN THOUSANDS, Except share data)

NOTE 16—STOCK-BASED COMPENSATION PLANS (Continued)

        The Company applied a forfeiture rate of 10.00% when calculating the amount of options and stock appreciation rights expected to vest at June 30, 2008. This rate is based upon historical activity and will be revised if necessary in subsequent periods if actual forfeitures differ from these estimates. The weighted-average grant date fair value of stock appreciation rights granted during the fiscal years 2008 and 2007 was $2.84 and $3.11. The weighted-average grant date fair value of options granted during the fiscal year 2006 was $3.83. The total intrinsic value of options exercised during the fiscal years 2008, 2007 and 2006, was $155, $269 and $194 respectively. During fiscal years 2008 and 2007, $53 and $101 respectively, were recorded as amortization expense. As of June 30, 2008, there was $103 of total unrecognized compensation cost related to nonvested SARs awards. The cost is expected to be recognized over a weighted-average period of 33 months for SARs awards. Cash received from the exercise of options and SARs for the fiscal years 2008, 2007 and 2006, was $432, $787 and $386 respectively. The tax benefit realized for the tax deductions from cashless option exercises totaled $7, $61 and $41 for the fiscal years 2008, 2007 and 2006, respectively. The company generally uses treasury shares to satisfy stock option exercises.

        Nonvested share activity for the fiscal years ended June 30, follows:

 
  2008   2007   2006  
 
  Shares   Weighted
Average
Grant Date
Fair Value
  Shares   Weighted
Average
Grant Date
Fair Value
  Shares   Weighted
Average
Grant Date
Fair Value
 

Nonvested Balance, beginning

    144,711   $ 16.11     158,177   $ 15.75     91,906   $ 13.46  

Granted

    19,165     16.62     11,866     16.78     85,572     17.42  

Vested

    (31,236 )   14.51     (17,890 )   13.83     (15,955 )   11.48  

Forfeited

    (10,894 )   16.44     (7,442 )   15.11     (3,346 )   15.85  
                           

Nonvested Balance, ending

    121,746   $ 16.57     144,711   $ 16.11     158,177   $ 15.75  
                           

        Pretax compensation expense recognized for nonvested shares for the fiscal years 2008, 2007 and 2006, was $419, $418 and $425 respectively. The tax benefit for the fiscal years 2008, 2007 and 2006 was $159, $159 and $162 respectively. As of June 30, 2008, there was $1,027 of total unrecognized compensation cost related to nonvested shares granted under the Plan. That cost is expected to be recognized over a weighted-average period of 22 months. The total fair value of shares vested during the fiscal years 2008, 2007 and 2006 was $453, $247 and $183 respectively.

        The Company had a Director Restricted Stock Plan which provided that awards of nonvested shares of the Company's common stock be made to outside directors of the Company. The plan was designed to allow for payment of the annual retainer fee in shares of the Company's common stock. Each outside director is entitled to all voting, dividend and distribution rights during the restriction period. The effective date of the plan was July 1, 1997. The plan had 90,750 shares allocated to it and was in effect for a period of ten years. During fiscal years 2007 and 2006, 6,041 and 4,824 shares were awarded and $103 and $96 of expense was incurred under the plan, respectively, as the annual retainer for the Company's Board of Directors. The Director Restricted Stock Plan expired on December 31, 2006. At June 30, 2008, there was no unrecognized compensation expense related to this plan.

106


HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2008 AND 2007

(DOLLARS IN THOUSANDS, Except share data)

NOTE 17—OTHER COMPREHENSIVE LOSS

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

 
  2008   2007   2006  

Net income

  $ 5,843   $ 5,383   $ 4,508  
               

Other comprehensive income (loss), net of tax:

                   
 

Securities available for sale:

                   
   

Net unrealized gains (losses)

    (1,069 )   1,707     (2,617 )
   

Reclassification adjustment for net gains realized in net income

    (3 )       (3 )
   

Income tax benefit (expense)

    408     (649 )   996  
               
     

Other comprehensive income (loss) on securities available for sale

    (664 )   1,058     (1,624 )
               
 

Defined benefit plan:

                   
   

Net unrealized (loss)

    (1,218 )        
   

Income tax benefit

    463          
               
     

Other comprehensive (loss) on defined benefit plan

    (755 )        
               
 

Derivatives and hedging activities:

                   
   

Net unrealized (losses)

    (121 )        
   

Income tax benefit

    41          
               
     

Other comprehensive (loss) on derivatives and hedging activities

    (80 )        
               
 

Retained interest:

                   
   

Net unrealized (loss)

            (3 )
   

Income tax benefit

            1  
               
     

Other comprehensive (loss) on retained interest

            (2 )
               
     

Total other comprehensive income (loss)

    (1,499 )   1,058     (1,626 )
               

Comprehensive income

  $ 4,344   $ 6,441   $ 2,882  
               

        Cumulative other comprehensive (loss) balances were:

 
  2008   2007   2006  

Unrealized loss on securities available for sale net of related tax effect of $1,268, $860 and $1,509

  $ (2,068 ) $ (1,404 ) $ (2,462 )

Unrealized loss on defined benefit plan net of related tax effect of $523 and $60

    (853 )   (98 )    

Unrealized loss on derivitives and hedging activities net of related tax effect of $41

    (80 )        
               

  $ (3,001 ) $ (1,502 ) $ (2,462 )
               

107


HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2008 AND 2007

(DOLLARS IN THOUSANDS, Except share data)

NOTE 18—FINANCIAL INSTRUMENTS

        The Bank is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, standby letters of credit and financial guarantees. Those instruments involve, to varying degrees, elements of credit and interest-rate risk in excess of amounts recognized in the consolidated statements of financial condition. The contract or notional amounts of those instruments reflect the extent of the Bank's involvement in particular classes of financial instruments.

        The Bank's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit, standby letters of credit, and financial guarantees written is represented by the contractual notional amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.

        Unless noted otherwise, the Bank does not require collateral or other security to support financial instruments with credit risk.

        The following methods and assumptions were used by the Company in estimating the fair value of its financial instruments:

Cash and cash equivalents—The carrying amounts reported in the statements of financial condition for cash and cash equivalents approximate their fair values.

Securities available for sale—Fair values for securities available for sale are based on quoted market prices, except for stock in the Federal Home Loan Bank for which fair value is assumed to equal cost.

Loans and leases receivable—The fair values for loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms and credit quality. Leases are stated at cost which equals fair value.

Accrued interest receivable—The carrying value of accrued interest receivable approximates its fair value.

Servicing rights—Fair values are estimated using discounted cash flows based on current market rates of interest.

Off-statement-of-financial-condition instruments—Fair values for the Company's off-statement-of-financial-condition instruments (unused lines of credit and letters of credit), which are based upon fees currently charged to enter into similar agreements taking into account the remaining terms of the agreements and counterparties' credit standing, are not significant.

Deposits—The fair values for deposits with no defined maturities equal their carrying amounts, which represent the amount payable on demand. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on a comparably termed wholesale funding alternative (i.e., FHLB borrowings).

Advances from Federal Home Loan Bank and other borrowings—The carrying amounts reported for variable rate advances approximate their fair values. Fair values for fixed-rate advances and other

108


HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2008 AND 2007

(DOLLARS IN THOUSANDS, Except share data)

NOTE 18—FINANCIAL INSTRUMENTS (Continued)


borrowings are estimated using a discounted cash flow calculation that applies interest rates currently being offered on advances and borrowings with corresponding maturity dates.

Subordinated debentures payable to trusts—The carrying amounts for subordinated debentures payable to trusts approximate their fair values.

Accrued interest payable and advances by borrowers for taxes and insurance—The carrying values of accrued interest payable and advances by borrowers for taxes and insurance approximate their fair values.

        Estimated fair values of the Company's financial instruments are as follows at June 30:

 
  2008   2007  
 
  Carrying
Amount
  Fair
Value
  Carrying
Amount
  Fair
Value
 

Financial assets

                         
 

Cash and cash equivalents

  $ 21,170   $ 21,170   $ 22,476   $ 22,476  
 

Securities available for sale

    225,004     225,004     142,223     142,223  
 

Federal Home Loan Bank stock

    11,245     11,245     5,058     5,058  
 

Loans and leases receivable

    786,573     790,420     770,375     757,337  
 

Accrued interest receivable

    7,540     7,540     8,495     8,495  
 

Servicing rights

    11,189     16,629     10,871     15,740  

Financial liabilities

                         
 

Deposits

    784,237     786,170     815,864     813,985  
 

Advances from Federal Home Loan Bank and other borrowings

    198,454     199,886     68,600     67,570  
 

Subordinated debentures payable to trusts

    27,837     27,837     27,837     27,837  
 

Accrued interest payable and advances by borrowers for taxes and insurance

    16,804     16,804     15,989     15,989  

NOTE 19—COMMITMENTS, CONTINGENCIES AND CREDIT RISK

        The Bank originates first mortgage, consumer and other loans primarily in eastern South Dakota and holds residential and commercial real estate loans which were purchased from other originators of loans located throughout the United States. Collateral for substantially all consumer loans are security agreements and/or Uniform Commercial Code (UCC) filings on the purchased asset. Unused lines of credit amounted to $83,254 and $73,851 at June 30, 2008, and 2007, respectively. Unused letters of credit amounted to $3,318 and $7,861 at June 30, 2008, and 2007, respectively. The lines of credit and letters of credit are collateralized in substantially the same manner as loans receivable.

        The Bank had outstanding commitments to originate or purchase loans of $40,447 and to sell loans of approximately $11,901 at June 30, 2008. The portion of commitments to originate or purchase fixed rate loans totaled $29,533 with a range in interest rates of 4.95% to 7.49%. No losses are expected to be sustained in the fulfillment of any of these commitments.

109


HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2008 AND 2007

(DOLLARS IN THOUSANDS, Except share data)

NOTE 19—COMMITMENTS, CONTINGENCIES AND CREDIT RISK (Continued)

        The Company is involved in various claims and legal actions arising in the ordinary course of business. In the opinion of management, based upon consultation with legal counsel, the ultimate disposition of these matters will not have a materially adverse effect on the Company's consolidated financial position.

NOTE 20—CASH FLOW INFORMATION

        Changes in other assets and liabilities for the years ended June 30, consist of:

 
  2008   2007   2006  

(Increase) decrease in accrued interest receivable

  $ 955   $ (1,615 ) $ (1,793 )

Earnings on cash value of life insurance

    (531 )   (506 )   (483 )

Increase (decrease) in net deferred loan fees and other assets

    742     (600 )   884  

Increase (decrease) in accrued expenses and other liabilities

    1,422     6,738     732  
               

  $ 2,588   $ 4,017   $ (660 )
               

Supplemental Disclosure of Cash Flows Information

                   
 

Cash payments for interest

  $ 32,940   $ 34,848   $ 26,540  
 

Cash payments for income and franchise taxes

    3,836     1,914     3,861  

Supplemental Disclosure of Noncash Investing and Financing Activities

                   
 

Foreclosed real estate and other properties acquired in settlement of loans

  $ 135   $ 481   $ 989  
 

Loans receivable reclassified as held for sale

            223  
 

Office property reclassified as held for sale

            153  

110


HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2008 AND 2007

(DOLLARS IN THOUSANDS, Except share data)

NOTE 21—FINANCIAL INFORMATION OF HF FINANCIAL CORP. (PARENT ONLY)

        The Company's condensed balance sheets as of June 30, 2008, and 2007 and related condensed statements of income and cash flows for each of the years in the three-year period ended June 30, 2008, are as follows:

Condensed Statement of Financial Condition

 
  2008   2007  

Assets

             
 

Cash primarily with the Bank

  $ 3,295   $ 2,727  
 

Investments in subsidiaries

    87,672     86,292  
 

Securities available for sale

    250     181  
 

Other assets

    1,300     1,483  
           

  $ 92,517   $ 90,683  
           

Liabilities

             
 

Subordinated debentures payable to trusts

  $ 27,837   $ 27,837  
 

Accrued expenses and other liabilities

    477     576  

Stockholders' equity

    64,203     62,270  
           

  $ 92,517   $ 90,683  
           

Condensed Statements of Income

 
  2008   2007   2006  

Dividends from subsidiaries

  $ 5,206   $ 2,950   $ 1,500  

Interest and other income

    109     129     3,697  

Expenses

    (2,628 )   (3,245 )   (2,669 )

Income tax benefit

    819     1,034     (389 )

Equity in undistributed income of subsidiaries

    2,337     4,515     2,369  
               
 

Net income

  $ 5,843   $ 5,383   $ 4,508  
               

111


HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2008 AND 2007

(DOLLARS IN THOUSANDS, Except share data)

NOTE 21—FINANCIAL INFORMATION OF HF FINANCIAL CORP. (PARENT ONLY) (Continued)

Condensed Statements of Cash Flows

 
  2008   2007   2006  

Cash Flows From Operating Activities

                   
 

Net income

  $ 5,843   $ 5,383   $ 4,508  
 

Adjustments to reconcile net income to net cash provided by (used in) operating activities

                   
   

Amortization

    141     317     34  
   

(Gain) on sale of land

            (3,557 )
   

Equity in (earnings) of subsidiaries

    (7,543 )   (7,465 )   (3,869 )
   

Cash dividends received from subsidiaries

    5,206     2,950     1,500  
   

Increase (decrease) in other liabilities

    (99 )   362     (886 )
   

Other, net

    (109 )   (21 )   (281 )
               

Net cash provided by (used in) operating activities

    3,439     1,526     (2,551 )
               

Cash Flows From Investing Activities

                   
 

Purchase of securities available for sale

    (69 )   (116 )   (28 )
 

Proceeds from sale of land

            4,863  
 

Capital contribution to the Bank

            (950 )
               

Net cash provided by (used in) investment activities

    (69 )   (116 )   3,885  
               

Cash Flows From Financing Activities

                   
 

Purchase of treasury stock

    (1,730 )        
 

Cash dividends paid

    (1,702 )   (1,662 )   (1,596 )
 

Proceeds from issuance of common stock

    630     904     2,052  
 

Proceeds from issuance of subordinated debentures

    5,000     10,000      
 

Redemption of subordinated debentures

    (5,000 )   (10,000 )    
 

Payments of other borrowings

            (705 )
 

Payments of debt issue costs

        (6 )   (7 )
               

Net cash provided by (used in) financing activities

    (2,802 )   (764 )   (256 )
               
 

Increase (decrease) in cash

    568     646     1,078  

Cash at beginning of period

    2,727     2,081     1,003  
               

Cash at end of period

  $ 3,295   $ 2,727   $ 2,081  
               

112


HF FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

JUNE 30, 2008 AND 2007

(DOLLARS IN THOUSANDS, Except share data)

NOTE 22—QUARTERLY FINANCIAL INFORMATION (UNAUDITED)

 
  1st
Quarter
  2nd
Quarter
  3rd
Quarter
  4th
Quarter
 

Fiscal Year 2008

                         

Total interest income

  $ 15,985   $ 16,085   $ 15,542   $ 15,562  

Net interest income

    6,668     6,996     7,695     8,517  

Provision for losses on loans and leases

    325     295     551     823  

Net income

    1,348     1,251     1,623     1,621  

Basic earnings per share

 
$

0.34
 
$

0.32
 
$

0.41
 
$

0.41
 

Diluted earnings per share

    0.33     0.31     0.40     0.40  

Fiscal Year 2007

                         

Total interest income

  $ 15,078   $ 15,663   $ 15,360   $ 15,773  

Net interest income

    6,418     6,060     6,403     6,753  

Provision for losses on loans and leases

    291     461     34     412  

Net income

    1,097     2,111     1,034     1,141  

Basic earnings per share

 
$

0.28
 
$

0.53
 
$

0.26
 
$

0.28
 

Diluted earnings per share

    0.27     0.52     0.25     0.27  

113


Item 9.    Changes in and Disagreements with Accountants on Accounting and Financial Disclosures

        Not applicable.

Item 9A.    Controls and Procedures

Evaluation of Disclosure Controls and Procedures

        As of June 30, 2008, an evaluation was performed by the Company's management, including the Company's Chairman, President and Chief Executive Officer and the Company's Executive Vice President, Chief Financial Officer and Treasurer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act). Based upon that evaluation, the Company's Chairman, President and Chief Executive Officer and the Company's Executive Vice President, Chief Financial Officer and Treasurer concluded that the Company's disclosure controls and procedures were effective as of June 30, 2008, to provide reasonable assurance that information required to be disclosed in the reports the Company files and submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms.

Management's Report on Internal Control over Financial Reporting

        Management's report on internal control over financial reporting is included in Part II, Item 8 "Financial Statements and Supplementary Data," and is furnished herein.

Changes in Internal Control Over Financial Reporting

        There were no changes in the Company's internal control over financial reporting that occurred during the fourth quarter ended June 30, 2008, that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.

Item 9B. Other Information

        None.


PART III

Item 10. Directors, Executive Officers and Corporate Governance

Directors

        Information regarding Directors of the Company is incorporated by reference from the discussion under the heading "Information with Respect to Nominees and Continuing Directors" in the Company's Proxy Statement for the Annual Meeting of Stockholders to be held in 2008, a copy of which will be filed not later than 120 days after June 30, 2008 (the "2008 Proxy Statement").

Executive Officers

        Information regarding the executive officers of the Company is contained in Part I, Item 1 "Business" of this Form 10-K pursuant to Instruction 3 to Item 401(b) of Regulation S-K, and is incorporated by reference herein.

Compliance with Section 16(a) of the Exchange Act

        Information regarding compliance with Section 16(a) of the Securities Exchange Act of 1934, as amended, is incorporated by reference from the discussion under the heading "Section 16(a) Beneficial Ownership Reporting Compliance" in the Company's 2008 Proxy Statement.

114


Code of Ethics

        Information regarding the Company's Code of Conduct and Ethics is incorporated by reference from the discussion under the heading "Code of Conduct and Ethics" in the Company's 2008 Proxy Statement.

Director Nominations

        Information regarding material changes, if any, to the procedures by which the Company's stockholders may recommend nominees to the Company's Board of Directors is incorporated by reference from the discussion under the heading "Director Nominations" in the Company's 2008 Proxy Statement.

Audit Committee and Audit Committee Financial Expert

        Information regarding the Company's Audit Committee and Audit Committee Financial Expert, is incorporated by reference from the discussion under the heading "Meetings of the Board of Directors, Compensation of Directors, Committees of the Board of Directors and Independent Directors" in the Company's 2008 Proxy Statement.

Item 11.    Executive Compensation

        Information concerning executive compensation and other related disclosures required by this Item are incorporated by reference from the discussion under the heading "Compensation, Discussion and Analysis," "Compensation Committee Report," "Executive Compensation," "Director Compensation" and "Personnel, Compensation And Benefits Committee Interlocks and Insider Participation" in the Company's 2008 Proxy Statement.

Item 12.    Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

        Information on the securities authorized for issuance under the Company's equity compensation plans is contained in Part II, Item 5 "Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities" of this Form 10-K, and is incorporated by reference herein.

        Information concerning security ownership of certain beneficial owners and management is incorporated by reference from the discussion under the heading "Security Ownership of Certain Beneficial Owners and Management" in the Company's 2008 Proxy Statement.

Item 13.    Certain Relationships and Related Transactions, and Director Independence

        Information concerning transactions with related persons and the review, approval or ratification thereof is incorporated by reference from the discussion under the heading "Certain Transactions" and "Policy on Review and Approval of Transactions with Related Persons" in the Company's 2008 Proxy Statement.

        Information concerning director independence is incorporated by reference from the discussion under the heading "Meetings of the Board of Directors, Compensation of Directors, Committees of the Board of Directors and Independent Directors" in the Company's 2008 Proxy Statement.

115


Item 14.    Principal Accountant Fees and Services

        Information concerning the fees for professional services rendered by the Company's registered public accounting firm is incorporated by reference from the discussion under the heading "Report of the Audit Committee" in the Company's 2008 Proxy Statement.

        Information concerning the pre-approval policies and procedures of the Company's Audit Committee is incorporated by reference from the discussion under the heading "Audit Committee Pre-Approval Policies" in the Company's 2008 Proxy Statement.


PART IV

Item 15.    Exhibits and Financial Statement Schedules

(a)
The following documents are as part of this Form 10-K:

(1)
Consolidated Financial Statements:

      Report of Independent Registered Public Accounting Firm

      Consolidated Statements of Financial Condition at June 30, 2008 and 2007

      Consolidated Statements of Income for the years ended June 30, 2008, 2007 and 2006

      Consolidated Statements of Stockholders' Equity for the years ended June 30, 2008, 2007 and 2006

      Consolidated Statements of Cash Flows for the years ended June 30, 2008, 2007 and 2006

      Notes to Consolidated Financial Statements

    (2)
    All financial statement schedules are omitted because of the absence of conditions under which they are required or because the information is shown in the Consolidated Financial Statements or notes thereto.

    (3)
    Exhibits

Exhibit No.
  Identification of Exhibit
  3.1   Articles of Incorporation (incorporated herein by reference to Exhibit 3.1 from the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 2007).

 

3.2

 

By-Laws (incorporated herein by reference to Exhibit 3.2 from the Company's Current Report on Form 8-K dated December 6, 2007, and filed with the SEC on December 7, 2007).

 

10.1

 

Guarantee Agreement dated July 11, 2002, by and between HF Financial Corp. and Wilmington Trust Company (incorporated herein by reference to Exhibit 10.1 from the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2002).

 

10.2

 

Indenture Agreement dated July 11, 2002, by and between HF Financial Corp. and Wilmington Trust Company (incorporated herein by reference to Exhibit 10.2 from the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2002).

 

10.3

 

Guarantee Agreement dated December 19, 2002, by and between HF Financial Corp. and Wilmington Trust Company (incorporated herein by reference to Exhibit 10.1 from the Company's Quarterly Report on Form 10-Q for the quarter ended December 31, 2002).

 

10.4

 

Indenture Agreement dated December 19, 2002, by and between HF Financial Corp. and Wilmington Trust Company (incorporated herein by reference to Exhibit 10.2 from the Company's Quarterly Report on Form 10-Q for the quarter ended December 31, 2002).

116


Exhibit No.
  Identification of Exhibit
  10.5   Guarantee Agreement dated September 25, 2003, by and between HF Financial Corp. and Wilmington Trust Company (incorporated herein by reference to Exhibit 10.1 from the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2003).

 

10.6

 

Indenture Agreement dated September 25, 2003, by and between HF Financial Corp. and Wilmington Trust Company (incorporated herein by reference to Exhibit 10.2 from the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2003).

 

10.7

 

Guarantee Agreement dated December 7, 2006, by and between HF Financial Corp. and Wilmington Trust Company (incorporated herein by reference to Exhibit 10.1 from the Company's Quarterly Report on Form 10-Q for the quarter ended December 31, 2006).

 

10.8

 

Indenture Agreement dated December 7, 2006, by and between HF Financial Corp. and Wilmington Trust Company (incorporated herein by reference to Exhibit 10.2 from the Company's Quarterly Report on Form 10-Q for the quarter ended December 31, 2006).

 

10.9

 

Letter Agreement dated June 3, 2003, between HF Financial Corp. and First Tennessee Bank, NA (incorporated herein by reference to Exhibit 10.20 from the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 2003).

 

10.10*

 

Letter Agreement dated June 26, 2008, between HF Financial Corp. and First Tennessee Bank, NA.

 

10.11#

 

HF Financial Corp. 1991 Stock Option and Incentive Plan (incorporated herein by reference to the exhibits from the Company's Annual Report on Form 10-K405 for the fiscal year ended June 30, 1993).

 

10.12#

 

Amendment to the HF Financial Corp. 1991 Stock Option and Incentive Plan (incorporated herein by reference to Exhibit 10.6 from the Company's Annual Report on Form 10-K405 for the fiscal year ended June 30, 1997).

 

10.13#

 

HF Financial Corp. 1996 Director Restricted Stock Plan (incorporated herein by reference to Exhibit 10.7 from the Company's Annual Report on Form 10-K405 for the fiscal year ended June 30, 1997).


 


10.14#


 


HF Financial Corp. 2002 Stock Option and Incentive Plan (incorporated herein by reference to Appendix A to the Company's Definitive Proxy Statement on Schedule 14A, filed with the SEC on October 15, 2002).

 

10.15#

 

Form of HF Financial Corp. 2002 Stock Option and Incentive Plan Stock Appreciation Rights Agreement (incorporated herein by reference to Exhibit 10.1 from the Company's Current Report on Form 8-K dated September 13, 2006, and filed with the SEC on September 19, 2006).

 

10.16#

 

Form of HF Financial Corp. 2002 Stock Option and Incentive Plan Stock Option Agreement (incorporated herein by reference to Exhibit 10.1 from the Company's Definitive Proxy Statement on Schedule 14A filed with the SEC on October 6, 2006).

 

10.17#

 

Home Federal Bank Short-Term Incentive Plan, as amended and restated effective July 2, 2007 (incorporated herein by reference to Exhibit 10.5 from the Company's Current Report on Form 8-K dated July 2, 2007, and filed with the SEC on July 9, 2007).

 

10.18#

 

Home Federal Bank Fourth Amended and Restated Long-Term Incentive Plan (incorporated herein by reference to Exhibit 10.6 from the Company's Current Report on Form 8-K dated July 2, 2007, and filed with the SEC on July 9, 2007).

117


Exhibit No.
  Identification of Exhibit
  10.19#   Employment Agreement by and between Home Federal Bank and Curtis L. Hage (incorporated herein by reference to Exhibit 10.1 from the Company's Current Report on Form 8-K dated July 2, 2007, and filed with the SEC on July 9, 2007).

 

10.20#

 

Change-in-Control Agreement by and between Home Federal Bank and Curtis L. Hage (incorporated herein by reference to Exhibit 10.3 from the Company's Current Report on Form 8-K dated July 2, 2007, and filed with the SEC on July 9, 2007).

 

10.21#

 

Form of Employment Agreement by and between Home Federal Bank and each of Darrel L. Posegate, David A. Brown, and Natalie A. Solberg (incorporated herein by reference to Exhibit 10.2 from the Company's Current Report on Form 8-K dated July 2, 2007, and filed with the SEC on July 9, 2007).

 

10.22#

 

Form of Change-in-Control Agreement by and between Home Federal Bank and each of Darrel L. Posegate, David A. Brown and Natalie A. Solberg (incorporated herein by reference to Exhibit 10.4 from the Company's Current Report on Form 8-K dated July 2, 2007, and filed with the SEC on July 9, 2007).

 

10.23#

 

Form of Employment Agreement by and between Home Federal Bank and each of Brent R. Olthoff, Mary F. Hitzemann, and Michael Westberg (incorporated herein by reference to Exhibit 10.2 from the Company's Current Report on Form 8-K dated July 2, 2007, and filed with the SEC on July 9, 2007).

 

10.24#

 

Form of Change-in-Control Agreement by and between Home Federal Bank and each of Brent R. Olthoff, Mary F. Hitzemann, and Michael Westberg (incorporated herein by reference to Exhibit 10.4 from the Company's Current Report on Form 8-K dated July 2, 2007, and filed with the SEC on July 9, 2007).

 

10.25#

 

Form of Employment Agreement by and between Home Federal Bank and Jon M. Gadberry (incorporated herein by reference to Exhibit 10.2 from the Company's Current Report on Form 8-K dated July 2, 2007 and filed with the SEC on July 9, 2007).

 

10.26#

 

Form of Change-in-Control Agreement by and between Home Federal Bank and Jon M. Gadberry (incorporated herein by reference to Exhibit 10.4 from the Company's Current Report on Form 8-K dated July 2, 2007 and filed with the SEC on July 9, 2007).

 

21.1*

 

Subsidiaries of Registrant.

 

23.1*

 

Consent of Independent Registered Accounting Firm.

 

31.1*

 

Certification of Chairman, President and Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

31.2*

 

Certification of Executive Vice President, Chief Financial Officer and Treasurer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

32.1**

 

Certification of Chairman, President and Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

32.2**

 

Certification of Executive Vice President, Chief Financial Officer and Treasurer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

*

  Filed herewith.

**

 

Furnished herewith.

#

 

Management contract or compensatory plan or arrangement required to be filed.

118



SIGNATURES

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

  HF FINANCIAL CORP.

Date: September 26, 2008                                    

 

By

 

/s/ CURTIS L. HAGE


Curtis L. Hage, Chairman, President and
Chief Executive Officer
(Duly Authorized Representative)

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

/s/ CURTIS L. HAGE

Curtis L. Hage, Chairman, President and Chief Executive Officer
(Principal Executive and Operating Officer)
  /s/ DARREL L. POSEGATE

Darrel L. Posegate, Executive Vice President, Chief Financial Officer and Treasurer
(Principal Financial and Accounting Officer)

Date: September 26, 2008

 

Date: September 26, 2008

/s/ 
THOMAS L. VAN WYHE

Thomas L. Van Wyhe,
Director

 

/s/ 
ROBERT L. HANSON

Robert L. Hanson,
Director

Date: September 26, 2008

 

Date: September 26, 2008

/s/ 
CURTIS J. BERNARD

Curtis J. Bernard,
Director

 

/s/ 
WILLIAM G. PEDERSON

William G. Pederson,
Director

Date: September 26, 2008

 

Date: September 26, 2008

/s/ 
CHARLES T. DAY

Charles T. Day,
Director

 

/s/ 
CHRISTINE E. HAMILTON

Christine E. Hamilton,
Director

Date: September 26, 2008

 

Date: September 26, 2008

119



Index of Attached Exhibits

Exhibit
Number
   
  10.10   Letter Agreement dated June 26, 2008, between HF Financial Corp. and First Tennessee Bank, NA


 


21.1


 


Subsidiaries of Registrant

 

23.1

 

Consent of Independent Registered Public Accounting Firm

 

31.1

 

Certification of Chairman, President and Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

 

31.2

 

Certification of Executive Vice President, Chief Financial Officer and Treasurer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

 

32.1

 

Certification of Chairman, President and Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

32.2

 

Certification of Executive Vice President, Chief Financial Officer and Treasurer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

120




QuickLinks

PART I
PART II
COMPARISON OF 5-YEAR CUMULATIVE TOTAL RETURN AMONG HF FINANCIAL CORP. NASDAQ MARKET INDEX AND NASDAQ BANK INDEX
FAS 114 Impaired Loan Summary
TABLE OF CONTENTS
HF FINANCIAL CORP. CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION JUNE 30, 2008 AND 2007 (DOLLARS IN THOUSANDS, except share data)
HF FINANCIAL CORP. CONSOLIDATED STATEMENTS OF INCOME YEARS ENDED JUNE 30, 2008, 2007 AND 2006 (DOLLARS IN THOUSANDS, except share data)
HF FINANCIAL CORP. CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED JUNE 30, 2008, 2007 AND 2006 (DOLLARS IN THOUSANDS, except share data)
HF FINANCIAL CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 2008 AND 2007 (DOLLARS IN THOUSANDS, Except share data)
PART III
PART IV
SIGNATURES
Index of Attached Exhibits
EX-10.10 2 a2188088zex-10_10.htm EXHIBIT 10.10

EXHIBIT 10.10

 

 

June 26, 2008

 

Brent Olthoff

HF Financial Corp.

P.O. Box 5000

Sioux Falls, SD 57117 – 5000

 

Dear Brent:

 

I am pleased to confirm First Tennessee Bank National Association’s reaffirmation of HF Financial Corp’s Six Million Dollar ($6,000,000.00) Revolving Line of Credit facility.  The line will mature on September 30, 2008.  The short maturity will allow FTN Financial the opportunity to perform an on-site due diligence of Home Federal Bank (Bank). Once complete, FTN Financial will submit a request to renew the line for a full one year.

 

In the interim, the Line of credit may be used for: i) capital infusion to its subsidiaries to support growth and/or other liquidity needs. Interest on the outstanding balance will be payable quarterly at a variable rate per annum on the outstanding balance. The variable rate of interest shall be a 1/4% discount to First Tennessee Bank’s Base Rate, which is currently 5.00%.  Thus, your borrowing rate today would equal 4.75%. Again, the maturity date of the commitment is September 30, 2008.

 

The line will continue to be governed by the following covenants:

 

·                  ROA >= 0.60% (Consolidated Basis)

·                  Leverage Ratio >= 6.00% (Bank)

·                  NPLs/TLs <2.50% (Consolidated Basis)

 

Please keep in mind that these covenants will be tested on a quarterly basis.  A portion of the bank’s stock will be required to secure the loan if Borrower and/or Bank is in default of one or all covenants governing the Line of Credit. This will only apply if the line is funded.

 

Brent, it is a pleasure of First Tennessee Bank to provide this commitment to your institution. I will be in touch in the coming weeks in order to schedule a due diligence trip.  Please do not hesitate to call if you have any questions.

 

Sincerely,

 

 

/s/ David House

 

David House

 

Vice President

 

Correspondent Services

 

 



EX-21.1 3 a2188088zex-21_1.htm EXHIBIT 21.1

EXHIBIT 21.1

 

Subsidiaries of the Registrant

 

Parent

 

Subsidiary

 

Percentage

of Ownership

 

State of Incorporation

or Organization

 

 

 

 

 

 

 

HF Financial Corp.

 

Home Federal Bank

 

100%

 

Delaware

 

 

 

 

 

 

 

HF Financial Corp.

 

HomeFirst Mortgage Corp.

 

100%

 

South Dakota

 

 

 

 

 

 

 

HF Financial Corp.

 

HF Financial Capital Trust III

 

100%

 

Delaware

 

 

 

 

 

 

 

HF Financial Corp.

 

HF Financial Capital Trust IV

 

100%

 

Delaware

 

 

 

 

 

 

 

HF Financial Corp.

 

HF Financial Capital Trust V

 

100%

 

Delaware

 

 

 

 

 

 

 

HF Financial Corp.

 

HF Financial Capital Trust VI

 

100%

 

Delaware

 

 

 

 

 

 

 

HF Financial Corp.

 

HF Financial Group, Inc.

 

100%

 

South Dakota

 

 

 

 

 

 

 

Home Federal Bank

 

Hometown Insurors, Inc.

 

100%

 

South Dakota

 

 

 

 

 

 

 

Home Federal Bank

 

Mid-America Service Corporation

 

100%

 

South Dakota

 

 

 

 

 

 

 

Home Federal Bank

 

PMD, Inc.

 

100%

 

South Dakota

 

 

 

 

 

 

 

Home Federal Bank

 

Mid America Capital Services, Inc. d/b/a/Mid America Leasing

 

100%

 

South Dakota

 

 

 

 

 

 

 

Home Federal Bank

 

Home Federal Securitization Corp.

 

100%

 

Delaware

 

The financial statements of HF Financial Corp. are consolidated with those of its subsidiaries.

 



EX-23.1 4 a2188088zex-23_1.htm EXHIBIT 23.1

EXHIBIT 23.1

 

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

We consent to the incorporation by reference in the Registration Statements on Form S-8 of HF Financial Corp., pertaining to the HF Financial Corp. 2002 Stock Option and Incentive Plan, the 1991 Stock Option and Incentive Plan, the 1996 Director Restricted Stock Plan, and the Retirement Savings Plan of our report dated September 26, 2008, accompanying the consolidated financial statements included in the Form 10-K Annual Report of HF Financial Corp. for the fiscal year ended June 30, 2008.

 

 

/s/ Eide Bailly, LLP

 

Sioux Falls, South Dakota

September 26, 2008

 



EX-31.1 5 a2188088zex-31_1.htm EXHIBIT 31.1

EXHIBIT 31.1

 

CERTIFICATION

 

I, Curtis L. Hage, certify that:

 

1.                                       I have reviewed this Annual Report on Form 10-K of HF Financial Corp.;

 

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(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

 

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

 

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

 

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

 

(d)                                 Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth 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 ov er financing reporting; and

 

5.                                       The registrant’s other certifying officer(s) 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 the registrant’s board of di rectors (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 financia l 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:

September 26, 2008

 

 

 

 

 

 

 

     /s/ Curtis L. Hage

 

Curtis L. Hage, Chairman, President and

 

Chief Executive Officer

 



EX-31.2 6 a2188088zex-31_2.htm EXHIBIT 31.2

EXHIBIT 31.2

 

CERTIFICATION

 

I, Darrel L. Posegate, certify that:

 

1.                                       I have reviewed this Annual Report on Form 10-K of HF Financial Corp.;

 

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(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

 

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

 

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

 

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

 

(d)                                 Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth 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 fi nancing reporting; and

 

5.                                       The registrant’s other certifying officer(s) 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 the registrant’s board of directo rs (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 inf ormation; 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:

September 26, 2008

 

 

 

 

 

 

 

     /s/ Darrel L. Posegate

 

Darrel L. Posegate

 

Executive Vice President,

 

Chief Financial Officer and Treasurer

 



EX-32.1 7 a2188088zex-32_1.htm EXHIBIT 32.1

EXHIBIT 32.1

 

CERTIFICATION PURSUANT TO

18 U.S.C. §1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

 

In connection with the Annual Report on Form 10-K of HF Financial Corp. (the “Company”) for the fiscal year ended June 30, 2008, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Curtis L. Hage, Chairman, President and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. §1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

 

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

 

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

 

 

 

/s/ Curtis L. Hage

 

Curtis L. Hage, Chairman, President

 

and Chief Executive Officer

 

 

 

Date:

  September 26, 2008

 


*

A signed original of this written statement required by Section 906 has been provided to HF Financial Corp. and will be retained by HF Financial Corp. and furnished to the Securities and Exchange Commission or its staff upon request.

 



EX-32.2 8 a2188088zex-32_2.htm EXHIBIT 32.2

EXHIBIT 32.2

 

CERTIFICATION PURSUANT TO

18 U.S.C. §1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

 

In connection with the Annual Report on Form 10-K of HF Financial Corp. (the “Company”) for the fiscal year ended June 30, 2008, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Darrel L. Posegate, Executive Vice President, Chief Financial Officer and Treasurer of the Company, certify, pursuant to 18 U.S.C. §1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

 

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

 

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

 

 

 

/s/ Darrel L. Posegate

 

Darrel L. Posegate, Executive Vice President,

 

Chief Financial Officer and Treasurer

 

 

 

Date:

  September 26, 2008

 


*

A signed original of this written statement required by Section 906 has been provided to HF Financial Corp. and will be retained by HF Financial Corp. and furnished to the Securities and Exchange Commission or its staff upon request.

 



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