10-K

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

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

For the fiscal year ended December 31, 2005

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: 0-24100.

HMN FINANCIAL, INC.

(Exact Name of Registrant as Specified in its Charter)

Delaware
(State or Other Jurisdiction of Incorporation or Organization) 41-1777397
(I.R.S. Employer Identification No.)

1016 Civic Center Drive Northwest, PO Box 6057
Rochester, Minnesota
(Address of Principal Executive Offices) 55901
(Zip Code)

(507) 535-1200	None
Registrant’s telephone number, including area code	Former name, former address and former fiscal year, if changed since last report

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

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

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 þ

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

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

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

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

Large accelerated filer o Accelerated filer þ Non-accelerated filer o

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

As of June 30, 2005, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was $103.1 million based on the closing stock price of $31.48 on such date as reported on the Nasdaq National Market.

As of February 13, 2006 the number of outstanding shares of common stock of the registrant was 4,422,964.

DOCUMENTS INCORPORATED BY REFERENCE

     Portions of the registrant’s annual report for the year ended December 31, 2005, are incorporated by reference in Parts I, II and IV of this Form 10-K. Portions of the registrant’s definitive proxy statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the close of the registrant’s fiscal year ended December 31, 2005 are incorporated by reference in Part III of this Form 10-K. The compensation committee report and the stock performance graph contained in the registrant’s proxy statement are expressly not incorporated by reference in this report.

TABLE OF CONTENTS

	Page
PART I
Item 1. Business
General		4
Market Area		4
Lending Activities		5
Origination, Purchases and Sales of Mortgage-Backed and Related Securities		12
Classified Assets and Delinquencies		14
Investment Activities		16
Sources of Funds		19
Other Information
Service Corporations of the Bank		22
Competition		23
Other Corporations Owned by HMN		23
Employees		23
Regulation and Supervision		23
Executive Officers		28
Item 1A. Risk Factors		29
Item 1B. Unresolved Staff Comments		32
Item 2. Properties		32
Item 3. Legal Proceedings		32
Item 4. Submission of Matters to a Vote of Security Holders		32
PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities		32
Item 6. Selected Financial Data		32
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations		33
Item 7A. Quantitative and Qualitative Disclosure About Market Risk		33
Item 8. Financial Statements and Supplementary Data		33
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure		33
Item 9A. Controls and Procedures		33
Item 9B. Other Information		35
PART III
Item 10. Directors and Executive Officers of the Registrant		35
Item 11. Executive Compensation		36
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters		36
Item 13. Certain Relationships and Related Transactions		36
Item 14. Principal Accountant Fees and Services		36
PART IV
Item 15. Exhibits and Financial Statement Schedules		37
Signatures		40
Index to Exhibits		41
Portions of Annual Report to Security Holders
Subsidiaries of Registrant
Consent of KPMG LLP
Certification of Chief Executive Officer
Certification of Chief Financial Officer
Section 1350 Certifications

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Forward-Looking Statements

The information presented or incorporated by reference in this Annual Report on Form 10-K under the headings “Item 1. Business” and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934. Words such as “anticipate”, “believe”, “expect”, “intend”, “would”, “could” and similar expressions, as they relate to us, are intended to identify such forward-looking statements. These statements are subject to risks and uncertainties, including those discussed under “Risk Factors” on pages 27-30 of this Form 10-K, that could cause actual results to differ materially from those projected. Because actual results may differ, we caution you not to place undue reliance on these forward-looking statements.

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PART I

ITEM 1. BUSINESS

General

HMN Financial, Inc. (HMN or the Company) is a stock savings bank holding company that owns 100 percent of Home Federal Savings Bank (the Bank). The Bank has a community banking philosophy and operates retail banking and loan production facilities in Minnesota and Iowa. The Bank has one wholly owned subsidiary, Osterud Insurance Agency, Inc. (OIA) which offers financial planning products and services. HMN has another wholly owned subsidiary, Security Finance Corporation (SFC) which acts as an intermediary for the Bank in transacting like kind property exchanges for Bank customers. During the period for which financial information is presented in this Form 10-K, the Bank had three other subsidiaries that are no longer operating. Home Federal Holding, Inc. (HFH), a wholly owned subsidiary, was the holding company for Home Federal REIT, Inc. (HFREIT) which invested in real estate loans acquired from the Bank. HFH and HFREIT were both dissolved in 2005. Federal Title Services, LLC (FTS), which was 80% owned by the Bank, performed mortgage title services for Bank customers and was dissolved in 2004. Home Federal Mortgage Services, LLC (HFMS), which was 51% owned by the Bank, was a mortgage banking and mortgage brokerage business that was dissolved in 2003.

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

Market Area

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

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

Based upon information obtained from the U.S. Census Bureau for 2004 (the last year for which information is available), the population of the six primary counties in the Bank’s southern Minnesota market area was estimated as follows: Fillmore — 21,321; Freeborn — 31,971; Houston - 19,890; Mower — 38,998; Olmsted — 133,283; and Winona — 49,046. The median household income for these six counties ranged from $36,651 to $51,316. With respect to Iowa, the population of Marshall County was 39,503 and the population of Tama County was 17,948. The median household income of these two counties ranged from $37,419 to $38,268.

The Company also serves a diverse high net worth customer base primarily in the seven county metropolitan area of Minneapolis and St. Paul from Eagle Crest Capital Bank, a division of the Bank, located in Edina, Minnesota.

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The Company serves a similar group of individuals and businesses in Olmsted county from its Eagle Crest Capital Bank location in Rochester, Minnesota.

Lending Activities

General. Historically, the Company has originated 15 and 30-year, fixed rate mortgage loans secured by one-to-four family residences for its loan portfolio. Over the past five years, the Company has focused on managing interest rate risk and increasing interest income by increasing its investment in shorter term and generally higher yielding commercial real estate, commercial business, consumer, and construction loans and reducing its investment in longer term one-to-four family real estate loans. The Company continues to originate 15 and 30 year fixed rate mortgage loans, adjustable rate mortgage loans that are fixed for an initial period of one, three or five years and some shorter term fixed rate loans that have certain characteristics. The shorter term fixed rate loans are placed into portfolio. The majority of the 15 and 30-year fixed rate mortgage loans are sold in the secondary mortgage market. The Company also offers an array of consumer loan products that include both open lines and closed end home equity loans. The home equity line of credit has an adjustable interest rate based upon the prime rate as published in the Wall Street Journal plus a margin. Refer to Note 4 of the Notes to Consolidated Financial Statements in the Annual Report for more information on the loan portfolio (incorporated by reference in Item 8. of Part II of this Form 10-K).

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

	2005					2004					2003					2002					2001
(Dollars in thousands)	Amount		Percent			Amount		Percent			Amount		Percent			Amount		Percent			Amount		Percent
Fixed rate Loans
Real Estate:
One-to-four family
GEM	$	14,812		6.94	%	$	16,133		2.01	%	$	13,387		1.89	%	$	17,394		3.18	%	$	30,727		6.38	%
Other		55,700		1.84			59,937		7.48			65,004		9.17			74,510		13.63			110,619		22.97
Total one-to-four family		70,512		8.78			76,070		9.49			78,391		11.06			91,904		16.81			141,346		29.35
Multi-family		5,956		0.74			6,387		0.79			6,471		0.91			6,588		1.20			7,644		1.59
GEM — multi-family		51		0.01			57		0.01			61		0.01			64		0.01			68		0.01
Commercial		89,905		11.19			51,390		6.41			52,563		7.42			37,878		6.93			29,756		6.18
Construction or development		12,919		1.61			27,557		3.44			17,215		2.43			17,234		3.15			15,542		3.22
Total fixed rate real estate loans		179,343		22.33			161,461		20.14			154,701		21.83			153,668		28.10			194,356		40.35
Consumer loans:
Savings		605		0.07			454		0.06			494		0.07			534		0.10			594		0.12
Automobile		5,462		0.68			9,496		1.18			14,754		2.08			11,062		2.02			6,624		1.38
Home equity		19,289		2.40			20,019		2.50			18,742		2.65			21,049		3.85			26,300		5.46
Mobile home		2,299		0.29			2,896		0.36			3,665		0.52			4,534		0.83			5,456		1.13
Land/Lot Loans		1,234		0.15			818		0.10			754		0.11			781		0.15			767		0.16
Other		2,569		0.32			3,134		0.39			3,105		0.43			3,299		0.60			3,326		0.69
Total consumer loans		31,458		3.91			36,817		4.59			41,514		5.86			41,259		7.55			43,067		8.94
Commercial business loans		49,297		6.14			69,671		8.69			51,609		7.28			42,272		7.73			37,123		7.71
Total other loans		80,755		10.05			106,488		13.28			93,123		13.14			83,531		15.28			80,190		16.65
Total fixed rate loans		260,098		32.38			267,949		33.42			247,824		34.97			237,199		43.38			274,546		57.00
Adjustable rate Loans
Real estate:
One-to-four family		56,563		7.04			62,938		7.85			65,924		9.30			59,662		10.91			74,102		15.38
Multi-family		34,745		4.33			35,478		4.43			25,008		3.53			9,113		1.67			6,657		1.38
Commercial		170,363		21.21			173,554		21.65			146,603		20.69			92,539		16.92			41,012		8.52
Construction or development		67,424		8.39			70,841		8.84			78,131		11.02			44,102		8.07			31,435		6.53
Total adjustable rate real estate loans		329,095		40.97			342,811		42.77			315,666		44.54			205,416		37.57			153,206		31.81
Consumer (home equity and other)		60,853		7.57			67,154		8.38			54,425		7.68			52,131		9.53			35,770		7.43
Land/Lot loans		8,197		1.02			10,754		1.34			9,732		1.38			2,809		0.52			83		0.02
Other		390		0.05			248		0.03			234		0.03			222		0.04			211		0.04
Total consumer loans		69,440		8.64			78,156		9.75			64,391		9.09			55,162		10.09			36,064		7.49
Commercial business loans		144,665		18.01			112,698		14.06			80,808		11.40			48,989		8.96			17,817		3.70
Total other loans		214,105		26.65			190,854		23.81			145,199		20.49			104,151		19.05			53,881		11.19
Total adjustable rate loans		543,200		67.62			533,665		66.58			460,865		65.03			309,567		56.62			207,087		43.00
Total loans		803,298		100.00	%		801,614		100.00	%		708,689		100.00	%		546,766		100.00	%		481,633		100.00	%
Less
Loans in process		7,008					7,561					11,298					6,826					4,692
Unamortized discounts		190					63					166					142					278
Net deferred loan fees		1,644					1,781					1,334					1,068					1,212
Allowance for losses on loans		8,778					8,996					6,940					4,824					3,783
Total loans receivable, net	$	785,678				$	783,213				$	688,951				$	533,906				$	471,668

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The following table illustrates the interest rate maturities of the Company’s loan portfolio at December 31, 2005. Loans which have adjustable or renegotiable interest rates are shown as maturing in the period during which the contract is due. Scheduled repayments of principal are reflected in the year in which they are scheduled to be paid.

	Real Estate
						Multi-family and
	One-to-four family					Commercial					Construction					Consumer					Commercial Business					Total
			Weighted					Weighted					Weighted					Weighted					Weighted					Weighted
Due During Years			Average					Average					Average					Average					Average					Average
Ending December 31,	Amount		Rate			Amount		Rate			Amount		Rate			Amount		Rate			Amount		Rate			Amount		Rate
2006 (1)	$	7,671		6.15	%	$	85,431		7.45	%	$	27,297		7.51	%	$	16,852		8.58	%	$	108,108		7.65	%	$	245,359		7.58	%
2007		6,493		5.90			48,745		7.60			14,348		8.32			10,183		8.02			25,916		7.29			105,685		7.56
2008		6,966		5.76			30,984		7.26			1,094		7.49			10,373		8.07			18,697		7.28			68,114		7.24
2009 through 2010		13,164		5.64			27,391		6.81			2,285		7.66			18,770		8.45			20,316		7.22			81,926		7.12
2011 through 2015		29,696		5.62			64,865		6.43			13,830		7.50			30,493		8.60			16,427		7.32			155,311		6.89
2016 through 2030		52,445		5.62			43,604		6.11			20,017		7.25			14,210		7.90			4,498		7.57			134,774		6.32
2031 and following		10,640		5.35			0		0.00			1,472		6.24			17		6.28			0		0.00			12,129		5.46
	$	127,075				$	301,020				$	80,343				$	100,898				$	193,962				$	803,298

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

The total amount of loans due after December 31, 2006 that have predetermined interest rates is $351.2 million, while the total amount of loans due after such date that have floating or adjustable interest rates is $206.7 million. Construction or development loans were $38.6 million for one to four family dwellings, $11.2 million for multifamily and $30.5 million for nonresidential.

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Under the Financial Institutions Reform, Recovery and Enforcement Act of 1989, the aggregate amount of loans that the Bank is permitted to make to any one borrower is generally limited to 15% of unimpaired capital and surplus (25% if the security for such loan has a “readily ascertainable” value or 30% for certain residential development loans). At December 31, 2005, based upon the 15% limitation, the Bank’s regulatory limit for loans to one borrower was approximately $13.2 million. At December 31, 2005, the dollar amount of outstanding loans to one group of related borrowers exceeded this amount, but some of the loans included in these loan totals were exempt from the lending limit because (a) some of the collateral securing these loans was certificates of deposit or marketable securities held by the Bank, providing the Bank with an expanded lending limit and (b) under the direct benefit and common enterprise rules of the Financial Institutions Reform, Recovery and Enforcement Act of 1989, a portion of these loans do not really benefit the same individual borrower. The total loans outstanding to this borrower at December 31, 2005 were $17.9 million. The borrower also had $800,000 of additional approved but undrawn credit available at December 31, 2005. The amount outstanding, excluding those loans that were exempt from the loans to one borrower limits because of the direct benefit and common enterprise rules, or because they were secured by deposits was $7.1 million. The largest borrowing relationship is secured by an entertainment facility, hotel, commercial real estate, and equipment and was performing in accordance with its terms at December 31, 2005.

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

The Bank’s Mortgage and Consumer Loan Committee is responsible for reviewing and approving all loans over the Federal Home Loan Mortgage Corporation/FNMA conforming loan dollar limit originated by the Bank that are not sold in the secondary loan market. This limit was $359,650 for 2005 and $333,700 for 2004. Approval of at least one member of the Mortgage and Consumer Loan Committee was obtained on all loans above this limit.

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

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

One-to-Four Family Residential Real Estate Lending. At December 31, 2005 the Company’s one-to-four family real estate loans, consisting of both fixed rate and adjustable rate loans, totaled $127.1 million, a decline of $11.9 million, from $139.0 million at December 31, 2004. This decrease in the one-to-four family loans is consistent with the Company’s strategy of changing the composition of its portfolio toward shorter term commercial real estate and commercial business loans.

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

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charged on the fixed rate loan products are based on the FNMA delivery rates, as well as other competitive factors. The Company also originates a limited number of fixed rate loans with terms up to 30 years that are insured by the Federal Housing Authority, Veterans Administration, Minnesota Housing Finance Agency or Iowa Finance Authority.

The Company also offers one-year adjustable rate mortgages (ARMs) at a margin (generally 275 to 375 basis points) over the yield on the Average Monthly One Year U.S. Treasury Constant Maturity Index for terms of up to 30 years. The ARM loans offered by the Company allow the borrower to select (subject to pricing) an initial period of one year, three years, or five years between the loan origination and the date the first interest rate change occurs. The ARMs generally have a 200 basis point annual interest rate change cap and a lifetime cap of 600 basis points over or under the initial rate. Initial interest rates offered on the ARM loans during 2005 ranged from 100 basis points below the fully indexed loan rate to 100 basis points over that rate. All borrowers are qualified for the loan at the fully indexed rate. The Company’s originated ARMs do not permit negative amortization of principal, generally do not contain prepayment penalties and are not convertible into fixed rate loans.

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

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

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

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

Permanent commercial real estate and multi-family loans are generally originated for a maximum term of 10 years and may have longer amortization periods with balloon maturity features. The interest rates may be fixed for the term of the loan or have adjustable features that are tied to the prime rate or a published index. Commercial real estate and multi-family loans are generally written in amounts up to 80% of the lesser of the appraised value of the property or the purchase price and generally have a debt service coverage ratio of at least 120%. The debt

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service coverage ratio is the ratio of net cash from operations to debt service payments. The Company may originate construction loans secured by commercial or multi-family real estate, or may purchase participation interests in third party originated construction loans secured by commercial or multi-family real estate.

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

At December 31, 2005, the Company’s two largest commercial real estate loans totaled $9.3 million and $9.1 million. These loans are secured by separate golf course housing developments in southeastern Minnesota and were performing at December 31, 2005.

Multi-family and commercial real estate loans generally present a higher level of risk than loans secured by one-to-four family residences. This greater risk is due to several factors, including the concentration of principal in a limited number of loans and borrowers, the effects of general economic conditions on income producing properties and the increased difficulty of evaluating and monitoring these types of loans. Furthermore, the repayment of loans secured by multi-family and commercial real estate is typically dependent upon the successful operation of the related real estate project. If the cash flow from the project is reduced (for example, if leases are not obtained or renewed), the borrower’s ability to repay the loan may be impaired. At December 31, 2005, $948,000 of loans in the commercial real estate portfolio were nonperforming. There were two nonperforming loans in this category at December 31, 2005 with the largest one being a $648,000 loan secured by a hotel. There can be no assurance that the amount of nonperforming loans will not increase in the future.

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

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

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

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

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

At December 31, 2005 construction loans totaled $80.3 million, of which one-to-four family residential totaled $38.6 million, multi-family residential totaled $11.2 million and commercial real estate totaled $30.5 million.

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

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

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

The Company’s home equity loans are written so that the total commitment amount, when combined with the balance of any other outstanding mortgage liens, may not exceed 100% of the appraised value of the property. The closed-end home equity loans are written with fixed or adjustable rates with terms up to 15 years. The open-end home equity lines are written with an adjustable rate with a 10 year draw period that requires “interest only” payments followed by a 10-year repayment period that fully amortizes the outstanding balance. The consumer may access the open-end home equity line either by making a withdrawal at the Bank or writing a check on the home equity line of credit account. Open and closed-end equity loans, which are generally secured by second mortgages on the borrower’s principal residence, represented 79.4% of the consumer loan portfolio at December 31, 2005.

The underwriting standards employed by the Bank for consumer loans include a determination of the applicant’s payment history on other debts and ability to meet existing obligations and payments on the proposed loan. Although creditworthiness of the applicant is of primary consideration, the underwriting process also includes a comparison of the value of the security, if any, in relation to the proposed loan amount. Consumer loans may entail greater credit risk than do residential mortgage loans, particularly in the case of consumer loans that are unsecured or are secured by rapidly depreciable assets, such as automobiles or mobile homes. In these cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation. In addition, consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be affected by adverse personal circumstances. Furthermore, the application of various Federal and state laws, including bankruptcy and insolvency laws, may limit the amount that can be recovered on such loans. At December 31, 2005, $496,000 of the consumer loan portfolio was non-performing. There can be no assurance that the amount of nonperforming loans will not increase in the future.

Commercial Business Lending. In order to satisfy the demand for financial services to individuals and businesses in its market area, the Company maintains a portfolio of commercial business loans primarily to retail and manufacturing operations and professional firms. The Company’s commercial business loans generally have terms ranging from six months to five years and may have either fixed or variable interest rates. The Company’s commercial business loans generally include personal guarantees and are usually, but not always, secured by

11

business assets such as inventory, equipment, leasehold interests in equipment, fixtures, real estate and accounts receivable. The underwriting process for commercial business loans includes consideration of the borrower’s financial statements, tax returns, projections of future business operations and inspection of the subject collateral, if any. The Company also purchases participation interests in commercial business loans originated outside of the Company’s market area from third party originators. These loans generally have underlying collateral of inventory or equipment and repayment periods of less than ten years.

Unlike residential mortgage loans, which generally are made on the basis of the borrower’s ability to make repayment from his or her income, and which are secured by real property with more easily ascertainable value, commercial business loans are of higher risk and typically are made on the basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business. As a result, the availability of funds for the repayment of commercial business loans may be substantially dependent on the success of the business itself. Furthermore, the collateral securing the loans may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business. At December 31, 2005, $259,000 of loans in the commercial business loan portfolio were non-performing. There can be no assurance that the amount of nonperforming loans will not increase in the future.

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

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

The Company originates both fixed and adjustable rate loans, however, its ability to originate loans is dependent upon the relative customer demand for loans in its markets. Demand for adjustable rate loans is affected by the interest rate environment. The Company originated for its portfolio $13.1 million of one-to-four family adjustable rate loans during 2005, a decrease of $3.7 million, from $16.8 million in 2004, compared to $25.4 million in 2003. The Company also originated for its portfolio $1.6 million of fixed rate one-to-four family loans during 2005, a decrease of $4.1 million, from $5.7 million for 2004, compared to $32.2 million for 2003.

During the past several years, the Company has focused its portfolio loan origination efforts on commercial real estate, commercial business and consumer loans because these loans have terms to maturity and adjustable interest rate characteristics that are generally more beneficial to the Company than single family fixed rate conventional loans. The Company originated $286.2 million of multi-family and commercial real estate, commercial business and consumer loans (which excludes commercial real estate loans in construction or development) during 2005, an increase of $81.8 million, from originations of $204.4 million for 2004, compared to $297.0 million for 2003.

In order to supplement loan demand in the Company’s market area and geographically diversify its loan portfolio, the Company purchases participations in real estate loans from selected sellers, with yields based upon current market rates. The Company reviews and underwrites all loans purchased to ensure that they meet the Company’s underwriting standards and the seller generally continues to service the loans. The Company purchased $32.3 million of loans during 2005, a decrease of $59.5 million, from $91.8 million during 2004, compared to $102.4 million during 2003. The majority of the purchased one-to-four family loans have interest rates that are fixed for a one, three or five year period and then adjust annually thereafter. The purchased commercial real estate and commercial business loans have terms and interest rates that are similar in nature to the Company’s originated commercial and business portfolio. Refer to Note 4 of the Notes to Consolidated Financial Statements in the Annual Report for more information on purchased loans (incorporated by reference in Item 8 of Part II of this Form 10-K).

The Company has some mortgage-backed and related securities that are held, based on investment intent, in the “available for sale” portfolio. The Company did not purchase any mortgage-backed securities during 2005 or 2004 compared to the $15.1 million purchased in 2003. The Company did not sell any mortgage-backed securities during 2005 or 2004, compared to $22.3 million sold in 2003. See – “Investment Activities.”

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

LOANS HELD FOR INVESTMENT

	Year Ended December 31,
(Dollars in thousands)	2005			2004			2003
Originations by type:
Adjustable rate:
Real estate -
- one-to-four family	$	13,064			16,840			25,433
- multi-family		258			2,391			5,316
- commercial		70,742			44,046			47,647
- construction or development		45,551			84,328			50,552
Non-real estate -
- consumer		12,964			13,822			30,561
- commercial business		91,697			50,467			84,406
Total adjustable rate		234,276			211,894			243,915
Fixed rate:
Real estate -
- one-to-four family		1,587			5,738			32,181
- multi-family		35			1,418			250
- commercial		41,534			17,544			42,370
- construction or development		10,144			38,731			25,040
Non-real estate -
- consumer		27,421			28,347			38,640
- commercial business		41,535			46,414			47,841
Total fixed rate		122,256			138,192			186,322
Total loans originated		356,532			350,086			430,237
Purchases:
Real estate -
- one-to-four family		130			0			15,277
- multi-family		0			0			7,830
- commercial		16,823			4,125			43,542
- construction or development		11,900			56,798			25,365
Non-real estate -
- commercial business		3,412			30,862			10,396
Total loans purchased		32,265			91,785			102,410
Sales and repayments:
Real estate -
- commercial		23,974			2,400			18,912
- construction or development		21,646			34,800			431
Non-real estate -
- consumer		1,248			0			0
- commercial business		8,813			9,000			4,105
Total sales		55,681			46,200			23,448
Transfers to loans held for sale		7,373			(2,437	)		3,555
Principal repayments		320,869			300,407			322,103
Total reductions		383,923			344,170			349,106
Decrease in other items, net		(3,190	)		(4,776	)		(21,618	)
Net increase	$	1,684			92,925			161,923

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LOANS HELD FOR SALE

	Year Ended December 31,
(Dollars in thousands)	2005			2004			2003
Originations by type:
Adjustable rate:
Real estate -
- one-to-four family	$	1,389			851			5,302
- construction or development		0			225			0
Total adjustable rate		1,389			1,076			5,302
Fixed rate:
Real estate -
- one-to-four family		77,924			83,469			269,475
- construction or development		1,093			2,896			5,184
Total fixed rate		79,017			86,365			274,659
Total loans originated		80,406			87,441			279,961
Sales and repayments:
Real estate -
- one-to-four family		89,089			88,808			292,163
Total sales		89,089			88,808			292,163
Transfers to (from) loans held for investment		(7,373	)		2,437			(3,555	)
Total reductions		81,716			91,245			288,608
Net Decrease	$	(1,310	)		(3,804	)		(8,647	)

MORTGAGE-BACKED AND RELATED SECURITIES

	Year Ended December 31,
(Dollars in thousands)	2005			2004			2003
Purchases:
Mortgage-backed securities:
CMOs and REMICs (1)	$	0			0			15,139
Total purchases		0			0			15,139
Sales:
Mortgage-backed securities:
CMOs and REMICs		0			0			22,268
Total sales		0			0			22,268
Principal repayments		(2,271	)		(3,898	)		(31,718	)
Net decrease	$	(2,271	)		(3,898	)		(38,847	)

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

Classified Assets and Delinquencies

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

14

appropriate FDIC personnel, depending on the regulator. On the basis of management’s review of its assets, at December 31, 2005, the Bank classified a total of $8.6 million of its loans and other assets as follows:

			Commercial
	One-to-Four		and				Commercial		Other
(Dollars in thousands)	Family		Multi-family		Consumer		Business		Assets		Total
Substandard	$	626		2,884		326		3,063		1,376		8,275
Doubtful		0		0		126		0		178		304
Loss		0		0		44		0		0		44
Total	$	626		2,884		496		3,063		1,554		8,623

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

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

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

The following table sets forth the Company’s loan delinquencies by loan type, amount and percentage of type at December 31, 2005.

	Loans Delinquent For:														Total Delinquent
	60-89 Days							90 Days and Over							Loans
					Percent							Percent							Percent
					of Loan							of Loan							of Loan
(Dollars in thousands)	Number		Amount		Category			Number		Amount		Category			Number		Amount		Category
One-to-four family real estate		3	$	194		0.15	%		5	$	626		0.49	%		8	$	820		0.65	%
Consumer		26		357		0.35			14		496		0.49			40		853		0.85
Commercial business		0		0		0.00			1		5		0.00			1		5		0.00
Total		29	$	551		0.07	%		20	$	1,127		0.14	%		49	$	1,678		0.21	%

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Investment Activities

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

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

The investment strategy of the Company and the Bank has been directed toward a mix of high-quality assets (primarily government agency obligations) with short and intermediate terms to maturity. At December 31, 2005, the Company did not own any investment securities of a single issuer that exceeded 10% of the Company’s stockholder’s equity other than U.S. government agency obligations.

The Bank invests a portion of its liquid assets in interest-earning overnight deposits of the Federal Home Loan Bank of Des Moines (FHLB) and other money market mutual funds. Other investments include high grade medium-term (up to three years) federal agency notes, and a variety of other types of mutual funds that invest in adjustable rate, mortgage-backed securities, asset-backed securities, repurchase agreements and U.S. Treasury and agency obligations. The Company invests in the same type of investment securities as the Bank and also invests in taxable and tax exempt municipal obligations and corporate equities such as preferred and common stock. Refer to Note 3 of the Notes to Consolidated Financial Statements in the Annual Report for additional information regarding the Company’s securities portfolio (incorporated by reference in Item 8 of Part II of this Form 10-K).

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

	2005										2004										2003
	Amort		Adjusted			Market		% of			Amort		Adjusted			Market		% of			Amort		Adjusted			Market		% of
	Cost		To			Value		Total			Cost		To			Value		Total			Cost		To			Value		Total
Securities available for sale:
U.S. Government agency obligations	$	110,110		(971	)		109,139		71.61	%	$	91,371		(575	)		90,796		77.42	%	$	86,658		930			87,588		67.32	%
Municipal obligations		0		0			0		0.00			65		0			65		0.06			177		(7	)		170		0.13
Corporate equity (1)		700		0			700		0.46			700		0			700		0.60			700		0			700		0.54
Preferred stock of federal agencies(1)		2,940		0			2,940		1.93			2,961		0			2,961		2.52			3,500		(343	)		3,157		2.43
Subtotal		113,750					112,779		74.00			95,097					94,522		80.60			91,035					91,615		70.42
Federal Home Loan Bank stock		8,365					8,365		5.49			9,293					9,293		7.92			10,004					10,004		7.69
Total investment securities and Federal Home Loan Bank stock		122,115					121,444		79.49			104,390					103,815		88.52			101,039					101,619		78.11
Average remaining life of investment securities excluding Federal Home Loan Bank stock	0.7 years										1.5 years										1.8 years
Other interest earning assets:
Cash equivalents		31,269					31,269		20.51			13,467					13,467		11.48			28,497					28,497		21.89
Total	$	153,384					152,413		100.00	%	$	117,857					117,282		100.00	%	$	129,536					130,116		100.00	%
Average remaining life or term to repricing of investment securities and other interest earning assets, excluding Federal Home Loan Bank stock	0.5 years										1.3 years										1.4 years

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

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

	December 31, 2005
				After 1			After 5
	1 Year			through 5			through 10			Over 10			No Stated
	or Less			Years			Years			Years			Maturity			Total Securities
	Amortized			Amortized			Amortized			Amortized			Amortized			Amortized			Adjusted			Market
(Dollars in thousands)	Cost			Cost			Cost			Cost			Cost			Cost			To			Value
Securities available for sale:
U.S. government agency securities	$	100,114			9,996			0			0			0			110,110			(971	)		109,139
Corporate equity		0			0			0			0			700			700			0			700
Preferred stock of federal agencies		0			0			0			0			2,940			2,940			0			2,940
Total stock	$	100,114			9,996			0			0			3,640			113,750			(971	)		112,779
Weighted average yield (1)		3.22	%		3.08	%		0.00	%		0.00	%		4.69	%		3.25	%

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

Mortgage-Backed and Related Securities. In order to supplement loan production and achieve its asset/liability management goals, the Company invests in mortgage-backed and related securities. All of the mortgage-backed and related securities owned by the Company are issued, insured or guaranteed either directly or indirectly by a federal agency or are rated “AA” or higher. The Company had $6.9 million of mortgage-backed and related securities classified as available for sale at December 31, 2005, compared to $9.2 million at December 31, 2004 and $13.0 million at December 31, 2003.

The contractual maturities of the mortgage-backed and related securities portfolio without any prepayment assumptions at December 31, 2005 are as follows:

													Dec. 31,
													2005
	5 Years			5 to 10			10 to 20			Over 20			Balance
(Dollars in thousands)	or Less			Years			Years			Years			Outstanding
Securities available for sale:
Federal Home Loan Mortgage Corporation	$	44			157			0			0			201
Government National Mortgage Association		0			0			15			0			15
Collateralized Mortgage Obligations		140			0			3,730			2,794			6,664
Total	$	184			157			3,745			2,794			6,880
Weighted average yield		6.67	%		6.50	%		3.70	%		4.00	%		3.96	%

At December 31, 2005, the Company did not have any non-agency mortgage-backed or related securities in excess of 10% of its stockholders’ equity.

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

At December 31, 2005, the Company had $34,000 invested in CMOs that have floating interest rates that change either monthly or quarterly, compared to $52,000 at December 31, 2004 and $84,000 at December 31, 2003.

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

Sources of Funds

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

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

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

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

	Year Ended December 31,
(Dollars in thousands)	2005			2004			2003
Opening balance	$	698,902			551,688			432,951
Deposits		4,202,022			3,750,395			2,498,532
Withdrawals		(4,185,251	)		(3,613,887	)		(2,388,783	)
Interest credited		15,864			10,706			8,988
Ending balance		731,537			698,902			551,688
Net increase	$	32,635			147,214			118,737
Percent increase		4.67	%		26.68	%		27.43	%

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

	2005					2004					2003
			Percent					Percent					Percent
(Dollars in thousands)	Amount		of Total			Amount		of Total			Amount		of Total
Transaction and Savings Deposits(1):
Non-interest checking	$	58,430		7.99	%	$	42,777		6.12	%	$	37,629		6.82	%
NOW Accounts - 2.08%(2)		101,942		13.94			95,294		13.63			61,271		11.11
Passbook Accounts - 2.04%(3)		84,858		11.60			47,416		6.78			35,883		6.50
Money Market Accounts - 2.59%(4)		96,947		13.25			129,098		18.47			91,315		16.57
Total Non-Certificates	$	342,177		46.78	%	$	314,585		45.00	%	$	226,098		41.00	%
Certificates:
0.00 - 0.99%	$	651		0.09	%	$	883		0.13	%	$	1,525		0.28	%
1.00 - 1.99%		5,846		0.80			62,833		8.99			55,629		10.08
2.00 - 2.99%		118,723		16.23			160,829		23.01			103,450		18.75
3.00 - 3.99%		211,019		28.84			108,938		15.59			71,691		12.99
4.00 - 4.99%		52,319		7.15			49,449		7.08			76,315		13.83
5.00 - 5.99%		797		0.11			1,266		0.20			16,621		3.01
6.00 - 6.99%		5		0.00			5		0.00			246		0.04
7.00 - 7.99%		0		0.00			114		0.00			113		0.02
Total Certificates		389,360		53.22			384,317		55.00			325,590		59.00
Total Deposits	$	731,537		100.00	%	$	698,902		100.00	%	$	551,688		100.00	%

(1)	Reflects rates paid on transaction and savings deposits at December 31, 2005.
(2)	The rate on NOW Accounts for 2004 was 1.09% and 2003 was 0.39%.
(3)	The rate on Passbook Accounts for 2004 was 0.19% and 2003 was 0.20%.
(4)	The rate on Money Market Accounts for 2004 was 1.72% and 2003 was 1.23%.

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The following table shows rate and maturity information for the Bank’s certificates of deposit as of December 31, 2005.

	0.00-			1.00-			2.00-			3.00-			4.00-			5.00-			6.00-						Percent
(Dollars in thousands)	0.99%			1.99%			2.99%			3.99%			4.99%			5.99%			6.99%			Total			of Total
Certificate accounts maturing in quarter ending:
March 31, 2006	$	109			3,217			31,573			10,882			1,592			126			0			47,499			12.20
June 30, 2006		51			1,696			16,423			35,015			1,289			353			0			54,827			14.08
September 30, 2006		39			582			6,857			26,797			2,010			8			5			36,298			9.32
December 31, 2006		71			189			35,439			16,110			8,812			0			0			60,621			15.57
March 31, 2007		27			124			5,225			33,473			11,933			94			0			50,876			13.07
June 30, 2007		25			11			5,384			26,573			5,123			17			0			37,133			9.54
September 30, 2007		37			25			6,591			21,781			7,612			0			0			36,046			9.26
December 31, 2007		53			0			2,133			10,648			1,526			135			0			14,495			3.72
March 31, 2008		15			0			898			3,642			427			0			0			4,982			1.28
June 30, 2008		13			0			736			5,384			1,248			0			0			7,381			1.90
September 30, 2008		7			0			1,589			7,136			1,255			0			0			9,987			2.56
December 31, 2008		11			0			1,600			8,217			1,574			60			0			11,462			2.94
Thereafter		193			2			4,275			5,361			7,918			4			0			17,753			4.56
Total	$	651			5,846			118,723			211,019			52,319			797			5			389,360			100.00	%
Percent of total		0.17	%		1.50	%		30.49	%		54.20	%		13.44	%		0.20	%		0.00	%		100.00	%

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     The following table indicates the amount of the Bank’s certificates of deposit and other deposits by time remaining until maturity as of December 31, 2005.

	Maturity
			Over		Over		Over
	3 Months		3 to 6		6 to 12		12
(Dollars in thousands)	or Less		Months		Months		Months		Total
Certificates of deposit less than $100,000	$	17,741		25,960		45,299		89,465		178,465
Certificates of deposit of $100,000 or more		27,603		28,279		49,369		97,258		202,509
Public funds less than $100,000(1)		73		88		151		46		358
Public funds of $100,000 or more(1)		2,082		500		2,100		3,346		8,028
Total certificates of deposit	$	47,499		54,827		96,919		190,115		389,360
Passbook of $100,000 or more	$	54,260		0		0		0		54,260
Accounts of $100,000 or more	$	83,945		28,779		51,469		100,604		264,797

⁽¹⁾ Deposits from governmental and other public entities.

For additional information regarding the composition of the Bank’s deposits, see Note 12 of the Notes to Consolidated Financial Statements in the Annual Report (incorporated by reference in Item 8 of Part II of this Form 10-K). For additional information on certificate maturities and the impact on the Company’s liquidity see “Management’s Discussion and Analysis of Financial Condition and Results of Operations -Liquidity and Capital Resources” of the Annual Report (incorporated by reference in Item 7 of Part II of this Form 10-K).

Borrowings. The Bank’s other available sources of funds include advances from the FHLB and other borrowings. As a member of the FHLB, the Bank is required to own capital stock in the FHLB and is authorized to apply for advances. Each FHLB credit program has its own interest rate, which may be fixed or variable, and range of maturities. The FHLB may prescribe the acceptable uses for these advances, as well as limitations on the size of the advances and repayment provisions. Consistent with its asset/liability management strategy, the Bank has utilized FHLB advances from time to time to fund loan demand and extend the term to maturity of its liabilities. The Bank also uses short-term FHLB borrowings to offset short term cash needs due to deposit outflows or loan fundings. At December 31, 2005, the Bank had $160.9 million of FHLB advances outstanding. On such date, the Bank had a collateral pledge arrangement with the FHLB of Des Moines pursuant to which the Bank may borrow up to an additional $29.9 million for liquidity purposes. Refer to Note 13 of the Notes to Consolidated Financial Statements in the Annual Report for more information on FHLB advances (incorporated by reference in Item 8 of Part II of this Form 10-K).

The Company had a $5.0 million revolving line of credit established with a bank that was not drawn at December 31, 2005.

Service Corporations of the Bank

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

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

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The Bank owned a 51% interest in HFMS, a Delaware limited liability company, which was formed in 2001 to operate a mortgage banking and mortgage brokerage business in Brooklyn Park, Minnesota. HFMS’s brokerage and production activity stopped in the third quarter of 2002, its assets were liquidated in 2003, and it was dissolved.

HFH was a wholly owned Delaware corporation that was formed in 2002, and had its principal office in Grand Cayman Islands. HFH was the holding company for HFREIT which invested in real estate loans acquired from the Bank. HFH and HFREIT were both dissolved in 2005.

The Bank owned an 80% interest in FTS, a Minnesota limited liability company formed in 2003 to operate a mortgage title services business located in Minnetonka, Minnesota. FTS stopped accepting title orders in the third quarter of 2004 and was dissolved.

Competition

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

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

Other Corporations Owned by the Company

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

Employees

At December 31, 2005 the Company had a total of 224 employees, including part-time employees. None of the employees of the Company or its subsidiaries are represented by any collective bargaining unit. Management considers its employee relations to be good.

Regulation and Supervision

The banking industry is highly regulated. As a savings and loan holding company, the Company is subject to regulation by the Office of Thrift Supervision (OTS). The Bank, a federally-chartered savings association, is subject to extensive regulation and examination by the OTS, which is the Bank’s primary federal regulator. The FDIC also has some authority to regulate the Bank. Subsidiaries of the Company and the Bank may also be subject to state regulation and/or licensing in connection with certain insurance and investment activities. The Company and the Bank are subject to numerous laws and regulations. These laws and regulations impose restrictions on activities, set minimum capital requirements, impose lending and deposit restrictions and establish other restrictions. References in this section to applicable statutes and regulations are brief and incomplete

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summaries only. You should consult the statutes and regulations for a full understanding of the details of their operation. Changes in statutes, regulation or regulatory policies applicable to the Bank or the Company, including interpretation or implementation thereof, could have a material effect on the Company’s business.

Holding Company Regulation

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

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

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

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

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

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

Bank Regulation

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

OTS regulations place limits on the Bank’s lending and investment powers. Savings associations are expected to conduct lending activities in a prudent, safe and sound manner. OTS regulations set aggregate limits on certain

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types of loans including commercial, commercial real estate, and consumer loans. OTS regulations also establish limits on loans to a single borrower. As of December 31, 2005, the Bank’s lending limit to one borrower was approximately $13.2 million. A federal savings association generally may not invest in noninvestment-grade debt securities. A federal savings association may establish subsidiaries to conduct any activity the association is authorized to conduct and may establish service corporation subsidiaries for limited preapproved activities.

Qualified Thrift Lender Test. Savings associations, including the Bank, must be qualified thrift lenders (QTLs). A savings association generally satisfies the QTL requirement if at least 65% of a specified asset base consists of things such as loans to small businesses and loans to purchase or improve domestic residential real estate. Savings associations may qualify as QTLs in other ways. Savings associations that do not qualify as QTLs are subject to significant restrictions on their operations. If the Bank fails to meet QTL requirements the Bank and HMN would face certain limitations, including limits on HMN’s ability to control non-financial firms. As of December 31, 2005, the Bank met the QTL test.

OTS Assessments. HOLA authorizes the OTS to charge assessments to recover the costs of examining savings associations, holding companies, and their affiliates. The assessment is done semi-annually. The OTS bases the assessment on three factors: 1) asset size; 2) condition; and 3) complexity of the institution. The Bank’s and Holding Company’s OTS assessments for the year ended December 31, 2005, were approximately $207,000.

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

Dividend Restrictions. Federal law limits the ability of a depository institution, such as the Bank, to pay dividends or make other capital distributions. The Bank, as a subsidiary of a savings and loan holding company, must file a notice with the OTS before payment of a dividend or approval of a proposed capital distribution by its board of directors and must obtain prior approval from the OTS if it fails to meet certain regulatory conditions. The Bank declared and distributed dividends to HMN of $4.0 million in 2005.

Deposit Insurance

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

The FDIC has established a risk-based system for setting deposit insurance assessments. Under the risk-based assessment system, an institution’s insurance assessments vary according to the level of capital the institution holds and the degree to which it is the subject of supervisory concern. In addition, regardless of the potential risk to the insurance fund, federal law requires the FDIC to establish assessment rates that will maintain each insurance fund’s ratio of reserves to insured deposits at $1.25 per $100. Both funds currently exceed this reserve ratio. During 2005, the assessment rate for both SAIF and BIF deposits ranged from zero to 0.27% of covered deposits. The Bank qualified for the lowest rate on SAIF deposits and thus paid $0 in 2005. It is possible that the

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reserve ratio will fall below 1.25% and accordingly, it is possible the Bank will have to pay deposit insurance assessments in 2006 or subsequent years.

In addition to deposit insurance assessments, the FDIC is authorized to collect assessments against insured deposits to be paid to the Financing Corporation (FICO) to service FICO debt incurred in the 1980s. The FICO assessment rate is adjusted quarterly. In 2005 the Bank paid an assessment of approximately $97,000.

Capital Requirements

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

The following table sets forth the current regulatory requirement for capital ratios for savings associations as compared with the Bank’s capital ratios at December 31, 2005:

	Core or Tier 1 Capital to			Tangible			Core or Tier 1			Total Capital to
	Adjusted			Capital to			Capital to Risk-			Risk-Weighted
	Total Assets			Assets			Weighted Assets			Assets
Regulatory Minimum		3.00%	(1)		1.50	%		4.00	%		8.00	%
The Bank’s Actual		8.18%			8.18	%		10.02	%		11.09	%

⁽¹⁾ Savings associations are required to maintain a leverage ratio of 4.00% or more to be considered adequately capitalized.

Capital Categories and Prompt Corrective Action

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

Other Regulations and Examination Authority

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

26

(including claims of the FDIC as subrogee of the insured institution) shall have priority over the claims of general unsecured creditors.

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

Federal Home Loan Bank (FHLB) System

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

As a member, the Bank is required to purchase and maintain stock in the FHLB of Des Moines. As of December 31, 2005, the Bank had $8.4 million in FHB stock, which was in compliance with this requirement. The Bank receives dividends on its FHB stock and over the past five calendar years dividends have averaged approximately 3.15% and averaged 2.84% in 2005.

Federal Reserve Regulation

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

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

Community Reinvestment Act

The Community Reinvestment Act (CRA) requires financial institutions regulated by the federal financial supervisory agencies to ascertain and help meet the credit needs of their delineated communities, including low-to moderate-income neighborhoods within those communities, while maintaining safe and sound banking practices. The regulatory agency assigns one of four possible ratings to an institution’s CRA performance and is required to make public an institution’s rating and written evaluation. The four possible ratings of meeting community credit needs are outstanding, satisfactory, needs improvement and substantial noncompliance. Under regulations that apply to all CRA performance evaluations after July 1, 1997, many factors play a role in assessing a financial institution’s CRA performance. The institution’s regulator must consider its financial capacity and size, legal impediments, local economic conditions and demographics, including the competitive environment in which it

27

operates. The evaluation does not rely on absolute standards, and the institutions are not required to perform specific activities or to provide specific amounts or types of credit. The Bank maintains a CRA statement for public viewing, as well as an annual CRA highlights document. These documents describe the Bank’s credit programs and services, community outreach activities, public comments and other efforts to meet community credit needs. The Bank’s last CRA exam was September 28, 2004 and the Bank received a “Satisfactory” rating.

Bank Secrecy Act

The Bank Secrecy Act (BSA) requires financial institutions to verify the identity of customers, keep records and file reports that are determined to have a high degree of usefulness in criminal, tax and regulatory matters, and to implement counter-money laundering programs and compliance procedures. The impact on Bank operations from the BSA depends on the types of customers served by the Bank.

Executive Officers

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

Michael McNeil, age 58. Mr. McNeil has been a director of the Company since 1999, the President of the Company since 2000 and the Chief Executive Officer of the Company since 2004. Mr. McNeil has been the President and Chief Executive Officer of the Bank since 1999 and a director of the Bank since 1998. From April 1998 through December 1998, Mr. McNeil was the Senior Vice President of Business Development of the Bank. Prior to joining the Bank, Mr. McNeil was the President and a director of Stearns Bank, N.A. in St. Cloud, Minnesota from 1991 until March 1998.

Jon J. Eberle, age 40. Mr. Eberle is Chief Financial Officer, Senior Vice President and Treasurer of the Company and the Bank. Mr. Eberle has held such positions since 2003. Prior to that he served as a Vice President since 2000 and as the Controller since 1998. From 1994 to 1998, he served as the Director of Internal Audit for the Company and the Bank.

Dwain C. Jorgensen, age 57. Mr. Jorgensen has served as Senior Vice President of Operations of the Company and the Bank since 1998. From 1989 to 1998, he served as Vice President, Controller and Chief Accounting Officer of the Company and the Bank. From 1983 to 1989, Mr. Jorgensen was an Assistant Vice President and Operations Officer for the Bank.

Susan K. Kolling, age 54. Ms. Kolling has been a director of the Company since 2001. Ms. Kolling served as a Vice President of the Bank from 1992 to 1994 and has served as a Senior Vice President of the Bank since 1995. In addition, from 1997 to 2003, Ms. Kolling was an owner of Kolling Family Corp. which is doing business as Valley Home Improvement, a retail lumber yard. Ms. Kolling became a director of Kolling Family Corp. in 2004.

Bradley C. Krehbiel, age 47. Mr. Krehbiel is Executive Vice President of the Bank, a position he has held since 2004. Mr. Krehbiel joined the Bank as Vice President of Business Banking in 1998. Prior to his employment at the Bank, Mr. Krehbiel held several positions in the financial services industry, including six years as a private banking consultant.

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Available Information

The Company’s website is www.hmnf.com. The Company makes available, free of charge, through its website its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) of the Securities Exchange Act of 1934, as soon as reasonably practicable after it electronically files these materials with, or furnishes them to, the Securities and Exchange Commission (the SEC).

Members of the public may read and copy any materials the Company files with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. Information on the operation of the Public Reference Room is available by calling the SEC at 1-800-SEC-0330. The SEC maintains a website that contains reports, proxy and information statements and other information about us and other issuers that file electronically at www.sec.gov.

ITEM 1A. RISK FACTORS

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

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

The earnings of the Company are primarily dependent on net interest income, which is the difference between interest earned on loans and investments, and interest paid on interest-bearing liabilities such as deposits and borrowings. Interest rates are highly sensitive to many factors, including government monetary and fiscal policies and domestic and international economic and political conditions. Conditions such as inflation, recession, unemployment, money supply, government borrowing and other factors beyond management’s control may also affect interest rates. If the Company’s interest-earning assets mature, reprice or prepay more quickly than interest-bearing liabilities in a given period, a decrease in market interest rates could adversely affect net interest income. Likewise, if interest-bearing liabilities mature or reprice, or, in the case of deposits, are withdrawn by the accountholder, more quickly than interest-earning assets in a given period, an increase in market interest rates could adversely affect net interest income. Given the Company’s current mix of assets and liabilities, a declining interest rate environment would negatively impact the Company’s results of operations.

Fixed rate loans increase the Company’s exposure to interest rate risk in a rising rate environment because interest-bearing liabilities would be subject to repricing before assets become subject to repricing. Adjustable rate loans decrease the risks to a lender associated with changes in interest rates but involve other risks. As interest rates rise, the payment by the borrower rises to the extent permitted by the terms of the loan, and the increased payment increases the potential for default. At the same time, for secured loans, the marketability of the underlying collateral may be adversely affected by higher interest rates. In a declining interest rate environment, there is likely to be an increase in prepayment activity on loans as the borrowers refinance their loans at lower interest rates. Under these circumstances, the Company’s results of operations could be negatively impacted.

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

29

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

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

Regional economic changes in the Company’s markets could adversely impact results from operations.

Like all banks, the Company is subject to the effects of any economic downturn, and in particular a significant decline in home values or reduced commercial development in the Company’s markets could have a negative effect on results of operations. The Company’s success depends primarily on the general economic conditions in the counties in which the Company conducts business, and in the southern Minnesota and northern Iowa area in general. Unlike larger banks that are more geographically diversified, the Company provides banking and financial services to customers primarily in the southern Minnesota counties of Fillmore, Freeborn, Houston, Mower, Olmsted and Winona and portions of Steele, Dodge, Goodhue and Wabasha counties, as well as Marshall and Tama counties in Iowa. The local economic conditions in these market areas have a significant impact on the Company’s ability to originate loans, the ability of the borrowers to repay these loans and the value of the collateral securing these loans. A significant decline in the general economic conditions caused by inflation, recession, unemployment or other factors beyond the Company’s control would affect these local economic conditions and could adversely affect the Company’s financial condition and results of operations. Additionally, because the Company has a significant amount of commercial real estate loans, decreases in tenant occupancy may also have a negative effect on the ability of many of the Company’s borrowers to make timely repayments of their loans, which would have an adverse impact on the Company’s earnings. A significant decline in home values would likely lead to increased delinquencies and defaults in both the consumer home equity loan and residential real estate loan portfolios and result in increased losses in these portfolios.

New or revised tax, accounting and other laws, regulations, rules and standards could significantly impact strategic initiatives, results of operations and financial condition.

The financial services industry is highly regulated and laws and regulations may sometimes impose significant limitations on operations. These limitations, and sources of potential liability for the violation of such laws and regulations, are described in Item 1 of Part I of this report under the heading “Business — Regulation and Supervision.” These regulations, along with the currently existing tax and accounting laws, regulations, rules and standards, control the methods by which financial institutions conduct business; implement strategic initiatives, as well as past, present, and contemplated tax planning; and govern financial disclosures. These laws, regulations, rules, and standards are constantly evolving and may change significantly over time. The nature, extent, and timing of the adoption of significant new laws, changes in existing laws, or repeal of existing laws may have a material impact on the Company’s results of operations and financial condition, the effects of which are impossible to predict at this time.

The extended disruption of vital infrastructure could negatively impact the Company’s results of operations and financial condition.

The Company’s operations depend upon, among other things, its technological and physical infrastructure, including its equipment and facilities. Extended disruption of its vital infrastructure by fire, power loss, natural disaster, telecommunications failure, computer hacking and viruses, terrorist activity or the domestic and foreign

30

response to such activity, or other events outside of the Company’s control, could have a material adverse impact either on the financial services industry as a whole, or on the Company’s business, results of operations, and financial condition.

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

The Company faces significant competition both in attracting deposits and in the origination of loans, as described under the heading “Business — Competition.” Mortgage bankers, commercial banks, credit unions and other savings institutions, which have offices in the Bank’s market area have historically provided most of the Company’s competition for deposits; however, the Company also competes with financial institutions that operate through Internet banking operations throughout the continental United States. In addition, and particularly in times of high interest rates, the Company faces additional and significant competition for funds from money market and mutual funds, securities firms, commercial banks, credit unions and other savings institutions located in the same communities and those that operate through Internet banking operations throughout the continental United States. Many competitors have substantially greater financial and other resources than the Company. Moreover, the Company may face increased competition in the origination of loans if competing thrift institutions convert to stock form, because such converting thrifts would likely seek to invest their new capital into loans. Finally, credit unions do not pay federal or state income taxes and are subject to fewer regulatory constraints than savings banks and as a result, they may enjoy a competitive advantage over the Company. The Bank competes for loans principally on the basis of the interest rates and loan fees it charges, the types of loans it originates and the quality of services it provides to borrowers. This advantage places significant competitive pressure on the prices of loans and deposits.

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

The Company has a number of large deposit customers that maintain balances in checking and money market accounts at the Bank. The ability to attract these types of deposits has a positive effect on the Company’s net interest margin as they provide a relatively low cost of funds to the Company compared to certificates of deposits or advances. If these depositors were to withdraw these funds and the Bank were not able to replace them with similar types of deposits, the Banks cost of funds would increase and the Company’s results of operation would be negatively impacted.

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

31

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

ITEM 2. PROPERTIES

The Company leases the corporate office at 1016 Civic Center Drive NW, Rochester, Minnesota and owns the buildings and land for 9 of its 11 full service branches. The remaining two full service branches are leased, as well as the Eagle Crest Capital Bank locations at 5201 Eden Avenue, Suite 170, Edina, Minnesota and 1016 Civic Center Drive NW, Rochester, Minnesota. The Bank uses all properties and they are all located in Minnesota, except for two full service branches located in Iowa.

ITEM 3. LEGAL PROCEEDINGS

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

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

None.

PART II

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

The information on page 19 under the caption “Dividends”, page 38 in paragraphs 1, 2, 3, 5 and 6 under the caption “Note 18 Stockholders’ Equity”, and page 48 under the caption “Common Stock Information” and the back cover page of the Annual Report to Security Holders for the year ended December 31, 2005 is incorporated herein by reference.

Set forth below is information concerning purchases of the Company’s common stock made by or on behalf of the Company during the year ended December 31, 2005:

							(d) Maximum Number
							(or Approximate
					(c) Total Number of		Dollar Value) of
					Shares (or Units)		Shares (or Units)
	(a) Total Number of		(b) Average Price		Purchased as Part of		that May Yet Be
	Shares (or Units)		Paid per Share (or		Publicly Announced Plans		Purchased Under the
Period	Purchased		Unit)		or Programs		Plans or Programs
October 1 through October 31, 2005		0		0		0		197,000
November 1 through November 30, 2005		0		0		0		197,000
December 1 through December 31, 2005		0		0		0		197,000
Total		0	$	0		0

ITEM 6. SELECTED FINANCIAL DATA

The information on page 5 under the caption “Five Year Consolidated Financial Highlights” of the Annual Report to Security Holders for the year ended December 31, 2005 is incorporated herein by reference.

32

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

The information on pages 6 through 21 under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, other than the section captioned “Market Risk”, of the Annual Report to Security Holders for the year ended December 31, 2005 is incorporated herein by reference.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

The information on pages 19 through 21under the captions “Market Risk” and “Asset/Liability Management” of the Annual Report to Security Holders for the year ended December 31, 2005 is incorporated herein by reference.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The financial statements (including the notes to the financial statements) on pages 22 through 48, other than the sections captioned “Other Financial Data” and “Common Stock Information”, of the Annual Report to Security Holders for the year ended December 31, 2005 is incorporated herein by reference.

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

None.

ITEM 9A. CONTROLS AND PROCEDURES

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

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

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

33

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

Under the supervision and with the participation of management, including the principal executive officer and principal financial officer, the Company conducted an evaluation of the effectiveness of its internal control over financial reporting based on the framework in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on the Company’s evaluation under this framework, the Company’s management concluded that the Company’s internal control over financial reporting was effective as of December 31, 2005.

Attestation Report of the Registered Public Accounting Firm. Management’s assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2005 has been audited by KPMG LLP, an independent registered public accounting firm, as stated in their report that follows:

Report of Independent Registered Public Accounting Firm

The Board of Directors
HMN Financial, Inc.:

We have audited management’s assessment, included in the accompanying Management Report, that HMN Financial, Inc. maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). HMN Financial, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.

We conducted our audit 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 effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

34

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, management’s assessment that HMN Financial, Inc. maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, HMN Financial, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of HMN Financial Inc. and subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of income, stockholders’ equity and comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 2005, and our report dated March 1, 2006 expressed an unqualified opinion on those consolidated financial statements.

KPMG LLP

Minneapolis, Minnesota
March 1, 2006

Changes in internal controls. No change in the Company’s internal control over financial reporting was identified in connection with the evaluation required by Rule 13a-15(d) of the Exchange Act that occurred during the period covered by this report and that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

ITEM 9B. OTHER INFORMATION

None.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The information required by this Item is incorporated by reference from the information under the caption “Executive Officers” in Item 1 of this report and under the captions “Director Nominees,” “Directors continuing in office after Annual Meeting,” “Directors Emeritus,” “Board Meetings and Committees” (excluding any information not related to the audit committee) and “Section 16(a) Beneficial Ownership Reporting Compliance” in the Company’s definitive proxy statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the close of the Company’s fiscal year ended December 31, 2005.

The Company has adopted a Code of Ethics that applies to its principal executive officer, principal financial and accounting officer, controller and other persons performing similar functions. The Company has posted the Code

35

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

ITEM 11. EXECUTIVE COMPENSATION

The information required by this Item is incorporated by reference from the information under the caption “Executive Compensation” (excluding information under caption “Compensation Committee Report on Executive Compensation” and “Stockholder Return Performance Presentation”), “Compensation Committee Interlocks and Insider Participation” and “Director Compensation” in the Company’s definitive proxy statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the close of the Company’s fiscal year ended December 31, 2005.

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

The information required by this Item is incorporated by reference from the information under the captions “Security Ownership of Management and Certain Beneficial Owners” in the Company’s definitive proxy statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the close of the Company’s fiscal year ended December 31, 2005.

The following table provides information as of December 31, 2005 for compensation plans under which equity securities may be issued.

	(a)		(b)		(c)
	Number of Securities to be		Weighted-average		Number of securities remaining
	issued upon exercise of		exercise price of		available for future issuance under
	outstanding options,		outstanding options,		equity compensation plans (excluding
Plan Category	warrants and rights		warrants and rights		securities reflected in column (a)) (1)
Equity compensation plans approved by stockholders		359,395	$	16.47		164,605
Equity compensation plans not approved by stockholders		0		0		0
Total		359,395	$	16.47		164,605

⁽¹⁾ Includes securities available for future issuance under stockholder approved compensation plans other than upon the exercise of an option, warrant or right, as follows: 164,605 shares under the Company’s 2001 Omnibus Stock Plan.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information required by this Item is incorporated by reference from the information under the captions “Certain Transactions” in the Company’s definitive proxy statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the close of the Company’s fiscal year ended December 31, 2005.

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

The information required by this Item is incorporated by reference from the information under the caption “Independent Auditor Fees” in the Company’s definitive proxy statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the close of the Company’s fiscal year ended December 31, 2005.

36

PART IV

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

1. Financial Statements

The following financial statements appearing in the Company’s Annual Report to Security Holders for the year ended December 31, 2005, are incorporated herein by reference.

	Pages in
	2005 Annual Report
Annual Report Section
Consolidated Balance Sheets —
December 31, 2005 and 2004	22
Consolidated Statements of Income — Each of the Years in the Three-Year Period Ended December 31, 2005	23
Consolidated Statements of Stockholders’ Equity and Comprehensive Income — Each of the Years in the Three-Year Period Ended December 31, 2005	24
Consolidated Statements of Cash Flows — Each of the Years in the Three-Year Period Ended December 31, 2005	25
Notes to Consolidated Financial Statements	26
Report of Independent Registered Public Accounting Firm	45

2. Financial Statement Schedules

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

37

3. Exhibits

Exhibit Number	Exhibit
3.1	Amended and Restated Certificate of Incorporation (1)
3.2	Amended and Restated By-laws (2)
4	Form of Common Stock Certificate (3)
10.1†	Change in Control Agreement with Michael McNeil dated as of March 1, 2004(4)
10.2†	Employment Agreement with Michael McNeil dated as of January 1, 2002 (5)
10.3†	Form of Change in Control Agreement with executive officers (6)
10.4†	Directors Deferred Compensation Plan (7)
10.5†	Amended and Restated HMN Financial, Inc. Stock Option and Incentive Plan dated July 29, 1998 (8)
10.6†	HMN Financial, Inc. 2001 Omnibus Stock Plan (9)
10.7†	Form of Incentive Stock Option Agreement for HMN Financial, Inc. 2001 Omnibus Stock (10)
10.8†	Form of Non-Statutory Stock Option Agreement for HMN Financial, Inc. 2001 Omnibus Stock (11)
10.9†	Form of Restricted Stock Agreement for HMN Financial, Inc. 2001 Omnibus Stock (12)
10.10†	Description of Michael McNeil 2006 Bonus Plan (13)
10.11†	2006 Officer Base Salaries(14)
13	Portions of Annual Report to Security Holders incorporated by reference*
14	Code of Business Conduct and Ethics(15)
21	Subsidiaries of Registrant*
23	Consent of KPMG LLP*
24	Powers of Attorney (included with signatures to this Annual Report on Form 10-K)*
31.1	Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer*
31.2	Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer*
32	Section 1350 Certifications*

†	Management contract or compensatory arrangement
*	Filed herewith
1	Incorporated by reference to Exhibit 3(a) to the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 1998 (File No. 0-24100).
2	Incorporated by reference to Exhibit 3 to the Company’s Current Report on Form 8-K dated February 22, 2005, filed on February 23, 2005 (File No. 0-24100).
3	Incorporated by reference to the same numbered exhibit to the Company’s Registration Statement on Form S-1 dated April 1, 1994 (File No. 33-77212).
4	Incorporated by reference to Exhibit 10.1 to the Company’s Annual Report on Form 10-K for the period ending December 31, 2004 (File No. 0-24100).
5	Incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2002 (File No. 0-24100).

38

6	Incorporated by reference to Exhibit 10 to the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2004 (File No. 0-24100).
7	Incorporated by reference to the same numbered exhibit to the Company’s Annual Report on Form 10-K for the period ended December 31, 1994 (File No. 0-24100).
8	Incorporated by reference to Exhibit 10.1(b) to the Company’s Quarterly Report on Form 10-Q for the period ended September 30, 1998 (File No. 0-24100).
9	Incorporated by reference to Exhibit B to the Company’s Proxy Statement for its Annual Meeting of Stockholders held on April 24, 2001 (File no. 0-24100).
10	Incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the period ended September 30, 2004 (File No. 0-24100).
11	Incorporated by reference to Exhibit 10.3 to the Company’s Quarterly Report on Form 10-Q for the period ended September 30, 2004 (File No. 0-24100).
12	Incorporated by reference to Exhibit 10.3 to the Company’s Current Report on Form 8-K dated January 24, 2005, filed on January 28, 2005 (File No. 0-24100).
13	Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K dated January 23, 2006, filed on January 27, 2006 (File No. 0-24100).
14	Incorporated by reference to the Company’s Current Report on Form 8-K dated January 23, 2006, filed on January 27, 2006 (File No. 0-24100).
15	Incorporated by reference to Exhibit 14 to the Company’s Quarterly Report on Form 10-Q for the period ended September 30, 2005 (File No. 0-24100).

39

SIGNATURES

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

	HMN FINANCIAL, INC.
Date: March 1, 2006	By:	/s/ Michael McNeil
		Michael McNeil,
		President and Chief Executive Officer

     Each of the undersigned hereby appoints Michael McNeil and Jon J. Eberle, and each of them (with full power to act alone), as attorneys and agents for the undersigned, with full power of substitution, for and in the name, place and stead of the undersigned, to sign and file with the Securities and Exchange Commission under the Securities Act of 1934, as amended, any and all amendments and exhibits to this Annual Report on Form 10-K and any and all applications, instruments, and other documents to be filed with the Securities and Exchange Commission pertaining to this Annual Report on Form 10-K or any amendments thereto, with full power and authority to do and perform any and all acts and things whatsoever requisite and necessary or desirable. Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities indicated on March 1, 2006.

Name	Title
/s/ Michael McNeil      Michael McNeil	President, Chief Executive Officer and Director (Principal Executive Officer)
/s/ Jon J. Eberle      Jon J. Eberle	Senior Vice President, Chief Financial Officer and Treasurer (Principal Financial and Accounting Officer)
/s/ Timothy R. Geisler      Timothy R. Geisler	Chairman of the Board
/s/ Allan R. DeBoer      Allan R. DeBoer	Director
/s/ Duane D. Benson      Duane D. Benson	Director
/s/ Michael J. Fogarty      Michael J. Fogarty	Director
/s/ Karen L. Himle      Karen L. Himle	Director
/s/ Susan K. Kolling      Susan K. Kolling	Director
/s/ Malcolm W. McDonald      Malcolm W. McDonald	Director
/s/ Mahlon C. Schneider      Mahlon C. Schneider	Director

40

INDEX TO EXHIBITS

Exhibit
Number	Exhibit	Filing Status
3.1	Amended and Restated Certificate of Incorporation	Incorporated by Reference
3.2	Amended and Restated By-laws	Incorporated by Reference
4	Form of Common Stock Certificate	Incorporated by Reference
10.1	Change in Control Agreement with Michael McNeil dated as of March 1, 2004	Incorporated by Reference
10.2	Employment Agreement with Michael McNeil dated as of January 1, 2002	Incorporated by Reference
10.3	Form of Change in Control Agreement with executive officers	Incorporated by Reference
10.4	Directors Deferred Compensation Plan	Incorporated by Reference
10.5	Amended and Restated HMN Financial, Inc. Stock Option and Incentive Plan dated July 29, 1998	Incorporated by Reference
10.6	HMN Financial, Inc. 2001 Omnibus Stock Plan	Incorporated by Reference
10.7	Form of Incentive Stock Option Agreement for HMN Financial, Inc. 2001 Omnibus Stock	Incorporated by Reference
10.8	Form of Non-Statutory Stock Option Agreement for HMN Financial, Inc. 2001 Omnibus Stock	Incorporated by Reference
10.9	Form of Restricted Stock Agreement for HMN Financial, Inc. 2001 Omnibus Stock	Incorporated by Reference
10.10	Description of Michael McNeil 2006 Bonus Plan	Incorporated by Reference
10.11	2006 Officer Base Salaries	Incorporated by Reference
13	Portions of Annual Report to Security Holders incorporated by reference	Filed Electronically
14	Code of Business Conduct and Ethics	Incorporated by Reference
21	Subsidiaries of Registrant	Filed Electronically
23	Consent of KPMG LLP	Filed Electronically
24	Powers of Attorney	Included with Signatures
31.1	Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer	Filed Electronically
31.2	Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer	Filed Electronically
32	Section 1350 Certifications	Filed Electronically

41

EX-13

FIVE — YEAR CONSOLIDATED FINANCIAL HIGHLIGHTS

Selected Operations Data:

	Year Ended December 31,
(Dollars in thousands, except per share data)	2005			2004			2003			2002			2001
Total interest income	$	60,281			51,617			44,937			42,868			51,468
Total interest expense		24,511			20,993			20,289			21,295			30,444
Net interest income		35,770			30,624			24,648			21,573			21,024
Provision for loan losses		2,674			2,755			2,610			2,376			1,150
Net interest income after provision for loan losses		33,096			27,869			22,038			19,197			19,874
Fees and service charges		2,719			2,776			2,304			1,723			1,563
Loan servicing fees		1,210			1,169			998			715			470
Securities gains (losses), net		(21	)		(535	)		1,275			422			(671	)
Gain on sales of loans		1,853			1,703			5,240			3,077			2,934
Losses in limited partnerships		(27	)		(26	)		(243	)		(659	)		(1,311	)
Other non-interest income		775			880			681			597			599
Total non-interest income		6,509			5,967			10,255			5,875			3,584
Total non-interest expense		21,801			20,162			19,653			17,849			15,749
Income tax expense		6,736			4,387			4,038			2,099			2,634
Income before minority interest		11,068			9,287			8,602			5,124			5,075
Minority interest		0			(3	)		(3	)		(142	)		(383	)
Net income	$	11,068			9,290			8,605			5,266			5,458
Per common share and common share equivalents:
Basic	$	2.89			2.40			2.26			1.40			1.45
Diluted		2.77			2.31			2.16			1.32			1.37

Selected Financial Condition Data:

	December 31,
(Dollars in thousands, except per share data)	2005			2004			2003			2002			2001
Total assets	$	991,237			960,673			866,726			737,523			721,114
Securities available for sale		119,659			103,672			104,664			121,397			119,895
Loans held for sale		1,435			2,712			6,543			15,127			68,018
Loans receivable, net		785,678			783,213			688,951			533,906			471,668
Deposits		731,537			698,902			551,688			432,951			421,843
Federal Home Loan Bank advances		160,900			170,900			203,900			218,300			217,800
Stockholders’ equity		90,728			83,771			80,931			76,065			72,161
Book value per share		20.59			18.95			17.93			17.28			16.41
Number of full service offices		13			13			12			13			12
Number of loan origination offices		3			2			6			2			1
Key Ratios(1)
Stockholders’ equity to total assets at year end		9.15	%		8.72	%		9.34	%		10.31	%		10.01	%
Average stockholders’ equity to average assets		9.05			9.17			10.15			10.66			9.91
Return on stockholders’ equity       (ratio of net income to average equity)		12.42			11.03			10.85			6.94			7.57
Return on assets       (ratio of net income to average assets)		1.12			1.01			1.10			0.74			0.75
Dividend payout ratio       (ratio of dividends paid to net income)		38.02			36.36			39.58			57.63			39.71

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

5

MANAGEMENT’S DISCUSSION AND ANALYSIS

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

OVERVIEW

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

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

Critical Accounting Policies

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

Allowance for Loan Losses and Related Provision

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

     The adequacy of the allowance for loan losses is dependent upon management’s estimates of variables affecting valuation, appraisals of collateral, evaluations of performance and status, and the amounts and timing of future cash flows expected to

6

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

Mortgage Servicing Rights

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

Income Taxes

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

Results of Operations

Net income was $11.1 million for the year ended December 31, 2005, compared to $9.3 million for the year ended December 31, 2004. Diluted earnings per common share for the year ended December 31, 2005 were $2.77, compared to $2.31 for the year ended December 31, 2004. Return on average assets was 1.12% and 1.01% and return on average equity was 12.42% and 11.03% for the years ended December 31, 2005 and 2004, respectively.

     In comparing the year ended December 31, 2005 to the year ended December 31, 2004, net interest income increased $5.2 million primarily because of an increase in interest rates and because of a higher concentration of commercial loans and increased checking and savings deposits. Non-interest income increased $542,000 primarily because of a decrease in the losses recognized on securities. Non-interest expense increased $1.6 million primarily because of increased compensation and benefits costs and increased occupancy costs due in part to additional corporate office facilities occupied in the first quarter of 2005.

Net Interest Income

Net interest income was $35.8 million for the year ended December 31, 2005, an increase of $5.2 million from $30.6 million in 2004. Interest income was $60.3 million for the year ended December 31, 2005, an increase of $8.7 million from $51.6 million for the same period in 2004. Interest income increased because of an increase in the average outstanding balance of interest-earning assets of $66 million between the periods and an increase in interest rates. Interest rates increased primarily because of the 200 basis point increase in the prime interest rate between the periods. Increases in the prime rate, which is the rate that banks charge their prime business customers, generally increase the rates on adjustable rate consumer and commercial loans in the portfolio and new loans originated. The increase in average interest-earning assets was primarily the result of the

7

MANAGEMENT’S DISCUSSION AND ANALYSIS

$85 million increase in the average outstanding balance of commercial loans between the periods. During 2005, the Company’s commercial portfolio continued to increase and represented 66.8% of the Company’s outstanding loans at December 31, 2005, compared to 63.6% at December 31, 2004. The average yield earned on interest-earning assets was 6.41% for the year ended December 31, 2005, an increase of 51 basis points from the 5.90% yield for the same period of 2004. Interest expense was $24.5 million for the year ended December 31, 2005, an increase of $3.5 million from $21.0 million for the same period in 2004. Interest expense increased primarily because of higher interest rates paid on deposits which were caused by the 200 basis point increase in the federal funds rate between the periods.

Increases in the federal funds rate, which is the rate that banks charge other banks for short term loans, generally increase the rates banks pay for deposits. Interest expense also increased because of the $58 million increase in the average outstanding interest bearing liabilities between the periods. The average interest rate paid on interest-bearing liabilities was 2.76% for the year ended December 31, 2005, an increase of 23 basis points from the 2.53% paid for the same period of 2004. The following table presents the total dollar amount of interest income from average interest-earning assets and the resultant yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and rates. Non-accruing loans have been included in the table as loans carrying a zero yield.

	Year Ended December 31,
	2005								2004								2003
	Average		Interest			Average			Average		Interest			Average			Average		Interest			Average
	Outstanding		Earned/			Yield/			Outstanding		Earned/			Yield/			Outstanding		Earned/			Yield/
(Dollars in thousands)	Balance		Paid			Rate			Balance		Paid			Rate			Balance		Paid			Rate
Interest-earning assets:
Securities available for sale:
Mortgage-backed and related securities	$	8,509		326			3.83	%	$	11,225		385			3.43	%	$	21,885		272			1.24	%
Other marketable securities		95,193		2,744			2.88			97,508		2,898			2.97			74,487		2,387			3.20
Loans held for sale		3,308		189			5.71			4,349		249			5.73			12,899		748			5.80
Loans receivable, net(1)(2)		802,637		56,189			7.00			732,638		47,714			6.51			602,653		41,052			6.81
Federal Home Loan Bank stock		8,960		253			2.82			9,889		207			2.10			11,464		349			3.04
Other, including cash equivalents		21,714		580			2.67			18,954		164			0.87			20,503		129			0.63
Total interest-earning assets	$	940,321		60,281			6.41		$	874,563		51,617			5.90		$	743,891		44,937			6.04
Interest-bearing liabilities:
Noninterest checking	$	45,263		0			0.00	%	$	38,862		0			0.00	%	$	28,964		0			0.00	%
NOW accounts		104,271		1,770			1.70			88,559		638			0.72			46,277		120			0.26
Passbooks		48,297		435			0.90			43,186		77			0.18			38,201		91			0.24
Money market accounts		106,819		2,273			2.13			106,943		1,519			1.42			73,800		878			1.19
Certificate accounts		411,034		12,753			3.10			354,811		10,163			2.86			286,238		9,185			3.21
Federal Home Loan Bank advances		170,914		7,278			4.26			196,662		8,595			4.37			221,503		10,015			4.52
Other interest-bearing liabilities		866		2			0.00			905		1			0.00			2,556		0			0.00
Total interest-bearing liabilities	$	887,464		24,511			2.76		$	829,928		20,993			2.53		$	697,539		20,289			2.91
Net interest income				35,770								30,624								24,648
Net interest rate spread							3.65	%							3.37	%							3.13	%
Net earning assets	$	52,857							$	44,635							$	46,352
Net interest margin							3.80	%							3.50	%							3.31	%
Average interest-earning assets to average interest-bearing liabilities				105.96	%							105.38	%							106.65	%

(1)	Tax exempt income was not significant; therefore, the yield was not presented on a tax equivalent basis for any of the years presented. The tax-exempt income was $1,112,000 for 2005, $1,000,300 for 2004 and $837,343 for 2003.
(2)	Calculated net of deferred loan fees, loan discounts, loans in process and loss reserve.

8

     Net interest margin increased to 3.80% in 2005 from 3.50% for 2004 primarily because of the growth in commercial loans, which generally have a higher yield than other interest-earning assets, and the increase in the outstanding average balance of checking accounts, which generally have a lower rate than other interest-bearing liabilities. Average net interest-earning assets were $52.9 million in 2005 compared to $44.6 million for 2004. Net interest-earning assets increased because of net income and an increase of $1.5 million in interest earning cash balances between the periods due to a reduction in the compensating balance requirements at the Federal Reserve Bank. Net interest-earning assets were reduced by the repurchase of HMN common stock and the payment of dividends. During 2005 and 2004 the Company paid $972,000 and $3.3 million to purchase its common stock in the open market, respectively, and paid dividends to stockholders of $3.5 million and $3.2 million, respectively.

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

	Year Ended December 31,
	2005 vs. 2004									2004 vs. 2003
	Increase (Decrease)						Total			Increase (Decrease)						Total
	Due to						Increase			Due to						Increase
(Dollars in thousands)	Volume(1)			Rate(1)			(Decrease)			Volume(1)			Rate(1)			(Decrease)
Interest-earning assets:
Securities available for sale:
Mortgage-backed and related securities	$	(100	)		41			(59	)	$	(184	)		297			113
Other marketable securities		(69	)		(85	)		(154	)		782			(271	)		511
Loans held for sale		(60	)		0			(60	)		(489	)		(10	)		(499	)
Loans receivable, net		5,099			3,376			8,475			8,947			(2,286	)		6,661
Cash equivalents		27			389			416			(11	)		46			35
Other		(20	)		67			47			(43	)		(99	)		(142	)
Total interest-earning assets	$	4,877			3,788			8,665		$	9,002			(2,323	)		6,679
Interest-bearing liabilities:
NOW accounts	$	241			891			1,132		$	231			286			517
Passbooks		10			348			358			13			(26	)		(13	)
Money market accounts		93			662			755			474			168			642
Certificates		1,936			653			2,589			2,454			(1,478	)		976
Federal Home Loan Bank advances		(1,148	)		(169	)		(1,317	)		(1,094	)		(326	)		(1,420	)
Other interest-bearing liabilities		0			2			2			0			1			1
Total interest-bearing liabilities	$	1,132			2,387			3,519		$	2,078			(1,375	)		703
Net interest income							$	35,770								$	30,624

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

9

MANAGEMENT’S DISCUSSION AND ANALYSIS

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

At December 31, 2005

Weighted average yield on:
Securities available for sale:
Mortgage-backed and related securities	3.75	%
Other marketable securities	3.27
Loans held for sale	5.87
Loans receivable, net	7.33
Cash equivalents	3.66
Other	2.80
Combined weighted average yield on interest-earning assets	6.47
Weighted average rate on:
NOW accounts	2.07	%
Passbooks	2.04
Money market accounts	2.59
Certificates	3.40
Federal Home Loan Bank advances	4.29
Combined weighted average rate on interest-bearing liabilities	2.97
Interest rate spread	3.50

Provision For Loan Losses

The provision for loan losses is recorded to maintain the allowance for loan losses at a level deemed appropriate by management based on the factors disclosed in the critical accounting policy previously discussed. The provision for loan losses was $2.7 million for 2005 compared to $2.8 million in 2004. The provision for loan losses decreased primarily because the commercial loan portfolio growth rate decreased from 13.5% in 2004 to 3.4% in 2005. The decrease in the provision related to reduced loan growth during the period was partially offset by an increase in the provision related to loan charge offs which increased from $738,000 in 2004 to $3.1 million in 2005. Loans charged off during 2005 included commercial loans of $2.6 million, consumer loans of $228,000, and mortgage loans of $234,000. The commercial loan charge offs were the result of acquiring multiple related real estate properties during the year that were subsequently sold at a loss.

Non-Interest Income

Non-interest income was $6.5 million for the year ended December 31, 2005, an increase of $542,000, from $6.0 million for the same period in 2004. The following table presents the components of non-interest income:

										Percentage
	Year Ended December 31,									Increase (Decrease)
(Dollars in thousands)	2005			2004			2003			2005/2004			2004/2003
Fees and service charges	$	2,719			2,776			2,304			(2.1	)%		20.5	%
Loan servicing fees		1,210			1,169			998			3.5			17.1
Securities gains (losses), net		(21	)		(535	)		1,275			96.1			(142.0	)
Gain on sales of loans		1,853			1,703			5,240			8.8			(67.5	)
Losses in limited partnerships		(27	)		(26	)		(243	)		(3.8	)		89.3
Other non-interest income		775			880			681			(11.9	)		29.2
Total non-interest income	$	6,509			5,967			10,255			9.1			(41.8	)

10

     Fees and service charges earned in 2005 decreased $57,000 from those earned in 2004 due to a decrease in overdraft fees and service charges because of customer behavior changes that resulted in a lower volume of activity in 2005. Title service fees also decreased because Federal Title Services, LLC was dissolved in 2004.

     Loan servicing fees increased $41,000 for the year ended December 31, 2005. Commercial loan servicing fees increased $57,000 as a result of an increase in loans serviced for others. The commercial loan servicing portfolio increased because the Bank continues to sell off participations in certain originated commercial loans in order to adhere to regulatory lending limits and manage credit risk within the portfolio. Single family loan servicing fees decreased $16,000 due to a decrease in the number of single-family loans that were serviced for others. The number of loans serviced decreased because of decreased single family loan production and because the servicing rights on many of the loans originated in 2005 were sold with the loans.

     Security losses decreased $514,000 for the year ended December 31, 2005 due to the $539,000 write down in the fourth quarter of 2004 of a Federal Home Loan Mortgage Corporation (FHLMC) preferred stock investment whose decline in value due to decreased interest rates was determined to be other than temporary. An additional write down of $21,000 was recorded on the same security in 2005. The ability to realize gains on the sale of securities is dependent on the type of securities in the securities portfolio and on changes in the general interest rate environment. There were no investment sales in 2005 and sales were limited in 2004 because the rising interest rate environment limited the opportunity to sell securities at a gain.

     Gain on sales of loans increased $150,000 in 2005. Gains on the sale of single-family loans decreased $321,000 in 2005 due to decreased loan originations. The decrease in single-family loan sales was offset entirely by an increase in the gains recognized on the sale of government guaranteed commercial loans sold in 2005. In an effort to diversify the Bank’s product offerings, the Bank began offering Small Business Administration (SBA) and U.S. Department of Agriculture (USDA) guaranteed loans in 2005. The Company expects mortgage interest rates to trend higher in 2006, which may result in lower loan originations and less gain on sales of single family loans than that experienced in 2005. Commercial loan sales volume is anticipated to increase in 2006.

     Other non-interest income consists primarily of fees and commissions earned on the sale of financial planning and insurance products and the gains and losses from the sale of assets. For 2005, other non-interest income decreased $105,000, primarily because of increased losses on the sale of repossessed and foreclosed assets that were partially offset by increased rental income from leasing space at an existing branch facility to a third party.

Non-Interest Expense

Non-interest expense for the year ended December 31, 2005 was $21.8 million, compared to $20.2 million for the year ended in 2004. The following table presents the components of non-interest expense:

							Percentage
	Year Ended December 31,						Increase (Decrease)
(Dollars in thousands)	2005		2004		2003		2005/2004			2004/2003
Compensation and benefits	$	11,140		10,187		8,676		9.4	%		17.4	%
Occupancy		4,081		3,630		3,424		12.4			6.0
Deposit insurance premiums		130		96		72		35.4			33.3
Advertising		384		430		393		(10.7	)		9.4
Data processing		1,032		930		1,109		11.0			(16.1	)
Amortization of mortgage servicing rights, net		1,020		1,061		1,982		(3.9	)		(46.5	)
Other		4,014		3,828		3,997		4.9			(4.2	)
Total non-interest expense	$	21,801		20,162		19,653		8.1			2.6

11

MANAGEMENT’S DISCUSSION AND ANALYSIS

     Non-interest expense increased $1.6 million in 2005 primarily because of a $954,000 increase in compensation and benefits expense due to increases in payroll costs primarily due to annual salary increases and increases in employee benefit costs. Occupancy expense increased $451,000 primarily because of the additional corporate office space that was occupied in the first quarter of 2005 and increased amortization expense on various software upgrades. Other operating expenses increased $186,000 primarily because of increased costs on foreclosed and repossessed assets and increased charitable contributions in 2005 when compared to 2004. Beginning January 1, 2006 the Company will be required to include all share-based payment transactions in compensation expense in accordance with the requirements of FAS 123R. See Note 1 of the Notes to Consolidated Financial Statements for additional information on the impact of FAS 123R.

Income Taxes

The Company considers the calculation of current and deferred income taxes to be a critical accounting policy that is subject to significant estimates. Actual results could differ significantly from the estimates and interpretations used in determining the current and deferred income tax assets and liabilities. Income tax expense was $6.7 million for the year ended December 31, 2005, compared to $4.4 million for 2004. Income tax expense increased between the periods due to an increase in taxable income and an increase in the effective tax rate from 32.1% in 2004 to 37.8% in 2005. The increase in the effective tax rate was primarily the result of additional state tax expense due to changes in state tax laws that occurred in 2005. Refer to Note 15 of the Notes to Consolidated Financial Statements for additional income tax information.

COMPARISON OF 2004 WITH 2003

Net income was $9.3 million for the year ended December 31, 2004, compared to $8.6 million for the year ended December 31, 2003. Diluted earnings per common share for the year ended December 31, 2004 were $2.31, compared to $2.16 for the year ended December 31, 2003. Return on average assets was 1.01% and 1.10% and return on average equity was 11.03% and 10.85% for the years ended December 31, 2004 and 2003, respectively.

     In comparing the year ended December 31, 2004 to the year ended December 31, 2003, net interest income increased by $6.0 million primarily because of an increase in interest-earning assets and because of a higher concentration of commercial and consumer loans and an increase in checking and money market deposit accounts. Non-interest income decreased by $4.3 million primarily due to decreases in the gains recognized on the sale of mortgage loans and securities. Non-interest expense increased by $500,000 primarily because of the $1.5 million increase in compensation and benefits costs due to increases in health insurance costs and the number of employees. This increase was partially offset by a $1.1 million decrease in the amortization of mortgage servicing rights that was primarily caused by a decrease in the prepayments of mortgage loans in 2004.

     Net interest income for the year ended December 31, 2004 was $30.6 million, an increase of $6.0 million, compared to $24.6 million in 2003. Interest income was $51.6 million for the year ended December 31, 2004, an increase of $6.7 million, from $44.9 million for the same period in 2003. Interest income increased primarily because of an increase in average interest-earning assets and because of a change in the mix of assets between the periods. The increase in interest-earning assets was caused primarily by the $105 million increase in the commercial and consumer loan portfolios between the periods. During 2004, the Company’s commercial and consumer loan portfolios continued to increase and these portfolios represented 77.9% of the Company’s outstanding loans at December 31, 2004, compared to 61.7% at December 31, 2003. The increase in interest income as a result of the increased interest-earning assets more than offset the decrease in the interest rates earned on the assets between the periods. The yield earned on interest-earning assets was 5.90% for the year ended December 31, 2004, a decrease of 14 basis points from the 6.04% yield for the same period of 2003. Interest expense was $21.0 million for the year ended December 31, 2004, an increase of $704,000, from the $20.3 million for the same period in 2003. Interest expense on deposits and Federal Home Loan Bank advances increased $2.1 million due to the $132 million in growth in the average outstanding balance of deposits and advances between the periods. This increase was partially offset by a $1.4 million decrease in interest expense due to a decline in the interest rates paid. The decline in interest rates paid is due in part to the $90 million increase in the outstanding average balance of checking and money market accounts between the periods, which generally have lower interest rates than other deposit accounts. The average interest rate paid on interest-bearing liabilities was 2.53% for the year ended December 31, 2004, a decrease of 38 basis points from the 2.91% in 2003.

     Net interest margin increased to 3.50% in 2004 compared to 3.31% for 2003 primarily because of the growth in commercial and consumer loans and the increase in the outstanding average balance of checking and money market accounts. Average net earning assets were $44.6 million in

12

2004 compared to $46.4 million for 2003. Net earning assets were reduced because of the repurchase of HMN common stock, the payment of dividends, an increase in non-interest earning cash due to the operation of more ATM machines in 2004, and an increase in non-interest bearing reserve accounts required to be maintained because of the increase in transaction account deposits between the periods. During 2004 and 2003 the Company paid $3.3 million and $1.4 million to purchase its common stock in the open market and paid dividends to stockholders of $3.2 million and $2.9 million, respectively. Non-interest bearing cash amounts increased by $2.4 million and the required non-interest bearing reserve balance on transaction accounts grew by $1.4 million.

     The provision for loan losses was $2.8 million for 2004 compared to $2.6 million for 2003. The provision for loan losses increased primarily because of an increase in the reserves established on two commercial lending relationships with combined outstanding balances of $10.4 million and loss reserves of $744,000 at December 31, 2004. The increased reserves were due to downgrades in the risk ratings assigned to these loans. Both of these loans were performing at December 31, 2004 and will continue to be monitored for changes in risk in accordance with the Company’s commercial credit policy. The increase in the provision because of these downgrades was partially offset by the $43 million decrease in loan growth that was experienced in the commercial and consumer loan portfolios during 2004 when compared to 2003. Commercial and consumer loans generally require a larger provision due to the greater inherent credit risk of these loans.

     Non-interest income was $6.0 million for the year ended December 31, 2004, a decrease of $4.3 million, from $10.3 million for the same period in 2003. Fees and service charges earned in 2004 increased $472,000 from those earned in 2003, primarily due to the full year effect of increased fees generated from an overdraft protection program that was implemented in the second quarter of 2003. Mortgage servicing fees increased $171,000 for the year ended December 31, 2004 due to the increased number of single-family loans that were serviced for others. The lower mortgage interest rates in 2003 resulted in increased loan originations and the majority of the loans were sold on the secondary mortgage market with the servicing rights retained. Security gains decreased $1.8 million for the year ended December 31, 2004 as fewer investments were sold and because of the $539,000 write down of a Federal Home Loan Mortgage Corporation (FHLMC) preferred stock investment whose decline in value due to changes in interest rates was determined to be other than temporary. The ability to realize gains on the sale of securities is dependent on the type of securities in the securities portfolio and on changes in the general interest rate environment. The Company was able to recognize gains on both its debt and equity security portfolios in the declining interest rate conditions that existed during 2003, but was not able to do this in the rising rate environment that existed in 2004. Gains on the sale of single-family loans decreased $3.5 million for the year ended December 31, 2004. Increases in interest rates from the historically low mortgage rates experienced during 2003 resulted in a significant decrease in mortgage loan origination activity in 2004 when compared to 2003. Losses from limited partnerships decreased $217,000 for the year ended December 31, 2004 primarily because the Company’s investment in a limited partnership that invested in mortgage servicing rights was dissolved in the second quarter of 2003. Generally, as interest rates rise the value of fixed rate mortgage servicing rights increases and as interest rates fall the value of mortgage servicing rights declines due to changes in the anticipated cash flows caused by prepayments on the loans being serviced. During 2003, declines in interest rates on single-family mortgages caused the Company to recognize losses on its investment in the mortgage servicing limited partnership. This partnership was dissolved in the second quarter of 2003 in order to eliminate future losses.

     Other non-interest income consists primarily of fees and commissions earned on the sale of financial planning and insurance products and the gains and losses from the sale of assets. For the year ended December 31, 2004, other non-interest income was $880,000 compared to $681,000 for 2003. The change in other non-interest income is principally due to increases in revenues from the sale of uninsured investment products.

     Non-interest expense increased $509,000 in 2004 primarily because of a $1.5 million increase in compensation and benefits expense due to increases in health insurance and payroll costs due to normal staffing growth during the year and annual salary increases. Occupancy expense increased $206,000 primarily because of real estate tax increases on existing facilities and increased expenses related to the additional corporate facilities that were put in place in the first quarter of 2004. Amortization expense on mortgage servicing rights decreased $921,000 between the periods because of a decrease in the prepayments on the mortgage loans being serviced. Data processing costs decreased $179,000 primarily because of the renegotiation of a third party service contract in the fourth quarter of 2003.

     During 2004 and 2003 the Company recorded income tax expense of $4.4 million and $4.0 million, respectively. The change in income tax expense is primarily the result of changes in taxable income.

13

MANAGEMENT’S DISCUSSION AND ANALYSIS

Financial Condition

Loans Receivable, Net

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

											December 31,
	2005					2004					2003					2002					2001
(Dollars in thousands)	Amount		Percent			Amount		Percent			Amount		Percent			Amount		Percent			Amount		Percent
Real Estate Loans:
One-to-four family	$	127,075		15.82	%	$	139,008		17.34	%	$	144,315		20.37	%	$	151,566		27.72	%	$	215,448		44.73	%
Multi-family		40,753		5.07			41,922		5.23			31,540		4.45			15,766		2.88			14,369		2.98
Commercial		260,268		32.40			224,945		28.06			199,124		28.10			130,417		23.85			70,768		14.69
Construction or development		80,342		10.00			98,397		12.28			95,346		13.45			61,336		11.22			46,977		9.75
Total real estate loans		508,438		63.29			504,272		62.91			470,325		66.37			359,085		65.67			347,562		72.15
Other Loans:
Consumer Loans:
Automobile		5,461		0.68			9,496		1.18			14,754		2.08			11,062		2.02			6,624		1.38
Home equity line		61,011		7.60			67,140		8.38			54,193		7.64			52,106		9.53			35,714		7.42
Home equity		19,076		2.37			20,033		2.50			18,974		2.68			21,075		3.85			26,356		5.47
Mobile home		2,299		0.29			2,896		0.36			3,665		0.52			4,534		0.83			5,456		1.13
Land/lot loans		9,487		1.18			11,572		1.44			10,486		1.48			3,590		0.66			850		0.18
Other		3,564		0.44			3,836		0.48			3,833		0.54			4,054		0.75			4,131		0.86
Total consumer loans		100,898		12.56			114,973		14.34			105,905		14.94			96,421		17.64			79,131		16.44
Commercial business loans		193,962		24.15			182,369		22.75			132,459		18.69			91,260		16.69			54,940		11.41
Total other loans		294,860		36.71			297,342		37.09			238,364		33.63			187,681		34.33			134,071		27.85
Total loans		803,298		100.00	%		801,614		100.00	%		708,689		100.00	%		546,766		100.00	%		481,633		100.00	%
Less:
Loans in process		7,008					7,561					11,298					6,826					4,692
Unamortized discounts		190					63					166					142					278
Net deferred loan fees		1,644					1,781					1,334					1,068					1,212
Allowance for losses		8,778					8,996					6,940					4,824					3,783
Total loans receivable , net	$	785,678				$	783,213				$	688,951				$	533,906				$	471,668

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

     One-to-four family real estate loans were $127.1 million at December 31, 2005, a decrease of $11.9 million, compared to $139.0 million at December 31, 2004. Loan originations decreased in 2005 and the mortgage loans that were originated and placed in portfolio were not enough to offset the principal payments received on the loans already in the portfolio. The decrease in the amount of mortgage loans placed in portfolio was the primary reason for the decline in the one-to-four family loan portfolio during 2005.

14

     Commercial real estate loans were $260.3 million at December 31, 2005, an increase of $35.4 million, compared to $224.9 million at December 31, 2004. Commercial business loans were $194.0 million at December 31, 2005, an increase of $11.6 million, compared to $182.4 million at December 31, 2004. The Company’s continued emphasis on commercial real estate and commercial business loans resulted in the origination or purchase of these loans totaling $265.7 million in 2005, compared to $193.4 million in 2004. An increase in loan production volume was the principal reason for the increase in commercial real estate and commercial business loans in 2005.

     Home equity line loans were $61.0 million at December 31, 2005, compared to $67.1 million at December 31, 2004. The open-end home equity lines are written with an adjustable rate with a 10 year draw period which requires “interest only” payments followed by a 10 year repayment period which fully amortizes the outstanding balance. Closed-end home equity loans are written with fixed or adjustable rates with terms up to 15 years. Home equity loans were $19.1 million at December 31, 2005, compared to $20.0 million at December 31, 2004. The prime interest rate increased 200 basis points in 2005 while long term mortgage rates decreased. Since most home equity loan rates are tied to the prime interest rate, some borrowers rolled their adjustable rate home equity loans into a mortgage loan in order to lock in a long term fixed rate.

Allowance for Loan Losses

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

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

     The allowance for loan losses was $8.8 million, or 1.09%, of gross loans at December 31, 2005, compared to $9.0 million, or 1.12%, of gross loans at December 31, 2004. The following table reflects the activity in the allowance for loan losses and selected statistics:

							December 31,
(Dollars in thousands)	2005			2004				2003		2002			2001
Balance at beginning of year	$	8,996			6,940			4,824			3,783			3,144
Provision for losses		2,674			2,755			2,610			2,376			1,150
Charge-offs:
One-to-four family		(234	)		(331	)		(69	)		(44	)		0
Consumer		(228	)		(407	)		(226	)		(310	)		(170	)
Commercial business and real estate		(2,615	)		0			(255	)		(1,015	)		(347	)
Recoveries		185			39			56			34			6
Net charge-offs		(2,892	)		(699	)		(494	)		(1,335	)		(511	)
Balance at end of year	$	8,778			8,996			6,940			4,824			3,783
Year end allowance for loan losses as a percent of year end gross loan balance		1.09	%		1.12	%		0.98	%		0.88	%		0.79	%
Ratio of net loan charge-offs to average loans outstanding		0.36			0.09			0.08			0.26			0.10

15

MANAGEMENT’S DISCUSSION AND ANALYSIS

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

													December 31,
	2005						2004						2003						2002						2001
				Percent						Percent						Percent						Percent						Percent
	Allocated			of loans			Allocated			of loans			Allocated			of loans			Allocated			of loans			Allocated			of loans
	allowance			in each			allowance			in each			allowance			in each			allowance			in each			allowance			in each
	as of %			category			as a %			category			as a %			category			as a %			category			as a %			category
	of loan			to total			of loan			to total			of loan			to total			of loan			to total			of loan			to total
	category			loans			category			loans			category			loans			category			loans			category			loans
Real estate loans:
One-to-four family		0.21	%		15.82	%		0.17	%		17.34	%		0.12	%		20.36	%		0.06	%		27.72	%		0.10	%		44.73	%
Multi-family		1.56			5.07			1.67			5.23			1.34			4.45			1.30			2.88			1.41			2.98
Commercial real estate		1.32			32.40			1.60			28.06			1.42			28.10			1.55			23.88			1.28			14.69
Construction or development		1.14			10.00			1.07			12.28			0.92			13.45			0.97			11.22			1.19			9.75
Consumer loans		0.88			12.56			0.81			14.34			0.98			14.95			0.56			17.63			0.71			16.44
Commercial business loans		1.36			24.15			1.36			22.75			1.20			18.69			1.48			16.67			2.44			11.41
Total		1.09	%		100.00	%		1.12	%		100.00	%		0.98	%		100.00	%		0.88	%		100.00	%		0.79	%		100.00	%

     The allocation of the allowance for loan losses increased in 2005 for one-to-four family and consumer loans due to an increase in the reserve for unclassified loans based on management’s assessment of the risk in these portfolios. The allocated percentage for construction or development loans increased in 2005 due to management’s assessment of the risk of certain individual loans in this category. The allocated percentage for multi-family and commercial real estate loans decreased between the years because some of the loans that were classified at the end of 2004 paid off or were charged off during 2005.

Allowance for Real Estate Losses

Real estate properties acquired or expected to be acquired through loan foreclosures are initially recorded at the lower of the related loan balance, less any specific allowance for loss, or fair value less estimated selling costs. Management periodically performs valuations and an allowance for losses is established if the carrying value of a property exceeds its fair value less estimated selling costs. There was limited activity in the allowance for real estate losses and the balance was $100,000 and $0 at December 31, 2005 and 2004, respectively.

Non-performing Assets

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

     Non-performing assets are comprised of non-accrual loans, restructured loans, impaired securities, delinquent accounts receivable, real estate acquired through foreclosure, and repossessed assets and totaled $3.9 million at December 31, 2005, compared to $4.9 million at December 31, 2004. The $1.0 million decrease in non-performing assets in 2005 relates primarily to a $2.0 million decrease in non-performing loans and a $23,000 decrease in non-performing other assets. These decreases are partially offset by an increase of $1.0 million in foreclosed and repossessed assets. The increase in this category is primarily related to a foreclosed commercial real estate property and single family homes that were acquired in 2005.

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

16

							December 31,
(Dollars in thousands)	2005			2004			2003			2002			2001
Non-accruing loans:
Real estate:
One-to-four family	$	626			1,864			1,177			695			771
Commercial real estate		948			1,114			2,162			1,719			187
Consumer		496			472			1,050			495			311
Commercial business		259			261			186			427			890
Total		2,329			3,711			4,575			3,336			2,159
Accruing loans delinquent 90 days or more:
One-to-four family		0			628			114			171			24
Other assets		178			201			211			866			1,390
Foreclosed and repossessed assets:
Real estate:
One-to-four family		565			141			73			300			0
Commercial real estate		750			0			0			127			0
Consumer		61			201			62			107			155
Commercial business		0			0			0			0			33
Total		1,376			342			135			534			188
Total non-performing assets	$	3,883		$	4,882		$	5,035		$	4,907		$	3,761
Total as a percentage of total assets		0.39	%		0.51	%		0.58	%		0.67	%		0.52	%
Total non-performing loans	$	2,329		$	4,339		$	4,689		$	3,507		$	2,183
Total as a percentage of total loans receivable, net		0.30	%		0.55	%		0.68	%		0.66	%		0.46	%
Allowance for loan losses to non-performing loans		376.88	%		207.30	%		147.99	%		134.60	%		173.29	%

     For the years ended December 31, 2005, 2004 and 2003, gross interest income which would have been recorded had the non-accruing loans been current in accordance with their original terms amounted to $327,280, $271,071 and $458,473, respectively. The amounts that were included in interest income on a cash basis for such loans were $273,458, $158,767 and $163,044, respectively.

     In addition to the non-performing assets set forth in the table above, as of December 31, 2005 there were no loans with known information about the possible credit problems of the borrowers or the cash flows of the secured properties that have caused management to have concerns as to the ability of the borrowers to comply with present loan repayment terms which may result in the future inclusion of such items in the non-performing asset categories. Management has considered the Bank’s non-performing and “of concern” assets in establishing its allowance for loan losses.

Liquidity and Capital Resources

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

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

     The primary financing activity is the attraction of retail and brokered deposits. The Bank has the ability to borrow additional funds from the FHLB by pledging additional securities or loans. Refer to Note 13 of the Notes to Consolidated Financial Statements for more information on additional advances that could be drawn based upon existing collateral levels with the FHLB. Information on outstanding advance maturities and related early call features is also included in Note 13.

17

MANAGEMENT’S DISCUSSION AND ANALYSIS

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

     Cash and cash equivalents at December 31, 2005 were $47.3 million, an increase of $13.0 million, compared to $34.3 million at December 31, 2004. Net cash provided by operating activities during 2005 was $25.1 million. The Company conducted the following major investing activities during 2005: principal received on payments and maturities of securities available for sale were $23.1 million, purchases of securities available for sale were $39.5 million, and loans receivable increased $14.5 million. The Company spent $1.2 million for the purchase of equipment and updating its premises. Net cash used by investing activities during 2005 was $31.1 million. The Company conducted the following major financing activities during 2005: purchased treasury stock of $972,000, paid $3.5 million in dividends to HMN stockholders, received proceeds from FHLB advances totaling $78.0 million, repaid FHLB advances totaling $88.0 million, and deposits increased $33.2 million. Net cash provided by financing activities was $19.0 million.

     The Company has certificates of deposit with outstanding balances of $199.2 million that mature during 2006. Based upon past experience management anticipates that the majority of the deposits will renew for another term. The Company believes that deposits that do not renew will be replaced with deposits from a combination of other customers or brokers. FHLB advances or the sale of securities could also be used to replace unanticipated outflows of deposits.

     The Company has no FHLB advances that mature in 2006 and it has $110.9 million of FHLB advances with maturities beyond 2006 that have call features that may be exercised by the FHLB during 2006. If the call features are exercised, the Company has the option of requesting any advance otherwise available to it pursuant to the credit policy of the FHLB.

     The credit policy of the FHLB may change such that the current collateral pledged to secure the advances is no longer acceptable or the formulas for determining the excess pledged collateral may change. If this were to happen, the Bank may not have additional collateral to pledge to secure the existing advances which could cause the FHLB advances to become a liquidity problem during 2006.

     The Company anticipates that its liquidity requirements for 2006 will be similar to the cash flows it experienced in 2005.

     On July 26, 2005, the Company’s Board of Directors authorized the extension of the stock repurchase program to February 25, 2007. The plan authorized HMN to repurchase up to 197,000 shares of its common stock in the open market and as of December 31, 2005, 197,000 shares remained authorized for repurchase.

Contractual Obligations and Commercial Commitments

The Company has certain obligations and commitments to make future payments under existing contracts. At December 31, 2005, the aggregate contractual obligations (excluding bank deposits) and commercial commitments were as follows:

			Payments Due by Period
			Less than 1						After 5
(Dollars in thousands)	Total		Year		1-3 Years		4-5 Years		Years
Contractual Obligations:
Total borrowings	$	160,900		0		60,000		10,000		90,900
Annual rental commitments under non-cancelable operating leases		948		596		267		85		0
	$	161,848		596		60,267		10,085		90,900

			Amount of Commitments-Expiring by Period
Other Commercial Commitments:
Commercial lines of credit	$	34,323		27,756	6,511	4	52
Commitments to lend		69,582		35,964	17,668	2,100	13,850
Standby letters of credit		10,158		7,486	2,672	0	0
	$	114,063		71,206	26,851	2,104	13,902

18

Regulatory Capital Requirements

As a result of the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA), banking and thrift regulators are required to take prompt regulatory action against institutions which are undercapitalized. FDICIA requires banking and thrift regulators to categorize institutions as “well capitalized”, “adequately capitalized”, “undercapitalized”, “significantly undercapitalized”, or “critically undercapitalized”. A savings institution will be deemed to be well capitalized if it: (i) has a total risk-based capital ratio of 10% or greater, (ii) has a Tier 1 (core) risk-based capital ratio of 6% or greater, (iii) has a leverage ratio of 5% or greater, and (iv) is not subject to any order or written directive by the Office of Thrift Supervision (OTS) to meet and maintain a specific capital level for any capital measure. Management believes that, as of December 31, 2005, the Bank met all of the capital requirements to which it was subject and is well capitalized based on the regulatory definition described above. Refer to Note 19 of the Notes to Consolidated Financial Statements for a table which reflects the Bank’s capital compared to its capital requirements.

Dividends

The declaration of dividends is subject to, among other things, the Company’s financial condition and results of operations, the Bank’s compliance with its regulatory capital requirements, tax considerations, industry standards, economic conditions, regulatory restrictions, general business practices and other factors. Refer to Note 18 of the Notes to Consolidated Financial Statements for information on regulatory limitations on dividends from the Bank to the Company and additional information on dividends. The payment of dividends is dependent upon the Company having adequate cash or other assets that can be converted to cash to pay dividends to its stockholders. The Company does not anticipate a liquidity problem in 2006 relating to the payment of dividends.

Impact of Inflation and Changing Prices

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

New Accounting Pronouncements

On December 16, 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment (FAS 123R), which replaces FAS 123, Accounting for Stock-Based Compensation, and supercedes Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees. Securities and Exchange Commission (SEC) registrants originally would have been required to adopt FAS 123R’s provisions at the beginning of their first interim period after June 15, 2005. On April 14, 2005, the SEC announced that registrants could delay adoption of FAS 123R’s provisions until the beginning of their next fiscal year. We adopted FAS 123R on January 1, 2006, using the “modified prospective” transition method. The scope of FAS 123R includes a wide range of stock-based compensation arrangements including stock options, restricted stock plans, performance-based awards, stock appreciation rights, and employee stock purchase plans. FAS 123R will require us to measure the cost of employee services received in exchange for an award of equity instruments based on the fair value of the award on the grant date. That cost must be recognized in the income statement over the vesting period of the award. Under the “modified prospective” transition method, awards that are granted, modified or settled beginning at the date of adoption will be measured and accounted for in accordance with FAS 123R. In addition, expense must be recognized in the statement of income for unvested awards that were granted prior to the date of adoption. The expense will be based on the fair value determined at the grant date. We anticipate that this expense will reduce 2006 earnings per share by approximately $0.01.

Market  Risk

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

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

     The Company utilizes a model that uses the discounted cash flows from its interest-earning assets and its interest-bearing liabilities to calculate the current market value of

19

MANAGEMENT’S DISCUSSION AND ANALYSIS

those assets and liabilities. The model also calculates the changes in market value of the interest-earning assets and interest-bearing liabilities under different interest rate changes.

     The following table discloses the projected changes in market value to the Company’s interest-earning assets and interest-bearing liabilities based upon incremental 100 basis point changes in interest rates from interest rates in effect on December 31, 2005.

	Market Value
(Dollars in thousands)
Basis point change in interest rates	-200			-100			0			+100			+200
Total market risk sensitive assets	$	999,512			992,546			983,307			970,678			956,540
Total market risk sensitive liabilities		877,150			861,017			846,515			834,032			823,381
Off-balance sheet financial instruments		(16	)		(3	)		0			102			191
Net market risk	$	122,378			131,532			136,792			136,544			132,968
Percentage change from current market value		(10.54	)%		(3.85	)%		0.00	%		(0.18	)%		(2.80	)%

     The preceding table was prepared utilizing the following assumptions (the Model Assumptions) regarding prepayment and decay ratios that were determined by management based upon their review of historical prepayment speeds and future prepayment projections. Fixed rate loans were assumed to prepay at annual rates of between 7% and 76%, depending on the note rate and the period to maturity. Adjustable rate mortgages (ARMs) were assumed to prepay at annual rates of between 11% and 31%, depending on the note rate and the period to maturity. Growing Equity Mortgage (GEM) loans were assumed to prepay at annual rates of between 6% and 50% depending on the note rate and the period to maturity. Mortgage-backed securities and Collateralized Mortgage Obligations (CMOs) were projected to have prepayments based upon the underlying collateral securing the instrument and the related cash flow priority of the CMO tranche owned. Certificate accounts were assumed not to be withdrawn until maturity. Passbook and money market accounts were assumed to decay at an annual rate of 29%. Non-interest checking and NOW accounts were assumed to decay at an annual rate of 15%. Commercial NOW and MMDA accounts were assumed to decay at an annual rate of 32%. FHLB advances were projected to be called at the first call date where the projected interest rate on similar remaining term advances exceeded the interest rate on the callable advance. Refer to Note 13 of the Notes to Consolidated Financial Statements for more information on call provisions of the FHLB advances.

     Certain shortcomings are inherent in the method of analysis presented in the foregoing table. The interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types of assets and liabilities may lag behind changes in market interest rates. The model assumes that the difference between the current interest rate being earned or paid compared to a treasury instrument or other interest index with a similar term to maturity (the Interest Spread) will remain constant over the interest changes disclosed in the table. Changes in Interest Spread could impact projected market value changes. Certain assets, such as ARMs, have features that restrict changes in interest rates on a short-term basis and over the life of the assets. The market value of the interest-bearing assets that are approaching their lifetime interest rate caps could be different from the values calculated in the table. In the event of a change in interest rates, prepayment and early withdrawal levels may deviate significantly from those assumed in calculating the foregoing table. The ability of many borrowers to service their debt may decrease in the event of a substantial sustained increase in interest rates.

20

Asset/Liability Management

The Company’s management reviews the impact that changing interest rates will have on the net interest income projected for the twelve months following December 31, 2005 to determine if its current level of interest rate risk is acceptable. The following table projects the estimated impact on net interest income of immediate interest rate changes called rate shocks:

Rate Shock	Net Interest			Percentage
in Basis Points	Change			Change
+200	$	1,692,000			4.49	%
+100	$	1,011,000			2.68	%
0		0			0.00	%
-100	$	(2,262,000	)		(6.00	)%
-200	$	(4,855,000	)		(12.88	)%

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

     In an attempt to manage its exposure to changes in interest rates, management closely monitors interest rate risk. The Company has an Asset/Liability Committee that meets frequently to discuss changes made to the interest rate risk position and projected profitability. The Committee makes adjustments to the asset-liability position of the Bank that are reviewed by the Board of Directors of the Bank. This Committee also reviews the Bank’s portfolio, formulates investment strategies and oversees the timing and implementation of transactions to assure attainment of the Bank’s objectives in the most effective manner. In addition, the Board reviews on a quarterly basis the Bank’s asset/liability position, including simulations of the effect on the Bank’s capital of various interest rate scenarios.

     In managing its asset/liability mix, the Bank may, at times, depending on the relationship between long and short-term interest rates, market conditions and consumer preference, place more emphasis on managing net interest margin than on better matching the interest rate sensitivity of its assets and liabilities in an effort to enhance net interest income. Management believes that the increased net interest income resulting from a mismatch in the maturity of its asset and liability portfolios can, in certain situations, provide high enough returns to justify the increased exposure to sudden and unexpected increases in interest rates.

     To the extent consistent with its interest rate spread objectives, the Bank attempts to manage its interest rate risk and has taken a number of steps to restructure its balance sheet in order to better match the maturities of its assets and liabilities. The Bank has primarily focused its fixed rate one-to-four family residential lending program on loans that are saleable to third parties and only places fixed rate loans that meet certain risk characteristics into its loan portfolio. The Bank does place into portfolio adjustable rate single-family loans that reprice over a one-year, three-year or five-year period. The Bank’s commercial loan production has primarily been in adjustable rate loans and the fixed rate commercial loans placed in portfolio have been shorter-term loans, usually with maturities of five years or less, in order to manage the Company’s interest rate risk exposure.

21

CONSOLIDATED BALANCE SHEETS

December 31, 2005 and 2004	2005			2004
ASSETS
Cash and cash equivalents	$	47,268,795			34,298,394
Securities available for sale:
Mortgage-backed and related securities (amortized cost $7,428,504 and $9,509,377)		6,879,756			9,150,871
Other marketable securities (amortized cost $113,749,841 and $95,097,051)		112,778,813			94,521,512
		119,658,569			103,672,383
Loans held for sale		1,435,141			2,711,760
Loans receivable, net		785,678,461			783,213,262
Accrued interest receivable		4,460,014			3,694,133
Real estate, net		1,214,621			140,608
Federal Home Loan Bank stock, at cost		8,364,600			9,292,800
Mortgage servicing rights, net		2,653,635			3,231,242
Premises and equipment, net		11,941,863			12,464,265
Investment in limited partnerships		141,048			168,258
Goodwill		3,800,938			3,800,938
Core deposit intangible, net		219,760			333,617
Prepaid expenses and other assets		1,854,948			2,638,681
Deferred tax assets		2,544,400			1,012,700
Total assets	$	991,236,793			960,673,041
LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits	$	731,536,560			698,902,185
Federal Home Loan Bank advances		160,900,000			170,900,000
Accrued interest payable		2,085,573			1,314,356
Customer escrows		1,038,575			762,737
Accrued expenses and other liabilities		4,947,816			5,022,927
Total liabilities		900,508,524			876,902,205
Commitments and contingencies
Stockholders’ equity:
Serial preferred stock ($.01 par value):
Authorized 500,000 shares; issued and outstanding none		0			0
Common stock ($.01 par value):
Authorized 11,000,000 shares; issued 9,128,662		91,287			91,287
Additional paid-in capital		58,011,099			57,875,595
Retained earnings, subject to certain restrictions		98,951,777			91,408,028
Accumulated other comprehensive loss		(917,577	)		(604,446	)
Unearned employee stock ownership plan shares		(4,350,999	)		(4,544,300	)
Unearned restricted stock awards		(182,521	)		0
Treasury stock, at cost 4,721,402 and 4,708,798 shares		(60,874,797	)		(60,455,328	)
Total stockholders’ equity		90,728,269			83,770,836
Total liabilities and stockholders’ equity	$	991,236,793			960,673,041

See accompanying notes to consolidated financial statements.

22

CONSOLIDATED STATEMENTS OF INCOME

Years ended December 31, 2005, 2004 and 2003	2005			2004			2003
Interest income:
Loans receivable	$	56,376,920			47,962,485			41,800,039
Securities available for sale:
Mortgage-backed and related		325,940			385,067			272,253
Other marketable		2,744,202			2,897,834			2,386,590
Cash equivalents		580,500			164,061			128,948
Other		253,611			207,240			349,150
Total interest income		60,281,173			51,616,687			44,936,980
Interest expense:
Deposits		17,233,400			12,398,505			10,274,188
Federal Home Loan Bank advances		7,278,050			8,594,790			10,014,865
Total interest expense		24,511,450			20,993,295			20,289,053
Net interest income		35,769,723			30,623,392			24,647,927
Provision for loan losses		2,674,000			2,755,000			2,610,000
Net interest income after provision for loan losses		33,095,723			27,868,392			22,037,927
Non-interest income:
Fees and service charges		2,719,004			2,776,553			2,304,090
Loan servicing fees		1,210,192			1,168,760			998,200
Securities (losses) gains, net		(21,000	)		(535,188	)		1,274,537
Gain on sales of loans		1,852,940			1,702,979			5,240,442
Losses in limited partnerships		(27,210	)		(26,118	)		(243,305	)
Other		775,294			880,233			681,518
Total non-interest income		6,509,220			5,967,219			10,255,482
Non-interest expense:
Compensation and benefits		11,140,329			10,186,538			8,675,596
Occupancy		4,080,880			3,629,766			3,423,745
Deposit insurance premiums		129,683			95,465			72,524
Advertising		384,184			430,417			392,833
Data processing		1,031,630			930,144			1,109,098
Amortization of mortgage servicing rights, net		1,019,766			1,061,407			1,982,337
Other		4,014,482			3,828,086			3,997,243
Total noninterest expense		21,800,954			20,161,823			19,653,376
Income before income tax expense		17,803,989			13,673,788			12,640,033
Income tax expense		6,736,100			4,387,100			4,037,800
Income before minority interest		11,067,889			9,286,688			8,602,233
Minority interest		0			(3,109	)		(3,014	)
Net income	$	11,067,889			9,289,797			8,605,247
Basic earnings per share	$	2.89			2.40			2.26
Diluted earnings per share	$	2.77			2.31			2.16

See accompanying notes to consolidated financial statements.

23

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME

												Unearned
												Employee
									Accumulated			Stock			Unearned
			Additional						Other			Ownership			Compensation						Total
	Common		Paid-In			Retained			Comprehensive			Plan			Restricted			Treasury			Stockholders’
	Stock		Capital			Earnings			Income (Loss)			Shares			Stock Awards			Stock			Equity
Balance, December 31, 2002	$	91,287		58,885,279			79,660,481			1,575,577			(4,931,385	)		0			(59,216,683	)		76,064,556
Net income							8,605,247															8,605,247
Other comprehensive loss, net of tax:
Net unrealized losses on securities available for sale										(1,626,302	)											(1,626,302	)
Total comprehensive income																						6,978,945
Treasury stock purchases																			(1,384,560	)		(1,384,560	)
Employee stock options exercised				(1,578,979	)														3,001,439			1,422,460
Tax benefits of exercised stock options				376,969																		376,969
Earned employee stock ownership plan shares				180,457									193,301									373,758
Dividends paid							(2,901,071	)														(2,901,071	)
Balance, December 31, 2003	$	91,287		57,863,726			85,364,657			(50,725	)		(4,738,084	)		0			(57,599,804	)		80,931,057
Net income							9,289,797															9,289,797
Other comprehensive loss, net of tax:
Net unrealized losses on securities available for sale										(553,721	)											(553,721	)
Total comprehensive income																						8,736,076
Treasury stock purchases																			(3,316,550	)		(3,316,550	)
Employee stock options exercised				(394,392	)														461,026			66,634
Tax benefits of exercised stock options				98,096																		98,096
Earned employee stock ownership plan shares				308,165									193,784									501,949
Dividends paid							(3,246,426	)														(3,246,426	)
Balance, December 31, 2004	$	91,287		57,875,595			91,408,028			(604,446	)		(4,544,300	)		0			(60,455,328	)		83,770,836
Net income							11,067,889															11,067,889
Other comprehensive loss, net of tax:
Net unrealized losses on securities available for sale										(313,131	)											(313,131	)
Total comprehensive income																						10,754,758
Treasury stock purchases																			(972,000	)		(972,000	)
Employee stock options exercised				(247,613	)														285,500			37,887
Tax benefits of exercised stock options				29,907																		29,907
Unearned compensation restricted stock awards				15,616												(326,528	)		310,912			0
Restricted stock awards forfeited				(2,204	)											46,085			(43,881	)		0
Amortization of restricted stock awards																97,922						97,922
Earned employee stock ownership plan shares				339,798									193,301									533,099
Dividends paid							(3,524,140	)														(3,524,140	)
Balance, December 31, 2005	$	91,287		58,011,099			98,951,777			(917,577	)		(4,350,999	)		(182,521	)		(60,874,797	)		90,728,269

See accompanying notes to consolidated financial statements.

24

CONSOLIDATED STATEMENTS OF CASH FLOWS

Years ended December 31, 2005, 2004 and 2003	2005			2004			2003
Cash flows from operating activities:
Net income	$	11,067,889			9,289,797			8,605,247
Adjustments to reconcile net income to cash provided by operating activities:
Provision for loan losses		2,674,000			2,755,000			2,610,000
Depreciation		1,750,953			1,596,252			1,549,997
Amortization of (discounts) premiums, net		(849,539	)		(353,598	)		652,344
Amortization of deferred loan fees		(1,071,078	)		(1,166,855	)		(690,176	)
Amortization of core deposit intangible		113,857			113,857			113,857
Amortization of mortgage servicing rights, net of valuation adjustments		1,019,766			1,061,407			1,982,337
Capitalized mortgage servicing rights		(442,159	)		(844,806	)		(2,522,231	)
Deferred income tax benefit		(1,259,100	)		(737,200	)		(540,900	)
Securities losses (gains), net		21,000			535,188			(1,274,537	)
Loss (gain) on sale of premises		0			43,440			(185,630	)
Loss on sales of real estate		17,575			21,775			115,710
Proceeds from sales of real estate		605,072			825,461			740,194
Gain on sales of loans		(1,852,940	)		(1,702,979	)		(5,240,442	)
Proceeds from sales of loans held for sale		97,015,434			90,118,839			297,862,680
Disbursements on loans held for sale		(85,200,488	)		(84,592,187	)		(280,633,930	)
Principal collected on loans held for sale		0			0			11,521
Amortization of restricted stock awards		97,922			0			0
Amortization of unearned ESOP Shares		193,301			193,784			193,301
Earned employee stock ownership shares priced above original cost		339,798			308,165			180,457
Increase in accrued interest receivable		(765,881	)		(231,912	)		(411,585	)
Increase (decrease) in accrued interest payable		771,217			547,519			(82,590	)
Equity losses of limited partnerships		27,210			26,118			243,305
Equity losses of minority interest		0			(3,109	)		(3,014	)
Decrease (increase) in other assets		776,290			(533,660	)		680,227
(Decrease) increase in other liabilities		(60,973	)		(1,820,633	)		663,785
Other, net		82,596			(62,873	)		178,627
Net cash provided by operating activities		25,071,722			15,386,790			24,798,554
Cash flows from investing activities:
Proceeds from sales of securities available for sale		0			15,129,325			50,372,919
Principal collected on securities available for sale		2,138,735			4,354,497			30,938,152
Proceeds collected on maturity of securities available for sale		21,000,000			15,000,000			10,000,000
Purchases of securities available for sale		(39,463,634	)		(34,877,137	)		(76,410,791	)
Redemption of interest in limited partnership		0			422,474			0
Purchase of Federal Home Loan Bank stock		(2,427,300	)		(1,793,200	)		(768,900	)
Redemption of Federal Home Loan Bank stock		3,355,500			2,504,800			2,645,000
Net increase in loans receivable		(14,532,425	)		(96,761,454	)		(161,455,973	)
Proceeds from sale of premises		0			266,972			416,354
Purchases of premises and equipment		(1,208,518	)		(2,220,610	)		(1,046,235	)
Net cash used by investing activities		(31,137,642	)		(97,974,333	)		(145,309,474	)
Cash flows from financing activities:
Increase in deposits		33,218,736			147,580,390			118,784,449
Purchase of treasury stock		(972,000	)		(3,316,550	)		(1,384,560	)
Stock options exercised		37,887			66,634			1,422,460
Dividends to stockholders		(3,524,140	)		(3,246,426	)		(2,901,071	)
Proceeds from Federal Home Loan Bank advances		78,000,000			54,900,000			161,000,000
Repayment of Federal Home Loan Bank advances		(88,000,000	)		(87,900,000	)		(175,400,000	)
Minority interest in limited partnership		0			0			7,000
Increase (decrease) in customer escrows		275,838			(21,694,934	)		21,750,458
Net cash provided by financing activities		19,036,321			86,389,114			123,278,736
Increase in cash and cash equivalents		12,970,401			3,801,571			2,767,816
Cash and cash equivalents, beginning of year		34,298,394			30,496,823			27,729,007
Cash and cash equivalents, end of year	$	47,268,795			34,298,394			30,496,823
Supplemental cash flow disclosures:
Cash paid for interest	$	23,740,233			20,445,776			20,371,643
Cash paid for income taxes		6,601,281			6,548,500			2,141,000
Supplemental noncash flow disclosures:
Loans transferred to loans held for sale		8,662,175			0			3,741,477
Transfer of loans to real estate		15,994,671			892,802			769,584
Transfer of real estate to loans		14,195,361			0			47,802

See accompanying notes to consolidated financial statements.

25

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2005, 2004 and 2003

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

HMN Financial, Inc. (HMN or the Company) is a stock savings bank holding company that owns 100 percent of Home Federal Savings Bank (the Bank). The Bank has a community banking philosophy and operates retail banking and loan production facilities in Minnesota and Iowa. The Bank has one wholly owned subsidiary, Osterud Insurance Agency, Inc. (OIA) which offers financial planning products and services. HMN has another wholly owned subsidiary, Security Finance Corporation (SFC) which acts as an intermediary for the Bank in transacting like-kind property exchanges for Bank customers. The Bank had three other subsidiaries that are no longer operating. Home Federal Holding, Inc. (HFH), a wholly owned subsidiary, was the holding company for Home Federal REIT, Inc. (HFREIT) which invested in real estate loans acquired from the Bank. HFH and HFREIT were both dissolved in 2005. Federal Title Services, LLC (FTS), which was 80% owned by the Bank, performed mortgage title services for Bank customers and was dissolved in 2004. Home Federal Mortgage Services, LLC (HFMS), which was 51% owned by the Bank, was a mortgage banking and mortgage brokerage business that was dissolved in 2003.

     The consolidated financial statements included herein are for HMN, SFC, the Bank and the Bank’s consolidated entities as described above. All significant intercompany accounts and transactions have been eliminated in consolidation.

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

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

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

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

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

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

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

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

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

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

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

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

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

26

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

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

     All impaired loans are valued at the present value of expected future cash flows discounted at the loan’s initial effective interest rate. The fair value of the collateral of an impaired collateral-dependent loan or an observable market price, if one exists, may be used as an alternative to discounting. If the value of the impaired loan is less than the recorded investment in the loan, impairment will be recognized through the allowance for loan losses. A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired loans include all loans which are delinquent as to principal and interest for 90 days or greater and all loans that are restructured in a troubled debt restructuring involving a modification of terms. All portfolio loans are reviewed for impairment on an individual basis.

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

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

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

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

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

Investment in Limited Partnerships The Company has investments in limited partnerships that invest in low to moderate income housing projects that generate tax credits for the Company. The Company accounts for the earnings or losses from the limited partnerships on the equity method.

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

Stock-Based Compensation The Company accounts for stock based compensation in accordance with Accounting Principles Board (APB) Opinion No. 25 and related interpretations which measure compensation cost using the intrinsic value method. See Note 16 for additional information relating to stock based compensation. Had compensation cost for the Company’s stock based plan been determined in accordance with the fair value method recommended by SFAS No. 123, the Company’s net income and earnings per share would have been adjusted to the following pro forma amounts:

	Year ended December 31,
	2005		2004		2003
Net income:
As reported	$	11,067,889		9,289,797		8,605,247
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects		54,619		37,822		44,935
Pro forma	$	11,013,270		9,251,975		8,560,312
Earnings per common share:
As reported:
Basic	$	2.89		2.40		2.26
Diluted		2.77		2.31		2.16
Pro forma:
Basic		2.88		2.39		2.25
Diluted		2.77		2.30		2.15

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

Earnings per Share Basic earnings per share (EPS) excludes dilution and is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential

27

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that shared in the earnings of the entity. See Note 17 for disclosure of EPS calculations.

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

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

New Accounting Pronouncement On December 16, 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment (FAS 123R), which replaces FAS 123, Accounting for Stock-Based Compensation, and supercedes Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees. Securities and Exchange Commission (SEC) registrants originally would have been required to adopt FAS 123R’s provisions at the beginning of their first interim period after June 15, 2005. On April 14, 2005, the SEC announced that registrants could delay adoption of FAS 123R’s provisions until the beginning of their next fiscal year. We adopted FAS 123R on January 1, 2006, using the “modified prospective” transition method. The scope of FAS 123R includes a wide range of stock-based compensation arrangements including stock options, restricted stock plans, performance-based awards, stock appreciation rights, and employee stock purchase plans. FAS 123R will require us to measure the cost of employee services received in exchange for an award of equity instruments based on the fair value of the award on the grant date. That cost must be recognized in the income statement over the vesting period of the award. Under the “modified prospective” transition method, awards that are granted, modified or settled beginning at the date of adoption will be measured and accounted for in accordance with FAS 123R. In addition, expense must be recognized in the statement of income for unvested awards that were granted prior to the date of adoption. The expense will be based on the fair value determined at the grant date. We anticipate that this expense will reduce 2006 earnings per share by approximately $0.01.

Derivative Financial Instruments The Company uses derivative financial instruments in order to manage the interest rate risk on residential loans held for sale and its commitments to extend credit for residential loans. The Company may also use interest rate swaps to manage interest rate risk. Derivative financial instruments include commitments to extend credit and forward mortgage loan sales commitments. See Note 21 for additional information concerning these derivative financial instruments.

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

NOTE 2 Other Comprehensive Income

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

	For the twelve months ended December 31,
(Dollars in thousands)	2005									2004
Securities available for sale:	Before tax			Tax effect			Net of tax			Before tax			Tax effect			Net of tax
Gross unrealized losses arising during the period	$	(607	)		(279	)		(328	)		(1,391	)		(491	)		(900	)
Less reclassification of net gains included in net income		(21	)		(6	)		(15	)		(535	)		(189	)		(346	)
Net unrealized losses arising during the period		(586	)		(273	)		(313	)		(856	)		(302	)		(554	)
Other comprehensive loss	$	(586	)		(273	)		(313	)		(856	)		(302	)		(554	)

28

NOTE 3 Securities Available for Sale

A summary of securities available for sale at December 31, 2005 and 2004 is as follows:

			Gross		Gross
	Amortized		unrealized		unrealized		Fair
	cost		gains		losses		value
December 31, 2005:
Mortgage-backed securities:
FHLMC	$	196,085		5,590		0		201,675
GNMA		14,229		276		0		14,505
Collateralized mortgage obligations:
FHLMC		3,117,121		0		302,494		2,814,627
FNMA		4,101,069		2,027		254,147		3,848,949
		7,428,504		7,893		556,641		6,879,756
Other marketable securities:
U.S. Government and agency obligations		110,109,841		0		971,028		109,138,813
Corporate and agency preferred stock		3,640,000		0		0		3,640,000
		113,749,841		0		971,028		112,778,813
	$	121,178,345		7,893		1,527,669		119,658,569
December 31, 2004:
Mortgage-backed securities:
FHLMC	$	242,841		12,798		0		255,639
GNMA		21,644		1,157		0		22,801
Collateralized mortgage obligations:
FHLMC		3,661,962		0		219,947		3,442,015
FNMA		5,582,930		18,589		171,103		5,430,416
		9,509,377		32,544		391,050		9,150,871
Other marketable securities:
U.S. Government and agency obligations		91,371,119		7,500		583,335		90,795,284
Corporate debt		64,932		296		0		65,228
Corporate and agency preferred stock		3,661,000		0		0		3,661,000
		95,097,051		7,796		583,335		94,521,512
	$	104,606,428		40,340		974,385		103,672,383

     The Company did not sell any securities available for sale during 2005 but did recognize a loss of $21,000 on a FHLMC preferred stock investment due to an other than temporary impairment. The fair market value of the FHLMC preferred stock was $2,940,000 at December 31, 2005. Proceeds from securities available for sale which were sold during 2004 were $15,129,325, resulting in gross gains of $8,029 and gross losses of $4,217. The Company also recognized a loss of $539,000 on a FHLMC preferred stock investment in 2004 due to an other than temporary impairment. The fair market value of the FHLMC preferred stock was $2,961,000 at December 31, 2004. Proceeds from securities available for sale which were sold during 2003 were $50,372,919, resulting in gross gains of $1,353,885 and gross losses of $79,348.

     The following table indicates amortized cost and estimated fair value of securities available for sale at December 31, 2005 based upon contractual maturity adjusted for scheduled repayments of principal and projected prepayments of principal based upon current economic conditions and interest rates. Actual maturities may differ from the maturities in the following table because obligors may have the right to call or prepay obligations with or without call or prepayment penalties:

	Amortized		Fair
	cost		value
Due less than one year	$	100,909,065		100,061,503
Due after one year through five years		12,510,957		12,164,063
Due after five years through ten years		1,592,052		1,475,007
Due after ten years		2,526,271		2,317,996
No stated maturity		3,640,000		3,640,000
Total	$	121,178,345		119,658,569

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

     The following table shows the gross unrealized losses and fair values for the securities available for sale portfolio aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at December 31, 2005:

29

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

	Less than twelve months							Twelve months or more							Total
	# of		Fair		Unrealized			# of		Fair		Unrealized			Fair		Unrealized
(Dollars in thousands)	Investments		Value		Losses			Investments		Value		Losses			Value		Losses
Mortgage backed securities:
FHLMC			$	0		0			2	$	2,814		(303	)	$	2,814		(303	)
FNMA		1		384		(11	)		2		3,304		(243	)		3,688		(254	)
Other marketable debt securities:
FNMA		1		4,958		(6	)		3		14,836		(147	)		19,794		(153	)
FHLMC		5		24,700		(13	)		4		19,725		(257	)		44,425		(270	)
FHLB		2		9,906		(62	)		7		35,014		(486	)		44,920		(548	)
Total temporarily impaired securities		9	$	39,948		(92	)		18	$	75,693		(1,436	)	$	115,641		(1,528	)

     These fixed rate investments are temporarily impaired due to changes in interest rates and the Company has the ability and intent to hold to maturity or until the temporary loss is recovered. Mortgage backed securities in the table above had an average life of less than four years and the other marketable securities had an average life of less than one year at December 31, 2005.

NOTE 4 Loans Receivable, Net

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

	2005			2004
Residential real estate loans:
1-4 family conventional	$	126,397,513			137,953,340
1-4 family conventional — construction		38,558,199			37,841,355
1-4 family FHA		450,087			647,006
1-4 family VA		227,055			408,074
		165,632,854			176,849,775
5 or more family		40,752,809			41,921,601
5 or more family — construction		11,210,771			19,153,847
		217,596,434			237,925,223
Commercial real estate:
Lodging		47,247,644			49,799,669
Retail/office		51,062,980			56,183,453
Nursing home/health care		6,868,065			7,719,285
Land developments		101,069,732			67,506,276
Golf courses		26,905,139			29,363,624
Restaurant/bar/café		4,402,806			4,013,659
Ethanol plants		8,898,424			9,431,878
Warehouse		8,092,314			8,793,067
Manufacturing		2,998,990			5,698,911
Churches/Community service		3,364,752			4,243,784
Other		29,930,294			23,593,335
		290,841,140			266,346,941
Other loans:
Autos		5,461,586			9,496,044
Home equity line		61,011,142			67,140,395
Home equity		19,075,822			20,032,508
Consumer — secured		979,349			1,522,682
Commercial business		193,962,012			182,368,675
Land/lot loans		9,486,634			11,572,361
Savings		605,383			453,522
Mobile home		2,298,816			2,896,209
Consumer — unsecured		1,979,533			1,859,611
		294,860,277			297,342,007
Total loans		803,297,851			801,614,171
Less:
Unamortized discounts		190,388			63,377
Net deferred loan fees		1,643,629			1,781,018
Allowance for losses		8,777,655			8,995,892
Loans in process		7,007,718			7,560,622
	$	785,678,461			783,213,262
Commitments to originate or purchase loans	$	44,927,627			68,751,130
Commitments to deliver loans to secondary market	$	4,690,823			6,433,115
Weighted average contractual loan rate		6.32	%		6.26	%
Loans serviced for others	$	541,597,254			523,635,219

     Included in total commitments to originate or purchase loans are fixed rate loans aggregating $10.4 million and $28.1 million as of December 31, 2005 and 2004, respectively. The interest rates on these commitments ranged from 5.50% to 8.15% at December 31, 2005 and from 4.63% to 7.00% at December 31, 2004.

     At December 31, 2005, 2004 and 2003, loans on nonaccrual status totaled $2.3 million, $3.7 million, and $4.6 million, respectively. Had the loans performed in accordance with their original terms, the Company would have recorded gross interest income on these loans of $327,280, $271,071 and $458,473 in 2005, 2004 and 2003, respectively. For the years ended December 31, 2005, 2004 and 2003, the Company recognized interest income of $273,458, $158,767 and $163,044 related to these loans, respectively. All of the interest income that was recognized for these loans was recognized using the cash basis method of income recognition.

     At December 31, 2005, 2004 and 2003, the recorded investment in loans that were considered to be impaired was $2.3 million, $4.3 million and $4.7 million, for which the related allowance for credit losses was $384,374, $523,312 and $1,045,495, respectively. The average investment in impaired loans during 2005, 2004 and 2003 was $4.9 million, $3.6 million and $4.8 million, respectively.

      At December 31, 2005 and 2004 no loans were included in loans receivable, net, with terms that had been modified in a troubled debt restructuring. There were no material commitments to lend additional funds to customers whose loans were classified as restructured or nonaccrual at December 31, 2005.

     The aggregate amounts of loans to executive officers and directors of the Company was $595,249, $706,869 and $1,038,119 at December 31, 2005, 2004 and 2003, respectively. During 2005 repayments on loans to executive officers and directors were $161,620, new loans to executive officers and directors totaled $768,500, sales of executive officer and director loans were $698,500 and net loans removed from the executive officer listing due to change in status of the officer were $20,000. During 2004 repayments on loans to executive officers and directors were $579,699, loans originated aggregated $517,570 and sales of executive officer and director loans totaled $240,000, and net loans removed from the executive officer listing due to change in status of the officer were $29,121. All loans were made in the ordinary course of business on normal credit terms, including interest rates and

30

collateral, as those prevailing at the time for comparable transactions with unrelated parties.

     At December 31, 2005, 2004 and 2003, the Company was servicing real estate loans for others with aggregate unpaid principal balances of approximately $541.6 million, $523.6 million and $483.6 million, respectively.

     The Company originates residential, commercial real estate and other loans primarily in Minnesota and Iowa. Prior to 2003, the Company also purchased loans from a third party broker located in the southeastern United States. At December 31, 2005 and 2004, the Company had in its portfolio single family and multi-family residential loans located in the following states:

	2005					2004
			Percent					Percent
	Amount		of Total			Amount		of Total
Alabama	$	1,114,760		0.5	%	$	1,544,742		0.6	%
Arizona		2,497,464		1.1			2,031,585		0.9
Florida		976,079		0.4			2,204,299		0.9
Georgia		3,071,349		1.4			5,236,234		2.2
Illinois		609,561		0.3			1,683,487		0.7
Iowa		13,059,087		6.0			16,944,040		7.1
Massachusetts		783,492		0.4			1,252,635		0.5
Minnesota		187,307,513		86.1			189,770,503		79.8
North Carolina		1,316,680		0.6			2,450,469		1.0
Texas		0		0.0			6,612,676		2.8
Wisconsin		4,567,778		2.1			4,548,029		1.9
Other states		2,292,671		1.1			3,646,524		1.6
Total	$	217,596,434		100.0	%	$	237,925,223		100.0	%

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

At December 31, 2005 and 2004, the Company had in its portfolio commercial real estate loans located in the following states:

	2005					2004
			Percent					Percent
	Amount		of Total			Amount		of Total
Arizona	$	3,159,523		1.1	%	$	3,346,259		1.3	%
California		1,000,000		0.3			1,000,000		0.3
Colorado		0		0.0			1,674,433		0.6
Illinois		658,800		0.2			658,800		0.3
Indiana		650,649		0.3			660,435		0.3
Iowa		15,757,914		5.4			25,144,085		9.4
Kansas		8,303,539		2.9			0		0.0
Minnesota		251,087,445		86.3			219,937,723		82.6
Missouri		4,298,961		1.5			4,376,886		1.6
Montana		2,026,126		0.7			2,114,048		0.8
Nebraska		947,905		0.3			947,905		0.4
South Dakota		944,281		0.3			1,603,132		0.6
Utah		1,840,143		0.6			1,892,340		0.7
Wisconsin		165,854		0.1			2,990,895		1.1
Total	$	290,841,140		100.0	%	$	266,346,941		100.0	%

NOTE 5 Allowance for Loan Losses

The allowance for loan losses is summarized as follows:

Balance, December 31, 2002	$	4,824,217
Provision for losses		2,610,000
Charge-offs		(550,580	)
Recoveries		55,965
Balance, December 31, 2003		6,939,602
Provision for losses		2,755,000
Charge-offs		(737,917	)
Recoveries		39,207
Balance, December 31, 2004		8,995,892
Provision for losses		2,674,000
Charge-offs		(3,076,815	)
Recoveries		184,578
Balance, December 31, 2005	$	8,777,655

NOTE 6 Accrued Interest Receivable

Accrued interest receivable at December 31 is summarized as follows:

	2005		2004
Securities available for sale	$	578,068		626,367
Loans receivable		3,881,946		3,067,766
	$	4,460,014		3,694,133

NOTE 7 Investment in Mortgage Servicing Rights

A summary of mortgage servicing activity is as follows:

	2005			2004
Mortgage servicing rights
Balance, beginning of year	$	3,231,242			3,447,843
Originations		442,159			844,806
Amortization		(1,019,766	)		(1,061,407	)
Balance, end of year		2,653,635			3,231,242
Valuation reserve		0			0
Mortgage servicing rights, net	$	2,653,635			3,231,242

     All of the loans being serviced were single family loans serviced for FNMA under the mortgage-backed security program or the individual loan sale program. The following is a summary of the risk characteristics of the loans being serviced at December 31, 2005:

						Weighted
			Weighted			Average
	Loan		Average			Remaining		Number
	Principal		Interest			Term		of
	Balance		Rate			(months)		Loans
Original term 30 year fixed rate	$	213,098,614		5.90	%		334		1,869
Original term 15 year fixed rate		205,868,685		5.27			150		2,618
Adjustable rate		6,118,532		5.29			324		57

31

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 8 Real Estate

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

	2005			2004
Real estate in judgment subject to redemption	$	43,052			116,000
Real estate acquired through foreclosure		521,569			24,608
Real estate acquired through deed in lieu of foreclosure		750,000			0
		1,314,621			140,608
Allowance for losses		(100,000	)		0
	$	1,214,621			140,608

NOTE 9 Investment in Limited Partnerships

The Company had an investment in low income housing limited partnerships of $141,048 at December 31, 2005 and $168,258 at December 31, 2004. The Company’s proportionate loss on these partnerships was $27,210 and $26,920 in 2005 and 2004, respectively. The Company also received low income housing credits totaling $42,000 in 2005 and $84,000 in 2004 that were credited to current income tax benefits. During 2004 the Company’s proportionate share of gains from a limited partnership that invested in the common stock of financial institutions was $803. This partnership was dissolved in 2004.

NOTE 10 Intangible Assets

The gross carrying amount of intangible assets and the associated accumulated amortization at December 31, 2005 and 2004 are presented in the following table. Amortization expense for intangible assets was $1,133,623, $1,175,264, and $1,889,276 for the years ended December 31, 2005, 2004 and 2003, respectively.

	Gross					Unamortized
	Carrying		Accumulated			Intangible
	Amount		Amortization			Assets
December 31, 2005
Amortized intangible assets:
Mortgage servicing rights	$	4,410,439		(1,756,804	)		2,653,635
Core deposit intangible		1,567,000		(1,347,240	)		219,760
Total	$	5,977,439		(3,104,044	)		2,873,395
December 31, 2004
Amortized intangible assets:
Mortgage servicing rights	$	4,555,552		(1,324,310	)		3,231,242
Core deposit intangible		1,567,000		(1,233,383	)		333,617
Total	$	6,122,552		(2,557,693	)		3,564,859

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

	Mortgage		Core
	Servicing		Deposit
	Rights		Intangible		Total
Year ended December 31,
2006	$	486,493		113,857		600,350
2007		405,806		105,903		511,709
2008		337,859		0		337,859
2009		280,694		0		280,694
2010		232,650		0		232,650

Projections of amortization are based on existing asset balances and the existing interest rate environment as of December 31, 2005. The Company’s actual experiences may be significantly different depending upon changes in mortgage interest rates and other market conditions.

32

NOTE 11 Premises and Equipment

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

	2005			2004
Land	$	1,309,519			1,309,519
Office buildings and improvements		9,428,917			9,309,207
Furniture and equipment		10,997,705			9,904,474
		21,736,141			20,523,200
Less accumulated depreciation		(9,794,278	)		(8,058,935	)
	$	11,941,863			12,464,265

NOTE 12 Deposits

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

	2005								2004
	Weighted					Percent of			Weighted					Percent of
	average rate			Amount		total			average rate			Amount		total
Noninterest checking		0.00	%	$	58,429,385		8.0	%		0.00	%	$	42,776,699		6.1	%
NOW accounts		2.08			101,942,029		13.9			1.01			95,294,144		13.6
Savings accounts		2.04			84,858,265		11.6			0.19			47,415,778		6.8
Money market accounts		2.59			96,947,209		13.3			1.72			129,098,425		18.5
					342,176,888		46.8						314,585,046		45.0
Certificates:
1-1.99%					6,497,132		0.9						63,716,056		9.1
2-2.99%					118,722,782		16.2						160,829,030		23.0
3-3.99%					211,018,548		28.8						108,937,895		15.6
4-4.99%					52,319,449		7.2						49,449,374		7.1
5-5.99%					796,604		0.1						1,266,218		0.2
6-6.99%					5,157		0.0						4,818		0.0
7-7.99%					0		0.0						113,748		0.0
Total certificates		3.39			389,359,672		53.2			2.86			384,317,139		55.0
Total deposits		2.67		$	731,536,560		100.0	%		2.01		$	698,902,185		100.0	%

     At December 31, 2005 and 2004, the Company had $264.8 million and $206.4 million, respectively, of deposit accounts with balances of $100,000 or more. The Company also had $165.5 million and $128.7 million of certificate accounts that were acquired through a broker, at December 31, 2005 and 2004, respectively.

     Certificates had the following maturities at December 31:

	2005					2004
			Weighted					Weighted
	Amount		average			Amount		average
Remaining term to maturity	(in thousands)		rate			(in thousands)		rate
1-6 months	$	102,326		3.06	%	$	110,550		2.54	%
7-12 months		96,919		3.25			87,099		2.60
13-36 months		172,362		3.65			150,222		3.10
Over 36 months		17,753		3.59			36,446		3.51
	$	389,360		3.39		$	384,317		2.86

     At December 31, 2005, mortgage loans and mortgage-backed and related securities with an amortized cost of approximately $28.3 million and letters of credit from the Federal Home Loan Bank (FHLB) of $3.7 million were pledged as collateral on Bank deposits.

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

	2005		2004		2003
NOW	$	1,770,001		702,102		211,736
Savings Accounts		435,164		77,293		90,421
Money Market		1,328,344		645,153		437,645
Certificates		13,699,891		10,973,957		9,534,386
	$	17,233,400		12,398,505		10,274,188

33

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 13 Federal Home Loan Bank Advances

Fixed rate Federal Home Loan Bank advances consisted of the following at December 31:

	2005					2004
Year of Maturity	Amount		Rate			Amount		Rate
2005						$	10,000,000		2.69	%
2007	$	40,000,000		2.91	%		40,000,000		2.91
2008		20,000,000		3.83			20,000,000		3.83
2010		10,000,000		6.48			10,000,000		6.48
2011		10,900,000		4.81			10,900,000		4.81
2013		80,000,000		4.75			80,000,000		4.75
		160,900,000		4.29			170,900,000		4.20
Lines of Credit		0					0
	$	160,900,000		4.29		$	170,900,000		4.20

     Many of the advances listed above have call provisions which allow the FHLB to request that the advance be paid back or refinanced at the rates then being offered by the FHLB. As of December 31, 2005, the Company had advances from the FHLB with the following call features:

	Callable Quarterly
Year of Maturity	in 2006
2008	$	10,000,000
2010		10,000,000
2011		10,900,000
2013		80,000,000
	$	110,900,000

     At December 31, 2005, the advances from the FHLB were collateralized by the Bank’s FHLB stock and mortgage loans with unamortized principal balances of $194.5 million. The Bank has the ability to draw additional borrowings of $29.9 million based upon the mortgage loans that are currently pledged, subject to a requirement to purchase additional FHLB stock.

NOTE 14 Other Borrowed Money

The Company had a $5.0 million revolving line of credit that expires on October 25, 2006 that was not drawn on at December 31, 2005. The Bank maintained an undrawn $2.5 million revolving line of credit at December 31, 2004.

NOTE 15 Income Taxes

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

	2005			2004			2003
Current:
Federal	$	6,251,100			4,688,700			4,080,500
State		1,744,100			435,600			498,200
Total current		7,995,200			5,124,300			4,578,700
Deferred:
Federal		(843,400	)		(683,200	)		(506,200	)
State		(415,700	)		(54,000	)		(34,700	)
Total deferred		(1,259,100	)		(737,200	)		(540,900	)
	$	6,736,100			4,387,100			4,037,800

34

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

	2005			2004			2003
Federal expected income tax expense	$	6,053,400			4,651,300			4,297,600
Items affecting federal income tax:
Dividend received deduction		(25,700	)		(16,200	)		(26,100	)
State income taxes, net of federal income tax benefit		974,900			247,900			249,700
Reduction of tax rate due to employee stock ownership plan dividends		0			(170,200	)		(160,500	)
Low income housing credits		(42,000	)		(84,000	)		(84,000	)
Tax exempt interest		(378,000	)		(340,300	)		(284,600	)
Other, net		153,500			98,600			45,700
	$	6,736,100			4,387,100			4,037,800

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

	2005		2004
Deferred tax assets:
Allowances for loan and real estate losses	$	3,560,900		3,144,400
Discounts on assets and liabilities acquired from Marshalltown Financial Corporation		100		200
Deferred compensation costs		195,800		162,400
Impairment losses on securities available for sale		221,900		188,400
Net unrealized loss on market value adjustments to securities available for sale		602,200		329,600
Deferred ESOP loan asset		506,900		0
Total gross deferred tax assets		5,087,800		3,825,000
Valuation allowance		0		0
Net deferred tax assets		5,087,800		3,825,000
Deferred tax liabilities:
Premium on assets acquired from Marshalltown Financial Corporation		87,300		117,000
Deferred loan fees and costs		475,200		452,600
Premises and equipment basis difference		835,500		1,078,100
Originated mortgage servicing rights		1,051,400		1,161,100
Other		94,000		3,500
Total gross deferred tax liabilities		2,543,400		2,812,300
Net deferred tax assets	$	2,544,400		1,012,700

     Retained earnings at December 31, 2005 included approximately $8.8 million for which no provision for income taxes was made. This amount represents allocations of income to bad debt deductions for tax purposes. Reduction of amounts so allocated for purposes other than absorbing losses will create income for tax purposes, which will be subject to the then-current corporate income tax rate. The Company has, in its judgment, made reasonable assumptions relating to the realization of deferred tax assets. Based upon these assumptions, the Company has determined that no valuation allowance is required with respect to the deferred tax assets.

35

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 16 Employee Benefits

All eligible full-time employees of the Bank that were hired prior to 2002 were included in a noncontributory retirement plan sponsored by the Financial Institutions Retirement Fund (FIRF). Effective September 1, 2002 the Bank froze the accrual of benefits for existing participants and no new enrollments were permitted into the plan. The actuarial present value of accumulated plan benefits and net assets available for benefits relating to the Bank’s employees is not available at December 31, 2005 because such information is not accumulated for each participating institution. As of June 30, 2005, the FIRF valuation report reflected that the Bank was obligated to make a contribution for the plan year ending June 30, 2005 totaling $205,744. The contribution was $83,355 in 2004 and $36,014 in 2003.

     The Company has a qualified, tax-exempt savings plan with a deferred feature qualifying under Section 401(k) of the Internal Revenue Code (the 401(k) Plan). All employees who have attained 18 years of age are eligible to participate in the Plan. Participants are permitted to make contributions to the 401(k) Plan equal to the lesser of 50% of the participant’s annual salary or the maximum allowed by law, which was $14,000 for 2005. The Company matches 25% of each participant’s contributions up to a maximum of 8% of the participant’s annual salary. Employee contributions above 8% are not matched by the Company. Participant contributions and earnings are fully and immediately vested. The Company’s contributions made prior to January 1, 2002 are vested on a five year cliff basis and contributions made after December 31, 2001 are vested on a three year cliff basis. The Company’s matching contributions to the 401(k) plan are expensed when made and were $122,428, $118,665, and $113,843, in 2005, 2004 and 2003, respectively.

     The Company has adopted an Employee Stock Ownership Plan (the ESOP) that meets the requirements of Section (e)(7) of the Internal Revenue Code and Section 407(d)(6) of the Employee Retirement Income Security Act of 1974, as amended (ERISA) and, as such the ESOP is empowered to borrow in order to finance purchases of the common stock of HMN. The ESOP borrowed $6,085,770 from the Company to purchase 912,866 shares of common stock in the initial public offering of HMN. As a result of a merger with Marshalltown Financial Corporation (MFC), the ESOP borrowed $1,476,000 to purchase 76,933 shares of HMN common stock to provide the employees from MFC with an ESOP benefit. The ESOP debt requires quarterly payments of principal plus interest at 7.52%. The Company has committed to make quarterly contributions to the ESOP necessary to repay the loan including interest. The Company contributed $525,229, $526,552 and $525,224 for 2005, 2004 and 2003, respectively.

     As the debt is repaid, ESOP shares that were pledged as collateral for the debt are committed to be released from collateral and allocated to active employees based on the proportion of debt service paid in the year. The Company accounts for its ESOP in accordance with Statement of Position 93-6, Employers’ Accounting for Employee Stock Ownership Plans. Accordingly, the shares pledged as collateral are reported as unearned ESOP shares in stockholders’ equity. As shares are determined to be ratably released from collateral, the Company reports compensation expense equal to the current market price of the shares, and the shares become outstanding for earnings per share computations. ESOP compensation expense was $756,166, $670,112, and $472,108, respectively, for 2005, 2004 and 2003.

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

	2005			2004			2003
Shares allocated to participants beginning of the year		270,884			275,588			245,031
Shares allocated to participants		24,317			24,380			24,317
Shares purchased with dividends from allocated shares		8,311			7,368			10,638
Shares distributed to participants		(17,494	)		(36,452	)		(4,398	)
Shares allocated to participants end of year		286,018			270,884			275,588
Unreleased shares beginning of the year		571,733			596,113			620,430
Shares released during year		(24,317	)		(24,380	)		(24,317	)
Unreleased shares end of year		547,416			571,733			596,113
Total ESOP shares end of year		833,434			842,617			871,701
Fair value of unreleased shares at December 31	$	16,148,772			18,861,472			14,479,585

     In June 1995, the Company adopted the 1995 Stock Option and Incentive Plan (1995 Plan). The 1995 Plan terminated on April 25, 2005, and options may no longer be granted from the plan. At December 31, 2005, there were 6,000 unvested and 118,000 vested options under the 1995 Plan that remained unexercised. The average exercise price of these options is $12.18. These options vest over a 5 year period and expire 10 years from the date of grant.

     In March 2001, the Company adopted the HMN Financial, Inc. 2001 Omnibus Stock Plan (2001 Plan). The purpose of the 2001 Plan is to promote the interests of the Company and its stockholders by providing key personnel with an opportunity to acquire a proprietary interest in the Company and reward them for achieving a high level of corporate performance and thereby develop a stronger incentive to put forth maximum effort for the success and growth of the Company. The total number of shares of HMN common stock available for distribution under the 2001 Plan in either restricted stock or stock options was 400,000 subject to adjustment for future stock splits, stock dividends and similar changes to the capitalization of the Company. No more than 100,000 shares may be issued from the 2001 Plan as restricted stock.

     The fair value of options granted under the 2001 Plan were $3.59, $2.62, $2.10 and $2.10 for May 2005, July 2004, March 2004, and February 2004, respectively. A summary of activities under both plans for the past three years is as follows:

36

	Shares									Award
	available for			Restricted			Options			value/		Vesting
	grant			shares			outstanding			exercise price		period
1995 Stock Option and Incentive Plan
December 31, 2002		9,397						407,248		$	10.15
Exercised		0						(228,493	)		9.21
December 31, 2003		9,397						178,755			11.36
Exercised		0						(43,814	)		9.47
December 31, 2004		9,397						134,941			11.97
Exercised		0						(10,941	)		9.56
Expired		(9,397	)								N/A
December 31, 2005		0						124,000			12.18
2001 Omnibus Stock Plan
December 31, 2002		187,590						212,410			16.13
Forfeited		16,447						(16,447	)		16.13
December 31, 2003		204,037						195,963			16.13
Granted February 13, 2004		(5,000	)					5,000			27.64	4 years
Granted March 3, 2004		(20,000	)					20,000			27.66	3 years
Granted July 27, 2004		(15,000	)					15,000			26.98	5 years
Forfeited		17,618						(17,618	)		19.05
December 31, 2004		181,655						218,345			17.96
Granted January 25, 2005		(10,047	)		10,047						32.50	3 years
Granted May 24, 2005		(15,000	)					15,000			30.00	5 years
Forfeited		7,997			(1,418	)		(6,579	)		16.13
December 31, 2005		164,605			8,629			226,766			18.81
Total both plans		164,605			8,629			350,766			16.47

     The following table summarizes information about stock options outstanding at December 31, 2005:

Options Outstanding
			Weighted average
Exercise	Number		remaining contractual		Number
price	outstanding		life in years		exercisable
$13.01		14,000		1.3		14,000
11.50		65,000		3.3		65,000
11.25		30,000		4.4		30,000
16.25		15,000		6.4		9,000
16.13		176,226		6.3		6,466
27.64		5,000		8.2		1,250
27.66		15,540		8.2		5,179
26.98		15,000		8.6		3,000
30.00		15,000		9.4		0
		350,766				133,895

     The Company uses the intrinsic value method as described in APB Opinion No. 25 and related interpretations to account for its stock incentive plans. Accordingly, no compensation cost has been recognized for the option plans. Proceeds from stock options exercised are credited to common stock and additional paid-in capital. There are no charges or credits to expense with respect to the granting or exercise of options since the options were issued at fair value on the respective grant dates. The pro forma disclosure requirements under FAS No. 123, as amended, are included in Note 1.

     The fair value for each option grant is estimated on the date of the grant using an option valuation model. The model incorporated the following assumptions:

	2005			2004
Risk-free interest rate		4.03	%		4.13	%
Expected life	9 years			9 years
Expected volatility		8.75	%		10.63	%
Expected dividends		2.9	%		3.9	%

37

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 17 Earnings per Share

The following table reconciles the weighted average shares outstanding and net income for basic and diluted EPS:

	Year ended December 31,
	2005		2004		2003
Weighted average number of common shares outstanding used in basic earnings per common share calculation		3,824,555		3,868,223		3,812,213
Net dilutive effect of:
Options		166,207		159,442		169,171
Restricted stock awards		7,683		0		0
Weighted average number of shares outstanding adjusted for effect of dilutive securities		3,998,445		4,027,665		3,981,384
Net income available to common shareholders	$	11,067,889		9,289,797		8,605,247
Basic earnings per common share	$	2.89		2.40		2.26
Diluted earnings per common share	$	2.77		2.31		2.16

NOTE 18 Stockholders’ Equity

The Company repurchased in the open market and placed in treasury 30,000 shares of its common stock in 2005, 123,000 shares in 2004, and 86,600 shares in 2003 for $972,000, $3,316,550, and $1,384,560, respectively.

     HMN declared and paid dividends as follows:

				Quarterly
		Dividend		Dividend
Record date	Payable date	per share		Payout Ratio
February 21, 2003	March 7, 2003	$	0.18		64.29	%
May 22, 2003	June 9, 2003	$	0.18		50.00	%
August 28, 2003	September 11, 2003	$	0.20		38.46	%
November 28, 2003	December 17, 2003	$	0.20		26.32	%
February 20, 2004	March 8, 2004	$	0.20		37.74	%
May 21, 2004	June 8, 2004	$	0.20		38.46	%
August 27, 2004	September 10, 2004	$	0.22		35.48	%
November 26, 2004	December 15, 2004	$	0.22		34.38	%
February 18, 2005	March 7, 2005	$	0.22		41.51	%
May 20, 2005	June 8, 2005	$	0.22		31.43	%
August 26, 2005	September 9, 2005	$	0.24		38.71	%
November 25, 2005	December 14, 2005	$	0.24		42.11	%

     On January 24, 2006 the Company declared a cash dividend of $0.24 per share payable on March 7, 2006, to stockholders of record on February 17, 2006. The annualized dividend payout ratios for 2005, 2004, and 2003 were 38.02%, 36.36%, and 39.58%, respectively.

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

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

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

NOTE 19 Federal Home Loan Bank Investment and Regulatory Capital Requirements

The Bank, as a member of the Federal Home Loan Bank System, is required to hold a specified number of shares of capital stock, which are carried at cost, in the Federal Home Loan Bank of Des Moines. The Bank met this requirement at December 31, 2005.

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

     Quantitative measures established by regulations to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the following table) of Tier I or Core capital, and Risk-based capital (as defined in the regulations) to total assets (as defined). Management believes, as of December 31, 2005 and 2004, that the Bank met all capital adequacy requirements to which it was subject.

     Management believes that based upon the Bank’s capital calculations at December 31, 2005 and 2004 and other conditions consistent with the Prompt Corrective Actions provisions of the OTS regulations, the Bank would be categorized as well capitalized.

38

     At December 31, 2005 and 2004 the Bank’s capital amounts and ratios are also presented for actual capital, required capital, and excess capital including amounts and ratios in order to qualify as being well capitalized under the Prompt Corrective Actions regulations:

																To Be Well Capitalized
						Required to										Under Prompt
						be Adequately										Corrective Actions
	Actual					Capitalized					Excess Capital					Provisions
			Percent of					Percent of					Percent of					Percent of
(Dollars in thousands)	Amount		Assets (1)			Amount		Assets (1)			Amount		Assets (1)			Amount		Assets (1)
December 31, 2005
Tier I or core capital	$	80,401		8.18	%	$	39,330		4.00	%	$	41,071		4.18	%	$	49,163		5.00	%
Tier I risk based capital	$	80,401		10.02	%	$	32,102		4.00	%	$	48,299		6.02	%	$	48,153		6.00	%
Risk-based capital to risk-weighted assets	$	89,007		11.09	%	$	64,204		8.00	%	$	24,803		3.09	%	$	80,254		10.00	%
December 31, 2004
Tier I or core capital	$	74,131		7.77	%	$	38,150		4.00	%	$	35,981		3.77	%	$	47,687		5.00	%
Tier I risk based capital	$	74,131		9.45	%	$	31,373		4.00	%	$	42,758		5.45	%	$	47,059		6.00	%
Risk-based capital to risk-weighted assets	$	82,274		10.49	%	$	62,746		8.00	%	$	19,528		2.49	%	$	78,432		10.00	%

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

NOTE 20 Financial Instruments with Off-Balance Sheet Risk

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

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

	December 31,
	Contract amount
(Dollars in thousands)	2005		2004
Financial instruments whose contract amount represents credit risk:
Commitments to originate, fund or purchase loans:
1-4 family mortgages	$	3,850		3,723
Multi-family mortgages		0		12,000
Commercial real estate mortgages		19,835		26,593
Non-mortgage loans		21,243		26,435
Undisbursed balance of loans closed		75,465		100,772
Unused lines of credit		97,445		78,930
Letters of credit		10,158		7,025
Total commitments to extend credit	$	227,996		255,478
Forward commitments	$	4,691		6,433

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

     Forward commitments represents commitments to sell loans to FNMA and are entered into in the normal course of business by the Bank.

     The Bank entered into two guaranty agreements with third parties in 2001 in order for Home Federal Mortgage Services, LLC (HFMS) to secure loan purchase agreements. Under the agreements, the Bank guaranteed to satisfy and discharge all obligations of HFMS arising from transactions entered into between HFMS and the third parties if HFMS failed to fulfill its obligations. The agreements are in effect until the obligations of HFMS are fully satisfied and the Bank’s guaranty is limited to a combined maximum of $3 million. No liability has been recorded in the consolidated financial statements of the Company for these guarantees and the Company is not aware of any outstanding obligations of HFMS to either of the third parties with whom a guarantee exists. HFMS was dissolved in 2003 and ceased doing business with both third parties in 2002. There is the possibility

39

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

that the Bank would be required to purchase loans that were previously sold to the third parties by HFMS prior to 2002 if the loans did not meet the requirements in the loan purchase agreements. If this were to occur, the proceeds from the subsequent sale of these loans would enable the Bank to recover a portion of the amounts paid under the guaranty.

     The Bank issued standby letters of credit which guarantee the performance of customers to third parties. The standby letters of credit outstanding at December 31, 2005 expire over the next 21 months and totaled $1.7 million at December 31, 2005 and $1.6 million at December 31, 2004. The letters of credit were collateralized primarily with commercial real estate mortgages.Since the conditions under which the Bank is required to fund the standby letters of credit may not materialize, the cash requirements are expected to be less than the total outstanding commitments.

NOTE 21 Derivative Instruments and Hedging Activities

The Company originates and purchases single family residential loans for sale into the secondary market and enters into commitments to sell those loans in order to mitigate the interest rate risk associated with holding the loans until they are sold. The Company accounts for these commitments in accordance with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities.

     The Company has commitments outstanding to extend credit to future borrowers that had not closed prior to the end of the year, which is referred to as its mortgage pipeline. As commitments to originate loans enter the mortgage pipeline, the Company generally enters into commitments to sell the loans into the secondary market. The commitments to originate and sell loans are derivatives that are recorded at market value. As a result of marking these derivatives to market for the period ended December 31, 2005, the Company recorded a decrease in other assets of $2,764, an increase in other liabilities of $15,769, and a net loss on the sale of loans of $18,533.

     As of December 31, 2005 the commitments to sell loans held for sale are derivatives that do not qualify for hedge accounting. As a result, these derivatives are marked to market. The loans held for sale that are not hedged are recorded at the lower of cost or market. As a result of marking these loans, the Company recorded an increase in loans held for sale of $4,680 and a decrease in other assets of $4,680.

NOTE 22 Fair Value of Financial Instruments

SFAS No. 107, Disclosures about Fair Values of Financial Instruments, requires disclosure of estimated fair values of the Company’s financial instruments, including assets, liabilities and off-balance sheet items for which it is practicable to estimate fair value. The fair value estimates are made as of December 31, 2005 and 2004 based upon relevant market information, if available, and upon the characteristics of the financial instruments themselves. Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based upon judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. The estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

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

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

	December 31,
				2005								2004
	Carrying			Estimated			Contract		Carrying			Estimated			Contract
(Dollars in thousands)	amount			fair value			amount		amount			fair value			amount
Financial assets:
Cash and cash equivalents	$	47,269			47,269					34,298			34,298
Securities available for sale		119,659			119,659					103,672			103,672
Loans held for sale		1,435			1,435					2,712			2,712
Loans receivable, net		785,678			785,189					783,213			785,533
Federal Home Loan Bank stock		8,365			8,365					9,293			9,293
Accrued interest receivable		4,460			4,460					3,694			3,694
Financial liabilities:
Deposits		731,536			684,586					698,902			672,757
Federal Home Loan Bank advances		160,900			161,929					170,900			175,973
Accrued interest payable		2,086			2,086					1,314			1,314
Off-balance sheet financial instruments:
Commitments to extend credit		5			5			229,189		13			13			213,846
Commitments to sell loans		(19	)		(19	)		4,691		(3	)		(3	)		6,433

40

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

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

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

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

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

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

Deposits Under SFAS No. 107, the fair value of deposits with no stated maturity such as checking, savings and money market accounts, is equal to the amount payable on demand. The fair value of certificates of deposit is based on the discounted value of contractual cash flows using as discount rates the rates that were offered by the Company as of December 31, 2005 and 2004 for deposits with maturities similar to the remaining maturities of the existing certificates of deposit.

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

Federal Home Loan Bank Advances The fair values of advances with fixed maturities are estimated based on discounted cash flow analysis using as discount rates the interest rates charged by the FHLB at December 31, 2005 and 2004 for borrowings of similar remaining maturities.

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

Commitments to Extend Credit The fair values of commitments to extend credit for 2005 and 2004 are estimated using the fees normally charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counter parties.

Commitments to Sell Loans The fair values of commitments to sell loans for 2005 and 2004 are estimated using the quoted market prices for loans with similar interest rates and terms to maturity.

41

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 23 HMN Financial, Inc. Financial Information (Parent Company Only)

The following are the condensed financial statements for the parent company only as of December 31, 2005 and 2004 and for the years ended December 31, 2005, 2004 and 2003.

	2005			2004			2003
Condensed Balance Sheets
Assets:
Cash and cash equivalents	$	4,885,596			5,608,727
Investment in subsidiaries		85,298,915			78,236,806
Real estate, net		750,000			0
Accrued interest receivable		0			8,462
Prepaid expenses and other assets		231,433			320,787
Deferred tax asset		195,400			162,000
Total assets	$	91,361,344			84,336,782
Liabilities and Stockholders’ Equity:
Accrued expenses and other liabilities	$	633,075			565,946
Total liabilities		633,075			565,946
Common stock		91,287			91,287
Additional paid-in capital		58,011,099			57,875,595
Retained earnings		98,951,777			91,408,028
Net unrealized loss on securities available for sale		(917,577	)		(604,446	)
Unearned employee stock option plan shares		(4,350,999	)		(4,544,300	)
Unearned compensation stock awards		(182,521	)		0
Treasury stock, at cost, 4,721,402 and 4,708,798 shares		(60,874,797	)		(60,455,328	)
Total stockholders’ equity		90,728,269			83,770,836
Total liabilities and stockholders’ equity	$	91,361,344			84,336,782
Condensed Statements of Income
Interest income	$	107,574			69,936			193,334
Securities gains, net		0			0			301,006
Equity earnings of subsidiaries		11,375,240			9,453,280			8,361,418
Equity earnings of limited partnerships		0			803			132,273
Compensation and benefits		(247,300	)		(207,300	)		(42,100	)
Occupancy		(20,400	)		(14,400	)		(6,005	)
Advertising		0			0			(2,500	)
Data processing		(3,600	)		(2,600	)		(1,200	)
Mortgage servicing		0			(145	)		(8,009	)
Other		(375,525	)		(409,377	)		(481,770	)
Income before income tax expense		10,835,989			8,890,197			8,446,447
Income tax benefit		(231,900	)		(399,600	)		(158,800	)
Net income	$	11,067,889			9,289,797			8,605,247

42

	2005			2004			2003
Condensed Statements of Cash Flows
Cash flows from operating activities:
Net income	$	11,067,889			9,289,797			8,605,247
Adjustments to reconcile net income to cash provided by operating activities:
Equity earnings of subsidiaries		(11,375,240	)		(9,453,280	)		(8,361,418	)
Equity earnings in limited partnership		0			(803	)		(132,273	)
Securities gains, net		0			0			(301,006	)
Deferred income taxes		(33,400	)		(128,400	)		(3,200	)
Earned employee stock ownership shares priced above original cost		339,798			308,165			180,457
Decrease in restricted stock awards		97,922			0			0
Decrease in unearned ESOP shares		193,301			193,784			193,301
Decrease (increase) in accrued interest receivable		8,462			(2,842	)		15,548
Increase in accrued expenses and other liabilities		67,129			340,696			26,526
Decrease in other assets		119,261			1,095,622			330,037
Other, net		0			(2	)		0
Net cash provided by operating activities		485,122			1,642,737			553,219
Cash flows from investing activities:
Proceeds from sales of securities available for sale		0			0			1,601,007
Purchase of real estate owned from subsidiary		(750,000	)		0			0
Decrease in loans receivable, net		0			110,000			1,491,383
Redemption of investment in limited partnership		0			422,474			0
Net decrease in loans receivable from subsidiaries		0			0			4,700,000
Net cash (used) provided by investing activities		(750,000	)		532,474			7,792,390
Cash flows from financing activities:
Purchase of treasury stock		(972,000	)		(3,316,550	)		(1,384,560	)
Stock options exercised		37,887			66,634			1,422,460
Dividends to stockholders		(3,524,140	)		(3,246,426	)		(2,901,071	)
Proceeds from dividends on Bank stock		4,000,000			4,000,000			0
Net cash used by financing activities		(458,253	)		(2,496,342	)		(2,863,171	)
(Decrease) increase in cash and cash equivalents		(723,131	)		(321,131	)		5,482,438
Cash and cash equivalents, beginning of year		5,608,727			5,929,858			447,420
Cash and cash equivalents, end of year	$	4,885,596			5,608,727			5,929,858

43

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 24 Business Segments

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

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

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

	Home Federal									Consolidated
(Dollars in thousands)	Savings Bank			Other			Eliminations			Total
At or for the year ended December 31, 2005:
Interest income — external customers	$	60,201			80			0			60,281
Non-interest income — external customers		6,536			0			0			6,536
Losses in limited partnerships		(27	)		0			0			(27	)
Intersegment interest income		0			28			(28	)		0
Intersegment non-interest income		134			11,375			(11,509	)		0
Interest expense		24,539			0			(28	)		24,511
Amortization of mortgage servicing rights, net		1,020			0			0			1,020
Other non-interest expense		20,260			655			(134	)		20,781
Income tax expense (benefit)		6,971			(235	)		0			6,736
Net income		11,380			11,063			(11,375	)		11,068
Goodwill		3,801			0			0			3,801
Total assets		985,456			91,410			(85,629	)		991,237
Net interest margin		3.80	%	NM			NM				3.80	%
Return on average assets		1.17		NM			NM				1.12
Return on average realized common equity		13.93		NM			NM				12.42
At or for the year ended December 31, 2004:
Interest income — external customers	$	51,568			49			0			51,617
Non-interest income — external customers		5,993			0			0			5,993
Earnings (losses) on limited partnerships		(27	)		1			0			(26	)
Intersegment interest income		0			21			(21	)		0
Intersegment non-interest income		174			9,453			(9,627	)		0
Interest expense		21,014			0			(21	)		20,993
Amortization of mortgage servicing rights, net		1,061			0			0			1,061
Other non-interest expense		18,633			642			(174	)		19,101
Income tax expense (benefit)		4,790			(403	)		0			4,387
Minority interest		(3	)		0			0			(3	)
Net income		9,458			9,285			(9,453	)		9,290
Goodwill		3,801			0			0			3,801
Total assets		954,779			84,391			(78,497	)		960,673
Net interest margin		3.51	%	NM			NM				3.50	%
Return on average assets		1.04		NM			NM				1.01
Return on average realized common equity		12.49		NM			NM				11.03
At or for the year ended December 31, 2003:
Interest income — external customers	$	44,775			162			0			44,937
Non-interest income — external customers		10,198			301			0			10,499
Earnings (losses) on limited partnerships		(376	)		132			0			(244	)
Intersegment interest income		28			31			(59	)		0
Intersegment non-interest income		868			8,361			(9,229	)		0
Interest expense		20,348			0			(59	)		20,289
Amortization of mortgage servicing rights, net		2,298			8			(324	)		1,982
Other non-interest expense		17,456			542			(327	)		17,671
Income tax expense (benefit)		4,200			(162	)		0			4,038
Minority interest		(3	)		0			0			(3	)
Net income		8,584			8,599			(8,578	)		8,605
Goodwill		3,801			0			0			3,801
Total assets		860,510			81,182			(74,966	)		866,726
Net interest margin		3.30	%	NM			NM				3.31	%
Return on average assets		1.08		NM			NM				1.10
Return on average realized common equity		11.88		NM			NM				10.85

NM – Not meaningful

44

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors
HMN Financial, Inc.:

We have audited the accompanying consolidated balance sheets of HMN Financial, Inc. and subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of income, stockholders’ equity and comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 2005. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

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

     In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of HMN Financial, Inc. and subsidiaries as of December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles.

     We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of HMN Financial, Inc.’s internal control over financial reporting as of December 31, 2005, based on Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 1, 2006 expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting.

KPMG LLP

Minneapolis, Minnesota
March 1, 2006

45

SELECTED QUARTERLY FINANCIAL DATA

	December 31,			September 30,			June 30,
(Dollars in thousands, except per share data)	2005			2005			2005
Selected Operations Data (3 months ended):
Interest income	$	16,074			15,238			14,773
Interest expense		6,667			6,292			6,027
Net interest income		9,407			8,946			8,746
Provision for loan losses		179			952			907
Net interest income after provision for loan losses		9,228			7,994			7,839
Noninterest income:
Fees and service charges		725			706			685
Loan servicing fees		308			305			304
Securities gains (losses), net		(21	)		0			0
Gain on sales of loans		611			625			324
Losses in limited partnerships		(7	)		(6	)		(6	)
Other noninterest income		171			91			268
Total noninterest income		1,787			1,721			1,575
Noninterest expense:
Compensation and benefits		2,800			2,781			2,785
Occupancy		1,002			1,042			1,042
Deposit insurance premiums		33			35			34
Advertising		93			102			105
Data processing		270			279			245
Amortization of mortgage servicing rights, net		253			257			271
Other noninterest expense		989			1,054			1,039
Total noninterest expense		5,440			5,550			5,521
Income before income tax expense		5,575			4,165			3,893
Income tax expense		2,098			1,889			1,393
Income before minority interest		3,477			2,276			2,500
Minority interest		0			0			0
Net income	$	3,477			2,276			2,500
Basic earnings per share	$	0.91			0.59			0.65
Diluted earnings per share	$	0.87			0.57			0.62
Financial Ratios:
Return on average assets(1)		1.39	%		0.92			1.01
Return on average equity(1)		15.03			10.02			11.41
Average equity to average assets		9.05			8.99			8.90
Dividend payout ratio		42.11			38.71			31.43
Net interest margin(1)(2)		3.94			3.79			3.70
(Dollars in thousands)
Selected Financial Condition Data:
Total assets	$	991,237			982,304			985,662
Securities available for sale:
Mortgage-backed and related securities		6,880			7,481			8,220
Other marketable securities		112,779			91,031			91,053
Loans held for sale		1,435			4,058			4,290
Loans receivable, net		785,678			815,164			819,940
Deposits		731,537			714,711			720,230
Federal Home Loan Bank advances		160,900			170,900			170,900
Stockholders’ equity		90,728			88,018			86,558

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

46

	March 31,			December 31,			September 30,			June 30,			March 31,
(Dollars in thousands, except per share data)	2005			2004			2004			2004			2004
Selected Operations Data (3 months ended):
Interest income		14,196			13,678			13,156			12,427			12,355
Interest expense		5,525			5,428			5,387			5,060			5,118
Net interest income		8,671			8,250			7,769			7,367			7,237
Provision for loan losses		636			714			775			447			819
Net interest income after provision for loan losses		8,035			7,536			6,994			6,920			6,418
Noninterest income:
Fees and service charges		603			762			742			705			568
Loan servicing fees		293			299			292			291			287
Securities gains (losses), net		0			(539	)		3			1			0
Gain on sales of loans		293			435			349			507			412
Losses in limited partnerships		(8	)		(7	)		(7	)		(7	)		(6	)
Other noninterest income		245			212			210			183			275
Total noninterest income		1,426			1,162			1,589			1,680			1,536
Noninterest expense:
Compensation and benefits		2,774			2,646			2,430			2,582			2,528
Occupancy		995			960			914			871			885
Deposit insurance premiums		28			25			24			28			19
Advertising		84			139			116			88			87
Data processing		238			278			233			228			191
Amortization of mortgage servicing rights, net		239			266			240			302			253
Other noninterest expense		932			1,045			923			898			962
Total noninterest expense		5,290			5,359			4,880			4,997			4,925
Income before income tax expense		4,171			3,339			3,703			3,603			3,029
Income tax expense		1,356			1,218			1,153			1,106			910
Income before minority interest		2,815			2,121			2,550			2,497			2,119
Minority interest		0			(1	)		0			0			(2	)
Net income		2,815			2,122			2,550			2,497			2,121
Basic earnings per share		0.74			0.55			0.66			0.65			0.54
Diluted earnings per share		0.70			0.53			0.64			0.62			0.52
Financial Ratios:
Return on average assets(1)		1.18			0.88			1.09			1.12			0.96
Return on average equity(1)		13.22			9.85			12.02			12.06			10.21
Average equity to average assets		8.92			9.17			9.23			9.34			9.42
Dividend payout ratio		41.51			34.38			35.48			38.46			37.74
Net interest margin(1)(2)		3.79			3.62			3.47			3.45			3.46
(Dollars in thousands)
Selected Financial Condition Data:
Total assets		991,326			960,673			955,335			914,098			899,725
Securities available for sale:
Mortgage-backed and related securities		8,470			9,151			9,393			9,882			11,937
Other marketable securities		90,980			94,522			95,404			99,947			97,066
Loans held for sale		1,510			2,712			3,652			3,767			4,955
Loans receivable, net		813,244			783,213			766,063			722,800			717,021
Deposits		727,815			698,902			666,752			627,305			611,656
Federal Home Loan Bank advances		170,900			170,900			198,900			198,900			198,900
Stockholders’ equity		84,488			83,771			82,791			81,127			82,148

47

OTHER FINANCIAL DATA

	Year Ended December 31,
(Dollars in thousands)	2005		2004		2003
Maximum Balance:
Federal Home Loan Bank advances	$	193,900		214,800		241,800
Federal Home Loan Bank short-term borrowings		33,000		43,900		69,400
Average Balance:
Federal Home Loan Bank advances		170,919		196,008		221,510
Federal Home Loan Bank short-term borrowings		10,047		26,918		41,169

The following table sets forth certain information as to the Bank’s Federal Home Loan Bank (FHLB) advances.

	December 31,
	2005					2004					2003
			Weighted					Weighted					Weighted
			Average					Average					Average
(Dollars in thousands)	Amount		Rate			Amount		Rate			Amount		Rate
FHLB short-term borrowings	$	0		0.00	%	$	10,000		2.69	%	$	33,000		5.01	%
Other FHLB long-term advances		160,900		4.29			160,900		4.29			170,900		4.20
Total	$	160,900		4.29		$	170,900		4.20		$	203,900		4.33

Refer to Note 13 of the Notes to Consolidated Financial Statements for more information on the Bank’s FHLB advances.

COMMON STOCK INFORMATION

The common stock of HMN Financial, Inc. is listed on the Nasdaq Stock Market under the symbol: HMNF. As of December 31, 2005, the Company had 9,128,662 shares of common stock outstanding and 4,721,402 shares in treasury stock. As of December 31, 2005 there were 715 stockholders of record and 1,200 estimated beneficial stockholders. The following table represents the stock price information for HMN Financial, Inc. as furnished by Nasdaq for each quarter starting with the quarter ended December 31, 2005 and regressing back to March 31, 2000.

	Dec. 30,		Sept. 30,		June 30,		March 31,		Dec. 31,		Sept. 30,		June 30,		March 31,
	2005		2005		2005		2005		2004		2004		2004		2004
HIGH	$	32.00		32.39		32.00		33.06		33.50		27.99		27.65		28.19
LOW		28.14		30.75		28.55		29.70		27.35		25.10		24.51		23.25
CLOSE		29.50		31.92		31.48		31.00		32.99		27.75		27.09		27.48

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

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

48

EX-21

Exhibit 21

Subsidiaries of Registrant

		Date and % of Voting
		Shares, Partnership
		Interests, Voting Trust
	Year &	Certificates, Capital
Name & Address	State Inc.	Contributions	Description of Activity
Home Federal Savings Bank	1934	6/29/94	Federally Chartered Stock
1016 Civic Center Drive NW	Federal	HMN owns 100% of voting	Savings Bank
Rochester, MN 55901	Charter	shares
Osterud Insurance Agency, Inc.	1983	12/1983	Investment products and
DBA Home Federal Investment Svcs.	MN	Bank owns 100%	financial planning
1016 Civic Center Drive NW
Rochester, MN 55901
Security Finance Corporation	1929	12/29/95	Corporation invests in
1016 Civic Center Drive NW	MN	HMN owns 100% of voting	Securities, loans and real estate
Rochester, MN 55901		shares

EX-23

Exhibit 23

Consent of Independent Registered Public Accounting Firm

The Board of Directors
HMN Financial, Inc.:

We consent to the incorporation by reference in the registration statements (Nos. 33-88228, 33-94388, 33-94386 and 333-64232) on Form S-8 of HMN Financial, Inc. of our reports dated March 1, 2006, with respect to the consolidated balance sheets of HMN Financial, Inc. as of December 31, 2005 and 2004, and the related consolidated statements of income, comprehensive income, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2005, management’s assessment of the effectiveness of internal control over financial reporting as of December 31, 2005 and the effectiveness of internal control over financial reporting as of December 31, 2005, which reports appear in the December 31, 2005 annual report on Form 10-K of HMN Financial, Inc.

/s/ KPMG LLP

Minneapolis, Minnesota
March 1, 2006

EX-31.1

EXHIBIT 31.1

CERTIFICATIONS

I, Michael McNeil, certify that:

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

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

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

4. The registrant’s other certifying officer(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 15a-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 cause such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

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

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

5. The registrant’s other certifying officer(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 registrant’s board of directors (or persons performing the equivalent functions):

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

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

Date: March 1, 2006	By:	/s/ Michael McNeil
		Michael McNeil
		President and Chief Executive Officer

EX-31.2

EXHIBIT 31.2

CERTIFICATIONS

I, Jon J. Eberle, certify that:

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

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

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

4. The registrant’s other certifying officer(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 15a-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 cause such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

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

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

5. The registrant’s other certifying officer(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 registrant’s board of directors (or persons performing the equivalent functions):

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

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

Date: March 1, 2006	By:	/s/Jon J. Eberle
		Jon J. Eberle
		Senior Vice President, Chief Financial Officer and Treasurer

EX-32

Exhibit 32

HMN FINANCIAL, INC.

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

In connection with the Annual Report of HMN Financial, Inc. (the “Company”) on Form 10-K for the period ending December 31, 2005 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Michael McNeil, President of the Company, and Jon Eberle, Senior Vice President and CFO of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that:

(1)	The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
(2)	The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company.

Date: March 1, 2006	/s/ Michael McNeil
	Michael McNeil President/Chief Executive Officer (Principal Executive Officer)
	/s/Jon Eberle
	Jon Eberle Senior Vice President/Chief Financial Officer (Principal Financial Officer)