-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, DBQFIdCtdPkfTe9brWGkv2XifTwhYuj42bqNGqlD2iSuF6Zm0rdoJ3nxOeVjmq+0 MZfQN82oQHAz/uRMLFHTTg== 0001047469-98-012760.txt : 19980415 0001047469-98-012760.hdr.sgml : 19980415 ACCESSION NUMBER: 0001047469-98-012760 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 9 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980331 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: HMN FINANCIAL INC CENTRAL INDEX KEY: 0000921183 STANDARD INDUSTRIAL CLASSIFICATION: 6035 IRS NUMBER: 411777397 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 000-24100 FILM NUMBER: 98580673 BUSINESS ADDRESS: STREET 1: 101 N BROADWAY CITY: SPRING VALLEY STATE: MN ZIP: 55975-1223 BUSINESS PHONE: 5073461100 10-K405 1 FORM 10-K405 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 -------------------------- FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] FOR THE TRANSITION PERIOD FROM _____ TO ______ COMMISSION FILE NUMBER 0-24100. HMN FINANCIAL, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 41-1777397 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) 101 NORTH BROADWAY, PO BOX 231 55975-0231 SPRING VALLEY, MINNESOTA (ZIP CODE) (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (507) 346-1100 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 CLASS) 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 twelve months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such requirements for the past 90 days. YES X NO --- --- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] As of March 19, 1998, the Registrant had issued and outstanding 4,144,368 shares of the Registrant's Common Stock. The aggregate market value of the voting stock held by non-affiliates of the Registrant as of March 19, 1998 was $97.8 million. (The exclusion from such amount of the market value of the shares owned by any person shall not be deemed an admission by the Registrant that such person is an affiliate of the Registrant.) DOCUMENTS INCORPORATED BY REFERENCE Parts of the Registrant's Annual Report for the year ended December 31, 1997, are incorporated by reference in Parts II and IV of this Form 10-K. Parts of the Registrant's Proxy Statement dated March 30, 1998, are incorporated by reference in Part III of this Form 10-K. TABLE OF CONTENTS PART I PAGE ---- Item 1. Business . . . . . . . . . . . . . . . . . . . . . . 3 General . . . . . . . . . . . . . . . . . . . . . . 3 Lending Activities . . . . . . . . . . . . . . . . 4 Investment Activities . . . . . . . . . . . . . . 21 Sources of Funds . . . . . . . . . . . . . . . . 25 Other Information Service Corporations . . . . . . . . . . . . . 29 Competition . . . . . . . . . . . . . . . . . 29 Employees . . . . . . . . . . . . . . . . . . 30 Executive Officers . . . . . . . . . . . . . . 30 Regulation . . . . . . . . . . . . . . . . . . . 30 Taxation . . . . . . . . . . . . . . . . . . . . 40 Item 2. Properties . . . . . . . . . . . . . . . . . . . . 42 Item 3. Legal Proceedings . . . . . . . . . . . . . . . . . 43 Item 4. Submission of Matters to a Vote of Security Holders 43 PART II Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters . . . . . . . . . . . 43 Item 6. Selected Financial Data . . . . . . . . . . . . . . 43 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations . . . . . . . 43 Item 7A. Quantitative and Qualitative Disclosure About Market Risk. . . . . . . . . . . . . . . . . . . . 43 Item 8. Financial Statements and Supplementary Data . . . . 44 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure . . . . . . . 44 PART III Item 10. Directors and Executive Officers of the Registrant . . . . . . . . . . . . . . . . . . . . 44 Item 11. Executive Compensation . . . . . . . . . . . . . . 44 Item 12. Security Ownership of Certain Beneficial Owners and Management . . . . . . . . . . . . . . . . . . 44 Item 13. Certain Relationships and Related Transactions . . . 44 PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K . . . . . . . . . . . . . . . 45 Signatures . . . . . . . . . . . . . . . . . . . . . . . . . 48 Index to Exhibits . . . . . . . . . . . . . . . . . . . . . . 49
2 PART I ITEM 1. BUSINESS GENERAL HMN Financial, Inc. ("HMN" or the "Corporation"), was incorporated under the laws of the State of Delaware in March 1994 for the purpose of becoming the savings and loan holding company of Home Federal Savings Bank ("Home Federal" or the "Bank") in connection with the Bank's conversion from a federally chartered mutual savings bank to a federally chartered stock savings bank. Home Federal has a community banking philosophy and operates retail banking facilities in Minnesota and Iowa. The Bank has two wholly owned subsidiaries, Osterud Insurance Agency, Inc. (OAI) and MSL Financial Corporation (MSL), which offer financial planning products and services. HMN has two other wholly owned subsidiaries, Security Finance Corporation (SFC) and HMN Mortgage Services, Inc. (MSI). SFC invests in commercial loans and commercial real-estate loans located throughout the United States which were originated by third parties. MSI operates mortgage banking and mortgage brokerage facilities located in Eden Prairie and Brooklyn Park, Minnesota. On December 5, 1997 HMN, through its wholly owned subsidiary, the Bank, completed its merger with Marshalltown Financial Corporation (MFC) pursuant to a merger agreement dated July 1, 1997. Refer to Note 2 of the Notes to Consolidated Financial Statements in the Annual Report for information on assets acquired in the merger, HMN's Current Report on Form 8-K dated December 5, 1997, filed on December 10, 1997 (file no. 0-24100) for a copy of the merger agreement and HMN's Current Report on Form 8-K dated December 5, 1997, filed on February 11, 1998 (file no. 0-24100) for a copy of financial statements of the acquired company and pro forma financial information. As a community-oriented financial institution, HMN seeks to serve the financial needs of communities in its market area. HMN's business involves attracting deposits from the general public and using such deposits to originate or purchase one-to-four family residential mortgage loans and, to a lesser extent, consumer, construction, commercial real estate, commercial business and multi-family loans. HMN also invests in mortgage-backed and related securities, investment securities (consisting primarily of U.S. government and government agency obligations) and other permissible investments. The executive offices of HMN are located at 101 N. Broadway, PO Box 231, Spring Valley, Minnesota 55975- 0231. It's telephone number at that address is (507) 346-1100. MARKET AREA HMN serves the Minnesota counties of Fillmore, Freeborn, Houston, Mower, Olmsted and Winona and portions of Steele, Dodge, Goodhue and Wabasha Counties, Minnesota, through its main office located in Spring Valley, Minnesota and its six branch offices located in Albert Lea, Austin, LaCrescent, Rochester and Winona, Minnesota. The portion of HMN's market area consisting of Rochester and the contiguous communities is composed of primarily urban and suburban communities, while the balance of HMN's market area consists primarily of rural areas and small towns. Primary industries in HMN's market area include manufacturing, agriculture, health care, wholesale and retail trade, service industries and education. Major employers include IBM, the Mayo Clinic, Hormel, a food processing company, and various small industrial and other companies. HMN's market area is also the home of Winona State University, Rochester Community College, Austin Community College and several vocational/technical schools. HMN 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 Int. - 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 operation. 3 Based upon 1990 census information, the population of the six primary counties in the Bank's market area was as follows: Fillmore - 20,800; Freeborn - 33,000; Houston - 18,500; Mower - 37,300; Olmsted - 101,000; and Winona - 47,900. Based upon 1990 U.S. Department of Commerce information, per capita income in these six counties ranged from approximately $15,000 to $21,000. Based upon 1990 census information, the population of Marshall County was 38,280 and the population of Tama County was 17,419. Based upon 1990 U.S. Department of Commerce information, per capita income of the above mentioned Iowa counties ranged from $11,300 to $12,800. During the fourth quarter of 1996, HMN opened a mortgage banking office in Edina, Minnesota which has subsequently moved to Eden Prairie. The office primarily purchases loans from third party originators located in the seven county metropolitan area of Minneapolis and St. Paul and sells the loans in the secondary market or place the loans in HMN's loan portfolio. The new office also purchases mortgage servicing rights from third parties for the purpose of generating loan servicing income. LENDING ACTIVITIES GENERAL. Historically, the Bank originated 30-year, fixed-rate mortgage loans secured by one-to-four family residences. Since 1979, in order to reduce its vulnerability to changes in interest rates, the Bank has emphasized the origination or purchase of mortgage loans having shorter terms to maturity or repricing, such as 15-year, fixed-rate residential loans, Adjustable Rate Mortgage loans ("ARMs") and Graduated Equity Mortgage loans ("GEMs"). Starting in 1995 and throughout 1997 HMN offered a competitive home equity line of credit. HMN also offers consumer loans and, to a lesser extent, construction, commercial real estate, multi-family and commercial business loans. See "- Originations, Purchases and Sales of Loans and Mortgage-Backed and Related Securities." 4 LOAN PORTFOLIO COMPOSITION. The following information concerning the composition of HMN'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, ------------------------------------------------------------------------------------------------------- 1997 1996 1995 1994 1993 ------------------ ------------------ --------------------- ----------------- ----------------- (DOLLARS IN THOUSANDS) Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent -------- ------- -------- ------- ------- ------- -------- ------- -------- ------- REAL ESTATE LOANS: One-to-four family . . . $395,668 87.58% $321,340 90.19% $292,497 90.62% $252,943 91.14% $233,009 92.18% Multi-family . . . . . . 2,717 0.60 280 0.08 361 0.11 311 0.11 349 0.14 Commercial . . . . . . . 10,572 2.34 7,918 2.22 8,744 2.71 8,316 3.00 4,559 1.80 Construction or development . . . . . 5,725 1.27 3,474 0.98 5,082 1.58 2,799 1.01 3,309 1.31 ------- ------ ------- ------ ------- ------ ------- ------ ------- ------ Total real estate loans . . . . . . . 414,682 91.79 333,012 93.47 306,684 95.02 264,369 95.26 241,226 95.43 ------- ------ ------- ------ ------- ------ ------- ------ ------- ------ OTHER LOANS: Consumer loans: Savings account . . . . 1,362 0.30 938 0.26 1,210 0.37 648 0.23 872 0.34 Education . . . . . . . 123 0.03 467 0.13 342 0.11 2,007 0.72 1,819 0.72 Automobile . . . . . . 2,438 0.54 566 0.16 671 0.21 520 0.19 681 0.27 Home equity line . . . 19,490 4.31 11,881 3.33 3,509 1.09 0 0.00 0 0.00 Home equity . . . . . . 7,176 1.59 5,927 1.67 7,997 2.47 7,716 2.78 5,604 2.22 Home improvement . . . 652 0.14 585 0.16 785 0.24 870 0.31 912 0.36 Other . . . . . . . . . 624 0.14 568 0.16 545 0.17 502 0.19 586 0.23 ------- ------ ------- ------ ------- ------ ------- ------ ------- ------ Total consumer loans 31,865 7.05 20,932 5.87 15,059 4.66 12,263 4.42 10,474 4.14 Commercial business loans . . . . . . . . 5,226 1.16 2,344 0.66 1,018 0.32 897 0.32 1,089 0.43 ------- ------ ------- ------ ------- ------ ------- ------ ------- ------ Total other loans . . 37,091 8.21 23,276 6.53 16,077 4.98 13,160 4.74 11,563 4.57 ------- ------ ------- ------ ------- ------ ------- ------ ------- ------ Total loans . . . 451,773 100.00% 356,288 100.00% 322,761 100.00% 277,529 100.00% 252,789 100.00% ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ LESS: Loans in process . . . . 4,562 2,814 3,531 2,327 2,333 Unamortized discounts . 547 417 289 162 14 Net deferred loan fees . 1,847 1,695 1,899 2,147 2,507 Allowance for losses on loans . . . . . . . . 2,748 2,340 2,191 1,893 1,489 -------- -------- -------- -------- -------- Total loans receivable, net $442,069 $349,022 $314,851 $271,000 $246,446 -------- -------- -------- -------- -------- -------- -------- -------- -------- --------
5 The following table shows the composition of HMN's loan portfolio by fixed and adjustable rate at the dates indicated.
December 31, ------------------------------------------------------------------------------------------------- 1997 1996 1995 1994 1993 ---------------- ---------------- ---------------- ---------------- ---------------- (DOLLARS IN THOUSANDS) Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent ------ ------- ------ ------- ------ ------- ------ ------- ------ ------- FIXED-RATE LOANS Real estate: One-to-four family GEM . . . . . . . . . . . . $ 53,258 11.79% $ 48,831 13.71% $ 30,175 9.35% $ 24,769 8.93% $ 22,304 8.83% Other . . . . . . . . . . . 256,263 56.72 187,519 52.63 181,401 56.20 168,272 60.63 171,503 67.84 ------- ------ ------- ------ ------- ------ ------- ------ ------- ------ Total one-to-four family . 309,521 68.51 236,350 66.34 211,576 65.55 193,041 69.56 193,807 76.67 Multi-family . . . . . . . . 2,490 0.55 223 0.06 302 0.10 311 0.11 349 0.13 Commercial . . . . . . . . . 1,914 0.42 1,276 0.36 1,518 0.47 1,612 0.58 626 0.25 Construction or development . 3,180 0.71 2,970 0.83 4,848 1.50 1,008 0.37 2,800 1.11 ------- ------ ------- ------ ------- ------ ------- ------ ------- ------ Total fixed-rate real estate loans . . . . . . 317,105 70.19 240,819 67.59 218,244 67.62 195,972 70.62 197,582 78.16 ------- ------ ------- ------ ------- ------ ------- ------ ------- ------ Consumer loans: Savings . . . . . . . . . . . 1,362 0.30 938 0.26 1,210 0.37 648 0.23 872 0.34 Education . . . . . . . . . . 0 0.00 434 0.12 299 0.09 1,278 0.46 1,819 0.72 Automobile . . . . . . . . . 2,437 0.54 566 0.16 671 0.21 520 0.19 681 0.27 Home equity . . . . . . . . . 6,701 1.48 5,338 1.50 7,254 2.25 7,258 2.62 5,604 2.22 Home improvement . . . . . . 652 0.14 585 0.16 785 0.24 870 0.31 912 0.36 Other . . . . . . . . . . . . 612 0.14 568 0.16 545 0.17 502 0.18 586 0.23 ------- ------ ------- ------ ------- ------ ------- ------ ------- ------ Total consumer loans . . . 11,764 2.60 8,429 2.36 10,764 3.33 11,076 3.99 10,474 4.14 ------- ------ ------- ------ ------- ------ ------- ------ ------- ------ Commercial business loans . . 5,226 1.16 1,344 0.38 1,018 0.32 897 0.32 1,089 0.43 ------- ------ ------- ------ ------- ------ ------- ------ ------- ------ Total other loans . . . . . 16,990 3.76 9,773 2.74 11,782 3.65 11,973 4.31 11,563 4.57 ------- ------ ------- ------ ------- ------ ------- ------ ------- ------ Total fixed-rate loans . . 334,095 73.95 250,592 70.33 230,026 71.27 207,945 74.93 209,145 82.73 ------- ------ ------- ------ ------- ------ ------- ------ ------- ------ ADJUSTABLE-RATE LOANS Real estate: One-to-four family . . . . . 86,147 19.07 84,990 23.85 80,921 25.07 59,901 21.58 39,202 15.51 Multi-family . . . . . . . . 227 0.05 57 0.02 59 0.02 0 0.00 0 0.00 Commercial . . . . . . . . . 8,658 1.92 6,642 1.87 7,226 2.24 6,704 2.42 3,933 1.56 Construction or development . 2,545 0.56 504 0.14 234 0.07 1,792 0.64 509 0.20 ------- ------ ------- ------ ------- ------ ------- ------ ------- ------ Total adjustable-rate real estate loans . . . . . . 97,577 21.60 92,193 25.88 88,440 27.40 68,397 24.64 43,644 17.27 Consumer . . . . . . . . . . . 20,101 4.45 12,503 3.51 4,295 1.33 1,187 0.43 0 0.00 Commercial business loans . . 0 0.00 1,000 0.28 0 0.00 0 0.00 0 0.00 ------- ------ ------- ------ ------- ------ ------- ------ ------- ------ Total adjustable-rate loans 117,678 26.05 105,696 29.67 92,735 28.73 69,584 25.07 43,644 17.27 ------- ------ ------- ------ ------- ------ ------- ------ ------- ------ Total loans . . . . . . . . 451,773 100.00% 356,288 100.00% 322,761 100.00% 277,529 100.00% 252,789 100.00% ------ ------ ------ ------ ------ ------- ------ ------- ------ ------- ------ ------- ------ ------- ------ LESS Loans in process . . . . . . . 4,562 2,814 3,531 2,327 2,333 Unamortized discounts . . . . 547 417 289 162 14 Net deferred loan fees . . . . 1,847 1,695 1,899 2,147 2,507 Allowance for losses on loans 2,748 2,340 2,191 1,893 1,489 -------- -------- -------- -------- -------- Total loans receivable, net $442,069 $349,022 $314,851 $271,000 $246,446 -------- -------- -------- -------- -------- -------- -------- -------- -------- --------
6 The following schedule illustrates the interest rate sensitivity of HMN's loan portfolio at December 31, 1997. 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 Commercial One-to-four family Commercial Construction Consumer Business Total ------------------ ---------------- ---------------- ---------------- ----------------- ---------------- Weighted Weighted Weighted Weighted Weighted Weighted Average Average Average Average Average Average (DOLLARS IN Amount Rate Amount Rate Amount Rate Amount Rate Amount Rate Amount Rate THOUSANDS) ------ -------- ------ -------- ------ -------- ------ -------- ------ -------- ------ -------- Due During Years Ending December 31, ------------ 1998(1) . . . . . . $ 23,133 7.31% $ 738 7.66% $ 1,018 8.73% $ 4,102 8.95% $ 946 8.66% $29,937 7.63% 1999 . . . . . . . 23,470 7.24 1,004 7.95 46 7.91 2,065 8.74 908 8.46 27,493 7.42 2000 . . . . . . . 23,334 7.19 794 7.66 57 7.91 1,705 8.65 1,179 8.72 27,069 7.36 2001 and 2002 . . . 46,695 7.31 1,879 8.37 151 7.92 2,224 8.66 1,138 8.12 52,087 7.43 2003 to 2007 . . . 116,578 7.35 4,398 8.55 609 7.93 21,343 8.99 1,055 10.21 143,983 7.65 2008 to 2022 . . . 146,861 7.52 4,476 7.95 3,139 7.83 426 9.23 0 0.00 154,902 7.54 2023 and following. 15,597 7.46 0 0.00 705 8.08 0 0.00 0 0.00 16,302 7.49 -------- ------- ------- ------- ------ ------- $395,668 $13,289 $ 5,725 $31,865 $5,226 $451,773 -------- ------- ------- ------- ------ ------- -------- ------- ------- ------- ------ ------- - - --------------------
(1) Includes demand loans, loans having no stated maturity, overdraft loans and education loans. The total amount of loans due after December 31, 1999 which have predetermined interest rates is $307.7 million, while the total amount of loans due after such dates which have floating or adjustable interest rates is $114.1 million. Construction or development loans for one-to-four family dwellings totaled $3.3 million, multi-family totaled $1.0 million, and non-residential totaled $1.4 million. 7 Under the Financial Institutions Reform, Recovery and Enforcement Act of 1989 ("FIRREA"), 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, 1997, based upon the 15% limitation, the Bank's regulatory loans-to-one borrower limit was approximately $9.2 million. On the same date, the Bank had no borrowers with outstanding balances in excess of this amount. At December 31, 1997, the largest dollar amount outstanding to one borrower or group of related borrowers was $960,000. This loan, which is secured by a commercial office building in Des Moines, was performing in accordance with its terms at December 31, 1997. The Bank's Loan Committee is responsible for review and approval of all loans over the FHLMC/FNMA conforming loan dollar limits (the Limit) originated by the Bank. At December 31, 1997 the Limit was $214,600. Approval of one member of the Loan Committee is required on all loans ranging from the Limit to $500,000. Loans greater than $500,000 must be approved by the Board of Directors of the Bank or its Executive Committee after review and preliminary approval by the Loan Committee. All loans closed each month are reviewed by the Board of Directors at the monthly meeting. Under the Bank's loan policy, the loan officer processing an application is responsible for ensuring that all documentation is obtained prior to the submission of the application to the Loan Committee. In addition, the loan officer verifies that the application meets the Bank's underwriting guidelines described below. Also, each application is assigned to a reviewing officer who reviews the file to assure its accuracy and completeness. The Branch Manager or the designated underwriter has the authority to approve all conforming loans up to the Limit. 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 (consistent with the Bank's appraisal policy) by the Bank's staff appraiser or 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 and/or confirmations. During 1997 the Bank introduced 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 which conform to FNMA underwriting guidelines. Generally, the Bank 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, depending on the type of loan. 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. The cornerstone of HMN's lending program is the origination of loans secured by mortgages on owner-occupied one-to-four family residences. At December 31, 1997, $395.7 million, or 87.58% of HMN's loan portfolio consisted of mortgage loans on one-to-four family residences. At December 31, 1997, $282.7 million of the residential loan portfolio was secured by properties located in HMN's market area. HMN had $120.0 million of purchased one-to-four family loans in its portfolio which were secured by properties located outside of its market area (primarily located in the Midwestern United States or the Southeastern United States). On December 5, 1997 the Bank merged with Marshalltown Financial Corporation ("MFC"). The Loan Portfolio Composition table includes for December 31, 1997 $62.9 million of one-to-four family residential loans, $2.3 of multi-family residential, $2.1 million of commercial real estate and $2.6 million of consumer loans which were acquired in the MFC merger. 8 Prior to 1979, the Bank originated for retention in its own portfolio 30-year fixed-rate loans secured by one-to-four family residential real estate. Beginning in 1979, the Bank began to emphasize the origination of fixed-rate loans with terms of 15 years or less for retention in its portfolio. In addition, in 1982, the Bank began to originate ARMs, subject to market conditions and consumer preference. Subsequently, the Bank also began to emphasize GEM originations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Asset/Liability Management" in the Annual Report attached as Exhibit 13 hereto (the "Annual Report"). HMN currently offers conventional fixed-rate loans with maximum terms of up to 30 years although HMN generally sells originations of loans with terms to maturity of 30 years. The interest rate on such loans is generally set based on the FHLMC delivery rates, as well as, other competitive factors. At December 31, 1997, HMN had $256.3 million of fixed-rate one-to-four family loans (excluding GEM loans) or 56.72% of HMN's total loan portfolio with a weighted average contractual term to maturity of 13.5 years. HMN also offers one-year ARMs at a margin (generally 275 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 currently offered by HMN allow the borrower to select (subject to pricing) an initial period of one year, three years, or five years between the loan origination and when the first interest rate change occurs. Generally the ARMs provide for an up to 200 basis point annual interest rate change cap and a lifetime cap generally 600 basis points over or under the initial rate. Initial interest rates offered on the ARM loans during 1997 ranged from 72 to 188 basis points below the fully indexed loan rate. All borrowers are now qualified for the loan at the fully indexed rate. See "-Delinquencies and Non-Performing Assets." In the past, the Bank offered one-year ARMs with a margin of 200 to 235 basis points over a specified index and an average annual cap of 145 basis points. At December 31, 1997, one-to-four family ARMs totaled $86.1 million, or 19.07% of HMN's total loan portfolio. HMN's originated ARMs do not permit negative amortization of principal, do not contain prepayment penalties and generally are not convertible into fixed-rate loans. HMN has $2.7 million of ARM loans purchased from a third party which are convertible at borrower's option into fixed-rate loans. It has an agreement with the third party to repurchase the ARM loans which convert to fixed rates at a stipulated price. The GEM loans carry required payments which 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 5%. Most of the GEM loans originated by HMN provide for at least three 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. HMN currently offers two GEM programs, one with a contractual maturity of approximately 17 years and one with a contractual maturity of approximately 22 years. The GEMs are generally priced based upon loans with similar contractual maturities. The GEMs have been popular with consumers who anticipate future increases in income and who desire an amortization schedule of less than 30 years. HMN believes that GEMs may increase in popularity in the future if interest rates rise and consumers are less easily able to afford the higher monthly payments required by 15-year, fixed-rate loans. HMN has also originated a limited number of fixed-rate loans with terms up to 30 years which are insured by the Federal Housing Authority ("FHA"), Veterans Administration ("VA") and Minnesota Home Finance Administration ("MHFA"). In underwriting one-to-four family residential real estate loans, HMN evaluates both the borrower's 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 HMN are appraised by independent fee appraisers or by HMN's staff appraiser. HMN originates residential mortgage 9 loans with loan-to-value ratios of up to 95% for owner-occupied homes and up to 70% for non-owner occupied homes; however, private mortgage insurance is required to reduce HMN's exposure to 80% or less. HMN generally seeks to underwrite its loans in accordance with secondary market standards. HMN'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 and the loan is not repaid. CONSTRUCTION LENDING. HMN makes construction loans to individuals for the construction of their residences, and to a much lesser extent, to builders for the construction of one-to-four family residences. It also makes a very limited number of loans to builders for houses built on speculation. The loan policy limits the total amount of construction loans outstanding at one time to 2.0% of assets. At December 31, 1997, HMN had $5.7 million of construction loans outstanding representing 1.3% of HMN's total loan portfolio. 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. The borrower also pays a construction fee up to $800 at the time of origination. 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 up to 15 years with a construction phase of up to seven months. Such loans generally do not permit the payment of interest from loan proceeds. At December 31, 1997, HMN had no construction loans to builders or developers. Construction loans to owner occupants are generally made in amounts of 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 loan-to-value ratios on loans to builders are limited to 70%. Prior to making a commitment to fund a construction loan, HMN requires an appraisal of the property and financial data and verification of income on the borrower. It generally 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. All construction loans have been located in HMN's market area. Construction loans are obtained principally through continued business from builders and developers who have previously borrowed from the Bank, as well as referrals from existing customers and walk-in customers. The application process includes a submission to the Bank of accurate plans, specifications and costs of the project to be constructed. These items are used as a basis to determine the appraised value of the subject property. The nature of construction loans is such that they are 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 and the estimated cost (including interest) of the project. If the estimate of value proves to be inaccurate, HMN may be confronted, at or prior to the maturity of the loan, with a project having a value which 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 such cases, HMN may be required to modify the terms of the loan. COMMERCIAL REAL ESTATE AND MULTI-FAMILY LENDING. HMN originates permanent commercial real estate and multi-family loans secured by properties located in its market area. It also purchases commercial real estate loans outside of its market area that are guaranteed by the Small Business Administration ("SBA") or originated by other third parties. At December 31, 1997, HMN had $10.6 million in commercial real 10 estate loans, representing 2.3% of HMN's total loan portfolio, and $2.7 million in multi-family loans, or 0.6% of its total loan portfolio. The commercial real estate and multi-family loan portfolio includes loans secured by motels, apartment buildings, churches, small office buildings, small business facilities, nursing homes and other non-residential building properties primarily located in Minnesota or Iowa. Permanent commercial real estate and multi-family loans are generally originated for a maximum term of 15 years and generally have adjustable interest rates. Prior to 1995 commercial real estate and multi-family loans could have either a fixed interest rate or an adjustable interest rate. Commercial real estate and multi-family loans are written in amounts of up to 70% of the lesser of the appraised value of the property or the purchase price and must have a debt service coverage ratio of at least 125%. The debt service coverage is the ratio of net cash from operations before payment of debt to debt service. HMN does not originate construction loans secured by commercial or multi-family real estate, but may purchase participation interests in third party originated construction loans secured by commercial or multi-family real estate. Appraisals on properties serving commercial real estate and multi-family loans originated by HMN are performed by independent appraisers prior to the time the loan is made. Generally all appraisals on commercial and multi-family real estate are reviewed by a member of the Bank's Loan Committee. The Bank's underwriting procedures require verification of the borrower's credit history, income and financial statements, banking relationships, references and income projections for the property. It also requires personal guarantees from the borrowers. In addition, HMN performs an annual on-site inspection on collateral properties for loans with balances in excess of $250,000. At December 31, 1997, HMN's two largest commercial real estate loans totaled $960,000 and $882,000. The first loan is secured by a commercial office building located in Des Moines, Iowa and the second loan is secured by a motel located in Rochester, Minnesota near the Mayo Clinic. Both of these loans were performing at December 31, 1997. 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, 1997, HMN had one commercial real estate loan totaling $79,000 and no multi-family loans which were 90 days or more delinquent. CONSUMER LENDING. HMN originates a variety of different types of consumer loans, including home equity loans (open-end and closed-end), education, automobile, home improvement, deposit account and other loans for household and personal purposes. At December 31, 1997, consumer loans totaled $31.9 million, or 7.05% of total loans outstanding. Consumer loan terms vary according to the type and value of collateral, length of contract and creditworthiness of the borrower. HMN's consumer loans are made at fixed and adjustable interest rates, with terms of up to 20 years for secured loans and up to three years for unsecured loans. HMN's home equity loans are written so that the total commitment amount, when combined with the balance of any other outstanding mortgage liens, may not exceed 90% of the appraised value of the property. The closed-end home equity loans are written with fixed or adjustable rates with terms of up to 15 years. The open-end home equity lines are written with an adjustable rate with terms of up to 20 years, a 10 year 11 draw period which requires "interest only" payments and a 10 year repayment period which 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. At December 31, 1997, HMN's home equity loans totaled $7.2 million, or 1.6% of the total loan portfolio and the home equity lines totaled $19.5 million, or 4.3% of the total loan portfolio. 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 which are unsecured or are secured by rapidly depreciable assets, such as automobiles. In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation. In addition, consumer loan collections are dependent on the borrower's continuing financial stability, 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 which can be recovered on such loans. At December 31, 1997, $44,000 of the consumer loan portfolio was non-performing. There can be no assurance that delinquencies will not increase in the future. COMMERCIAL BUSINESS LENDING. In order to satisfy the demand for financial services available to individuals and businesses in its market area, HMN has maintained a portfolio of commercial business loans primarily to small retail operations, small manufacturing concerns and professional firms. Most of HMN's commercial business loans have terms ranging from six months to five years and carry fixed interest rates. HMN's commercial business loans generally include personal guarantees and are usually, but not always, secured by business assets such as inventory, equipment, fixtures, real estate and accounts receivables. 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. HMN has also purchased participation interests in commercial business loans from third party originators. The underlying collateral for the loans are generally equipment and generally have repayment periods of less than ten years. At December 31, 1997, HMN had $5.2 million of commercial business loans outstanding, or 1.3% of the total loan portfolio. In addition, on that date, HMN had $20,000 of letters of credit outstanding. Unlike residential mortgage loans, which generally are made on the basis of the borrower's ability to make repayment from his or her employment and other income, and which are secured by real property whose value tends to be more easily ascertainable, 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. Further, 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, 1997, there were no delinquent commercial business loans. 12 ORIGINATIONS, PURCHASES AND SALES OF LOANS AND MORTGAGE-BACKED AND RELATED SECURITIES Real estate loans are generally originated by HMN's staff of salaried and commissioned loan officers. Loan applications are taken and processed in all branch offices. While HMN originates both fixed and adjustable-rate loans, its ability to originate loans is dependent upon the relative customer demand for loans in its market. Demand is affected by the interest rate environment. During the last several years, the dollar volume of conventional fixed-rate, one-to-four family loans has exceeded the dollar volume of GEMs and ARMs. Currently, substantially all residential mortgage loans originated by the Bank are retained in the loan portfolio except 30 year fixed rate loans. In order to supplement loan demand in HMN's market area and geographically diversify its loan portfolio, HMN purchases real estate loans from selected sellers, with yields based upon current market rates. HMN carefully reviews and underwrites all loans to be purchased to ensure that they meet HMN's underwriting standards. The seller generally continues to service these purchased loans. During 1997, HMN originated $70.3 million of real estate and consumer loans and it purchased $67.2 million of single family residential loans originated outside of its market area. The majority of the purchased loans have interest rates that are fixed for a one, three or five year period and then adjust annually thereafter or were 15 year fixed rate loans. All purchased loans are reviewed to determine that each loan meets certain underwriting requirements. Refer to Note 5 of the Notes to Consolidated Financial Statements in the Annual Report for more information on purchased loans. HMN has substantial holdings of mortgage-backed and related securities which are held, depending on the investment intent, in the "available for sale" portfolio. During 1997, HMN purchased $3.4 million of mortgaged-backed securities and $24.0 million of mortgage-related securities, primarily CMOs. See "- Investment Activities." During the same period, HMN sold $67.9 million of mortgage-backed and related securities. 13 The following table shows the loan and mortgage-backed and related securities origination, purchase, sale and repayment activities of HMN for the periods indicated.
Year Ended December 31, (DOLLARS IN THOUSANDS) LOANS 1997 1996 1995 ------------------------- ORIGINATIONS BY TYPE: Adjustable-rate: Real estate - one-to-four family . . . . . . . . $ 1,987 5,441 2,117 - multi-family . . . . . . . . . . . 0 0 58 - commercial . . . . . . . . . . . . 1,000 0 0 - construction or development . . . 375 916 691 Non-real estate - consumer . . . . . . . . . . . 16,871 12,012 4,575 --------- ------ ------ Total adjustable-rate . . . . . . . . . . 20,233 18,369 7,441 --------- ------ ------ Fixed-rate: Real estate - one-to-four family . . . . . . . . 32,024 27,036 23,565 - multi-family . . . . . . . . . . . 263 145 0 - commercial . . . . . . . . . . . . 50 30 150 - construction or development . . . 6,539 6,181 4,847 Non-real estate - consumer . . . . . . . . . . . 7,579 4,583 7,267 - commercial business . . . . . 1,409 430 610 --------- ------ ------ Total fixed-rate . . . . . . . . . . . . . 47,864 38,405 36,439 --------- ------ ------ Total loans originated . . . . . . . . . . 68,097 56,774 43,880 --------- ------ ------ Purchases: Real estate - one-to-four family . . . . . . . . 67,213 55,839 47,136 Commercial real estate guaranteed by SBA . . . . 0 0 946 Construction or development . . . . . . . . . . 2,425 0 0 Non-real estate - commercial business . . . . . 2,174 1,500 0 --------- ------ ------ Total purchased . . . . . . . . . . . . . 71,812 57,339 48,082 ACQUISITION: Real estate - one-to-four family . . . . . . . . 63,328 0 0 - multi-family . . . . . . . . . . . 2,308 0 0 - commercial . . . . . . . . . . . . 2,099 0 0 Non-real estate - consumer . . . . . . . . . . . 2,599 0 0 --------- ------ ------ Total loans acquired . . . . . . . . . . . 70,334 0 0 TRANSFERS FROM LOANS HELD FOR SALE . . . . . . . . 96 0 0 SALES AND REPAYMENTS: Real estate - one-to-four family . . . . . . . . 8,969 2,310 2,414 Non-real estate - consumer . . . . . . . . . . . 339 176 1,791 --------- ------ ------ Total sales . . . . . . . . . . . . . . . 9,308 2,486 4,205 Loans securitized and transferred to securities 16,526 15,441 0 Transfers to loans held for sale . . . . . . . . 21,211 1,407 0 Principal repayments . . . . . . . . . . . . . . 64,846 58,262 39,215 --------- ------ ------ Total reductions . . . . . . . . . . . . . 111,891 77,596 43,420 --------- ------ ------ Increase (decrease) in other items, net . . . . (2,963) (2,990) (3,310) --------- ------ ------ Net increase . . . . . . . . . . . . . . . $ 95,485 33,527 45,232 --------- ------ ------ --------- ------ ------ MORTGAGE-BACKED AND RELATED SECURITIES Loans securitized and transferred to $ 16,526 15,441 0 securities . . . . . . . . . . . . . . . . PURCHASES: Mortgage-backed securities:(1) Adjustable-rate . . . . . . . . . . . . . . . . 0 0 0 Fixed-rate . . . . . . . . . . . . . . . . . . 3,426 7,266 10,139 CMOs and REMICs: Adjustable-rate . . . . . . . . . . . . . . . . 3,417 6,527 55,321 Fixed-rate . . . . . . . . . . . . . . . . . . 20,617 43,831 11,881 --------- ------ ------ Total purchases . . . . . . . . . . . . . . 27,460 57,624 77,341 --------- ------ ------ ACQUISITION: Adjustable rate . . . . . . . . . . . . . . . . 12,522 0 0 Fixed rate . . . . . . . . . . . . . . . . . . . 25,738 0 0 --------- ----- ------ Total acquisitions . . . . . . . . . . . . 38,260 0 0 --------- ------ ------
14 SALES: Mortgage-backed securities:(1) Adjustable-rate . . . . . . . . . . . . . . . . 9,535 0 23,073 Fixed-rate . . . . . . . . . . . . . . . . . . 344 24,786 11,953 CMOs and REMICs: Adjustable-rate . . . . . . . . . . . . . . . . 26,486 23,876 9,008 Fixed-rate . . . . . . . . . . . . . . . . . . 31,529 32,487 13,681 --------- ------ ------ Total sales . . . . . . . . . . . . . . . . 67,894 81,149 57,715 --------- ------ ------ PRINCIPAL REPAYMENTS: Decrease in other items, net . . . . . . . . . . 13,578 28,915 4,440 --------- ------ ------ Net increase (decrease) . . . . . . . . . . . $ 774 (36,999) 15,186 --------- ------ ------ --------- ------ ------ - - -------------------
(1) Consists of pass-through securities. 15 DELINQUENCIES AND NON-PERFORMING ASSETS DELINQUENCY PROCEDURES. When a borrower fails to make a required payment on a loan, HMN 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 may be made with the borrower between 30 and 60 days after the due date. If the loan is contractually delinquent 90 days, HMN usually 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 HMN. Delinquent consumer loans are generally handled in a similar manner. HMN's procedures for repossession and sale of consumer collateral are subject to various requirements under state consumer protection laws. Real estate acquired by HMN as a result of foreclosure or by deed in lieu of foreclosure is classified as real estate in judgement for six months to one year 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 HMN's loan delinquencies by type, by amount and by percentage of type at December 31, 1997.
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 . . . . 5 $ 412 0.10 % 8 $ 541 0.14% 13 $ 953 0.24% Multi-family . . . . 0 0 0.00 0 0 0.00 0 0 0.00 Commercial . . . . . 0 0 0.00 1 79 0.75 1 79 0.75 Construction or development . . . . 0 0 0.00 0 0 0.00 0 0 0.00 Consumer . . . . . . 3 26 0.08 6 45 0.14 9 71 0.22 Commercial business . . . . . . 0 0 0.00 0 0 0.00 0 0 0.00 --- ----- --- ----- --- ------ Total . . . . . . 8 $ 438 0.10 % 15 $ 665 0.15% 23 $1,103 0.24% --- ----- --- ----- --- ------ --- ----- --- ----- --- ------
CLASSIFICATION OF ASSETS. Federal regulations require that each savings institution classify its own assets on a regular basis. In addition, in connection with examinations of savings institutions, OTS and FDIC examiners have authority to identify problem assets and, if appropriate, require them to be classified. There are three classifications for problem assets: Substandard, Doubtful and Loss. Substandard assets 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. Doubtful assets have the weaknesses of Substandard assets, with the additional characteristics that the weaknesses 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 examiner's classification of an asset, it may appeal this determination to the District Director of the OTS. On the basis of management's review of its assets, at December 31, 1997, the Bank had classified a total of $901,000 of its loans and other assets as follows: 16
One-to- Commercial Real (DOLLARS IN Four Construction or Estate and Commercial THOUSANDS) Family Development Multi-Family Consumer Business ------- --------------- ---------------- -------- ---------- Substandard . . . . . $ 722 0 79 53 45 Doubtful . . . . . . 0 0 0 0 0 Loss . . . . . . . . 0 0 0 2 0 --- --- --- --- --- Total . . . . . . $ 722 0 79 55 45 --- --- --- --- --- --- --- --- --- ---
The Bank's classified assets consist of the non-performing loans and loans and other assets of concern discussed herein. As of the date hereof, these asset classifications are materially consistent with those of the OTS and FDIC. NON-PERFORMING ASSETS. Loans are reviewed quarterly and any loan whose collectibility is doubtful is placed on non-accrual status. Loans are placed on nonaccrual 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 (which involved forgiving a portion of interest or principal on any loans or making loans at a rate materially less than the market rate). Foreclosed assets include assets acquired in settlement of loans. The following table sets forth the amounts and categories of non-performing assets in the Bank's portfolio.
December 31, ------------------------------------------- (DOLLARS IN THOUSANDS) 1997 1996 1995 1994 1993 ------ ------ ------ ------ ------ Non-accruing loans: Real estate: One-to-four family . . . . . $ 177 235 196 178 80 Multi-family . . . . . . . . 0 0 0 0 0 Commercial real estate . . . 79 83 85 0 0 Consumer . . . . . . . . . . 7 7 32 57 58 Commercial business . . . . 0 13 128 0 --- --- --- --- --- Total . . . . . . . . . . 263 338 441 235 138 --- --- --- --- --- Accruing loans delinquent 90 One-to-four family . . . . . 365 0 0 0 23 Consumer . . . . . . . . . . 37 0 0 0 0 --- --- --- --- --- Total . . . . . . . . . . 402 0 0 0 23 --- --- --- --- --- Restructured loans: Multi-family . . . . . . . . 0 0 94 199 0 Foreclosed assets: Real estate: One-to-four family . . . . . 142 23 315 64 316 Commercial real estate . . . 0 0 0 0 95 Construction or development 0 0 0 0 0 Consumer . . . . . . . . . . 0 0 0 0 10 --- --- --- --- --- Total . . . . . . . . . . 142 23 315 64 421 --- --- --- --- --- Total non-performing assets . . $ 807 361 850 498 582 --- --- --- --- --- --- --- --- --- --- Total as a percentage of total assets . . . . . . . . . . . . 0.12 % 0.07 % 0.16 % 0.10 % 0.14% ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- Total non-performing loans . . $ 665 $ 338 $ 535 $ 434 $ 161 ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- Total as a percentage of total loans receivable, net . . . . 0.15 % 0.10 % 0.17 % 0.16 % 0.07% ---- ---- ---- ---- ---- ---- ---- ---- ---- ----
17 For the year ended December 31, 1997, gross interest income which would have been recorded had the non-accruing loans been current in accordance with their original terms amounted to $27,690. The amounts that were included in interest income on such loans during 1997 were $14,444. Total non-performing assets were $807,000 at December 31, 1997, an increase of $446,000, compared to $361,000 at December 31, 1996. The increase in non-performing assets is primarily the result of three one-to-four family purchased loans totaling $365,000 that are behind on their payments by more than 90 days and the foreclosure of two one-to-four family mortgages totaling $142,000. The decrease in the non-accruing loans is the result of the normal inflow and outflow of delinquent loans caused by borrowers getting behind on their payments and then bringing the loans current again. Total non-performing assets were $361,000 at December 31, 1996, a decrease of $489,000, compared to $850,000 at December 31, 1995. The decrease in non-performing assets is the result of the sale of foreclosed assets of $315,000, the charge-off of $72,000 of commercial loans, and the normal inflow and outflow of delinquent loans caused by borrowers getting behind on their payments and then bringing the loans current again. OTHER LOANS OF CONCERN. In addition to the non-performing assets set forth in the table above, as of December 31, 1997 there were $94,000 of loans with respect to which known information about the possible credit problems of the borrowers or the cash flows of the secured properties have caused management to have concerns as to the ability of the borrowers to comply with present loan repayment terms and 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. 18 ALLOWANCE FOR LOSSES ON LOANS. The following table sets forth an analysis of the Bank's allowance for loan losses for the year ended:
(DOLLARS IN THOUSANDS) 1997 1996 1995 1994 1993 ------ ------ ------ ------ ------ Balance at beginning of year . . . $2,341 2,191 1,893 1,489 831 MFC allowance for losses acquired . 122 0 0 0 0 CHARGE-OFFS Real estate: One-to-four family . . . . . . . (4) 0 (1) (6) (1) Multi-family . . . . . . . . . . 0 (88) 0 0 0 Consumer . . . . . . . . . . . . (7) (1) 0 0 (1) Commercial business . . . . . . . (12) (61) (1) 0 0 ------ ------ ------ ------ ------ (23) (150) (2) (6) (2) ------ ------ ------ ------ ------ RECOVERIES Real estate: Commercial business . . . . . . . 8 0 0 0 0 ------ ------ ------ ------ ------ 8 0 0 0 0 Net charge-offs . . . . . . . . . . (15) (150) (2) (6) (2) Additions charged to operations . . 300 300 300 410 660 ------ ------ ------ ------ ------ Balance at end of year . . . . . . $2,748 2,341 2,191 1,893 1,489 ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ Ratio of net charge-offs during the year to average loans outstanding during the year . . . . . . . . . . 0.01% 0.05% 0.00% 0.00% 0.00% ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ Ratio of allowance for losses on loans to total non-performing loans, at end of year . . . . . . . . . . 413.17 691.84 409.13 436.52 924.84 ------ ------ ------ ------ ------ ------ ------ ------ ------ ------
19 The distribution of the Bank's allowance for losses on loans at the dates indicated is summarized as follows:
December 31, --------------------------------------------------------------------------------------------------------- 1997 1996 1995 1994 1993 ------------------- ------------------- ------------------ ------------------- ------------------ Percent Percent Percent Percent Percent of Loans of Loans of Loans of Loans of Loans in Each in Each in Each in Each in Each Category Category Category Category Category to Total to Total to Total to Total to Total (DOLLARS IN THOUSANDS) Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- Real Estate: One-to-four family . . $ 560 87.58% $ 496 90.19% $ 452 90.62% $ 475 92.18% $ 374 92.18% Multi-family . . . . . . 80 0.60 8 0.08 21 0.11 21 0.14 10 0.14 Commercial real estate . 198 2.34 113 2.22 125 2.71 128 1.80 140 1.80 Construction or development. . . . . . . 172 1.27 104 0.98 153 1.58 84 1.31 1 1.31 Consumer . . . . . . . . 527 7.05 473 5.87 286 4.66 280 4.14 234 4.14 Commercial business . . . 46 1.16 29 0.66 37 0.32 27 0.43 30 0.43 Unallocated . . . . . . . 1,165 0.00 1,118 0.00 1,117 0.00 878 0.00 700 0.00 -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- Total . . . . . . . .$ 2,748 100.00% $ 2,341 100.00% $ 2,191 100.00% $ 1,893 100.00% $ 1,489 100.00% -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- --------
20 The allowance for losses on loans is established through a provision for losses on loans charged to earnings based on management's evaluation of the risk inherent in its entire loan portfolio and changes in the nature and volume of its loan activity. Such evaluation, which includes a review of all loans of which full collectibility may not be reasonably assured, considers specific occurrences, general and local economic conditions, loan portfolio composition, historical and local experience and other factors that warrant recognition in providing for an adequate allowance for loan losses. In determining the general reserves under these policies, historical charge-offs and recoveries, changes in the mix and levels of the various types of loans, the general level of non-performing assets and the anticipated net realizable values, the current loan portfolio and current economic conditions are considered. The Bank also requires additional reserves for all classified loans. While management believes that it uses the best information available to determine the allowance for losses on loans, unforeseen market conditions could result in adjustments to the allowance for losses on loans, and net earnings could be significantly affected, if circumstances differ substantially from the assumptions used in making the final determination. INVESTMENT ACTIVITIES HMN and the Bank utilize the available for sale securities portfolio in virtually all aspects of asset/liability management strategy. 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 projected cash flow requirements. The Bank must maintain minimum levels of investments that qualify as liquid assets under OTS regulations. Liquidity may increase or decrease depending upon the availability of funds and comparative yields on investments in relation to the return on loans. Cash flow projections are regularly reviewed and updated to assure that adequate liquidity is maintained. At December 31, 1997, the Bank's liquidity ratio (liquid assets as a percentage of net withdrawable savings deposits and current borrowings) was 19.39%. The Bank's level of liquidity is a result of management's asset/liability strategy. See "Regulation - Liquidity." 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, federally chartered savings institutions may also invest their assets in commercial paper, investment grade corporate debt securities and mutual funds whose assets conform to the investments that a federally chartered savings institution is otherwise authorized to make directly. The investment strategy of HMN and the Bank has been directed toward a mix of high-quality assets (primarily government and agency obligations) with short and intermediate terms to maturity. At December 31, 1997, HMN did not own any investment securities of a single issuer which exceeded 10% of HMN's stockholder's equity other than U.S. government or federal agency obligations. The Bank invests a portion of its liquid assets in interest-earning overnight deposits of the Federal Home Loan Bank ("FHLB") of Des Moines and various money market mutual funds. Other investments include high grade medium-term (up to three years) corporate debt securities, medium-term federal agency notes, and a variety of other types of mutual funds which invest in adjustable-rate, mortgage-backed securities, asset-backed securities, repurchase agreements and U.S. Treasury and agency obligations. HMN 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. See Notes 3 and 4 of the Notes to Consolidated Financial Statements in the Annual Report for additional information regarding HMN's securities portfolio. 21 The following table sets forth the composition of HMN's securities portfolio, excluding mortgage-backed and related securities, at the dates indicated.
December 31, ------------------------------------------------------------------------------------------- 1997 1996 ------------------------------------------ -------------------------------------------- Amortized Adjusted Market % of Amortized Adjusted Market % of (DOLLARS IN THOUSANDS) Cost To Value Total Cost To Value Total --------- -------- ------ ----- --------- -------- ------ ----- Securities available for sale: U.S. government and agency obligations . . . . . . . . . . $ 43,403 (60) 43,343 49.98% $29,600 (322) 29,278 49.93% Municipal obligations . . . . . . 0 0 0 0.00 0 0 0 0.00 Corporate debt . . . . . . . . . 2,903 0 2,903 3.35 1,091 1 1,092 1.86 Corporate equity(1) . . . . . . . 8,017 1,021 9,038 10.42 7,796 386 8,182 13.96 Stock of federal agencies(1). . . 14,034 605 14,639 16.88 3,874 49 3,923 6.69 Securities held to maturity: U.S. agency obligations . . . . . 0 0 0.00 0 0 0.00 Municipal obligations . . . . . . 0 0 0.00 0 0 0.00 Corporate debt . . . . . . . . . 0 0 0.00 1,000 1,001 1.71 --------- ------ ----- --------- ------ ----- Subtotal . . . . . . . . . . . 68,357 69,923 80.63 43,361 43,476 74.15 FHLB stock . . . . . . . . . . 7,432 7,432 8.57 5,434 5,434 9.27 --------- ------ ----- --------- ------ ----- Total investment securities and FHLB stock. . . . . . . . . 75,789 77,355 89.20 48,795 48,910 83.42 --------- ------ ----- --------- ------ ----- Average remaining life of investment securities excluding FHLB stock. . . . . . . . . . . . 2.5 years 3.4 years Other Interest-earning Assets: Cash equivalents . . . . . . . . 9,365 9,365 10.80 9,718 9,718 16.58 --------- ------ ----- --------- ------ ----- Total . . . . . . . . . . . . . $ 85,154 86,720 100.00% $58,513 58,628 100.00% --------- ------ ----- --------- ------ ----- --------- ------ ----- --------- ------ ----- Average remaining life or term to repricing of investment securities and other interest-earning assets, excluding FHLB stock . . . . . 2.3 years 2.8 years December 31, ------------------------------------------ 1995 ------------------------------------------ Amortized Adjusted Market % of (DOLLARS IN THOUSANDS) Cost To Value Total --------- -------- ------ ----- Securities available for sale: U.S. government and agency obligations . . . . . . . . . . $ 21,896 (566) 21,330 50.58% Municipal obligations . . . . . . 1,600 1 1,601 3.80 Corporate debt . . . . . . . . . 851 9 860 2.04 Corporate equity(1) . . . . . . . 6,898 174 7,072 16.77 Stock of federal agencies(1). . . 1,004 37 1,041 2.47 Securities held to maturity: U.S. agency obligations . . . . . 0 0 0.00 Municipal obligations . . . . . . 228 229 0.54 Corporate debt . . . . . . . . . 2,999 2,995 7.10 --------- ------ ----- Subtotal . . . . . . . . . . . 35,476 35,128 83.30 FHLB stock . . . . . . . . . . . . 3,802 3,802 9.02 --------- ------ ----- Total investment securities and FHLB stock . . . . . . . . 39,278 38,930 92.32 Average remaining life of investment securities excluding FHLB stock . . . . . . . . . . . 3.0 years Other Interest-earning Assets: Cash equivalents . . . . . . . . $ 3,238 3,238 7.68 --------- ------ ----- Total . . . . . . . . . . . . . 42,516 42,168 100.00% --------- ------ ----- --------- ------ ----- Average remaining life or term to repricing of investment securities and other interest-earning assets, excluding FHLB stock . . . . . . . 2.7 years
(1)Average life assigned to corporate equity holdings and stock of federal agencies is five years. 22 The composition and maturities of the securities portfolio, excluding FHLB stock, mortgage-backed and other related securities, are indicated in the following table.
December 31, 1997 ------------------------------------------------------------------------------------------ After 1 After 5 1 Year through 5 through 10 No Stated Total or Less Years Years Maturity Securities --------- --------- --------- --------- ------------------------------------ Amortized Amortized Amortized Amortized Amortized Adjusted Market (DOLLARS IN THOUSANDS) Cost Cost Cost Cost Cost To Value --------- --------- --------- --------- --------- -------- --------- Securities available for sale: U.S. government securities . . . . $ 11,482 31,921 0 0 43,403 (60) 43,343 Corporate debt . . . . . . . . . . 993 910 1,000 0 2,903 0 2,903 Corporate equity . . . . . . . . . 0 0 0 8,017 8,017 1,021 9,038 Stock of federal agencies . . . . . 0 0 0 14,034 14,034 605 14,639 --------- --------- --------- --------- --------- --------- Total stock . . . . . . . . . . . . . $ 12,475 32,831 1,000 22,051 68,357 69,923 --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- Weighted average yield . . . . . . . 4.22% 6.46% 8.80% 6.12% 5.98%
23 MORTGAGE-BACKED AND RELATED SECURITIES. In order to supplement loan production (particularly those of interest rate sensitive loans) and achieve its asset/liability management goals, HMN invests in mortgage-backed and related securities. All of the mortgage-backed and related securities owned by HMN are issued, insured or guaranteed either directly or indirectly by a federal agency or are rated "AA" or higher. At December 31, 1997, HMN had $135.9 million of mortgage-backed and related securities all classified as available for sale, compared to $135.2 at December 31, 1996, of which $133.4 million were classified as available for sale. At December 31, 1997, HMN had $23.3 million invested in CMOs which have floating interest rates that change either monthly or quarterly compared to $43.5 million at December 31, 1996 and $69.8 million at December 31, 1995. HMN decreased its investment in floating rate CMOs in order to invest in mortgage loans and meet other cash needs. The projected weighted average life of the $61.8 million fixed rate CMO security portfolio is approximately 2.5 years using median prepayment speeds projected by the Bloomberg security system. The contractual maturities of the mortgage-backed and related securities portfolio without any prepayment assumptions at December 31, 1997 is as follows:
December 31, 1997 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. . . . $ 17,256 1,409 4,166 7,249 30,080 Federal National Mortgage Association . . . . 3,444 1,922 2,629 6,345 14,340 Government National Mortgage Association. . . 0 17 2,621 3,581 6,219 Other mortgage-backed securities. . . . . . . 0 0 0 185 185 Collateralized Mortgage Obligations . . . . . 2,793 3,736 25,583 52,999 85,111 -------- -------- -------- -------- -------- Total . . . . . . . . . . . . . . . . . . $ 23,493 7,084 34,999 70,359 135,935 -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- Weighted average yield . . . . . . . . . . . 6.33% 7.23% 7.02% 6.78% 6.79%
At December 31, 1997, HMN did not have any non-agency mortgage-backed or related securities in excess of 10% of its stockholders' equity, except for a $12.0 million collateralized mortgage obligation issued by Bear Stearns with an AAA rating by Moody's. 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 HMN'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. To assess price volatility, the Federal Financial Institutions Examination Council ("FFIEC") adopted a policy in 1992 which requires an annual "stress" test of mortgage derivative securities. This policy, which has been adopted by the OTS, requires the Bank to annually test its CMOs and other mortgage-related securities to determine whether they are "high-risk" or "nonhigh-risk securities". At December 31, 1997, the Bank had $6.7 million of CMO's which were classified as high-risk securities under the OTS guidelines. 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. For information regarding the carrying and 24 market values of HMN's mortgage-backed and related securities portfolio, see Notes 3 and 4 of the Notes to Consolidated Financial Statements in the Annual Report. MERGERS AND ACQUISITIONS. On December 5, 1997 HMN, through its wholly owned subsidiary, the Bank, completed its merger with Marshalltown Financial Corporation (MFC) pursuant to a merger agreement dated July 1, 1997. Refer to Note 2 of the Notes to Consolidated Financial Statements in the Annual Report for information on assets acquired in the merger. SOURCES OF FUNDS GENERAL. The Bank's primary sources of funds are deposits, payments (including prepayments) of loan principal, interest earned on loans and securities, repayments 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, NOW, money market, non-interest bearing checking and certificate accounts (including individual retirement accounts). The Bank relies primarily on competitive pricing policies and customer service to attract and retain these deposits. The variety of deposit accounts offered by the Bank has allowed it to be competitive in obtaining funds and to respond with flexibility to changes in consumer demand. As customers have become more interest rate conscious, the Bank has become more susceptible to short-term fluctuations in deposit flows. The Bank manages the pricing of its deposits in keeping with its asset/liability management, profitability and growth objectives. Based on its experience, the Bank believes that its passbook and NOW accounts are relatively stable sources of deposits. However, the ability of the Bank to attract and maintain 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) 1997 1996 1995 ---------- ---------- ---------- Opening balance . . . . . . . . . . . $ 362,477 373,539 350,575 MFC deposits acquired . . . . . . . . . 103,612 0 0 Deposits . . . . . . . . . . . . . . . 370,761 351,330 339,781 Withdrawals . . . . . . . . . . . . . . 385,002 378,009 331,481 Interest credited . . . . . . . . . . . 15,500 15,617 14,664 ---------- ---------- ---------- Ending balance . . . . . . . . . . . 467,348 362,477 373,539 ---------- ---------- ---------- Net increase (decrease) . . . . . . . $ 104,871 (11,062) 22,964 ---------- ---------- ---------- ---------- ---------- ---------- Percent increase (decrease) . . . . . . 28.93% (2.96)% 6.55% ---------- ---------- ---------- ---------- ---------- ----------
25 The following table sets forth the dollar amount of savings deposits in the various types of deposit programs offered by the Bank as of December 31:
1997 1996 1995 ---------------------- ----------------------- ---------------------- Percent Percent Percent (DOLLARS IN THOUSANDS) Amount of Total Amount of Total Amount of Total --------- -------- --------- -------- --------- -------- TRANSACTIONS AND SAVINGS DEPOSITS(1): Non-interest checking . . . . . . . . . . . . $ 3,833 0.82% $ 2,389 0.66% $ 2,505 0.67% NOW Accounts - 1.5% (2) . . . . . . . . . . . 23,144 4.95 17,589 4.85 15,997 4.28 Passbook Accounts - 2.62%(3). . . . . . . . . 36,199 7.75 30,070 8.29 29,384 7.86 Money Market Accounts - 3.34% (4) . . . . . . 24,807 5.31 16,533 4.56 18,472 4.95 --------- -------- --------- -------- --------- -------- Total Non-Certificates . . . . . . . . . . $ 87,983 18.83% $ 66,581 18.36% $ 66,358 17.76% --------- -------- --------- -------- --------- -------- CERTIFICATES: 3.00 - 3.99% . . . . . . . . . . . . . . . $ 727 0.15% $ 425 0.12% $ 0 0.00% 4.00 - 4.99% . . . . . . . . . . . . . . . 24,155 5.17 22,553 6.22 22,440 6.01 5.00 - 5.99% . . . . . . . . . . . . . . . 162,916 34.86 168,040 46.36 152,971 40.95 6.00 - 6.99% . . . . . . . . . . . . . . . 178,847 38.27 76,704 21.16 89,754 24.03 7.00 - 7.99% . . . . . . . . . . . . . . . 11,627 2.49 28,077 7.75 40,721 10.90 8.00 - 8.99% . . . . . . . . . . . . . . . 1,091 0.23 96 0.03 1,294 0.35 9.00 - 9.99% . . . . . . . . . . . . . . . 2 0.00 1 0.00 1 0.00 10.00% and over . . . . . . . . . . . . . . . 0 0.00 0 0.00 0 0.00 --------- -------- --------- -------- --------- -------- Total Certificates . . . . . . . . . . . . 379,365 81.17 295,896 81.64 307,181 82.24 --------- -------- --------- -------- --------- -------- Total Deposits . . . . . . . . . . . . . $ 467,348 100.00% $ 362,477 100.00% $ 373,539 100.00% --------- -------- --------- -------- --------- -------- --------- -------- --------- -------- --------- --------
- - ----------------------------- (1) Reflects rates paid on transaction and savings deposits at December 31, 1997. (2) The rate on NOW Accounts for 1996 was 2.01% and 1995 was 2.22%. (3) The rate on Passbook Accounts for 1996 and 1995 was 2.50%. (4) The rate on Money Market Accounts for 1996 and 1995 was 2.83%. 26 The following table shows rate and maturity information for the Bank's certificates of deposit as of December 31, 1997.
3.00- 4.00- 5.00- 6.00- 7.00- 8.00- 9.00- Percent (DOLLARS IN THOUSANDS) 3.99% 4.99% 5.99% 6.99% 7.99% 8.99% 9.99% Total of Total ----- ----- ----- ----- ----- ----- ----- ------- -------- Certificate accounts maturing in quarter ending: March 31, 1998 . . . . . . . . . $ 709 8,756 38,831 10,304 5,525 594 0 64,719 17.05 June 30, 1998 . . . . . . . . . . 18 6,845 30,059 17,525 1,906 95 0 56,448 14.88 September 30, 1998 . . . . . . . 0 2,769 29,934 31,065 1,407 93 0 65,268 17.20 December 31, 1998 . . . . . . . . 0 3,690 16,620 51,060 1,476 50 0 72,896 19.22 March 31, 1999 . . . . . . . . . 0 494 14,321 21,027 473 247 0 36,562 9.64 June 30, 1999 . . . . . . . . . . 0 587 7,057 8,933 241 12 2 16,832 4.44 September 30, 1999 . . . . . . . 0 403 5,324 5,745 335 0 0 11,807 3.11 December 31, 1999 . . . . . . . . 0 420 3,031 1,662 264 0 0 5,377 1.42 March 31, 2000 . . . . . . . . . 0 136 1,287 1,383 0 0 0 2,806 0.74 June 30, 2000 . . . . . . . . . . 0 55 1,402 1,562 0 0 0 3,019 0.80 September 30, 2000 . . . . . . . 0 0 2,256 13,675 0 0 0 15,931 4.20 December 31, 2000 . . . . . . . . 0 0 2,789 3,536 0 0 0 6,325 1.67 Thereafter . . . . . . . . . . . 0 0 10,005 11,370 0 0 0 21,375 5.63 ------- ------ ------- ------- ------ ----- ---- ------- ------- Total . . . . . . . . . . . $ 727 24,155 162,916 178,847 11,627 1,091 2 379,365 100.00% ------- ------ ------- ------- ------ ----- ---- ------- ------- ------- ------ ------- ------- ------ ----- ---- ------- ------- Percent of total . . . . . . . 0.19% 6.37% 42.95% 47.14% 3.06% 0.29% 0.00% 100.00% ------- ------ ------- ------- ------ ----- ---- ------- ------- ------ ------- ------- ------ ----- ---- -------
27 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, 1997.
Maturity ---------------------------------------- Over Over 3 Months 3 to 6 6 to 12 Over or Less Months Months 12 months Total -------- ------ ------- --------- ------- (DOLLARS IN THOUSANDS) Certificates of deposit less than $100,000 . . . . . . . . $ 51,964 48,648 126,772 111,159 338,543 Certificates of deposit of $100,000 or more . . . . . . . . 5,120 4,277 8,025 8,874 26,296 Public funds (1) . . . . . . . . . 7,635 3,523 3,368 0 14,526 --------- ------ ------- ------- ------- Total certificates of deposit . . . . . . . . . . $ 64,719 56,448 138,165 120,033 379,365 --------- ------ ------- ------- ------- --------- ------ ------- ------- -------
- - --------------- (1)Deposits from governmental and other public entities. For additional information regarding the composition of the Bank's deposits, see Note 11 of the Notes to Consolidated Financial Statements in the Annual Report. For additional information on certificate maturities and the impact on HMN's liquidity see Liquidity Management starting on page 20 of the Annual Report. BORROWINGS. The Bank's other available sources of funds include advances from the Federal Home Loan Bank ("FHLB") of Des Moines and other borrowings. As a member of the FHLB of Des Moines, the Bank is required to own capital stock in the FHLB of Des Moines and is authorized to apply for advances from the FHLB of Des Moines. Each FHLB credit program has its own interest rate, which may be fixed or variable, and range of maturities. The FHLB of Des Moines 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 extend the term to maturity of its liabilities. Also, the Bank has used FHLB borrowings to fund loan demand and other investment opportunities and to offset deposit outflows. At December 31, 1997, the Bank had $127.7 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 $150.0 million for liquidity purposes. See "Financial Review - Federal Home Loan Bank Advances" and Note 10 of the Notes to Consolidated Financial Statements in the Annual Report. The following table sets forth the maximum month-end balance and average balance of FHLB advances and other borrowings for the periods indicated.
Year Ended December 31, -------------------------- 1997 1996 1995 (DOLLARS IN THOUSANDS) ------ ------ ------ MAXIMUM BALANCE: FHLB advances . . . . . . . . . . . . . . . . $128,007 106,436 74,534 FHLB short-term borrowings and open line of credit . . . . . . . . . . . . . . . . . . . . 60,429 64,429 42,429 AVERAGE BALANCE: FHLB advances . . . . . . . . . . . . . . . . . 112,500 89,656 65,069 FHLB short-term borrowings . . . . . . . . . . 45,598 47,949 20,812
28 The following table sets forth certain information as to the Bank's FHLB advances at the dates indicated.
December 31, ------------------------ 1997 1996 1995 ------ ------ ------ (DOLLARS IN THOUSANDS) FHLB short-term borrowings . . . . . . . . . . $43,250 46,429 33,429 Weighted average interest rate of FHLB short-term borrowings . . . . . . . . . . . 5.85% 5.52% 6.05%
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 such 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 which a federal savings bank may engage in directly. Osterud Insurance Agency, Inc. ("OIAI"), a Minnesota corporation, was organized in 1983. OIAI operated as an insurance agency until 1986 when its assets were sold. OIAI remained inactive until 1993 when it began offering credit life insurance, annuity products and mutual fund products to the Bank's customers and others. At December 31, 1997, the Bank's liability related to OIAI was $21,000. OIAI recorded net income of $12,000 for the year ended December 31, 1997. MSL Financial Corporation ("MSL") was acquired in the MFC merger. MSL offered annuity products to MFC customers and also has an investment in FHLMC preferred stock. COMPETITION The Bank faces strong competition both in originating real estate loans and in attracting deposits. Competition in originating loans comes primarily from mortgage bankers, commercial banks, credit unions and other savings institutions, which also make loans secured by real estate located in the Bank's market area. 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 those deposits is principally from money market and mutual funds, securities firms, commercial banks and other savings institutions located in the same communities. 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, convenient locations 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 HMN HMN has two other wholly owned subsidiaries, HMN Mortgage Services, Inc. ("MSI") and Security Finance Corporation ("SFC"). MSI operates a mortgage banking and mortgage brokerage facilities located in Eden Prairie and Brooklyn Park, Minnesota. Eden Prairie and Brooklyn Park are located in the Minneapolis/St. Paul Metropolitan area. MSI's primary function is to originate and/or purchase single family residential loans for resale on the secondary market to FNMA, FHLMC or other third parties. It also from 29 time to time purchases mortgage servicing rights from other lenders. SFC invests in commercial loans and commercial real estate loans located throughout the United States which were originated by third parties. EMPLOYEES At December 31, 1997, HMN had a total of 150 full-time equivalent employees. None of the employees of HMN or its subsidiaries are represented by any collective bargaining unit. Management considers its employee relations to be good. EXECUTIVE OFFICERS OF THE REGISTRANT WHO ARE NOT DIRECTORS Officers are elected annually by the Board of Directors of HMN and the Bank. The business experience of each executive officer of HMN and the Bank who is not also a director of HMN is set forth below. Unless otherwise indicated, such individuals have held their current positions for at least five years. DWAIN C. JORGENSEN. Mr. Jorgensen, age 49, is Vice President, Controller and Chief Accounting Officer of HMN and the Bank. Mr. Jorgensen has held such positions with the Bank since 1989. From 1983 to 1989, Mr. Jorgensen was an Assistant Vice President and Operations Officer with the Bank. SUSAN K. KOLLING. Mrs. Kolling, age 46, is Senior Vice President of HMN and is Senior Vice President of Marketing of the Bank, a position she has held since 1995. Prior to such time, she served as Vice President from 1992 through 1994 and as a Loan Officer from 1981 through 1991. Mrs. Kolling began her career with the Bank in 1969. TIMOTHY P. JOHNSON. Mr. Johnson, age 45, is Vice President and Treasurer of HMN and the Bank, a position he has held since 1997. Prior to such time, he served as Treasurer from 1992 to 1997. From 1983 to 1992, Mr. Johnson was Chief Financial Officer of St. Louis Bank for Savings, Duluth, Minnesota. ROXANNE M. HELLICKSON. Mrs. Hellickson, age 37, is Vice President/Loan Administrator and Corporate Secretary of HMN and the Bank. She served as Assistant Secretary of the Bank from 1992 to 1994 and was secretary to the Bank's President and a loan officer from 1989 to 1992. Mrs. Hellickson began her career with the Bank in 1979. REGULATION GENERAL The Bank is a federally chartered savings bank, the deposits of which are federally insured and backed by the full faith and credit of the United States Government. Accordingly, the Bank is subject to broad federal regulation and oversight extending to all its operations. The Bank is a member of the FHLB of Des Moines and is subject to certain limited regulation by the Federal Reserve Board. The Bank is a member of the Savings Association Insurance Fund ("SAIF") and the deposits of the Bank are insured by the FDIC. As a result, the FDIC has certain regulatory and examination authority over the Bank. As the savings and loan holding company of the Bank, HMN also is subject to federal regulation and oversight. The purpose of the regulation of HMN and other holding companies is to protect subsidiary savings associations. Certain of these regulatory requirements and restrictions are discussed below. FEDERAL REGULATION OF SAVINGS ASSOCIATIONS The OTS has extensive authority over the operations of savings associations. As part of this authority, the Bank is required to file periodic reports with the OTS and is subject to periodic examinations 30 by the OTS and the FDIC. The last regular OTS examination of the Bank was dated May 1997. The Bank has not been scheduled for an examination in 1998, except for an on-site year 2000 examination which started on March 23, 1998. When these examinations are conducted by the OTS and the FDIC, the examiners may require the Bank to provide for higher general or specific loan loss reserves. Financial institutions in various regions of the United States have been called upon by examiners to write down assets and to establish increased levels of reserves, primarily as a result of perceived weaknesses in real estate values and a more restrictive regulatory climate. The OTS has established a schedule for the assessment of fees upon all savings associations to fund the operations of the OTS. The general assessment, to be paid on a semi-annual basis, is computed upon the savings association's total assets as reported in the association's latest quarterly thrift financial report. Savings associations (unlike the Bank) that are classified as "troubled" (I.E., having a supervisory rating of "4" or "5" or subject to a conservatorship) are required to pay a 50% premium over the standard assessment. The Bank's OTS assessment for the year ended December 31, 1997 was approximately $122,000. The OTS also has extensive enforcement authority over all savings institutions and their holding companies, including the Bank and HMN. This enforcement authority includes, among other things, the ability to assess civil money penalties, to issue cease-and-desist or removal orders and to initiate injunctive actions. In general, these enforcement actions may be initiated for violations of laws and regulations and unsafe or unsound practices. Other actions or inactions may provide the basis for enforcement action, including misleading or untimely reports filed with the OTS. Except under certain circumstances, public disclosure of final enforcement actions by the OTS is required. In addition, the investment, lending and branching authority of the Bank is prescribed by federal laws and regulations, and it is prohibited from engaging in any activities not permitted by such laws and regulations. For instance, no savings institution may invest in non-investment grade corporate debt securities. In addition, unless approved by the OTS, the permissible level of investment by federal associations in loans secured by non-residential real property may not exceed 400% of regulatory capital. Federal savings associations are also generally authorized to branch nationwide. The Bank is in compliance with the noted restrictions. The Bank's general permissible lending limit for loans-to-one-borrower is equal to the greater of $500,000, or 15%, of unimpaired capital and surplus (except for loans fully secured by certain readily marketable collateral, in which case this limit is increased to 25% of unimpaired capital and surplus). At December 31, 1997, the Bank's lending limit under this restriction was $9.2 million. The Bank is in compliance with the loans-to-one borrower limitation. In December 1991, the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") was enacted into law. FDICIA provides for, among other things, the recapitalization of the Bank Insurance Fund; adoption of safety and soundness standards; enhanced federal supervision of depository institutions, including greater authority for the appointment of a conservator or receiver for undercapitalized institutions; the establishment of risk-based deposit insurance premiums; liberalization of the qualified thrift lender test; greater restrictions on transactions with affiliates; and mandated consumer protection disclosures with respect to deposit accounts. See "- Insurance of Accounts and Regulation by the FDIC," "- Regulatory Capital Requirements" and "- Qualified Thrift Lender Test." The OTS, as well as the other federal banking agencies, have issued proposed safety and soundness standards on matters such as loan underwriting and documentation, internal controls and audit systems, interest rate risk exposure, compensation and other employee benefits. The proposal also establishes the maximum ratio of classified assets to total capital (which for this purpose includes loss allowances exceeding the amount includable for regulatory capital purposes) at 100% and the minimum level of earnings sufficient to absorb losses without impairing capital. Earnings will be sufficient if the net income over the last four 31 quarters is assumed to continue over the next four quarters and the institution would otherwise remain in capital compliance. Any institution which fails to comply with these standards must submit a compliance plan. A failure to submit a plan or to comply with an approved plan will subject the institution to further enforcement action. The proposal also requires savings and loan holding companies to ensure that transactions and relationships with their subsidiary savings associations do not have a detrimental effect on the safe and sound operation of the association. No assurance can be given as to the final form of the proposed regulations. The Bank is subject to a wide array of other laws and regulations, both federal and state, including, but not limited to, usury laws, the CRA and regulations thereunder, the Equal Credit Opportunity Act and Regulation B, Regulation E Electronic Funds Transfer requirements, the Truth-in-Lending Act and Regulation Z, the Real Estate Settlement Procedures Act and Regulation X. The Bank is also subject to laws and regulations that may impose liablitiy on lenders and owners for clean-up costs and other costs stemming from hazardous waste located on property securing real estate loans made by lenders or on real estate that is owned by lenders following a foreclosure or otherwise. INSURANCE OF ACCOUNTS AND REGULATION BY THE FDIC The Bank is a member of the SAIF, which is administered by the FDIC. Savings deposits are insured up to applicable limits by the FDIC and such insurance is backed by the full faith and credit of the United States Government. As insurer, the FDIC imposes deposit insurance premiums and is authorized to conduct examinations of and to require reporting by FDIC-insured institutions. It also may prohibit any FDIC-insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious risk to the SAIF. The FDIC also has the authority to initiate enforcement actions against savings associations, after giving the OTS an opportunity to take such action, and may terminate the deposit insurance if it determines that the institution has engaged or is engaging in unsafe or unsound practices, or is in an unsafe or unsound condition. FDICIA also requires the FDIC to implement a risk-based deposit insurance assessment system. Pursuant to this requirement, the FDIC adopted a transitional risk-based assessment system, effective January 1, 1993, under which all insured depository institutions are placed into one of nine categories and assessed insurance premiums, ranging from .23% to .31% of deposits, based upon their level of capital and supervisory evaluation. The permanent system, adopted in June 1993 and effective January 1, 1994, continued the risk classification system established under the transitional rule. Under the system, institutions classified as well capitalized (I.E., a core capital ratio of at least 5%, a ratio of Tier 1 or core capital to risk-weighted assets ("Tier 1 risk-based capital") of at least 6% and a risk-based capital ratio of at least 10%) and considered healthy would pay the lowest premium while institutions that are less than adequately capitalized (I.E., core and Tier 1 risk-based capital ratios of less than 4% or a risk-based capital ratio of less than 8%) and considered of substantial supervisory concern would pay the highest premium. Risk classification of all insured institutions will be made by the FDIC for each semi-annual assessment period. The FDIC is authorized to increase assessment rates, on a semi-annual basis, if it determines that the reserve ratio of the SAIF will be less than the designated reserve ratio of 1.25% of SAIF insured deposits. In setting these increased assessments, the FDIC must seek to restore the reserve ratio to that designated reserve level, or such higher reserve ratio as established by the FDIC. In addition, under FDICIA, the FDIC may impose special assessments on SAIF members to repay amounts borrowed from the United States Treasury or for any other reason deemed necessary by the FDIC. The Deposit Insurance Fund Act of 1996 (DIFA) was enacted on September 30, 1996. DIFA addressed the inadequate funding of the (SAIF). In order to recapitalize the SAIF, DIFA imposed a one-time assessment on all thrift institutions. The Bank's assessment was a pretax charge of $2,351,563 and was recognized in the third quarter of 1996. 32 DIFA also addressed the funding for the Financing Corp. (FICO) bonds. Thrifts will pay 6.4 basis points per $100 of deposits from January 1, 1997 to December 31, 1999. From January 1, 2000 until the FICO bonds are retired in 2019, the estimated assessment to retire the FICO bonds is expected to be 2.5 basis points per $100 of deposits. DIFA proposed that the Bank Insurance Fund (BIF) and SAIF be merged on January 1, 1999, provided no insurance depository institution is a savings association on that date. At this time, HMN does not know what effect, if any, the proposed legislation or charter revisions will have on future operations. REGULATORY CAPITAL REQUIREMENTS Federally insured savings associations, such as the Bank, are required to maintain a minimum level of regulatory capital. The OTS has established capital standards, including a tangible capital requirement, a leverage ratio (or core capital) requirement and a risk-based capital requirement applicable to such savings associations. These capital requirements must be generally as stringent as the comparable capital requirements for national banks. The OTS is also authorized to impose capital requirements in excess of these standards on individual associations on a case-by-case basis. The capital regulations require tangible capital of at least 1.5% of adjusted total assets (as defined by regulation). Tangible capital generally includes common stockholders' equity and retained earnings, and certain noncumulative perpetual preferred stock. In addition, all intangible assets, other than a limited amount of purchased mortgage servicing rights, must be deducted from tangible capital. At December 31, 1997, the Bank had goodwill of $6.0 million and $510,000 of mortgage servicing rights which were required to be deducted from stockholders' equity to arrive at tangible capital. The OTS regulations establish special capitalization requirements for savings associations that own subsidiaries. Under these regulations certain subsidiaries are consolidated for capital purposes and others are excluded from assets and capital. In determining compliance with the capital requirements, all subsidiaries engaged solely in activities permissible for national banks or engaged in certain other activities solely as agent for its customers are "includable" subsidiaries that are consolidated for capital purposes in proportion to the association's level of ownership, including the assets of includable subsidiaries in which the association has a minority interest that is not consolidated for GAAP purposes. For excludable subsidiaries the debt and equity investments in such subsidiaries are deducted from assets and capital. The subsidiary of the Bank is an includable subsidiary. At December 31, 1997, the Bank had tangible capital of $54.1 million, or 8.2% of adjusted total assets, which is $44.2 million above the minimum requirement of 1.5% of adjusted total assets in effect on that date. The capital standards also require core capital equal to at least 3% of adjusted total assets (as defined by regulation). Core capital generally consists of tangible capital plus certain intangible assets. As a result of the prompt corrective action provisions of FDICIA discussed below, however, a savings association must maintain a core capital ratio of at least 4% to be considered adequately capitalized unless its supervisory condition is such to allow it to maintain a 3% ratio. As required by federal law, the OTS has proposed a rule revising its minimum core capital requirement to be no less stringent than that imposed on national banks. The OTS has proposed that only those savings associations rated a composite one (the highest rating) under the safety and soundness rating system for savings associations will be permitted to operate at or near the regulatory minimum leverage ratio of 3%. All other savings associations will be required to maintain a minimum leverage ratio of 4% to 5%. The OTS will assess each individual savings association through the supervisory process on a case-by-case basis to determine the applicable requirement. No assurance can be given as to the final form of any such 33 regulation, the date of its effectiveness or the requirement applicable to the Bank. At December 31, 1997, the Bank had core capital equal to $54.1 million, or 8.2%, of adjusted total assets, which is $34.3 million above the minimum leverage ratio requirement of 3% as in effect on that date. The OTS risk-based requirement requires savings associations to have total capital of at least 8% of risk-weighted assets. Total capital consists of core capital, as defined above, and supplementary capital. Supplementary capital consists of certain permanent and maturing capital instruments that do not qualify as core capital and general valuation loan and lease loss allowances up to a maximum of 1.25% of risk-weighted assets. Supplementary capital may be used to satisfy the risk-based requirement only to the extent of core capital. At December 31, 1997, the Bank had $2.7 million of general loss reserves, which were included in capital. Certain exclusions from capital and assets are required to be made for the purpose of calculating total capital, in addition to the adjustments required for calculating core capital. Such exclusions consist of equity investments (as defined by regulation) and that portion of land loans and nonresidential construction loans in excess of an 80% loan-to-value ratio and reciprocal holdings of qualifying capital instruments. At December 31, 1997 the Bank had $266,000 of exclusions from capital. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet items, will be multiplied by a risk weight, ranging from 0% to 100%, based on the risk inherent in the type of asset. For example, the OTS has assigned a risk weight of 50% for prudently underwritten permanent one-to-four family first lien mortgage loans not more than 90 days delinquent and having a loan to value ratio of not more than 80% at origination unless insured to such ratio by an insurer approved by the FNMA or the FHLMC. On December 31, 1997, the Bank had total "risk-based" capital of $56.6 million and risk-weighted assets of $303.4 million, or total capital of 18.7% of risk-weighted assets. This amount was $32.4 million above the 8% requirement in effect on that date. Under FDICIA, all the federal banking agencies, including the OTS, were required to revise their risk-based capital requirements to ensure that such requirements account for interest rate risk, concentration of credit risk and the risks of non-traditional activities, and that they reflect the actual performance of and expected loss on multi-family loans. Such standards were adopted with the enactment of FDICIA. The OTS had adopted a rule that required every savings association with more than normal interest rate risk to deduct from its total capital, for purposes of determining compliance with such requirement, an interest rate risk component ("IRR component") equal to 50% of its interest-rate risk exposure multiplied by the present value of its assets. The IRR component is a measure of the potential decline in the net portfolio value ("NPV") of a savings association, greater than 2% of the present value of its assets, based upon a hypothetical 200 basis point increase or decrease in interest rates (whichever results in a greater decline). NPV is the present value of expected cash flows from assets, liabilities and off-balance sheet contracts. The rule provided for a two quarter lag between calculating interest rate risk and recognizing any deduction from capital. The OTS has decided not to require the IRR component to be deducted from the capital calculations of all institutions. It has reserved the right to take the IRR component into account in assessing the capital requirements for an individual institution. Based upon an IRR component analysis at December 31, 1997, the Bank was deemed to have more than "normal" interest rate risk and may, at some time in the future, be required to deduct an amount from capital. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Asset/Liability Management" in the Annual Report. 34 Pursuant to FDICIA, the federal banking agencies, including the OTS, have adopted regulations authorizing the agencies to require a depository institution to maintain an additional amount of total capital to account for concentration of credit risk and the risk of non-traditional activities. The OTS and the FDIC are authorized and, under certain circumstances, required to take certain actions against associations that fail to meet capital requirements. Effective December 19, 1992, the federal banking agencies, including the OTS, were given additional enforcement authority over undercapitalized depository institutions. The OTS is generally required to take action to restrict the activities of an "undercapitalized association" (generally defined to be one with less than either a 4% core ratio, a Tier 1 risked-based capital ratio or an 8% risk-based capital ratio). Any such association must submit a capital restoration plan and until such plan is approved by the OTS may not increase its assets, acquire another institution, establish a branch or engage in any new activities, and generally may not make capital distributions. The OTS is authorized to impose the additional restrictions, discussed below, that are applicable to significantly undercapitalized associations. As a condition to the approval of the capital restoration plan, any company controlling an undercapitalized association must agree that it will enter into a limited capital maintenance guarantee with respect to the institution's achievement of its capital requirements. Any savings association that fails to comply with its capital plan or is "significantly undercapitalized" (I.E., Tier 1 risk-based or core capital ratios of less than 3% or a risk-based capital ratio of less than 6%) must be made subject to one or more additional specified actions and operating restrictions mandated by FDICIA. These actions and restrictions include requiring the issuance of additional voting securities; limitations on asset growth; mandated asset reduction; changes in senior management; divestiture, merger or acquisition of the association; restrictions on executive compensation; and any other action the OTS deems appropriate. An association that becomes "critically undercapitalized" (I.E., a tangible equity to total asset ratio of 2% or less) is subject to further mandatory restrictions on its activities in addition to those applicable to significantly undercapitalized associations. In addition, the OTS must appoint a receiver (or conservator with the concurrence of the FDIC) for a savings association, with certain limited exceptions, within 90 days after it becomes critically undercapitalized. Any undercapitalized association is also subject to other possible enforcement actions by the OTS or the FDIC. Such actions could include a capital directive, a cease-and-desist order, civil money penalties, the establishment of restrictions on all aspects of the association's operations, the appointment of a receiver or conservator or a forced merger into another institution. If the OTS determines that an association is in an unsafe or unsound condition, or is engaged in an unsafe or unsound practice, it is authorized to reclassify a well-capitalized association as an adequately capitalized association, and if the association is adequately capitalized, to impose the restrictions applicable to an undercapitalized association. If the association is undercapitalized, the OTS is authorized to impose the restrictions applicable to a significantly undercapitalized association. The imposition by the OTS or the FDIC of any of these measures on the Bank may have a substantial adverse effect on the Bank's operations and profitability and the value of HMN's stock. HMN shareholders do not have preemptive rights, and therefore, if HMN is directed by the OTS or the FDIC to issue additional shares of common stock, such issuance may result in the dilution in the percentage of ownership of existing stockholders of HMN. At December 31, 1997 the Bank would be considered to be "well capitalized" under the prompt corrective actions provisions mentioned above. See Note 16 "Federal Home Loan Bank Investment, Regulatory Liquidity and Regulatory Capital Requirements" in the Notes to Consolidated Financial Statements in the Annual Report for more information on the Bank's capital. 35 LIMITATIONS ON DIVIDENDS AND OTHER CAPITAL DISTRIBUTIONS OTS regulations impose various restrictions or requirements on associations with respect to their ability to pay dividends or make other distributions of capital. OTS regulations prohibit an association from declaring or paying any dividends or from repurchasing any of its stock if, as a result, the regulatory capital of the association would be reduced below the amount required to be maintained for the liquidation account established in connection with its mutual to stock conversion. The OTS utilizes a three-tiered approach to permit associations, based on their capital level and supervisory condition, to make capital distributions which include dividends, stock redemptions or repurchases, cash-out mergers and other transactions charged to the capital account. See "- Regulatory Capital Requirements." Generally, Tier 1 associations, which are associations that before and after the proposed distribution meet their fully phased-in capital requirements, may make capital distributions during any calendar year equal to the greater of 100% of net income for the year-to-date plus 50% of the amount by which the lesser of the association's tangible, core or risk-based capital exceeds its fully phased-in capital requirement for such capital component, as measured at the beginning of the calendar year, or the amount authorized for a Tier 2 association. However, a Tier 1 association deemed to be in need of more than normal supervision by the OTS may be downgraded to a Tier 2 or Tier 3 association as a result of such a determination. The Bank meets the requirements for a Tier 1 association and has not been notified of a need for more than normal supervision. Tier 2 associations, which are associations that before and after the proposed distribution meet their current minimum capital requirements, may make capital distributions of up to 75% of net income over the most recent four quarter period. Tier 3 associations (which are associations that do not meet current minimum capital requirements) that propose to make any capital distribution and Tier 2 associations that propose to make a capital distribution in excess of the noted safe harbor level must obtain OTS approval prior to making such distribution. Tier 2 associations proposing to make a capital distribution within the safe harbor provisions and Tier 1 associations proposing to make any capital distribution need only submit written notice to the OTS 30 days prior to such distribution. As a subsidiary of HMN, the Bank will also be required to give the OTS 30 days' notice prior to declaring any dividend on its stock. The OTS may object to the distribution during that 30-day period based on safety and soundness concerns. See "- Regulatory Capital Requirements." The OTS has proposed regulations that would revise the current capital distribution restrictions. The proposal eliminates the current tiered structure and the safe-harbor percentage limitations. Under the proposal a savings association may make a capital distribution without notice to the OTS (unless it is a subsidiary of a holding company) provided that it has a CAMELS 1 or 2 rating, is not in troubled condition and would remain adequately capitalized (as defined in the OTS prompt corrective action regulations) following the proposed distribution. Savings associations that would remain adequately capitalized following the proposed distribution but do not meet the other noted requirements must notify the OTS 30 days prior to declaring a capital distribution. The OTS stated it will generally regard as permissible that amount of capital distributions that do not exceed 50% of the institution's excess regulatory capital plus net income to date during the calendar year. A savings association may not make a capital distribution without prior approval of the OTS and the FDIC if it is undercapitalized before, or as a result of, such a distribution. A savings association will be considered in troubled condition if it has a CAMELS rating of 4 or 5, is subject to an enforcement action relating to its safety and soundness or financial viability or has been informed in writing by the OTS that it is in troubled condition. As under the current rule, the OTS may object to a capital distribution if it would constitute an unsafe or unsound practice. No assurance may be given as to whether or in what form the regulations may be adopted. 36 In March of 1998, the Bank received confirmation from OTS that a dividend from the Bank to HMN of $15.0 million could be paid during 1998 and not violate the dividend limitations mentioned above. LIQUIDITY All savings associations, including the Bank, are required to maintain an average daily balance of liquid assets equal to a certain percentage of the sum of its average daily balance of net withdrawable deposit accounts and borrowings payable in one year or less. For a discussion of what the Bank includes in liquid assets, see "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity Management" in the Annual Report. This liquid asset ratio requirement may vary from time to time (between 4% and 10%) depending upon economic conditions and savings flows of all savings associations. At the present time, the minimum liquid asset ratio is 4%. In addition, short-term liquid assets (E.G., cash, certain time deposits, certain bankers acceptances and short-term United States Treasury obligations) currently must constitute at least 1% of the association's average daily balance of net withdrawable deposit accounts and current borrowings. Penalties may be imposed upon associations for violations of either liquid asset ratio requirement. At December 31, 1997, the Bank had an overall liquid asset ratio of 19.4% and a short-term liquid asset ratio of 6.4%. ACCOUNTING An OTS policy statement applicable to all savings associations clarifies and re-emphasizes that the investment activities of a savings association must be in compliance with approved and documented investment policies and strategies, and must be accounted for in accordance with GAAP. Under the policy statement, management must support its classification of and accounting for loans and securities (I.E., whether held to maturity, sale or trading) with appropriate documentation. The Bank is in compliance with these amended rules. The OTS has adopted an amendment to its accounting regulations, which may be made more stringent than GAAP, to require that transactions be reported in a manner that best reflects their underlying economic substance and inherent risk and that financial reports must incorporate any other accounting regulations or orders prescribed by the OTS. QUALIFIED THRIFT LENDER TEST All savings associations, including the Bank, are required to meet a qualified thrift lender ("QTL") test to avoid certain restrictions on their operations. This test requires a savings association to have at least 65% of its portfolio assets (which consists of total assets less intangibles, properties used to conduct the savings association's business and liquid assets not exceeding 20% of total assets) in qualified thrift investments on a monthly average for nine out of every 12 months on a rolling basis. For HMN such assets primarily consist of residential housing related loans and investments. At December 31, 1997, the Bank met the test and has always met the test since its effectiveness. Any savings association that fails to meet the QTL test must convert to a national bank charter, unless it requalifies as a QTL and thereafter remains a QTL. If an association does not requalify and converts to a national bank charter, it must remain SAIF-insured until the FDIC permits it to transfer to the Bank Insurance Fund. If an association that fails the test has not yet requalified and has not converted to a national bank, its new investments and activities are limited to those permissible for both a savings association and a national bank, and it is limited to national bank branching rights in its home state. In addition, the association is immediately ineligible to receive any new FHLB borrowings and is subject to national bank limits for payment of dividends. If such association has not requalified or converted to a national bank within three years after the failure, it must divest of all investments and cease all activities not permissible for a national 37 bank. In addition, it must repay promptly any outstanding FHLB borrowings, which may result in prepayment penalties. If any association that fails the QTL test is controlled by a holding company, then within one year after the failure, the holding company must register as a bank holding company and become subject to all restrictions on bank holding companies. See "- Holding Company Regulation." TRANSACTIONS WITH AFFILIATES Generally, transactions between a savings association or its subsidiaries and its affiliates are required to be on terms as favorable to the association as transactions with non-affiliates. In addition, certain of these transactions are restricted to a percentage of the association's capital. Affiliates of the Bank include HMN and any company which is under common control with the Bank. In addition, a savings association may not lend to any affiliate engaged in activities not permissible for a bank holding company or acquire the securities of most affiliates. The Bank's subsidiaries are not deemed affiliates, however, the OTS has the discretion to treat subsidiaries of savings associations as affiliates on a case by case basis. Certain transactions with directors, officers or controlling persons are also subject to conflict of interest regulations enforced by the OTS. These conflict of interest regulations and other statutes also impose restrictions on loans to such persons and their related interests. Among other things, such loans must be made on terms substantially the same as for loans to unaffiliated individuals. HOLDING COMPANY REGULATION HMN is a unitary savings and loan holding company subject to regulatory oversight by the OTS. As such, HMN is registered and required to file reports with and subject to regulation and examination by the OTS. In addition, the OTS has enforcement authority over HMN and its non-savings association subsidiaries which also permits the OTS to restrict or prohibit activities that are determined to be a serious risk to the subsidiary savings association. As a unitary savings and loan holding company, HMN generally is not subject to activity restrictions. If HMN acquires control of another savings association as a separate subsidiary, it would become a multiple savings and loan holding company, and the activities of HMN and any of its subsidiaries (other than the Bank or any other SAIF-insured savings association) would become subject to such restrictions unless such other associations qualify as QTLs and were acquired in a supervisory acquisition. If the Bank fails the QTL test, HMN must obtain the approval of the OTS prior to continuing after such failure, directly or through its other subsidiaries, any business activity other than those approved for multiple savings and loan holding companies or their subsidiaries. In addition, within one year of such failure HMN must register as, and will become subject to, the restrictions applicable to bank holding companies. The activities authorized for a bank holding company are more limited than are the activities authorized for a unitary or multiple savings and loan holding company. See "- Qualified Thrift Lender Test." HMN must obtain approval from the OTS before acquiring control of any other SAIF-insured association. Such acquisitions are generally prohibited if they result in a multiple savings and loan holding company controlling savings associations in more than one state. However, such interstate acquisitions are permitted based on specific state authorization or in a supervisory acquisition of a failing savings association. FEDERAL SECURITIES LAW The stock of HMN is registered with the SEC under the Securities Exchange Act of 1934, as amended (the "Exchange Act"). HMN is subject to the information, proxy solicitation, insider trading restrictions and other requirements of the SEC under the Exchange Act. 38 HMN stock held by persons who are affiliates (generally officers, directors and principal stockholders) of HMN may not be resold without registration or unless sold in accordance with certain resale restrictions. If HMN meets specified current public information requirements, each affiliate of HMN is able to sell in the public market, without registration, a limited number of shares in any three-month period. FEDERAL RESERVE SYSTEM The Federal Reserve Board requires all depository institutions to maintain non-interest bearing reserves at specified levels against their transaction accounts (primarily checking, NOW and Super NOW checking accounts). At December 31, 1997, the Bank was in compliance with these reserve requirements. The balances maintained to meet the reserve requirements imposed by the Federal Reserve Board may be used to satisfy liquidity requirements that may be imposed by the OTS. See "- Liquidity." Savings associations are authorized to borrow from the Federal Reserve Bank "discount window," but Federal Reserve Board regulations require associations to exhaust other reasonable alternative sources of funds, including FHLB borrowings, before borrowing from the Federal Reserve Bank. FEDERAL HOME LOAN BANK SYSTEM The Bank is a member of the FHLB of Des Moines, which is one of 12 regional FHLBs, that administers the home financing credit function of savings associations. Each FHLB serves as a reserve or central bank for its members within its assigned region. It is funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB System. It makes loans to members (I.E., advances) in accordance with policies and procedures established by the board of directors of the FHLB. These policies and procedures are subject to the regulation and oversight of the Federal Housing Finance Board. All advances from the FHLB are required to be fully secured by sufficient collateral as determined by the FHLB. In addition, all long-term advances are required to provide funds for residential home financing. As a member, the Bank is required to purchase and maintain stock in the FHLB of Des Moines. At December 31, 1997, the Bank had $7.4 million in FHLB stock, which was in compliance with this requirement. In past years, the Bank has received dividends on its FHLB stock. Over the past five calendar years such dividends have averaged 7.41% and were 7.00% for calendar year 1997. For the year ended December 31, 1997, dividends paid by the FHLB of Des Moines to the Bank totaled $421,000. Under federal law the FHLBs are required to provide funds for the resolution of troubled savings associations and to contribute to low and moderately priced housing programs through direct loans or interest subsidies on advances targeted for community investment and low- and moderate-income housing projects. These contributions have affected adversely the level of FHLB dividends paid and could continue to do so in the future. These contributions could also have an adverse effect on the value of FHLB stock in the future. A reduction in value of the Bank's FHLB stock may result in a corresponding reduction in the Bank's capital. 39 FEDERAL AND STATE TAXATION FEDERAL TAXATION. HMN and its subsidiaries file consolidated federal income tax returns on a calendar year basis using the accrual method of accounting. Prior to 1996, savings institutions were subject to special bad debt reserve rules and certain other rules. During this period of time, a savings institution that held 60% or more of its assets in "qualifying assets" (as defined in the Internal Revenue Code) was permitted to maintain reserves for bad debts and to make annual additions to such reserves that qualified as deductions from taxable income, HMN was in compliance with this requirement. A qualifying thrift institution could elect annually to compute its allowable additons to bad debt reserves under either the percentage of taxable income method or the experience method. The percentage of taxable income method of calculating bad debt reserves limited the applicable percentage deduction to 8% of taxable income and could not cause the reserves to exceed 6% of qualifying loans at the end of the taxable year. HMN used the experience method to calculate additions to tax bad debt reserves through tax year 1995. Beginning in 1996, the favorable bad debt method described above was repealed putting savings insitutions on the same tax bad debt method as commercial banks. This legislation requires recapture of the amount of the tax bad debt reserves to the extent that they exceed the adjusted base year reserve ("the applicable excess reserves"). The applicable excess reserves are recaptured over a six-year period. This recapture period can be deferred for a period of up to two years to the extent that a certain residential lending test is met. HMN has previously provided taxes for the applicable excess reserves. In addition to the regular income tax, corporations, including savings associations such as the Bank, generally are subject to a minimum tax. An alternative minimum tax is imposed at a minimum tax rate of 20% on alternative minimum taxable income, which is the sum of a corporation's regular taxable income (with certain adjustments) and tax preference items, less any available exemption. The alternative minimum tax is imposed to the extent it exceeds the corporation's regular income tax and net operating losses can offset no more than 90% of alternative minimum taxable income. To the extent earnings appropriated to a savings association's bad debt reserves for "qualifying real property loans" and deducted for federal income tax purposes before 1988 exceed the allowable amount of such reserves computed under the experience method and to the extent of the association's supplemental reserves for losses on loans ("Excess"), such Excess may not, without adverse tax consequences, be utilized for the payment of cash dividends or other distributions to a shareholder (including distributions on redemption, dissolution or liquidation) or for any other purpose (except to absorb bad debt losses). As of December 31, 1997, the Bank's Excess for tax purposes totaled approximately $8.8 million. HMN was incorporated in 1994 and filed its first consolidated Federal income tax return with its subsidiaries for the year ended December 31, 1994. The return required to be filed for 1997 has been extended and will be filed by September 1998. The Bank and its consolidated subsidiaries have been audited by the IRS with respect to consolidated federal income tax returns through December 31, 1983. With respect to years examined by the IRS, either all deficiencies have been satisfied or sufficient reserves have been established to satisfy asserted deficiencies. In the opinion of management, any examination of still open returns (including returns of subsidiaries and predecessors of, or entities merged into, the Bank) would not result in a deficiency which could have a material adverse effect on the consolidated financial condition of HMN. MINNESOTA TAXATION. HMN and its subsidiaries that operate in Minnesota are subject to Minnesota state taxation. A Minnesota corporation's income or loss is allocated based on a three-factor apportionment of the corporation's Minnesota gross receipts, payroll and property over the total gross receipts, payroll and property of all corporations in the unitary group. The corporate tax rate in Minnesota is 9.8%. The Minnesota Alternative Minimum Tax rate is 5.8%. 40 The Bank and it subsidiaries have not been audited by the Minnesota taxation authorities. IOWA TAXATION. On December 5, 1997 the Bank acquired MFC and its subsidiaries which were located in the state of Iowa. The Bank is now subject to Iowa Franchise tax on an apportionment basis weighted based upon deposits located within Iowa to total deposits of the Bank. Income apportioned to Iowa is subject to a 5% tax rate. DELAWARE TAXATION. As a Delaware holding company, HMN is exempted from Delaware corporate income tax but is required to file an annual report with and pay an annual fee to the State of Delaware. HMN is also subject to an annual franchise tax imposed by the State of Delaware. 41 ITEM 2. PROPERTIES The following table sets forth information concerning the main office and each branch office of HMN at December 31, 1997. At December 31, 1997, HMN's premises had an aggregate net book value of approximately $4.6 million.
YEAR OWNED OR NET BOOK VALUE AT LOCATION ACQUIRED LEASED DECEMBER 31, 1997(1) - - ------------------------------ -------- -------- -------------------- (In Thousands) MAIN OFFICE: 101 North Broadway 1975 Owned 341 Spring Valley, Minnesota FULL SERVICE BRANCHES: 201 Oakland Avenue 1960 Owned 176 Austin, Minnesota Crossroads Shopping Center 1962 Owned 500 Rochester, Minnesota 4th & Center 1973 Owned 123 Winona, Minnesota 208 South Walnut 1975 Owned 90 LaCrescent, Minnesota 1110 6th St., NW 1982 Owned 878 Rochester, Minnesota 143 West Clark Street 1993 Owned 582 Albert Lea, Minnesota 303 W. Main St. 1997 Owned 636 Marshalltown, Iowa 119 W. High St. 1997 Leased 3 Toledo, Iowa 29 S. Center 1997 Owned 159 Marshalltown, Iowa MORTGAGE BANKING/BROKERAGE OFFICES: 9973 Valley View Road 1996 Leased --- Eden Prairie, Minnesota 7101 Northland Circle, Suite 105 1997 Leased --- Brooklyn Park, Minnesota
- - --------------------- (1) Does not include $955,163 of net furniture and equipment distributed between all of the above offices or its subsidiaries. 42 During 1997 HMN purchased land totaling $392,700 in order to build new retail banking facilities in Spring Valley and Winona. During 1997 HMN spent $700,000 for construction in process on the two banking facilities. During 1998 HMN will spend approximately $2,200,000 to complete its building projects and provide the buildings with furniture and equipment. The facilities will replace the existing retail facilities in both locations. HMN believes that its remaining facilities are adequate to meet their present needs. The Bank's depositor and borrower customer files are maintained by an independent data processing company. The net book value of the data processing and computer equipment utilized by the Bank at December 31, 1997 was approximately $575,000. ITEM 3. LEGAL PROCEEDINGS From time to time, the Bank and HMN 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 HMN'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 AND RELATED SECURITY HOLDER MATTERS The information on pages 26, 48 and the back cover page of the Annual Report to Security Holders for the year ended December 31, 1997 is incorporated herein by reference. ITEM 6. SELECTED FINANCIAL DATA The information on page 11 of the Annual Report to Security Holders for the year ended December 31, 1997 is incorporated herein by reference. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The information on pages 12 through 26 of the Annual Report to Security Holders for the year ended December 31, 1997 is incorporated herein by reference. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK The information on pages 21 through 23 of the Annual Report to Security Holders for the year ended December 31, 1997 is incorporated herein by reference. 43 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The information on pages 27 through 48 of the Annual Report to Security Holders for the year ended December 31, 1997 is incorporated herein by reference. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information on pages 5 through 8 of the Registrant's definitive Proxy Statement dated March 30, 1998 is incorporated herein by reference. See "Business - Executive Officers" in Part I of the Form 10-K for information regarding executive officers. ITEM 11. EXECUTIVE COMPENSATION The information on pages 8 through 14 of the Registrant's definitive Proxy Statement dated March 30, 1998 is incorporated herein be reference, except for information contained under the heading "Compensation Committee Report on Executive Compensation". ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information on pages 2 through 4 of the Registrant's definitive Proxy Statement dated March 30, 1998 is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS None. 44 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) FINANCIAL STATEMENTS, FINANCIAL STATEMENT SCHEDULES AND EXHIBITS 1. Financial Statements The following information appearing in the Registrant's Annual Report to Security Holders for the year ended December 31, 1997, is incorporated by reference in this Form 10-K Annual Report as Exhibit 13.
Pages in 1997 Annual Annual Report Section Report --------------------- ----------- Five Year Consolidated Financial Highlights 11 Consolidated Balance Sheets -- December 31, 1997 and 1996 27 Consolidated Statements of Income -- Each of the Years in the Three-Year Period Ended December 31, 1997 28 Consolidated Statement of Stockholders' Equity -- Each of the Years in the Three-Year Period Ended December 31, 1997 29 Consolidated Statements of Cash Flows -- Each of the Years in the Three-Year Period Ended December 31, 1997 30 Notes to Consolidated Financial Statements 31 - 44 Independent Auditors' Report 45 Selected Quarterly Financial Data 46 - 47 Other Financial Data 48 Common Stock Price Information 48
2. Financial Statement Schedules All financial statement schedules have been omitted as information is not required under the related instructions, is not applicable or has been included in the Notes to Consolidated Financial Statements. 45 3. Exhibits
Reference Sequential to Prior Page Numbering Filing or Where Attached Exhibit Exhibits Are Regulation S-K Number Located in This Exhibit Number Document Attached Hereto Form 10-K Report -------------- ---------------------------- --------------- ---------------- 2 Agreement and Plan of Merger ***** Not applicable dated July 1, 1997 3 (i) Articles of Incorporation * Not applicable (ii) By-laws ****** Not applicable 4 Instruments defining the rights of security * Not applicable holders, including indentures 9 Voting trust agreement Not applicable Not applicable 10.1 + Employment agreement for Mr. Weise ** Not applicable dated June 29, 1994 Extension of Employment Contract ******* Not applicable 10.2 + Employment agreement for Mr. Gardner ** Not applicable dated June 29, 1994 Extension of Employment Contract ******* Not applicable 10.3 + Directors Deferred Compensation Plan ** Not applicable 10.4 + 1995 Recognition and Retention Plan *** Not applicable 10.5 + 1995 Stock Option and Incentive Plan *** Not applicable 11 Statement re: Computation of per share 11 Filed electronically earnings 12 Statement re: Computation of ratios Not applicable Not applicable 13 Annual Report to Security Holders 13 Filed electronically 16 Letter re: Change in certifying accountant Not applicable Not applicable 18 Letter re: Change in accounting principles Not applicable Not applicable 21 Subsidiaries of Registrant 21 Filed electronically + Management contract of compensatory arrangement.
46
Reference Sequential to Prior Page Numbering Filing or Where Attached Exhibit Exhibits Are Regulation S-K Number Located in This Exhibit Number Document Attached Hereto Form 10-K Report -------------- ---------------------------- --------------- ---------------- 22 Published report regarding matters Not applicable Not applicable submitted to vote of security holders 23 Consent of KPMG Peat Marwick LLP 23 Filed electronically dated March 26, 1998 24 Power of Attorney Not applicable Not applicable 27.1 Finacial Data Schedule 27.1 Filed electronically Year ended 1997 27.2 Financial Data Schedule 27.2 Filed electronically Restated for quarters ended March 31, 1997 June 30, 1997 and September 30, 1997 27.3 Financial Data Schedule 27.3 Filed electronically Restated for March 31, 1996, June 30, 1996 September 30, 1996 and December 31, 1996 27.4 Financial Data Schedule 27.4 Filed electronically Restated for the year ended December 31, 1995 28 Information from reports furnished to None Not applicable state insurance regulatory authorities 99 Additional exhibits None Not applicable
- - ------------- * Filed April 1, 1994, as exhibits to the Registrant's Form S-1 registration statement (Registration No. 33-77212) pursuant to the Securities Act of 1933. All of such previously filed documents are hereby incorporated herein by reference in accordance with Item 601 of Regulation S-K. ** Filed as an exhibit to the Registrant's Form 10-K for 1994 (file no. 0-24100). All previously filed documents are hereby incorporated by reference in accordance with Item 601 of Regulation S-K. *** Filed as an exhibit to the Registrant's Form 10-K for 1995 (file no. 0-24100). All previously filed documents are hereby incorporated by reference in accordance with Item 601 of Regulation S-K. ****Filed as an exhibit to the Registrant's Form 10-K for 1996 (file no. 0-24100). All previously filed documents are hereby incorporated by reference in accordance with Item 601 of Regulation S-K. *****Filed as an exhibit to Current Report of Form 8-K dated July 1, 1997, filed on July 10, 1997. All previously filed documents are hereby incorporated by reference. ******Filed as an exhibit to the Registrant's Form 10-Q for the third quarter of 1997 (file no. 0-24100). All previously filed documents are hereby incorporated by reference. *******Filed as an exhibit to the Registrant's Form 10-Q for the second quarter of 1997 (file no. 0-24100). All previously filed documents are hereby incorporated by reference. 47 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 31, 1998 By: /s/ Roger P. Weise ----------------------------- ------------------------------------- Roger P. Weise (Duly Authorized Representative) Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. By: /s/ Roger P. Weise By: /s/ James B. Gardner ----------------------------- ------------------------------------- Roger P. Weise, Chairman of James B. Gardner, the Board, President and Chief Executive Vice President and Director Executive Officer (Principal (Principal Financial Officer) Executive and Operating Officer) Date: March 31, 1998 Date: March 31, 1998 ----------------------------- ----------------------------------- By: /s/ Irma R. Rathbun By: /s/ Timothy R. Geisler ------------------------------- ------------------------------------- Irma R. Rathbun, Director Timothy R. Geisler, Director Date: March 31, 1998 Date: March 31, 1998 ----------------------------- ----------------------------------- By: /s/ M. F. Schumann By: /s/ Duane D. Benson ------------------------------- ------------------------------------- M.F. Schumann, Director Duane D. Benson, Director Date: March 31, 1998 Date: March 31, 1998 ----------------------------- ----------------------------------- By: /s/ Dwain C. Jorgensen ------------------------------- Dwain C. Jorgensen, Vice President and Controller (Principal Accounting Officer) Date: March 31, 1998 ----------------------------- 48 INDEX TO EXHIBITS
Sequential Page Numbering Where Attached Exhibits Are Regulation S-K Located in This Exhibit Number Document Form 10-K Report -------------- ------------------------------------- ---------------- 11 Statement re: Computation of per share earnings Filed electronically 13 Annual Report to Security Holders Filed electronically 21 Subsidiaries of Registrant Filed electronically 23 Consent of KPMG Peat Marwick LLP Filed electronically dated March 26, 1998 27.1 Finacial Data Schedule Filed electronically Year ended 1997 27.2 Financial Data Schedule Filed electronically Restated for quarters ended March 31, 1997, June 30, 1997 and September 30, 1997 27.3 Financial Data Schedule Filed electronically Restated for March 31, 1996, June 30, 1996, September 30, 1996 and December 31, 1996 27.4 Financial Data Schedule Filed electronically Restated for the year ended December 31, 1995
49 EX-11 2 EXHIBIT 11 Exhibit 11 HMN Financial, Inc. Computation of Earnings Per Common Share
Year Ended December 31, ----------------------------------------- 1997 1996 1995 ----------------------------------------- Computation of Earnings Per Common Share: Weighted average number of common shares out- standing used in basic earnings per common share calculation . . . . . . . . . . . . . . 3,683,458 4,315,410 5,109,989 Net dilutive effect of: Options . . . . . . . . . . . . . . . . . . . 209,388 54,838 19,062 Restricted stock awards . . . . . . . . . . . 50,767 67,003 42,887 ---------- --------- ---------- Weighted average number of shares outstanding adjusted for effect of dilutive securities. . 3,943,613 4,437,251 5,171,938 ---------- --------- ---------- ---------- --------- ---------- Income available to common shareholders. . . . $5,578,866 4,274,349 5,620,377 Basic earnings per common share . . . . . . . $1.51 0.99 1.10 Diluted earnings per common share . . . . . . $1.41 0.96 1.09
EX-13 3 EXHIBIT 13 FIVE-YEAR CONSOLIDATED FINANCIAL HIGHLIGHTS
SELECTED OPERATIONS DATA:(1) YEAR ENDED DECEMBER 31, -------------------------------------------------- (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) 1997 1996 1995 1994 1993 - - --------------------------------------------------------------------------------------------------------------------- Total interest income....................................... $ 41,090 39,864 38,328 32,277 32,427 Total interest expense...................................... 25,643 24,194 22,555 18,067 18,399 ------- ------ ------ ------ ------ Net interest income...................................... 15,447 15,670 15,773 14,210 14,028 Provision for loan losses................................... 300 300 300 410 660 ------- ------ ------ ------ ------ Net interest income after provision for loan losses...... 15,147 15,370 15,473 13,800 13,368 ------- ------ ------ ------ ------ Fees and service charges.................................... 487 359 325 311 305 Securities gains, net....................................... 1,250 1,030 416 65 1,180 Gain on sales of loans...................................... 469 39 102 3 0 Other non-interest income................................... 516 495 155 216 152 ------- ------ ------ ------ ------ Total non-interest income................................ 2,722 1,923 998 595 1,637 SAIF assessment............................................. 0 2,352 0 0 0 Other non-interest expense.................................. 9,022 8,157 7,470 6,574 5,976 ------- ------ ------ ------ ------ Total non-interest expense............................... 9,022 10,509 7,470 6,574 5,976 Income tax expense.......................................... 3,268 2,510 3,381 3,116 3,799 ------- ------ ------ ------ ------ Net income............................................... $ 5,579 4,274 5,620 4,705 5,230 ------- ------ ------ ------ ------ ------- ------ ------ ------ ------ Earnings per share: Basic.................................................... $ 1.51 0.99 1.10 Diluted.................................................. 1.41 0.96 1.09 Basic and diluted (1994: June 29 through December 31)........................................... 0.48 N/A Pro forma basic and diluted (January 1 through December 31)........................ 0.86 N/A SELECTED FINANCIAL CONDITION DATA:(1) DECEMBER 31, --------------------------------------------------- (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) 1997 1996 1995 1994 1993 - - --------------------------------------------------------------------------------------------------------------------- Total assets................................................ $691,232 554,732 537,949 494,868 430,782 Securities held for sale.................................... 0 0 0 0 7,598 Securities available for sale............................... 205,859 175,830 190,320 183,512 71,868 Securities held to maturity................................. 0 2,806 16,972 12,678 85,672 Loans held for sale ........................................ 2,287 739 0 0 0 Loans receivable, net....................................... 442,069 349,022 314,851 271,000 246,446 Deposits.................................................... 467,348 362,477 373,539 350,575 353,581 Federal Home Loan Bank advances............................. 127,650 106,079 68,877 51,986 33,964 Stockholders' equity........................................ 84,470 82,099 91,687 89,047 40,046 Book value per share........................................ 20.38 18.52 17.29 14.63 N/A Tangible book value per share............................... 18.92 18.52 17.29 14.63 N/A Number of full service offices.............................. 10 7 7 7 7 Number of mortgage origination offices...................... 2 1 0 0 0 Key Ratios(2) Stockholders' equity to total assets at year end............ 12.22% 14.80% 17.04% 17.99% 9.30% Average stockholders' equity to average assets.............. 14.36 16.12 18.24 14.57 8.82 Return on stockholders' equity (ratio of net income to average equity).................. 6.84 4.82 5.86 6.86 13.79 Return on assets (ratio of net income to average assets).................. 0.98 0.78 1.07 1.00 1.22 - - ---------------------------------------------------------------------------------------------------------------------
(1) HMN Financial, Inc. (HMN) completed a public stock offering on June 29, 1994, which generated net proceeds of $59.2 million. HMN purchased all of the stock of Home Federal Savings Bank (the Bank) with a portion of the conversion proceeds. The information represents the financial condition and the results of operations for the consolidated HMN for 1997, 1996, 1995 and 1994 and Bank only information for 1993. (2) Average balances were calculated based upon amortized cost without the market value impact of SFAS 115. N/A Not applicable because the bank was not a publicly held corporation. On December 5, 1997 HMN acquired Marshalltown Financial Corporation, refer to Note 2 of the Notes to Consolidated Financial Statements for details on the acquisition. - - -------------------------------------------------------------------------------- HMN FINANCIAL, INC. 11 MANAGEMENT'S DISCUSSION AND ANALYSIS FINANCIAL REVIEW The financial review presents management's discussion and analysis of the consolidated financial condition and results of operations of HMN Financial, Inc. and subsidiaries (HMN). This review should be read in conjunction with the consolidated financial statements and other financial data beginning on page 27. HMN was incorporated under the laws of the State of Delaware for the purpose of becoming the savings and loan holding company of Home Federal Savings Bank (the Bank) in connection with the Bank's conversion from a federally chartered mutual savings bank to a federally chartered stock savings bank, pursuant to its plan of conversion. The conversion was completed on June 29, 1994. Refer to Note 15 of the Notes to Consolidated Financial Statements for more information regarding the Bank's stock conversion. Information presented for years ended prior to December 31, 1994 reflect the financial condition and the results of operations of only the consolidated Bank. RESULTS OF OPERATIONS Net income for the year ended December 31, 1997 was $5.6 million, an increase of $1.3 million, or 31%, from $4.3 million for the year ended December 31, 1996. Basic earnings per share was $1.51 for the year ended December 31, 1997, an increase of $0.52 per share, or 53%, from $0.99 basic earnings per share for December 31, 1996. Diluted earnings per share was $1.41 for the year ended December 31, 1997, an increase of $0.45 per share, or 47%, from $0.96 diluted earnings per share for the year ended in 1996. In September of 1996, Congress enacted the Savings Association Insurance Fund (SAIF) legislation which assessed a one time charge against all SAIF insured institutions in order to recapitalize the fund. The Bank was assessed $2.35 million which was charged directly to earnings and reduced after tax earnings by $1.46 million. The assessment reduced basic earnings per share and diluted earnings per share for the year ended 1996 by $0.34 and $0.33, respectively. Net income for the year ended December 31, 1996 was $4.3 million, a decrease of $1.3 million, or 24%, from $5.6 million for the year ended December 31, 1995. Basic earnings per share was $0.99 for the year ended December 31, 1996, a decrease of $0.11 per share from basic earnings per share of $1.10 for the year ended December 31, 1995. Diluted earnings per share was $0.96 for the year ended December 31, 1996, a decrease of $0.13 per share from $1.09 for the year ended in 1995. The SAIF assessment of $2.35 million was the primary reason for the decline in net income from 1995 to 1996. Other changes noted were net interest income decreased by $103,000, non-interest income increased by $924,000 due to security gains and other non-recurring income, and was partially offset by increased non-interest expenses of $687,000 related to compensation and benefit expenses, occupancy costs and other costs. Return on average assets was 0.98%, 0.78% and 1.07% for 1997, 1996 and 1995, respectively. The return on average assets for 1996, excluding the SAIF assessment, was 1.04%. Return on average equity was 6.84%, 4.82% and 5.86%, for 1997, 1996 and 1995, respectively. NET INTEREST INCOME HMN's net income is dependent primarily on its net interest income, which is the difference between interest earned on securities, loans and other interest-earning assets (interest income) and interest paid respectively on deposits and Federal Home Loan Bank advances (interest expense). Net interest margin is calculated by dividing net interest income by the average interest-earning assets. The arithmetic difference between the yield on interest-earning assets and the cost of interest-bearing liabilities expressed as a percentage is referred to as the net interest rate spread. 12 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, ---------------------------------------------------------------------------- 1997 1996 ------------------------------------- ------------------------------------ Average Interest Average Interest Outstanding Earned/ Yield/ Outstanding Earned/ Yield/ (DOLLARS IN THOUSANDS) Balance Paid Rate Balance Paid Rate - - -------------------------------------------------------------------------------------------------------------------- Interest-earning assets: Securities available for sale: Mortgage-backed and related securities................... $121,805 8,256 6.78% $148,400 10,027 6.76% Other marketable securities(1)......... 61,977 3,699 5.97 40,549 2,425 5.98 Securities held to maturity: Mortgage-backed and related securities................... 379 33 8.82 10,160 765 7.53 Other marketable securities............ 167 10 6.00 1,861 104 5.61 Loans held for sale..................... 2,426 175 7.22 107 8 7.61 Loans receivable, net(2)................ 355,657 28,154 7.92 324,851 25,713 7.92 Federal Home Loan Bank stock............ 6,007 421 7.00 4,671 328 7.01 Other interest-earning assets including cash equivalents............. 8,413 342 4.07 11,039 494 4.48 -------- ------ -------- ------ Total interest-earning assets........... $556,831 41,090 7.38 $541,638 39,864 7.36 -------- ------ ---- -------- ------ ---- -------- ------ -------- ------ Interest-bearing liabilities: Noninterest checking.................... $ 2,626 0 0.00% $2,016 0 0.00% NOW accounts............................ 17,306 257 1.49 16,051 323 2.01 Passbooks............................... 29,893 763 2.55 30,295 760 2.51 Money market accounts................... 16,879 490 2.90 17,724 501 2.83 Certificate accounts.................... 303,926 17,546 5.77 299,903 17,366 5.79 Federal Home Loan Bank advances.......................... 112,500 6,587 5.85 89,656 5,244 5.85 -------- ------ -------- ------ Total interest-bearing liabilities...... $483,130 25,643 5.31 $455,645 24,194 5.31 -------- ------ ---- -------- ------ ---- -------- ------ -------- ------ Net interest income..................... 15,447 15,670 ------ ------ ------ ------ Net interest rate spread................ 2.07% 2.05% ---- ---- ---- ---- Net earning assets...................... $ 73,701 $ 85,993 -------- -------- -------- -------- Net interest margin..................... 2.77% 2.89% ---- ---- ---- ---- Average interest-earning assets to average interest-bearing liabilities............................ 115.25% 118.87% ------ ------ ------ ------ Year Ended December 31, -------------------------------------- 1995 -------------------------------------- Average Interest Outstanding Earned/ Yield/ (DOLLARS IN THOUSANDS) Balance Paid Rate - - ------------------------------------------------------------------------------- Interest-earning assets: Securities available for sale: Mortgage-backed and related securities................... $153,150 10,294 6.72% Other marketable securities(1)......... 47,289 2,858 6.04 Securities held to maturity: Mortgage-backed and related securities................... 9,242 746 8.07 Other marketable securities............ 6,145 390 6.34 Loans held for sale..................... 0 0 0.00 Loans receivable, net(2)................ 290,243 23,375 8.05 Federal Home Loan Bank stock............ 3,485 253 7.25 Other interest-earning assets including cash equivalents............. 8,611 412 4.78 -------- ------ Total interest-earning assets........... $518,165 38,328 7.40 -------- ------ ---- -------- ------ Interest-bearing liabilities: Noninterest checking.................... $1,735 0 0.00% NOW accounts............................ 14,361 311 2.17 Passbooks............................... 30,378 759 2.50 Money market accounts................... 19,499 548 2.81 Certificate accounts.................... 293,844 16,961 5.77 Federal Home Loan Bank advances.......................... 65,069 3,976 6.11 -------- ------ Total interest-bearing liabilities...... $424,886 22,555 5.31 -------- ------ ---- -------- ------ Net interest income..................... 15,773 ------ ------ Net interest rate spread................ 2.09% ---- ---- Net earning assets...................... $ 93,279 -------- -------- Net interest margin..................... 3.04% ---- ---- Average interest-earning assets to average interest-bearing liabilities............................ 121.95% ------ ------
(1) Tax exempt income was not significant; therefore, the yield was not presented on a tax equivalent basis. The tax exempt income was $9,400 for 1997 and $87,474 in 1995. There was no tax exempt income earned in 1996. (2) Calculated net of deferred loan fees, loan discounts, loans in process and loss reserve. - - -------------------------------------------------------------------------------- HMN FINANCIAL, INC. 13 MANAGEMENT'S DISCUSSION AND ANALYSIS Net interest income for the year ended December 31, 1997 was $15.4 million, a decrease of $223,000, or 1.4%, from $15.7 million for the same year ended in 1996. Interest income for the year ended December 31, 1997 was $41.1 million, an increase of $1.2 million, or 3.1%, compared to $39.9 million for the year ended in 1996. The increased interest income was primarily due to increased loan purchases, originations and, to a minor extent, loans added as a result of the acquisition of Marshalltown Financial Corporation (MFC)(1). Average outstanding loans receivable for 1997 increased by $30.8 million over average outstanding loans receivable for 1996. HMN has been increasing its investment in loans in order to increase interest income. Interest income earned on the security portfolio decreased by $1.3 million primarily because securities were sold or matured and the proceeds were reinvested into loans or other assets. The average outstanding securities portfolio decreased by $16.7 million from $201.0 million at December 31, 1996 to $184.3 million at December 31, 1997. Interest expense for the year ended December 31, 1997 was $25.6 million, an increase of $1.4 million, or 6.0%, from $24.2 million for the year ended December 31, 1996. Interest expense increased during 1997 due to additional advances from the FHLB which were used to fund loan purchases and the purchase of MFC. The increase in interest expense totally offset the increase in interest income and therefore caused net interest income for the year ended December 31, 1997 to decline by $223,000 from the year ended December 31, 1996. Net interest income for 1996 was $15.7 million, a decrease of $103,000, or 0.7%, from $15.8 million for 1995. Interest income for 1996 was $39.9 million, an increase of $1.5 million, or 4.0%, compared to $38.3 million for 1995. The average interest-earning assets for 1996 were $23.5 million higher than average interest-earning assets for 1995. The increase in average interest-earning assets caused HMN to earn additional interest income of $2.0 million which was partially offset by a decrease in interest income of $483,000 due to a decrease in the yield earned on interest-earning assets. During 1996 HMN decreased its weighted average securities portfolio by $14.9 million in order to increase its loan portfolio. HMN purchased $55.8 million of single-family residential loans with a weighted average interest rate of 6.96%. It originated $56.8 million of mortgage and consumer loans with a weighted average rate of 8.18%. The net impact of the loan purchases and originations on the loan portfolio after taking into account total loan payments and payoffs was a $34.7 million increase in the average outstanding loan portfolio for 1996 compared to 1995. The combined weighted average interest rate for purchased and originated loans was 7.58% which lowered the yield on the existing loan portfolio during 1996. Included in the loans purchased during 1996 were $34.2 million of adjustable rate loans with a weighted average interest rate of 6.56%. Interest rates in general were lower during 1996 compared to 1995, therefore new loan originations and purchases had lower interest rates during 1996 compared to 1995, which caused the yield on interest-earning assets to decline during 1996. Interest expense for 1996 was $24.2 million, an increase of $1.6 million, or 7.3%, compared to $22.6 million for 1995. Interest expense increased $1.7 million due to a $30.8 million increase in the average outstanding interest-bearing liabilities and was partially offset by a $121,000 decrease in interest expense due to lower interest rates. During 1996 HMN had to pay higher interest rates in order to maintain its certificate accounts, therefore interest expense on certificate accounts increased despite the fact that interest rates during 1996 were generally lower than interest rates were during 1995. Average outstanding FHLB advances increased by $24.6 million during 1996 primarily due to the purchase of additional interest-earning assets and the stock repurchase program. The increased average FHLB advances caused interest expense during 1996 to increase by $1.3 million over the interest expense recognized during 1995. HMN's average net earning assets were $86.0 million at December 31, 1996, a decrease of $7.3 million, or 7.8%, compared to $93.3 million for December 31, 1995. The decrease in net interest-earning assets was primarily due to HMN's stock repurchase program. Stock repurchases temporarily reduced interest-earning assets when investments were sold to repurchase HMN's stock. Other replacement interest-earning assets were purchased later by borrowing funds from the FHLB. Net interest margin was 2.77%, 2.89% and 3.04% for the years ended December 31, 1997, 1996 and 1995, respectively. Average net earning assets were $73,701, $85,993 and $93,279 for the years ended December 31, 1997, 1996 and 1995. During 1995 HMN began purchasing its own common stock in the open market. During 1997, 1996 and 1995 it paid $6.0 million, $14.4 million and $12.5 million, respectively to purchase its own common stock in the open market. During 1996 and throughout 1997 HMN has been increasing its investment in assets which were not interest-earning assets. The income on these assets is included in non-interest income. The impact of the stock repurchase program, when coupled with purchasing investments which are not interest-earning assets, caused HMN's net interest-earning assets to decline, which in turn caused net interest margin to decline. (1) Refer to Note 2 of the Notes to Consolidated Financial Statements for more information on the MFC acquisition. 14 The following schedule presents the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities. It distinguishes between the increase related to higher outstanding balances and that due to the levels and volatility of interest rates. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in volume (i.e., changes in volume multiplied by old rate) and (ii) changes in rate (i.e., changes in rate multiplied by old volume).
Year Ended December 31, ----------------------------------------------------------------------- 1996 vs. 1997 1995 vs. 1996 ----------------------------------------------------------------------- Increase (Decrease) Increase (Decrease) Due to Due To ---------------------------------- ---------------------------------- Total Total Increase Increase (DOLLARS IN THOUSANDS) Volume(1) Rate(2) (Decrease) Volume(1) Rate(2) (Decrease) - - ----------------------------------------------------------------------------------------------------------------- Interest-earning assets: Securities available for sale: Mortgage-backed and related securities $(1,817) 46 (1,771) (323) 56 (267) Other marketable securities.......... 1,286 (12) 1,274 (403) (30) (433) Securities held to maturity: Mortgage-backed and related securities (890) 158 (732) 59 (40) 19 Other marketable securities.......... (102) 8 (94) (244) (42) (286) Loans held for sale, net............. 167 0 167 8 0 8 Loans receivable, net.................. 2,439 2 2,441 2,732 (394) 2,338 Federal Home Loan Bank stock........... 93 0 93 83 (8) 75 Other including cash equivalents....... (110) (42) (152) 107 (25) 82 ------- ----- ------- ----- ----- ------ Total interest-earning assets........ $ 1,066 160 1,226 2,019 (483) 1,536 ------- ----- ------- ----- ----- ------ ------- ----- ------- ----- ----- ------ Interest-bearing liabilities: Noninterest checking................... $ 0 0 0 0 0 0 NOW accounts........................... 28 (94) (66) 30 (18) 12 Passbooks.............................. (10) 13 3 (2) 3 1 Money market accounts.................. (26) 15 (11) (50) 3 (47) Certificates........................... 232 (52) 180 351 54 405 Federal Home Loan Bank advances........ 1,337 6 1,343 1,431 (163) 1,268 ------- ----- ------- ----- ----- ------ Total interest-bearing liabilities... $ 1,561 (112) 1,449 1,760 (121) 1,639 ------- ----- ------- ----- ----- ------ ------- ----- ------- ----- ----- ------ Net interest income..................... $15,447 15,670 ------- ------ ------- ------
(1) For purposes of this table, changes attributable to both rate and volume which cannot be segregated, have been allocated proportionately to the change due to volume and the change due to rate. - - -------------------------------------------------------------------------------- The following table sets forth the weighted average yields on HMN'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, 1997 - - --------------------------------------------------------------------------------------------------------------- Weighted average yield on: Weighted average rate on: Securities available for sale: Non-interest checking..................... 0.00% Mortgage-backed and related NOW accounts.............................. 1.50 securities....................... 6.50% Passbooks................................. 2.62 Other marketable securities......... 6.09 Money market accounts..................... 3.34 Loans held for sale.................... 7.67 Certificates.............................. 5.82 Loans receivable, net................ 7.73 Federal Home Loan Bank advances........... 5.80 Federal Home Loan Bank stock........... 7.00 Combined weighted average rate on Other interest-earning assets.......... 4.68 interest-bearing liabilities........... 5.29 Combined weighted average yield on Interest rate spread...................... 1.98% interest-earning assets............. 7.27 - - ---------------------------------------------------------------------------------------------------------------
HMN FINANCIAL, INC. 15 MANAGEMENT'S DISCUSSION AND ANALYSIS PROVISION FOR LOSSES ON LOANS The provision for losses on loans is the result of management's evaluation of the loan portfolio including its evaluation of national and regional economic indicators (including the possibility at each year end that there would be an increase in general interest rates), such as national and regional unemployment data, single family loan delinquencies as reported separately by the Federal National Mortgage Association (FNMA) and the Federal Home Loan Bank Mortgage Corporation (FHLMC), local single family construction permits and local economic growth rates and the current regulatory and general economic environment. HMN will continue to monitor and modify its allowance for losses as these conditions dictate. Although HMN maintains its allowance for losses at a level it considers adequate to provide for probable losses, there can be no assurance that such losses will not exceed the estimated amount or that additional provisions for loan losses will not be required in future periods. The provision for losses on loans for 1997 and 1996 was $300,000 for each year. The provision for losses on loans for 1995 was $300,000, a decrease of $110,000, from $410,000 for 1994. Based upon management's evaluation of the loan portfolio and its understanding of the economic conditions in the areas where it has a concentration of loans, a provision of $300,000 was deemed adequate for each of the years in the three year period ended December 31, 1997. HMN incurred $22,700 of loan charge-offs during 1997 and it also recovered $7,825 on loans previously charged-off. The loan charge-offs were not significant for 1997 and general economic conditions in the markets served by HMN did not cause management to determine that a change in the provision was required. HMN incurred $150,000 of loan charge-offs during 1996 which were primarily related to two loans which were not single-family residential loans. The charge-offs were not deemed to be indicative of a trend that would call for a higher loan loss provision. For information on the allowance for loan losses refer to Note 6 of the Notes to Consolidated Financial Statements. NON-INTEREST INCOME Non-interest income was $2.7 million for 1997, an increase of $800,000, or 41.5% compared to $1.9 million for 1996 and $998,000 for 1995. The following table presents certain components of non-interest income:
- - --------------------------------------------------------------------------------------------- Percentage Year Ended December 31, Increase (Decrease) ------------------------------------------------- (DOLLARS IN THOUSANDS) 1997 1996 1995 1997/1996 1996/1995 - - --------------------------------------------------------------------------------------------- Fees and service charges................ $ 487 359 325 35.7% 10.5% Securities gains, net................... 1,250 1,030 416 21.4 147.6 Gain on sales of loans.................. 469 39 102 1,102.6 (61.8) Other non-interest income............... 516 495 155 4.2 219.4 ------ ----- --- Total non-interest income............ $2,722 1,923 998 41.5 92.7 ------ ----- --- ------ ----- --- - - ---------------------------------------------------------------------------------------------
Fees and service charges earned for the year ended December 31, 1997 increased by $128,000 over the amount earned in 1996 due to an increase in fees earned on loan servicing activities and increased fees on deposit accounts. The $34,000 increase in fees and service charges for the year ended December 31, 1996 over the amount earned in 1995 was also related to increased fees on deposit accounts. The ability to realize gains on the sale of securities is dependent on the type of securities in the securities portfolio and upon changes in the general interest rate environment. During 1997 and 1996 economic conditions existed which allowed HMN to sell securities at a net gain of $1.25 million and $1.0 million, respectively. The proceeds from the securities sold during 1997 were invested in the loan portfolio, used to acquire MFC, invested in other assets or reinvested in securities. During 1995 economic conditions did not warrant the sale of securities to the same extent as were sold in 1996 or 1997. During 1997, HMN became more active in the mortgage banking business and recognized $469,000 profit from the sale of $46.5 million of primarily single family mortgage loans. During 1996, HMN received $1.7 million in proceeds from the sale of primarily 30 year fixed rate loans and recognized a $39,000 gain. During 1995 HMN sold $2.4 million of fixed rate 30 year loans and $1.8 million of student loans at a gain of $102,000. Periodically HMN evaluates its loan portfolio and sells loans that do not meet its long-term asset/liability goals. The net $21,000 increase in other non-interest income recognized in 1997 compared to 1996 represents fees and commissions earned on financial planning services and income earned on equity investments in limited partnerships. The $340,000 increase in other non-interest income recognized in 1996 compared to 1995 represents a $169,000 increase in commissions earned on the sale of uninsured products, a $71,000 gain on the sale of an equity interest in a data processing center, and $100,000 of other non-recurring income. 16 NON-INTEREST EXPENSE Non-interest expense for the year ended December 31, 1997 was $9.0 million, a decrease of $1.5 million, or 14.1%, from $10.5 million for the year ended in 1996 and $7.5 million for 1995. The following table presents the components of non-interest expense:
- - ------------------------------------------------------------------------------------------------- Percentage Year Ended December 31, Increase (Decrease) ----------------------------------------------------- (DOLLARS IN THOUSANDS) 1997 1996 1995 1997/1996 1996/1995 - - ------------------------------------------------------------------------------------------------- Compensation and benefits............... $5,590 4,591 4,160 21.8% 10.4% Occupancy............................... 983 826 698 19.0 18.3 Federal deposit insurance premiums...... 238 800 811 (70.3) (1.4) SAIF assessment......................... 0 2,352 0 (100.0) N/A Advertising............................. 316 308 312 2.6 (1.3) Data processing......................... 509 489 476 4.1 2.7 Provision for real estate losses........ 18 2 9 800.0 (77.8) Other................................... 1,368 1,141 1,004 19.9 13.6 ------ ------ ----- Total non-interest expense........... $9,022 10,509 7,470 (14.1) 40.7 ------ ------ ----- ------ ------ ----- - - -------------------------------------------------------------------------------------------------
The $1.5 million decrease in non-interest expense from 1996 to 1997 was due to the one time SAIF assessment of $2.35 million not repeating itself in 1997. As a result of the SAIF assessment recapitalizing the SAIF, the FDIC insurance premium expense decreased by $561,000 from 1996 to 1997. The decrease in non-interest expense was partially offset by a $999,000 increase in compensation and benefits, an increase in occupancy of $158,000 and an increase in other expense of $227,000. Compensation and benefits expense increased as a result of adding new employees in mortgage banking activities, the purchase of MFC and normal merit and salary increases to existing employees. Occupancy increased for the year ended December 31, 1997 compared to 1996 because of the purchase of MFC and depreciation resulting from continued remodeling and updating of offices for new technological advances. Non-interest expense was $10.5 million for 1996, an increase of $3.0 million, or 40.7%, from $7.5 million for 1995. The majority of the increase is the result of a $2.35 million SAIF assessment made during the third quarter of 1996. Compensation and benefit expense increased by $431,000, or 10.4%, and was the result of adding new employees, normal merit and salary increases, a full year's impact of stock awards granted under the Recognition and Retention Plan granted in June of 1995 and the increased expense of the employee stock option plan related to recognizing benefit expense based upon the fair value of the shares being awarded in the plan. Occupancy expense for 1996 increased by $128,000, or 18.3%, partly due to building improvements made during 1995 being depreciated for a full year in 1996 and partly due to HMN opening a mortgage banking office in Eden Prairie, Minnesota during the fourth quarter of 1996. Other expense increased by $137,000, or 13.6% from 1995 to 1996. The increase is the result of professional fees and other non-recurring expenses recognized during 1996. INCOME TAXES HMN recorded income tax expense of $3.3 million in 1997, compared to $2.5 million and $3.4 million for 1996 and 1995, respectively. The increase in income tax expense from 1996 to 1997 and the decrease from 1995 to 1996 is primarily the result of changes in taxable income between the years. For more information on income taxes refer to Note 12 of the Notes to Consolidated Financial Statements. FINANCIAL CONDITION LOANS RECEIVABLE, NET The table on the following page, sets forth the information on HMN'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. HMN FINANCIAL, INC. 17 MANAGEMENT'S DISCUSSION AND ANALYSIS
- - --------------------------------------------------------------------------------------------------------------------------------- December 31, ------------------------------------------------------------------------------------------------- 1997 1996 1995 1994 1993 ----------------- ----------------- ----------------- ----------------- ----------------- (DOLLARS IN THOUSANDS) Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent - - --------------------------------------------------------------------------------------------------------------------------------- REAL ESTATE LOANS: One-to-four family........ $395,668 87.58% $321,340 90.19% $292,497 90.62% $252,943 91.14% $233,009 92.18% Multi-family.............. 2,717 0.60 280 0.08 361 0.11 311 0.11 349 0.14 Commercial................ 10,572 2.34 7,918 2.22 8,744 2.71 8,316 3.00 4,559 1.80 Construction or development ............ 5,725 1.27 3,474 0.98 5,082 1.58 2,799 1.01 3,309 1.31 -------- ------ -------- ------ -------- ------ -------- ------ -------- ------ Total real estate..... 414,682 91.79 333,012 93.47 306,684 95.02 264,369 95.26 241,226 95.43 -------- ------ -------- ------ -------- ------ -------- ------ -------- ------ OTHER LOANS: Consumer Loans: Savings account......... 1,362 0.30 938 0.26 1,210 0.37 648 0.23 872 0.34 Education............... 123 0.03 467 0.13 342 0.11 2,007 0.72 1,819 0.72 Automobile.............. 2,438 0.54 566 0.16 671 0.21 520 0.19 681 0.27 Home equity line........ 19,490 4.31 11,881 3.33 3,509 1.09 0 0.00 0 0.00 Home equity............. 7,176 1.59 5,927 1.67 7,997 2.47 7,716 2.78 5,604 2.22 Home improvement........... 652 0.14 585 0.16 785 0.24 870 0.31 912 0.36 Other................... 624 0.14 568 0.16 545 0.17 502 0.19 586 0.23 -------- ------ -------- ------ -------- ------ -------- ------ -------- ------ Total consumer loans . 31,865 7.05 20,932 5.87 15,059 4.66 12,263 4.42 10,474 4.14 Commercial business loans................... 5,226 1.16 2,344 0.66 1,018 0.32 897 0.32 1,089 0.43 -------- ------ -------- ------ -------- ------ -------- ------ -------- ------ Total other loans..... 37,091 8.21 23,276 6.53 16,077 4.98 13,160 4.74 11,563 4.57 -------- ------ -------- ------ -------- ------ -------- ------ -------- ------ Total loans........... 451,773 100.00% 356,288 100.00% 322,761 100.00% 277,529 100.00% 252,789 100.00% ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ LESS: Loans in process.......... 4,562 2,814 3,531 2,327 2,333 Unamortized discounts............... 547 417 289 162 14 Net deferred loan fees............... 1,847 1,695 1,899 2,147 2,507 Allowance for losses.............. 2,748 2,340 2,191 1,893 1,489 -------- -------- -------- -------- -------- Total loans receivable, net....... $442,069 $349,022 $314,851 $271,000 $246,446 -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- - - ---------------------------------------------------------------------------------------------------------------------------------
One-to-four family real estate loans were $395.7 million at December 31, 1997, an increase of $74.4 million, or 23.1%, compared to $321.3 million at December 31, 1996. During 1997 HMN had the following one-to-four family real estate loan activity: originated $34.0 million, purchased $67.2 million, securitized $16.6 million, acquired from MFC $63.3 million, sold $9.0 million and received principal repayments of $64.5 million. One-to-four family real estate loans were $321.3 million at December 31, 1996, an increase of $28.8 million, or 9.8%, compared to $292.5 million at December 31, 1995. During 1996 HMN had the following one-to-four family real estate loan activity: originated $32.5 million, purchased $55.8 million, securitized $15.4 million, sold $2.3 million and received principal repayments of $41.8 million. One-to-four family real estate loans increased $39.6 million to $292.5 million at December 31, 1995 from $252.9 million at December 31, 1994. During 1995 HMN had the following one-to-four family real estate loan activity: originated $25.7 million, purchased $47.1 million, sold $2.4 million and received principal repayments of $30.8 million. One-to-four family real estate loans increased $19.9 million to $252.9 million at December 31, 1994 from $233 million at December 31, 1993. During 1994 HMN originated $31.9 million, purchased $17.2 million and received principal repayments of $29.2 million. Home equity line loans were $19.5 million at December 31, 1997, an increase of $7.6 million, or 64.0%, compared to $11.9 million at December 31, 1996 and $3.5 million at December 31, 1995. During the second half of 1995 the Bank introduced these revolving home equity lines of credit which loan up to 90% of the equity 18 in a home to the borrower. The interest rate has always been competitive and the customers have liked the convenient features of the program. HMN has focused its marketing efforts on its customers to promote the home equity line of credit. HMN purchases commercial business loans and commercial real estate loans primarily from third party originators in the form of participation interests. The increase in commercial real estate loans and commercial business loans in the table above is primarily due to the purchase of participation interests or loans acquired in 1997 in connection with the acquisition of MFC. ALLOWANCES FOR LOAN AND REAL ESTATE LOSSES HMN recognizes that credit losses will be experienced and that the risk of loss will vary with, among other things, the type of loans being made, the creditworthiness of the borrower over the term of the loan, general economic conditions and, in the case of a secured loan, the quality of the collateral. It is management's policy to maintain an allowance for loan losses based on, among other things, the Bank's and the industry's historical loan loss experience, evaluation of economic conditions, regular reviews of delinquencies and loan portfolio quality and evolving standards imposed by OTS examiners. HMN increases its allowance for loan losses by charging 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 that have not yet been identified but can be expected to occur. 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 the 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 $2.7 million, or 0.62%, of total loans at December 31, 1997, compared to $2.3 million, or 0.66% of total loans at December 31, 1996, and $2.2 million, or 0.68% of total loans at December 31, 1995. The following table reflects the activity in the allowance for loan losses and selected statistics:
- - --------------------------------------------------------------------------------------------------------------------------- December 31, ------------------------------------------------------- (DOLLARS IN THOUSANDS) 1997 1996 1995 1994 1993 - - --------------------------------------------------------------------------------------------------------------------------- Balance at the beginning of year.............................. $2,341 2,191 1,893 1,489 831 MFC allowance for loan losses acquired...................... 122 0 0 0 0 Provision for losses........................................ 300 300 300 410 660 Charge-offs................................................. (23) (150) (2) (6) (2) Recoveries.................................................. 8 0 0 0 0 ------ ----- ----- ----- ----- Net charge-offs........................................... (15) (150) (2) (6) (2) ------ ----- ----- ----- ----- Balance at end of year........................................ $2,748 2,341 2,191 1,893 1,489 ------ ----- ----- ----- ----- ------ ----- ----- ----- ----- Year end allowance for loan losses as a percent of year end gross loan balance................................. 0.62% 0.66% 0.68% 0.68% 0.59% Ratio of net loan charge-offs to average loans outstanding.... 0.01 0.05 0.00 0.00 0.00 Allowance for loan losses as a percentage of total assets at year end.......................................... 0.40 0.42 0.41 0.38 0.35 - - ---------------------------------------------------------------------------------------------------------------------------
The ratio of net loan charge-offs to average loans outstanding for each of the past five years has been very low due to the credit quality of the loan portfolio. The following table reflects the activity of the allowance for real estate losses:
- - --------------------------------------------------------------------------------------------------------------------------------- December 31, ------------------------------------------------------ (DOLLARS IN THOUSANDS) 1997 1996 1995 1994 1993 - - -------------------------------------------------------------------------------------------------------------------------- Balance at the beginning of year............................ $ 2 35 37 126 100 Provision for losses...................................... 18 2 9 0 45 Charge-offs............................................... (12) 0 (11) 0 (19) Recoveries................................................ 0 0 0 0 0 ------ ----- ----- ----- ----- Net charge-offs......................................... (12) 0 (11) 0 (19) ------ ----- ----- ----- ----- Other..................................................... 0 (35) 0 (89) 0 ------ ----- ----- ----- ----- Balance at the end of year.................................. $ 8 2 35 37 126 ------ ----- ----- ----- ----- ------ ----- ----- ----- ----- - - --------------------------------------------------------------------------------------------------------------------------
HMN FINANCIAL, INC. 19 MANAGEMENT'S DISCUSSION AND ANALYSIS 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. Valuations are periodically performed by management and an allowance for losses is established if the carrying value of a property exceeds its fair value less estimated selling costs. NON-PERFORMING ASSETS Non-performing assets (comprised of non-accrual loans, restructured loans, and real estate acquired through foreclosure) totaled $807,000 at December 31, 1997, an increase of $446,000 compared to $361,000 at December 31, 1996. Non-performing assets had the following activity during 1997: sales of $42,000, charge-offs of $35,000, payments of $80,000 and net transfers to non-performing assets of $603,000. Non-performing assets at December 31, 1996 were $361,000, a decrease of $489,000, compared to $850,000 at December 31, 1995. Non-performing assets had the following activity during 1996: sales of $314,000, charge-offs of $61,000, payments of $128,000, and net transfers to non-performing assets of $14,000. Non-performing assets are summarized in the following table:
- - -------------------------------------------------------------------------------------------------------------------------- December 31, ------------------------------------------------------ (DOLLARS IN THOUSANDS) 1997 1996 1995 1994 1993 - - -------------------------------------------------------------------------------------------------------------------------- Non-accrual loans......................................... $263 338 441 235 138 Accruing loans delinquent 90 days or more................. 402 0 0 0 23 Restructured loans........................................ 0 0 94 199 0 Foreclosed assets......................................... 142 23 315 64 421 --- --- --- --- --- Total non-performing assets............................. $807 361 850 498 582 --- --- --- --- --- --- --- --- --- --- Non-performing assets as a percentage of total assets....... 0.12% 0.07% 0.16% 0.10% 0.14% Total non-performing loans.................................. $665 338 535 434 161 Non-performing loans as a percentage of loans receivable, net..................................... 0.15% 0.10% 0.17% 0.16% 0.07% Allowance for loan losses to non-performing loans........... 413.17% 691.84% 409.13% 436.52% 924.84% - - --------------------------------------------------------------------------------------------------------------------------
The non-performing assets reflected above primarily consist of one-to-four family mortgage loans or consumer loans. STOCKHOLDERS' EQUITY Stockholders' equity was $84.5 million on December 31, 1997, an increase of $2.4 million, or 2.9%, from $82.1 million at December 31, 1996. During 1997 HMN purchased 298,334 shares of its own common stock for a total cost of $6.4 million. During 1995 the Board of Directors approved a management Recognition and Retention Plan (RRP) which awarded 84,486 shares of restricted HMN common stock to management and directors. The restricted stock used for the RRP was issued from treasury stock and vests over a five year period. As the RRP participants earn their awards stockholders' equity is credited and compensation is expensed. On June 29, 1994, HMN completed a public stock Offering which generated net proceeds of $59.2 million net of costs of $1.7 million. An ESOP was established which borrowed $6.1 million from HMN. The loan is treated as a reduction of stockholders' equity. For more information refer to the Consolidated Statement of Stockholders' Equity and Note 15 of the Notes to Consolidated Financial Statements. REGULATORY CAPITAL REQUIREMENTS Federal savings institutions are required to satisfy three capital requirements: (i) a requirement that "tangible capital" equal or exceed 1.5% of adjusted total assets, (ii) a requirement that "core capital" equal or exceed 3% of adjusted total assets, and (iii) a requirement that "risk-based capital" equal or exceed 8% of risk-weighted assets. With certain exceptions, all three capital standards must generally conform to and be no less stringent than, the capital standards published by the Comptroller of the Currency for national banks. 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 (core) ratio of 5% or greater, and (iv) is not subject to any order or written directive by the OTS to meet and maintain a specific capital level for any capital measure. The Bank is of the opinion that it is considered well capitalized at December 31, 1997. Refer to Note 16 of the Notes to Consolidated Financial Statements for a table which reflects the Bank's capital compared to its capital requirements. LIQUIDITY HMN 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 20 to convert assets to cash through the maturity of the asset or the sale of the asset. Liability liquidity results from the ability of the Bank to attract depositors or borrow funds from third party sources such as the FHLB. The Bank is required by regulation to maintain a monthly average minimum asset liquidity ratio of 4%. The Bank has maintained an average monthly liquidity ratio in excess of the 4% requirement and does not anticipate that it will fall below the requirement in the future. The primary investing activities are the origination or purchase of loans and the purchase of securities. Principal and interest payments on mortgages and securities are a primary source of cash for HMN. Additional cash can be obtained by selling securities from the available for sale portfolio or by selling loans. Loans could also be securitized by FNMA or FHLMC and used as collateral for additional borrowing with the FHLB. In December of 1997 HMN, through its wholly owned subsidiary, acquired Marshalltown Financial Corporation (MFC) by purchasing MFC's outstanding stock with cash. Refer to Note 2 of the Notes to Financial Statements for more details related to the acquisition. The primary financing activity is the attraction of retail deposits. The Bank has the ability to borrow additional funds from the FHLB by pledging additional securities or loans. Refer to Note 11 of the Notes to Consolidated Financial Statements for more information on undrawn open lines of credit and additional advances that could be drawn upon based upon existing collateral levels with the FHLB. Information on outstanding advance maturities is also included in Note 11. *HMN anticipates that its liquidity requirements for 1998 will be similar to the cash flows it experienced in 1997 with the exception of the MFC acquisition and construction disbursements for completion of the Spring Valley retail banking facility and a new retail banking facility in Winona. Construction disbursements are estimated to total $2.2 million on a combined basis for Spring Valley and Winona and additional other expenditures of $1.0 million for premises and equipment. HMN has agreed to loan $1.5 million to the HMN Employee Stock Ownership Plan to allow it to purchase additional shares of HMN common stock. The Bank will need $3.6 million to purchase the outstanding MFC common stock and options not tendered to the settlement agent at December 31, 1997. The cash needed to fund the mortgage banking activities of HMN Mortgage Services, Inc. will range from $5.0 million to $15.0 million during 1998. HMN'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, 1997 were $9.4 million, a decrease of $1.2 million compared to $10.6 million at December 31, 1996. Net cash provided from operating activities during 1997 was $6.6 million. HMN conducted the following major investing activities during 1997: proceeds from the sale of securities available for sale were $94.5 million, principal received on payments and maturities of securities available for sale was $49.1 million, purchases were $103.1 million of securities available for sale, principal received on payments and maturities of securities held to maturity were $1.2 million, purchases of interests in limited partnerships were $2.4 million, proceeds from sale of loans were $24.8 million, purchases of mortgage servicing rights were $845,000, purchase of FHLB stock was $803,000 and net increase in loans receivable was due primarily to loan originations and loan purchases of $68.6 million. HMN spent $1.9 million for the purchase of premises and equipment and it expended net cash for the acquisition of MFC of $16.8 million. Net cash used by investing activities during 1997 was $24.4 million. HMN conducted the following major financing activities during 1997: increase in deposits of $1.3 million, purchase of treasury stock $6.4 million, proceeds from FHLB advances $151.8 million and repayments of FHLB advances totaled $130.2 million. Net cash provided from financing activities was $16.6 million. *HMN has certificates of deposit with outstanding balances of $258.6 million that come due during 1998. Based upon past experience management anticipates that the majority of the deposits will renew for another term. HMN believes that deposits which do not renew will be replaced with deposits from other customers, or funded with advances from the FHLB, or will be funded through the sale of securities. Management does not anticipate that it will have a liquidity problem due to maturing deposits. MARKET RISK Market risk is the risk of loss from adverse changes in market prices and rates. HMN's market risk arises primarily from interest rate risk inherent in its investing, lending and deposit taking activities. Management actively monitors and manages its interest rate risk exposure. HMN's profitability is affected by fluctuations in interest rates. A sudden and substantial increase in interest rates may adversely impact HMN's earnings to the extent that the interest rates borne by assets and liabilities do not change at the same speed, to the same extent, or on the same basis. HMN monitors how its assets will mature or reprice in comparison to how its liabilities will mature or reprice. The MATURITY OR REPRICING TABLE located below in the Asset/ Liability Management section of this report is used as part of the monitoring process. HMN also monitors the projected changes in net interest income that occur if interest rates were to suddenly change up or down. The RATE SHOCK TABLE located below in the Asset/Liability Management section of this report discloses HMN's projected changes in net interest income based upon immediate interest rate changes called rate shocks. *This paragraph contains a forward-looking statement(s). Refer to information regarding Forward-looking Information on page 25 of this discussion. HMN FINANCIAL, INC. 21 MANAGEMENT'S DISCUSSION AND ANALYSIS *HMN utilizes a model which uses the discounted cash flows from its interest-earning assets and its interest-bearing liabilities to calculate the current market value of those assets and liabilities. The model also calculates the changes in market value of the interest-earning assets and interest-bearing liabilities due to different interest rate changes. HMN believes that over the next twelve months interest rates could conceivably fluctuate in a range of 200 basis points up or down from where the rates were at December 31, 1997. HMN does not have a trading portfolio. The following table discloses the projected changes in market value to HMN's interest-earning assets and interest-bearing liabilities based upon incremental 100 basis point changes in interest rates from interest rates in effect on December 31, 1997.
Other than trading portfolio Market Value (DOLLARS IN THOUSANDS) -------------------------------------------------------- Basis point change in interest rates -200 -100 0 +100 +200 - - -------------------------------------------------------------------------------------------------------------------------- Cash equivalents............................................ $ 8,371 8,364 8,357 8,350 8,344 Fixed-rate CMOs............................................. 62,590 62,313 61,989 60,415 58,215 Variable-rate CMOs.......................................... 22,821 23,022 22,922 22,259 21,413 Fixed-rate available for sale mortgage-backed and related securities.................................... 31,450 31,188 30,844 30,458 29,995 Variable-rate available for sale mortgage-backed and related securities.................... 20,316 19,973 19,728 19,505 19,231 Fixed-rate available for sale other marketable securities..................................... 72,987 71,229 69,433 67,717 66,081 Variable-rate available for sale other marketable securities..................................... 6,963 6,949 6,935 6,920 6,906 Fixed-rate loans held for sale.............................. 2,291 2,289 2,287 2,285 2,283 Fixed-rate real estate loans................................ 327,871 325,548 317,189 306,082 294,462 Variable-rate real estate loans............................. 89,328 88,745 87,874 86,869 85,507 Fixed-rate other loans...................................... 18,227 18,065 17,916 17,666 17,427 Variable-rate other loans................................... 30,891 30,811 30,746 30,687 30,626 ------- ------- ------- ------- ------- Total market risk sensitive assets.......................... 694,106 688,496 676,220 659,213 640,490 ------- ------- ------- ------- ------- NOW deposits................................................ 26,957 26,935 26,912 26,890 26,868 Passbook deposits........................................... 36,121 34,472 32,969 31,596 30,336 Money market deposits....................................... 25,466 24,264 23,173 22,178 21,269 Certificate deposits........................................ 388,929 385,056 381,261 377,539 373,887 Fixed-rate Federal Home Loan Bank advances.................. 82,581 80,329 78,176 76,116 74,144 Variable-rate Federal Home Loan Bank advances............... 49,052 49,011 48,971 48,931 48,890 ------- ------- ------- ------- ------- Total market risk sensitive liabilities..................... 609,106 600,067 591,462 583,250 575,394 ------- ------- ------- ------- ------- Off-balance sheet financial instruments: Commitments to extend credit................................ 52 51 50 48 46 Net market risk............................................. $ 85,052 88,480 84,808 76,011 65,142 ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- Percentage change from current market value................. 0.29% 4.33% 0.00% (10.37)% (23.19)% ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- - - --------------------------------------------------------------------------------------------------------------------------
The preceding table was prepared utilizing the following assumptions (the "Model Assumptions") regarding prepayment and decay ratios which were determined by management based upon their review of historical prepayment speeds and future prepayment projections. Fixed rate loans were assumed to prepay at annual rates of between 6% to 31%, depending on the coupon and period to maturity. ARMs were assumed to prepay at annual rates of between 12% and 22%, depending on coupon and the period to maturity. Growing Equity Mortgage (GEM) loans were assumed to prepay at annual rates of between 16% and 38% depending on the coupon 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. Certificate accounts were assumed not to be withdrawn until maturity. Passbook and money market accounts were assumed to decay at an annual rate of 20%. *This paragraph contains a forward-looking statement(s). Refer to information regarding Forward-looking Information on page 25 of this discussion. 22 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 which restrict changes in interest rates on a short- term basis and over the life of the assets. The market value of the interest- bearing assets which are approaching their lifetime interest rate caps could be different from the values disclosed in the table. In the event of a change in interest rates, prepayment and early withdrawal levels may deviate significantly from those assumed in calculating the foregoing table. The ability of many borrowers to service their debt may decrease in the event of an interest rate increase. ASSET/LIABILITY MANAGEMENT *HMN's management reviews the impact that changing interest rates will have on its net interest income projected for the twelve months following December 31, 1997 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 Income Change - - ----------------------------------------------------------------------- +200 $17,758,000 (3.20)% +100 18,182,000 (0.89)% 0 18,345,000 0.00% -100 18,544,000 1.08% -200 18,370,000 0.14% - - -----------------------------------------------------------------------
The preceding table was prepared utilizing the Model Assumptions regarding prepayment and decay ratios which were determined by management based upon their review of historical prepayment speeds and future prepayment projections. Certain shortcomings are inherent in the method of analysis presented in the foregoing table. In the event of a change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed in calculating the foregoing table. The ability of many borrowers to service their debt may decrease in the event of a substantial increase in interest rates and could impact net interest income. In an attempt to manage its exposure to changes in interest rates, management closely monitors interest rate risk. The Bank has an Asset/Liability Committee consisting of executive officers which meets at least quarterly to review the interest rate risk position and projected profitability. The committee makes recommendations for adjustments to the asset liability position of the Bank to the Board of Directors of the Bank. This committee also reviews the Bank's portfolio, formulates investment strategies and oversees the timing and implementation of transactions to assure attainment of the Board's objectives in the most effective manner. In addition, the Board reviews on a quarterly basis the Bank's asset/liability position, including simulations of the effect on the Bank's capital of various interest rate scenarios. In managing its asset/liability mix, the Bank, at times, depending on the relationship between long- and short-term interest rates, market conditions and consumer preference, may place more emphasis on managing net interest margin than on better matching the interest rate sensitivity of its assets and liabilities in an effort to enhance net interest income. Management believes that the increased net interest income resulting from a mismatch in the maturity of its asset and liability portfolios can, during periods of declining or stable interest rates, provide high enough returns to justify the increased exposure to sudden and unexpected increases in interest rates. To the extent consistent with its interest rate spread objectives, the Bank attempts to reduce its interest rate risk and has taken a number of steps to restructure its assets and liabilities. The Bank has primarily focused its fixed rate one-to-four family residential lending program on loans with contractual terms of 20 years or less. The Bank generally follows the practice of selling all of its fixed rate single family loans with contractual maturities of thirty years. At times, depending on its interest rate sensitivity, the Bank may sell fixed rate single family loans with shorter contractual maturities than thirty years in order to reduce interest rate risk and record a gain on the sale of loans. *This paragraph contains a forward-looking statement(s). Refer to information regarding Forward-looking Information on page 26 of this discussion. HMN FINANCIAL, INC. 23 MANAGEMENT'S DISCUSSION AND ANALYSIS The following gap table sets forth the interest rate sensitivity of HMN's assets and liabilities at December 31, 1997, using certain assumptions that are described in more detail below:
- - ---------------------------------------------------------------------------------------------------------------------------------- Maturing or Repricing --------------------------------------------------------------------- Over 6 6 Months Months to Over 1-3 Over 3-5 Over 5 No Stated (DOLLARS IN THOUSANDS) or Less One Year Years Years Years Maturity Total - - ---------------------------------------------------------------------------------------------------------------------------------- Cash equivalents............................................ $ 8,365 0 0 0 0 0 8,365 Securities available for sale: Mortgage-backed and related securities(1)..................................... 48,009 17,552 40,545 20,162 9,330 0 135,598 Other marketable securities............................... 24,723 11,555 8,392 10,670 0 13,017 68,357 Loans held for sale......................................... 2,287 0 0 0 0 0 2,287 Loans receivable, net:(1)(2) Fixed rate one-to-four family(3).......................... 26,548 24,107 79,925 55,659 119,091 0 305,330 Adjustable rate one-to-four family(3)..................... 25,158 34,420 15,792 14,355 1,528 0 91,253 Multi family.............................................. 386 291 991 429 600 0 2,697 Fixed rate commercial real estate....................... 824 370 1,020 244 76 0 2,534 Adjustable rate commercial real estate.................... 7,118 366 727 0 0 0 8,211 Commercial business....................................... 2,059 642 1,717 767 42 0 5,227 Consumer loans.......................................... 22,325 1,660 3,457 1,643 480 0 29,565 Federal Home Loan Bank stock................................ 0 0 0 0 0 7,432 7,432 ------- ------- -------- ------- ------- ------- ------- Total interest-earning assets........................... 167,802 90,963 152,566 103,929 131,147 20,449 666,856 ------- ------- -------- ------- ------- ------- ------- Non-interest checking....................................... 3,833 0 0 0 0 0 3,833 NOW accounts................................................ 23,143 0 0 0 0 0 23,143 Passbooks................................................... 3,822 3,418 10,426 6,672 11,861 0 36,199 Money market accounts....................................... 2,622 2,342 7,145 4,572 8,127 0 24,808 Certificates................................................ 119,627 139,004 99,852 18,342 2,540 0 379,365 Federal Home Loan Bank advances............................. 58,714 8,536 29,000 21,000 10,400 0 127,650 ------- ------- -------- ------- ------- ------- ------- Total interest-bearing liabilities...................... 211,761 153,300 146,423 50,586 32,928 0 594,998 ------- ------- -------- ------- ------- ------- ------- Interest-earning assets less interest-bearing liabilities.............................. $ (43,959) (62,337) 6,143 53,343 98,219 20,449 71,858 ------- ------- -------- ------- ------- ------- ------- ------- ------- -------- ------- ------- ------- ------- Cumulative interest-rate sensitivity gap........................................... $ (43,959) (106,296) (100,153) (46,810) 51,409 71,858 71,858 ------- ------- -------- ------- ------- ------- ------- ------- ------- -------- ------- ------- ------- ------- Cumulative interest-rate gap as a percentage of total assets at December 31, 1997......................................... (6.36)% (15.38)% (14.49)% (6.77)% 7.44% 10.40% 10.40% ------- ------- -------- ------- ------- ------- ------- ------- ------- -------- ------- ------- ------- ------- Cumulative interest-rate gap as a percentage of total assets at December 31, 1996......................................... (4.61) (10.66) ------- ------- ------- ------- - - ----------------------------------------------------------------------------------------------------------------------------------
(1) Schedule prepared based upon the earlier of contractual maturity or repricing date, if applicable, adjusted for scheduled repayments of principal and projected prepayments of principal based upon experience. (2) Loans receivable are presented net of loans in process and deferred loan fees. (3) Construction and development loans are all one-to-four family loans and therefore have been included in the fixed rate one-to-four family and adjustable rate one-to-four family lines. 24 The preceding table was prepared utilizing the Model Assumptions regarding prepayment and decay ratios which were determined by management based upon their review of historical prepayment speeds and future prepayment projections. Fixed rate loans were assumed to prepay at annual rates of between 6% to 31%, depending on the coupon and period to maturity. ARMs were assumed to prepay at annual rates of between 12% and 22%, depending on coupon and the period to maturity. GEM loans were assumed to prepay at annual rates of between 16% and 38% depending on the coupon and the period to maturity. Mortgage-backed securities and CMOs were projected to have prepayments based upon the underlying collateral securing the instrument. Certificate accounts were assumed not to be withdrawn until maturity. Passbook and money market accounts were assumed to decay at an annual rate of 20%. Certain shortcomings are inherent in the method of analysis presented in the foregoing table. Although certain assets and liabilities may have similar maturities and periods of repricing, they may react in different degrees to changes in market interest rates. 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. Certain assets, such as adjustable-rate mortgages, have features which restrict changes in interest rates on a short-term basis and over the life of the asset. 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 an interest rate increase. Refer to Regulatory Capital Requirements above for a discussion of the Bank's interest rate risk component. YEAR 2000 *The Bank has formed a committee which has analyzed its exposure to year 2000 computer hardware and software issues. A major portion of the Bank's data processing is provided by a third party vender which is committed to being year 2000 compliant by early 1999. The committee is monitoring the data processing vender's progress on year 2000 issues. The committee reviewed all hardware and software used internally by HMN or any of its subsidiaries and determined which hardware and/or software would need to be replaced by the year 2000. The cost of becoming year 2000 compliant is not deemed to be material. FORWARD-LOOKING INFORMATION The following statements within Management's Discussion and Analysis of Financial Condition and Results of Operations contain forward-looking statements and actual results may differ materially from the expectations disclosed within this Discussion and Analysis. These forward-looking statements are subject to risks and uncertainties, including those discussed below. HMN assumes no obligations to publicly release results of any revision or updates to these forward-looking statements to reflect future events or unanticipated occurrences. LIQUIDITY HMN anticipates that its liquidity requirements for 1998 will be similar to the cash flows it experienced in 1997 with the exception of the MFC acquisition and construction disbursements for completion of the Spring Valley retail banking facility and a new retail banking facility in Winona. Construction disbursements are estimated to total $2.2 million on a combined basis for Spring Valley and Winona and additional other expenditures of $1.0 million for premises and equipment. The cash needed to fund the mortgage banking activities of HMN Mortgage Services, Inc. will range from $5.0 million to $15.0 million during 1998. Construction costs could increase due to unknown construction supply issues or unforeseen labor issues. The mortgage banking activities of MSI may exceed the estimated range of $5 million to $15 million due to additional loan originations generated in its market area. In either situation mentioned above additional cash would be generated from the sale of securities or the advances from the FHLB. HMN has certificates of deposit with outstanding balances of $258.6 million that come due during 1998. Based upon past experience management anticipates that the majority of the deposits will renew for another term. Any deposits which do not renew will be replaced with deposits from other customers, or funded with advances from the FHLB, or will be funded through the sale of securities. Management does not anticipate that it will have a liquidity problem due to maturing deposits. Competitive pricing by other institutions, the desire of a competitor to pay interest rates on deposits that are above the current rates paid by HMN, or desire by customers to put more of their funds into nontraditional bank products such as stocks and bonds could be circumstances that would cause the maturing certificates to become a liquidity problem. MARKET RISK HMN believes that over the next twelve months interest rates could conceivably fluctuate in a range of 200 basis points up or down from where the rates were at December 31, 1997. Actual interest rates could fluctuate by more than 200 basis points up or down from rates in effect on December 31, 1997 due to unanticipated occurrences such as the start of another war in the gulf. Many Asian countries are experiencing economic difficulties which may have a larger impact on the economy of the United States than is currently anticipated and thereby cause general interest rates to fluctuate by more than 200 basis points. *This paragraph contains a forward-looking statement(s). Refer to information regarding Forward-looking Information on page 26 of this discussion. HMN FINANCIAL, INC. 25 HMN's actual market value changes for interest earning assets and interest bearing liabilities may differ from the projected market values disclosed in the table in the Market Risk section. Certain shortcomings are inherent in the method of analysis in the table presented in the Market Risk section above. 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 rate 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 which restrict changes in interest rates on a short-term basis and over the life of the assets. The market value of the interest-bearing assets which are approaching their life time interest rate caps could be different from the values disclosed in the table. In the event of a change in interest rates, prepayment and early withdrawal levels may deviate significantly from those assumed in calculating the foregoing table. The ability of many borrowers to service their debt may decrease in the event of an interest rate increase. ASSET/LIABILITY MANAGEMENT HMN's management reviews the impact that changing interest rates will have on its net interest income projected for the twelve months following December 31, 1997 to determine if its current level of interest rate risk is acceptable. HMN's actual net interest income caused by interest rate changes may differ from the amounts reflected in the table which projects the estimated impact on net interest income of immediate interest rate changes called rate shocks. HMN's actual maturing and repricing results of its interest-earning assets and interest-bearing liabilities may differ from the amounts reflected in the gap table. Certain shortcomings are inherent in the method of analysis presented in each of the tables. 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 tables. 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. YEAR 2000 The cost of becoming year 2000 compliant is not deemed to be material. The estimated costs are dependent upon HMN's third party data processing center successfully converting its hardware and software to be year 2000 compliant. The data processing center may not successfully complete their conversion which may cause HMN's cost to substantially increase. DIVIDENDS HMN has not paid any dividends since its incorporation in March 1994. However, the Board of Directors may consider a policy of paying cash dividends in the future. The declaration of dividends are subject to, among other things, HMN's financial condition and results of operations, the Bank's compliance with its regulatory capital requirements, including the fully phased-in capital requirements, tax considerations, industry standards, economic conditions, regulatory restrictions, general business practices and other factors. Refer to Note 15 of the Notes to Consolidated Financial Statements for information on regulatory limitations on dividends from the Bank to HMN. In February of 1998, the Board of Directors of HMN authorized a stock split in the form of a 50% stock dividend subject to HMN stockholder approval of an increase in the number of authorized shares of common stock from 7.0 million to 11.0 million at the annual meeting of stockholders on April 28, 1998. IMPACT OF INFLATION AND CHANGING PRICES The Consolidated Financial Statements and Notes presented herein have been prepared in accordance with generally accepted accounting principles, which require the measurement of financial position and operation results that are primarily in terms of historical dollars without considering the changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of operations. Unlike most industrial companies, nearly all of the assets and liabilities of HMN are monetary in nature. As a result, interest rates have a greater impact on HMN'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. MERGER AND ACQUISITIONS From time to time HMN reviews the possibility of acquiring or merging with different companies which would complement the business conducted by HMN. HMN's Board of Directors has adopted the policy of not disclosing to the public its intent to acquire or merge until a formal definitive agreement has been signed by all parties involved with the transaction except as otherwise required by law. On December 5, 1997 HMN, through its wholly owned subsidiary, Home Federal Savings Bank, completed its merger with Marshalltown Financial Corporation pursuant to a merger agreement dated July 1, 1997. Refer to Note 2 of the Notes to Consolidated Financial Statements for more information on the merger. 26 CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1997 AND 1996 1997 1996 - - -------------------------------------------------------------------------------------------------------------- ASSETS Cash and cash equivalents....................................................... $ 9,364,635 10,583,717 Securities available for sale: Mortgage-backed and related securities (amortized cost $135,598,404 and $134,474,167)........................... 135,935,482 133,355,278 Other marketable securities (amortized cost $68,356,926 and $42,360,499)............................. 69,923,477 42,474,810 ------------ ----------- 205,858,959 175,830,088 ------------ ----------- Securities held to maturity: Mortgage-backed and related securities (fair value $0 and $1,904,993)........................................... 0 1,805,744 Other marketable securities (fair value $0 and $1,000,550)........................................... 0 999,812 ------------ ----------- 0 2,805,556 ------------ ----------- Loans held for sale............................................................. 2,287,265 739,316 Loans receivable, net........................................................... 442,068,600 349,022,236 Federal Home Loan Bank stock, at cost........................................... 7,432,200 5,434,000 Real estate, net................................................................ 133,939 20,610 Premises and equipment, net..................................................... 5,880,710 3,581,497 Accrued interest receivable..................................................... 4,038,131 3,415,152 Investment in limited partnerships.............................................. 5,989,399 2,887,525 Goodwill...................................................................... 4,500,873 0 Core deposit intangible......................................................... 1,546,273 0 Investment in mortgage servicing rights......................................... 781,005 4,681 Prepaid expenses and other assets............................................... 1,349,521 407,221 ------------ ----------- Total assets .............................................................. $691,231,510 554,731,599 ------------ ----------- ------------ ----------- LIABILITIES AND STOCKHOLDERS' EQUITY Deposits........................................................................ $467,347,688 362,476,944 Federal Home Loan Bank advances................................................. 127,650,021 106,078,589 Accrued interest payable........................................................ 1,365,064 1,542,773 Advance payments by borrowers for taxes and insurance........................... 786,619 518,911 Accrued expenses and other liabilities.......................................... 6,056,356 2,014,938 Due to stockholders of Marshalltown Financial Corporation....................... 3,555,352 0 ------------ ----------- Total liabilities.......................................................... 606,761,100 472,632,155 ------------ ----------- Commitments and contingencies Stockholders' equity: Serial preferred stock ($.01 par value): authorized 500,000 shares; issued and outstanding none.............................................. 0 0 Common stock ($.01 par value): authorized shares 7,000,000; issued shares 6,085,775.................................................. 60,858 60,858 Additional paid-in capital................................................. 59,729,090 59,428,768 Retained earnings, subject to certain restrictions......................... 60,224,253 54,645,387 Net unrealized gain (loss) on securities available for sale................ 1,129,818 (598,045) Unearned employee stock ownership plan shares.............................. (4,554,280) (4,938,520) Unearned compensation restricted stock awards.............................. (600,668) (793,289) Treasury stock, at cost 1,941,407 and 1,651,615............................ (31,518,661) (25,705,715) ------------ ----------- Total stockholders' equity............................................... 84,470,410 82,099,444 ------------ ----------- Total liabilities and stockholders' equity................................. $691,231,510 554,731,599 ------------ ----------- ------------ -----------
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. HMN FINANCIAL, INC. 27 CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 1997 1996 1995 - - ----------------------------------------------------------------------------------------------------------------------------- Interest income: Loans receivable........................................................... $28,328,864 25,721,042 23,375,334 Securities available for sale: Mortgage-backed and related.............................................. 8,255,402 10,027,438 10,294,056 Other marketable......................................................... 3,699,378 2,424,628 2,857,884 Securities held to maturity: Mortgage-backed and related.............................................. 33,400 765,120 746,100 Other marketable......................................................... 10,032 104,448 389,381 Cash equivalents........................................................... 342,433 494,129 412,259 Other...................................................................... 420,722 327,520 253,170 ----------- ---------- ---------- Total interest income.................................................... 41,090,231 39,864,325 38,328,184 ----------- ---------- ---------- Interest expense: Deposits................................................................... 19,056,164 18,949,937 18,578,744 Federal Home Loan Bank advances............................................ 6,586,855 5,243,853 3,976,353 ----------- ---------- ---------- Total interest expense................................................... 25,643,019 24,193,790 22,555,097 ----------- ---------- ---------- Net interest income...................................................... 15,447,212 15,670,535 15,773,087 Provision for loan losses....................................................... 300,000 300,000 300,000 ----------- ---------- ---------- Net interest income after provision for loan losses........................ 15,147,212 15,370,535 15,473,087 ----------- ---------- ---------- Noninterest income: Fees and service charges................................................... 487,085 359,249 324,492 Securities gains, net...................................................... 1,249,569 1,029,638 415,955 Gain on sales of loans..................................................... 469,461 39,306 102,368 Other...................................................................... 516,244 494,507 155,434 ----------- ---------- ---------- Total noninterest income................................................. 2,722,359 1,922,700 998,249 ----------- ---------- ---------- Noninterest expense: Compensation and benefits.................................................. 5,590,297 4,591,367 4,160,248 Occupancy.................................................................. 983,238 825,609 697,602 Federal deposit insurance premiums......................................... 238,654 799,890 810,432 SAIF assessment............................................................ 0 2,351,563 0 Advertising................................................................ 315,771 308,464 312,366 Data processing............................................................ 508,930 489,045 476,402 Provision for real estate losses........................................... 18,000 2,000 9,327 Other...................................................................... 1,367,815 1,140,948 1,003,682 ----------- ---------- ---------- Total noninterest expense................................................ 9,022,705 10,508,886 7,470,059 ----------- ---------- ---------- Income before income tax expense......................................... 8,846,866 6,784,349 9,001,277 Income tax expense.............................................................. 3,268,000 2,510,000 3,380,900 ----------- ---------- ---------- Net income............................................................... $5,578,866 4,274,349 5,620,377 ----------- ---------- ---------- ----------- ---------- ---------- Basic earnings per share........................................................ $ 1.51 0.99 1.10 ----------- ---------- ---------- ----------- ---------- ---------- Diluted earnings per share...................................................... $ 1.41 0.96 1.09 ----------- ---------- ---------- ----------- ---------- ----------
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 28 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Net Unearned Unrealized Employee Gain (Loss) Stock Additional on Securities Ownership YEARS ENDED DECEMBER 31, Common Paid-In Retained Available for Plan 1997, 1996 AND 1995 Stock Capital earnings Sale Shares - - --------------------------------------------------------------------------------------------------------------------- Balance, December 31, 1994....................... $60,858 59,155,995 44,750,661 (9,174,623) (5,745,880) Net income............................. 5,620,377 Change in unrealized loss on securities available for sale.................... 8,909,265 Treasury stock purchases............................. Unearned compensation restricted stock awards............... 36,319 Amortization of restricted stock awards............... Earned employee stock ownership plan shares................. 93,267 409,730 --------- ---------- ---------- ---------- ----------- Balance, December 31, 1995....................... $60,858 59,285,581 50,371,038 (265,358) (5,336,150) Net income............................. 4,274,349 Change in unrealized loss on securities available for sale.................... (332,687) Treasury stock purchases............................. Stock options exercised................ (10,817) Restricted stock awards cancelled............................. (808) Amortization of restricted stock awards............... Restricted stock awards tax benefit.................... 13,677 Earned employee stock ownership plan shares................. 141,135 397,630 --------- ---------- ---------- ---------- ----------- Balance, December 31, 1996....................... 60,858 59,428,768 54,645,387 (598,045) (4,938,520) Net income............................. 5,578,866 Change in unrealized loss on securities available for sale.................... 1,727,863 Treasury stock purchases............................. Amoritization of restricted stock awards............... Recognition and retention.............. awards granted........................ 2,250 Stock options exercised................ (82,009) Restricted stock awards tax benefit........................... 61,092 Stock option tax benefit .............. 20,751 Earned employee stock ownership plan shares................. 298,238 384,240 --------- ---------- ---------- ---------- ----------- Balance, December 31, 1997....................... $60,858 59,729,090 60,224,253 1,129,818 (4,554,280) --------- ---------- ---------- ---------- ----------- --------- ---------- ---------- ---------- ----------- Unearned Compensation Total Stock- YEARS ENDED DECEMBER 31, Restricted Treasury holders' 1997, 1996 AND 1995 Stock Awards Stock Equity - - ------------------------------------------------------------------------------------------- Balance, December 31, 1994....................... 89,047,011 Net income............................. 5,620,377 Change in unrealized loss on securities available for sale.................... 8,909,265 Treasury stock purchases............................. (12,509,667) (12,509,667) Unearned compensation restricted stock awards............... (1,167,005) 1,130,686 0 Amortization of restricted stock awards............... 116,700 116,700 Earned employee stock ownership plan shares................. 502,997 ----------- ------------- ------------ Balance, December 31, 1995....................... (1,050,305) (11,378,981) 91,686,683 Net income............................. 4,274,349 Change in unrealized loss on securities available for sale.................... (332,687) Treasury stock purchases............................. (14,364,754) (14,364,754) Stock options exercised................ 63,180 52,363 Restricted stock awards cancelled............................. 25,968 (25,160) 0 Amortization of restricted stock awards............... 231,048 231,048 Restricted stock awards tax benefit.................... 13,677 Earned employee stock ownership plan shares................. 538,765 ----------- ------------- ------------ Balance, December 31, 1996....................... (793,289) (25,705,715) 82,099,444 Net income............................. 5,578,866 Change in unrealized loss on securities available for sale.................... 1,727,863 Treasury stock purchases............................. (5,988,450) (5,988,450) Amoritization of restricted stock awards............... 231,621 231,621 Recognition and retention.............. awards granted........................ (39,000) 36,750 0 Stock options exercised................ 138,754 56,745 Restricted stock awards tax benefit........................... 61,092 Stock option tax benefit .............. 20,751 Earned employee stock ownership plan shares................. 682,478 ----------- ------------- ------------ Balance, December 31, 1997....................... (600,668) (31,518,661) 84,470,410 ----------- ------------- ------------ ----------- ------------- ------------
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. HMN FINANCIAL, INC. 29 CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 1997 1996 1995 - - ----------------------------------------------------------------------------------------------------------------------------- Cash flows from operating activities: Net income................................................................. $ 5,578,866 4,274,349 5,620,377 Adjustments to reconcile net income to cash provided by operating activities: Provision for loan losses................................................ 300,000 300,000 300,000 Provision for real estate losses......................................... 18,000 2,000 9,327 Depreciation............................................................. 434,493 378,753 352,580 Amortization of (discounts) premiums, net................................ (216,978) (129,636) (272,862) Amortization of deferred loan fees....................................... (410,111) (440,580) (613,037) Amortization of goodwill................................................. 13,858 0 0 Amortization of core deposit intangible.................................. 20,727 0 0 Amortization of loans and deposits mark, net............................. 38,379 0 0 Amortization of mortgage servicing rights................................ 39,514 0 0 Provision for deferred income taxes...................................... 83,895 110,400 568,050 Federal Home Loan Bank stock dividend.................................... 0 0 (75,100) Securities gains, net.................................................... (1,249,569) (1,029,638) (415,955) Gain on sales of real estate............................................. (3,743) (46,625) (14,241) Gain on sales of loans................................................... (469,461) (39,306) (102,368) Proceeds from sales of loans held for sale............................... 21,626,615 1,779,361 260,848 Disbursements on loans held for sale..................................... (18,753,844) 0 0 Principal collected on loans held for sale............................... (1,946) 0 0 Amortization of restricted stock awards.................................. 231,621 231,048 116,700 Amortization of unearned ESOP shares..................................... 384,240 397,630 409,730 Earned employee stock ownership shares priced above original cost........ 298,238 141,135 93,267 Decrease (increase) in accrued interest receivable....................... 190,834 (33,645) (100,280) Increase (decrease) in accrued interest payable.......................... (1,720,271) (19,574) 561,969 Equity earnings of limited partnerships.................................. (220,278) (7,400) 0 Increase in other assets................................................. (745,309) (48,974) (173,133) Increase (decrease) in other liabilities................................. 1,218,475 35,995 (540,164) Other, net............................................................... (99,980) (56,470) (35,803) ------------ ------------ ----------- Net cash provided by operating activities.............................. 6,586,265 5,798,823 5,949,905 ------------ ------------ ----------- Cash flows from investing activities: Proceeds from sales of securities available for sale....................... 94,462,303 101,157,643 85,454,779 Principal collected on securities available for sale....................... 15,028,627 16,530,585 15,427,074 Proceeds collected on maturity of securities available for sale............ 34,118,412 20,500,000 18,815,000 Purchases of securities available for sale................................. (103,102,213) (107,860,451) (110,993,058) Proceeds from sales of securities held to maturity......................... 348,871 0 0 Principal collected on securities held to maturity......................... 240,441 2,276,661 1,076,805 Proceeds collected on maturity of securities held to maturity.............. 1,000,000 12,652,343 5,000,000 Purchases of securities held to maturity................................... 0 (709,765) (10,993,313) Proceeds from sales of loans receivable.................................... 24,806,862 1,408,015 3,996,710 Purchases of mortgage servicing rights..................................... (844,601) 0 0 Purchase interest in limited partnerships.................................. (2,438,750) (2,880,125) 0 Purchase of Federal Home Loan Bank stock................................... (802,700) (1,632,100) (688,100) Net increase in loans receivable........................................... (68,579,885) (53,214,798) (47,904,546) Proceeds from sale of real estate.......................................... 35,627 379,789 199,020 Purchases of premises and equipment........................................ (1,856,365) (314,714) (458,666) Acquisition of Marshalltown Financial Corporation, net of cash acquired.... (16,822,639) 0 0 ------------ ------------ ----------- Net cash used by investing activities.................................... (24,406,010) (11,706,917) (41,068,295) ------------ ------------ ----------- Cash flows from financing activities: Increase (decrease) in deposits............................................ 1,258,293 (11,062,524) 22,964,821 Purchase of treasury stock................................................. (6,350,950) (14,002,254) (12,509,667) Stock options exercised.................................................... 56,745 52,363 0 Proceeds from Federal Home Loan Bank advances.............................. 151,800,000 130,000,000 82,150,000 Repayment of Federal Home Loan Bank advances............................... (130,228,568) (92,798,389) (65,258,747) Increase (decrease) in advance payments by borrowers for taxes and insurance 65,143 (32,079) 9,521 ------------ ------------ ----------- Net cash provided by financing activities................................ 16,600,663 12,157,117 27,355,928 ------------ ------------ ----------- Increase (decrease) in cash and cash equivalents......................... (1,219,082) 6,249,023 (7,762,462) Cash and cash equivalents, beginning of year.................................... 10,583,717 4,334,694 12,097,156 ------------ ------------ ----------- Cash and cash equivalents, end of year.......................................... $ 9,364,635 10,583,717 4,334,694 ------------ ------------ ----------- ------------ ------------ ----------- Supplemental cash flow disclosures: Cash paid for interest..................................................... $ 27,363,290 24,213,364 21,993,128 Cash paid for income taxes................................................. 3,000,500 2,725,433 2,994,755 Supplemental noncash flow disclosures: Loans securitized and transferred to securities available for sale......... $ 16,526,399 15,411,803 0 Securities held to maturity transferred to securities available for sale... 1,295,147 0 651,594 Loans transferred to loans held for sale................................... 4,346,602 2,491,820 254,912 Loans transferred to loans held for investment............................. 95,503 0 0 Transfer of loans to real estate........................................... 232,071 188,054 413,853 Transfer of real estate to loans........................................... 84,772 161,954 0 Treasury stock purchased with liability due to broker...................... 0 362,500 0 Due to stockholders of Marshalltown Financial Corporation.................. 3,555,352 0 0
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 30 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1997, 1996 AND 1995 NOTE 1 DESCRIPTION OF THE BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES HMN Financial, Inc. (HMN) is a stock savings bank holding company which owns 100 percent of Home Federal Savings Bank (the Bank or Home Federal). Home Federal has a community banking philosophy and operates retail banking facilities in Minnesota and Iowa. The Bank has two wholly owned subsidiaries, Osterud Insurance Agency, Inc. (OAI) and MSL Financial Corporation (MSL), which offer financial planning products and services. HMN has two other wholly owned subsidiaries, Security Finance Corporation (SFC) and HMN Mortgage Services, Inc. (MSI). SFC invests in commercial loans and commercial real-estate loans located throughout the United States which were originated by third parties. MSI operates mortgage banking and mortgage brokerage facilities located in Eden Prairie and Brooklyn Park, Minnesota. The consolidated financial statements included herein are for HMN, SFC, MSI, the Bank and the Bank's wholly owned subsidiaries, OAI and MSL. All significant intercompany accounts and transactions have been eliminated in consolidation. The consolidated financial statements have been prepared in conformity with generally accepted accounting principles. The following items set forth the significant accounting policies which HMN follows in presenting its financial statements. MATERIAL ESTIMATES In preparing the 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. Material estimates that are particularly susceptible to change relate to the determination of the allowance for losses on loans and the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans. In connection with the determination of the allowances for loan and real estate losses, management obtains independent appraisals for significant properties. Management believes that the allowances for losses on loans and real estate are adequate. While management uses available information to recognize losses on loans and real estate, future additions to the allowances 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 allowances for losses on loans and real estate. Such agencies may require additions to the allowances based on their judgement about information available to them at the time of their examination. CASH EQUIVALENTS For purposes of the statements of cash flows, HMN considers highly liquid investments with original maturities of three months or less to be cash equivalents. SECURITIES HMN classifies its debt and equity securities in one of three categories: trading, available for sale, or held to maturity. Trading securities are bought and held principally for the purpose of selling them in the near term. Securities available for sale 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. Securities held to maturity represent securities which HMN has the positive intent and ability to hold to maturity. Securities available for sale are carried at market value. Net unrealized gains and losses, net of tax effect, are included as a separate component of stockholders' equity. Securities held to maturity are carried at cost, adjusted for amortization of premiums and discounts, as management has the ability and intent to hold them to maturity. Premiums and discounts are amortized using the level-yield method over the period to maturity. Gains and losses on the sale of securities are determined using the specific-identification method. 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. Gains are recognized on 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. 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 to provide for probable losses. The allowance for losses on loans is based on periodic analysis of the loan portfolio by management. In this analysis, management considers factors including, but not limited to, specific occurrences which include loan impairment, general economic conditions, loan portfolio composition and historical experience. Loans are charged off to the extent they are deemed to be uncollectible. Interest income is recognized on an accrual basis except when collectibility is in doubt. When loans are placed on a nonaccrual 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 judgement, principal is collectible. All impaired loans, including all loans that are restructured in a troubled debt restructuring involving a modification of terms, are measured 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 measure 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 a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired loans are all loans which are delinquent as to principal and interest for 120 days or greater and all loans that are restructured in a troubled debt restructuring involving a modification of terms. All portfolio loans are reviewed on an individual basis. HMN FINANCIAL, INC. 31 MORTGAGE SERVICING RIGHTS Effective January 1, 1996, HMN adopted Statement of Financial Accounting Standards (SFAS) No. 122, ACCOUNTING FOR MORTGAGE SERVICING RIGHTS. HMN recognizes as a separate asset the rights to service mortgage loans for others whether the servicing rights are acquired through loan origination or purchase. The fair value of capitalized mortgage servicing rights is based upon the present value of estimated future cash flows. Based upon current fair values capitalized mortgage servicing rights are periodically assessed for impairment, which is recognized in the statement of income during the period in which the impairment occurs as an adjustment to the corresponding valuation allowance. For purposes of performing its impairment evaluation, HMN stratifies its portfolio on the basis of certain risk characteristics including loan type and note rate. Capitalized mortgage servicing rights are amortized over the estimated remaining life of the underlying loans and take into account appropriate prepayment assumptions. The effect of adopting SFAS No. 122 did not have a material impact on HMN's financial condition or the results of its operations during 1996. In June, 1996 SFAS No. 122 was superceded by SFAS No. 125. In June 1996, the Financial Accounting Standards Board (FASB) issued SFAS No. 125, ACCOUNTING FOR TRANSFERS AND SERVICING OF FINANCIAL ASSETS AND EXTINGUISHMENT OF LIABILITIES. SFAS No. 125 applies to transfers and servicing of financial assets and extinguishments of liabilities. It requires a financial-components approach that focuses on control. Under the approach, after a transfer of financial assets, an entity recognizes the financial and servicing assets it controls and the liabilities it has incurred, derecognizes financial assets when control has been surrendered, and derecognizes liabilities when extinguished. In December 1996, the FASB issued SFAS No. 127 which postpones the effective date by one year for certain provisions of SFAS No. 125. The sections dealing with secured borrowings and collateral are deferred for all transfers of financial assets until after December 31, 1997. Likewise transfers related to repurchase agreements, dollar-rolls, securities lending and similar transactions are deferred until after December 31, 1997. The effect of adopting SFAS No. 125 as amended by SFAS No. 127 did not have a material impact on HMN's financial condition or the results of its operations. REAL ESTATE, NET Real estate properties 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 periodically performed 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 10 to 40 years for office buildings and improvements and 3 to 12 years for furniture and equipment. IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF Effective January 1, 1996, HMN adopted SFAS No. 121, ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF. HMN 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. The effect of adopting SFAS No. 121 on January 1, 1996 did not have a material impact on HMN's financial condition or the results of its operations. INTANGIBLE ASSETS Goodwill resulting from acquisitions is amortized on a straight line basis over 25 years. Deposit base intangible is amortized on an accelerated basis as the certificates of deposit mature over the next eleven years. Management reviews intangible assets for impairment as events or circumstances indicate that the assets may not be recoverable. STOCK-BASED COMPENSATION Effective January 1, 1996, HMN adopted SFAS No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION. It elected to continue using the accounting methods prescribed by Accounting Principles Board (APB) Opinion No. 25 and related interpretations which measure compensation cost using the intrinsic value method. HMN has included in Note 13, "Employee Benefits" the impact of the fair value of employee stock-based compensation plans on net income and earnings per share on a pro forma basis for awards granted after January 1, 1995. 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 bases. 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. NEW ACCOUNTING STANDARDS Refer to "Earnings per Share" below for information on adopting SFAS No. 128. In July 1997, the FASB issued SFAS No. 130, REPORTING COMPREHENSIVE INCOME which establishes standards of disclosure and financial statement display for reporting total comprehensive income and the individual components thereof. Comprehensive income is defined as the change in equity (net assets) of a business enterprise during a period from transactions and other events and circumstances from nonowner sources. It includes all changes in equity during a period except those resulting from investments by owners and distributions to owners. As used in SFAS No. 130, the term comprehensive income thus encompasses net income. The term other comprehensive income refers to components of comprehensive income that are excluded from net income under generally accepted accounting principles. Comprehensive income may be presented in any of the following financial statements: in a separate statement of comprehensive income; in a statement of changes in equity; or below the total of net income or loss in the income statement. SFAS No. 130 is effective for fiscal years beginning after December 15, 1997, with earlier application permitted. Comparative statements for previous years must be reclassified, although reclassification adjustments are not required to be shown for such earlier periods. Management will be adopting SFAS No. 130 on January 1, 1998 and will report comprehensive income in statements issued for financial reporting periods occurring during 1998. In July 1997, the FASB issued SFAS No. 131, DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION which establishes new standards for determining a reportable segment and for disclosing information regarding each such segment. The amount of each segment item reported should be 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 should be included in determining reported segment profit or loss only 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 is used by the chief operating decision maker should be reported for 32 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS that segment. SFAS No. 131 is effective for fiscal years beginning after December 15, 1997, with earlier application encouraged. Management will disclose segment information starting with financial reporting periods occurring during 1998. In February 1998, the FASB issued SFAS No. 132, EMPLOYERS' DISCLOSURES ABOUT PENSIONS AND OTHER POSTRETIREMENT BENEFITS which revises employers' disclosures about pension and other post retirement benefit plans. It does not change the measurement or recognition of those plans. It standardizes the disclosure requirements for pensions and other postretirement benefits to the extent practicable, requires additional information on changes in the benefit obligation and fair values of plan assets that will facilitate financial analysis, and eliminates certain disclosures that are no longer as useful as they were when FASB Statements No. 87, EMPLOYERS' ACCOUNTING FOR PENSIONS, No. 88, EMPLOYERS' ACCOUNTING FOR SETTLEMENT AND CURTAILMENTS OF DEFINED BENEFIT PENSION PLANS AND FOR TERMINATION BENEFITS, and No. 106, EMPLOYERS' ACCOUNTING FOR POSTRETIREMENT BENEFITS OTHER THAN PENSIONS, were issued. SFAS No. 132 suggests combined formats for presentation of pension and other postretirement benefit disclosures. It is effective for fiscal years beginning after December 15, 1997. Restatement of disclosures for earlier periods provided for comparative purposes is required unless the information is not readily available. Management is currently studying the impact of adopting SFAS No. 132. EARNINGS PER SHARE In February 1997, the FASB issued SFAS No. 128, EARNINGS PER SHARE. SFAS No. 128 establishes standards for computing and presenting earnings per share (EPS) and applies to entities with publicly held common stock or potential common stock. SFAS No. 128 simplifies the standards for computing earnings per share previously found in APB Opinion No. 15, EARNINGS PER SHARE, and makes them comparable to international EPS standards. It replaces the presentation of primary EPS with a presentation of basic EPS. It also requires dual presentation of basic and diluted EPS on the face of the income statement for all entities with complex capital structures and requires a reconciliation of the numerator and denominator of the basic EPS computation to the numerator and denominator of the diluted EPS computation. Basic 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 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 then shared in the earnings of the entity. Diluted EPS is computed similarly to fully diluted EPS pursuant to APB Opinion No. 15. HMN adopted SFAS No. 128 effective December 31, 1997 and, in conformity with SFAS No. 128, has restated all prior-period EPS data presented in this financial statement. The following table reconciles the weighted average shares outstanding and the income available to common shareholders used for basic and diluted EPS:
- - ------------------------------------------------------------------------------------------------- Year Ended December 31, ------------------------------------------- 1997 1996 1995 ------------------------------------------- Weighted average number of common shares outstanding used in basic earnings per common share calculation.......................... 3,683,458 4,315,410 5,109,989 Net dilutive effect of: Options........................................... 209,388 54,838 19,062 Restricted stock awards........................... 50,767 67,003 42,887 ---------- ----------- --------- Weighted average number of shares outstanding adjusted for effect of dilutive securities................. 3,943,613 4,437,251 5,171,938 ---------- ----------- --------- ---------- ----------- --------- Income available to common shareholders...................................... $5,578,866 4,274,349 5,620,377 Basic earnings per common share...................................... $1.51 0.99 1.10 Diluted earnings per common share...................................... $1.41 0.96 1.09 - - -------------------------------------------------------------------------------------------------
In February of 1998 HMN announced that its Board of Directors voted to request stockholder approval at the annual meeting of stockholders to be held on April 28, 1998 for an increase in HMN's authorized common stock from 7.0 million shares to 11.0 million shares. Subject to stockholder approval of the increase, the Board has authorized a three-for-two stock split of its common stock, to be effected in the form of a fifty percent stock dividend. The record date and distribution date for such dividend are expected to be set by the Board immediately following the annual stockholders' meeting. RECLASSIFICATIONS Certain amounts in the consolidated financial statements for prior years have been reclassified to conform with the current year presentation. NOTE 2 BUSINESS COMBINATIONS AND ACQUISITIONS On December 5, 1997 HMN, through its wholly owned subsidiary, Home Federal, completed its merger (the Merger) with Marshalltown Financial Corporation (MFC) pursuant to a merger agreement dated July 1, 1997. The aggregate consideration per the merger agreement was $24.8 million, consisting of $23.7 million for 1.35 million outstanding shares of MFC stock, or $17.51 per share, and $1.1 million for the outstanding MFC options. HMN owned 60,000 shares of MFC stock with a historical cost of $1.0 million which were cancelled upon the completion of the merger. The purchase method of accounting was used to record the merger transaction. The transaction was funded through a combination of the sale of securities, and short-term borrowings from the Federal Home Loan Bank of Des Moines ("FHLB"). Pursuant to the merger agreement, the Bank is obligated to provide cash to MFC stockholders when they submit their MFC stock or outstanding MFC options. As of December 31, 1997 MFC stockholders had not submitted 216,165 shares or options for $3,555,352. The merger consideration of $24.8 million plus the cancellation of 60,000 shares of MFC common stock owned by HMN with a historical cost of $1.0 million was allocated as follows: HMN FINANCIAL, INC. 33 - - --------------------------------------------------------------------------- Cash and cash equivalents............................. $ 5,437,603 Investment securities................................. 48,580,533 Loans receivable, net................................. 69,759,162 Federal Home Loan Bank stock, at cost................. 1,195,500 Premises and equipment................................ 744,793 Goodwill.............................................. 4,514,730 Core deposit intangible .............................. 1,567,000 Other assets.......................................... 2,210,518 Deposits.............................................. (103,580,493) Net deferred tax liabilities.......................... (1,003,330) Other liabilities .................................... (3,578,464) ------------- Purchase price...................................... $ 25,847,552 ------------- ------------- - - ---------------------------------------------------------------------------
The following Unaudited Pro Forma Condensed Combined Statements of Income for the years ended December 31, 1997 and 1996 combine HMN's income statement for the year ended December 31 with MFC's income statement for the year ended September 30. The statements are presented as if the Merger had been effective at the beginning of each period presented, after giving effect to certain pro forma adjustments described in the accompanying notes. The Unaudited Pro Forma Condensed Combined Financial Information and notes thereto (the Information) reflect the application of the purchase method of accounting for the Merger. Under this method, the assets acquired and liabilities assumed from MFC and its subsidiaries are recorded at their fair market values on the date of the Merger. The amount of the purchase price in excess of the fair market value of the tangible and identifiable intangible assets acquired less the fair market value of the liabilities assumed is recorded as goodwill. Certain historical information of the consolidated MFC has been reclassified to conform to HMN's financial statement presentation. The Information is not necessarily indicative of the results of future operations of the combined entity or the actual results that would have been achieved had the Merger of MFC been consummated prior to the periods indicated. HMN FINANCIAL, INC. AND SUBSIDIARIES MARSHALLTOWN FINANCIAL CORPORATION AND SUBSIDIARIES UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENTS OF INCOME FOR THE YEAR ENDED DECEMBER 31, 1997
HMN MFC Pro Forma Year Ended Year Ended ------------------------------ 12-31-97 9-30-97 Adjustments Combined - - --------------------------------------------------------------------------------------------------------- Total interest income................... $ 41,090,231 8,849,795 (2,004,299)(1)(2) 47,935,727 Total interest expense.................. 25,643,019 5,484,065 387,570 (3)(4) 31,514,654 ------------ ---------- ---------- ---------- Net interest income................... 15,447,212 3,365,730 (2,391,869) 16,421,073 Provision for loan losses............... 300,000 10,000 310,000 Non-interest income..................... 2,722,359 202,010 2,924,369 Non-interest expense.................... 9,022,705 2,378,914 494,242 (5)(6) 11,895,861 ------------ ---------- ---------- ---------- Income before income tax expense...... 8,846,866 1,178,826 (2,886,111) 7,139,581 Income tax expense...................... 3,268,000 331,771 (1,024,971) 2,574,800 ------------ ---------- ---------- ---------- Net income............................ $ 5,578,866 847,055 (1,861,140) 4,564,781 ------------ ---------- ---------- ---------- ------------ ---------- ---------- ---------- Basic earnings per share................ $ 1.51 0.58 1.24 Diluted earnings per share.............. $ 1.41 0.57 1.16 Weighted average shares outstanding: Basic................................. 3,683,458 1,470,885 3,683,458 Diluted............................... 3,943,613 1,477,287 3,943,613 UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENTS OF INCOME FOR THE YEAR ENDED DECEMBER 31, 1996 HMN MFC Pro Forma Year Ended Year Ended ----------------------------- 12-31-96 9-30-96 Adjustments Combined - - -------------------------------------------------------------------------------------------------------- Total interest income................... $39,864,325 8,756,211 (2,004,299)(1)(2) 46,616,237 Total interest expense.................. 24,193,790 5,579,496 387,570 (3)(4) 30,160,856 ------------ ---------- ---------- ---------- Net interest income................... 15,670,535 3,176,715 (2,391,869) 16,455,381 Provision for loan losses............... 300,000 10,000 310,000 Non-interest income..................... 1,922,700 152,643 2,075,343 Non-interest expense.................... 10,508,886 3,187,416 494,242 (5)(6) 14,190,544 ------------ ---------- ---------- ---------- Income before income tax expense...... 6,784,349 131,942 (2,886,111) 4,030,180 Income tax expense...................... 2,510,000 57,212 (1,009,212) 1,558,000 ------------ ---------- ---------- ---------- Net income............................ $ 4,274,349 74,730 (1,876,899) 2,472,180 ------------ ---------- ---------- ---------- ------------ ---------- ---------- ---------- Basic earnings per share................ $ 0.99 0.05 0.57 Diluted earnings per share.............. $ 0.96 0.05 0.56 Weighted average shares outstanding: Basic................................. 4,315,410 1,472,185 4,315,410 Diluted............................... 4,437,251 1,473,784 4,437,251
34 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTES TO UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENTS OF INCOME Pursuant to the Merger and consistent with GAAP, certain adjustments were recorded, primarily to accrue for specific, identified costs related to the merger of MFC. The amounts of the Merger related costs are preliminary estimates and are subject to revisions as economic conditions change or as more information becomes available. HMN expects to achieve operating cost savings primarily through reductions in staff and the consolidation of certain functions such as data processing, investments and other back office operations at MFC. The operating cost savings are expected to be achieved in various amounts at various times during the years subsequent to the acquisition of MFC and not ratably over, or at the beginning or end of, such periods. No adjustment has been reflected in the Unaudited Pro Forma Condensed Combined Statement of Income for the year ended December 31, 1997 or 1996 for the anticipated cost savings. (1) Represents amortization of MFC mark-to-market adjustments under the purchase method of accounting for loans. (2) Represents amortization of MFC mark-to-market adjustments under the purchase method of accounting for securities, and the forgone interest income resulting from the planned sale of $15.8 million of securities. (3) Represents amortization of MFC mark-to-market adjustments under the purchase method of accounting for deposits. (4) Represents the net interest cost of borrowing $10.0 million to fund the MFC acquisition. (5) Represents amortization of goodwill and core deposit intangible. (6) Represents the additional depreciation on premises and equipment related to the MFC mark-to-market adjustments. Provided the accounting estimates related to the acquisition of MFC are not revised, the estimated impact of amortizing goodwill and other purchase accounting adjustments will reduce pretax income by the following amounts in each of the following years: $1,256,000 for 1998, $593,000 for 1999, $564,000 for 2000, $426,694 for 2001 and $346,674 for 2002. NOTE 3 SECURITIES AVAILABLE FOR SALE A summary of securities available for sale at December 31, 1997 and 1996 is as follows:
- - ---------------------------------------------------------------------------------------------------------- Gross Gross Amortized unrealized unrealized Fair cost gains losses value - - ---------------------------------------------------------------------------------------------------------- DECEMBER 31, 1997: Mortgage-backed securities: FHLMC..................................... $ 29,934,261 159,036 13,126 30,080,171 FNMA...................................... 14,352,421 46,710 59,159 14,339,972 GNMA...................................... 6,213,917 12,741 7,885 6,218,773 Other..................................... 186,523 0 881 185,642 Collateralized mortgage obligations: FHLMC..................................... 21,583,016 227,165 207,710 21,602,471 FNMA...................................... 38,603,926 271,415 217,204 38,658,137 Other..................................... 24,724,340 127,068 1,092 24,850,316 ----------- ---------- ---------- ----------- 135,598,404 844,135 507,057 135,935,482 ----------- ---------- ---------- ----------- Other marketable securities: U.S. Government and agency obligations.... 43,403,323 40,398 100,965 43,342,756 Corporate debt............................ 2,903,330 0 182 2,903,148 Corporate equity.......................... 22,050,273 1,632,826 5,526 23,677,573 ----------- ---------- ---------- ----------- 68,356,926 1,673,224 106,673 69,923,477 ----------- ---------- ---------- ----------- $203,955,330 2,517,359 613,730 205,858,959 ----------- ---------- ---------- ----------- ----------- ---------- ---------- ----------- DECEMBER 31, 1996: Mortgage-backed securities: FHLMC..................................... $ 1,776,252 32,567 0 1,808,819 FNMA...................................... 968,924 14,833 0 983,757 Collateralized mortgage obligations: FHLMC..................................... 56,867,103 98,316 1,162,269 55,803,150 FNMA...................................... 45,236,461 113,800 596,858 44,753,403 Other..................................... 29,625,427 449,747 69,025 30,006,149 ----------- ---------- ---------- ----------- 134,474,167 709,263 1,828,152 133,355,278 ----------- ---------- ---------- ----------- Other marketable securities: U.S. Government and agency obligations.... 29,599,717 33,566 355,602 29,277,681 Corporate debt............................ 1,090,420 1,218 0 1,091,638 Corporate equity.......................... 11,670,362 555,608 120,479 12,105,491 ----------- ---------- ---------- ----------- 42,360,499 590,392 476,081 42,474,810 ----------- ---------- ---------- ----------- $176,834,666 1,299,655 2,304,233 175,830,088 ----------- ---------- ---------- ----------- ----------- ---------- ---------- ----------- - - ----------------------------------------------------------------------------------------------------------
Proceeds from securities available for sale which were sold during 1997 were $94,462,303, resulting in gross gains of $1,533,046 and gross losses of $283,477. Proceeds from securities available for sale which were sold during 1996 were $101,157,643, resulting in gross gains of $1,235,754 and gross losses of $206,116. Proceeds from securities available for sale which were sold during 1995 were $85,454,779, resulting in gross gains of $565,441 and gross losses of $149,486. HMN FINANCIAL, INC. 35 The following table indicates amortized cost and estimated fair value of securities available for sale at December 31, 1997, 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.................. $101,595,473 101,749,806 Due after one year through five years... 71,013,632 71,121,508 Due after five years through ten years . 6,732,965 6,743,193 After ten years......................... 2,562,987 2,566,880 No stated maturity...................... 22,050,273 23,677,572 ------------ ------------ Total................................. $203,955,330 205,858,959 ------------ ------------ ------------ ------------ - - ------------------------------------------------------------------------
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. NOTE 4 SECURITIES HELD TO MATURITY During the first quarter of 1997, HMN determined that it no longer had the intent to hold its securities classified as held to maturity to the actual maturity date of the securities. Therefore, it sold one security and on March 31, 1997 it transferred all the remaining securities in the held to maturity portfolio to the available for sale portfolio. The following information summarizes the sale and transfer of the securities held to maturity during 1997.
- - ------------------------------------------------------------------------------------------------------------------------------- Unrealized Unrealized Holding Gain, Amortized Fair Realized Holding Net of Tax, Cost Value Gain Gain in Equity - - ------------------------------------------------------------------------------------------------------------------------------- Security sold..................................... $ 344,139 348,871 4,732 Securities transferred to available for sale...... $1,223,753 1,295,147 71,394 42,641 - - -----------------------------------------------------------------------------------------------------------------------------
A summary of securities held to maturity at December 31, 1996 is as follows: - - ----------------------------------------------------------------------------
Gross Gross Amortized unrealized unrealized Fair cost gains losses value - - ----------------------------------------------------------------------------------------------------------------------------- DECEMBER 31, 1996: Mortgage-backed securities: FHLMC........................... $1,403,866 90,477 0 1,494,343 FNMA............................ 158,425 9,941 0 168,366 Other........................... 243,453 0 1,169 242,284 --------- -------- --------- ---------- 1,805,744 100,418 1,169 1,904,993 --------- -------- --------- ---------- Other marketable securities: Corporate debt.................. 999,812 738 0 1,000,550 --------- -------- --------- ---------- $2,805,556 101,156 1,169 2,905,543 --------- -------- --------- ---------- --------- -------- --------- ---------- - - -----------------------------------------------------------------------------------------------------------------------------
There were no sales of securities held to maturity in 1996.
NOTE 5 LOANS RECEIVABLE, NET A summary of loans receivable at December 31 is as follows: - - --------------------------------------------------------------------------------- 1997 1996 --------------------------------- Residential real estate loans: Conventional.............................. $399,029,974 320,317,356 FHA....................................... 1,797,006 2,203,983 VA........................................ 1,857,827 2,572,878 ------------ ----------- 402,684,807 325,094,217 ------------ ----------- Other loans: Commercial real estate 11,997,014 7,917,882 Autos..................................... 2,437,516 565,464 Home equity line.......................... 19,490,392 11,881,305 Home equity............................... 7,176,253 5,926,753 Other consumer............................ 411,100 370,417 Commercial business ...................... 5,226,095 2,344,421 Savings .................................. 1,362,186 938,308 Education................................. 123,313 466,576 Other..................................... 864,238 782,885 ------------ ----------- 49,088,107 31,194,011 ------------ ----------- Total loans............................. 451,772,914 356,288,228 Less: Unamortized discounts..................... 547,007 417,031 Net deferred loan fees.................... 1,846,692 1,694,730 Allowance for losses...................... 2,748,219 2,340,585 Loans in process.......................... 4,562,396 2,813,646 ------------ ----------- $442,068,600 349,022,236 ------------ ----------- ------------ ----------- Weighted average contractual interest rate............................. 7.39% 7.67% Commitments to originate, fund or purchase loans.................... $ 7,367,650 24,504,320 - - ---------------------------------------------------------------------------------
Included in total commitments to originate or purchase loans are fixed rate loans aggregating approximately $6,010,250 and $2,861,025 as of December 31, 1997 and 1996, respectively. The interest rates on these commitments ranged from 6.678% to 7.5% at December 31, 1997 and from 7.11% to 8.375% at December 31, 1996. At December 31, 1997 and 1996, loans on nonaccrual status totaled $263,329 and $338,310, respectively. Had the loans performed in accordance with their original terms throughout 1997, HMN would have recorded gross interest income of $27,690 for these loans. Interest income of $14,444 has been recorded on these loans for the year ended December 31, 1997. At December 31, 1997 and 1996 there were no loans 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, 1997. At December 31, 1997, 1996 and 1995, the recorded investment in loans that are considered to be impaired were $665,151, $338,310 and $535,450, respectively, for which the related allowance for credit losses were $34,762, $17,571 and $70,097, respectively. The average investment in impaired loans during 1997, 1996 and 1995 were $443,754, $423,042 and $466,288, respectively. For the years ended December 31, 1997, 1996 and 1995, HMN recognized interest income on impaired loans of $36,564, $24,662 and $40,553, respectively. All of the interest 36 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS income that was recognized during 1997, 1996 and 1995 for impaired loans was recognized using the cash basis method of income recognition. The aggregate amount of loans to executive officers and directors of HMN were $884,244, $385,023, and $169,489 at December 31, 1997, 1996 and 1995, respectively. During 1997 repayments on loans to executive officers and directors aggregated $30,679 and loans originated aggregated $529,900. At December 31, 1997, 1996 and 1995, HMN was servicing real estate loans for others with aggregate unpaid principal balances of approximately $8,218,564, $1,417,954 and $1,130,649, respectively. HMN originates residential, commercial real estate and other loans primarily in southern Minnesota and after December 5, 1997 in Iowa. HMN also purchases loans from a third party broker located in the Southeastern United States. At December 31, 1997, HMN owned single family residential loans located in the following states:
- - ------------------------------------------------------------------------------- Percent Amount of Total - - ------------------------------------------------------------------------------- Alabama............. $ 4,462,834 1.1% California.......... 9,054,681 2.2 Georgia............. 46,309,887 11.5 Iowa................ 49,705,322 12.3 Minnesota........... 233,002,052 57.9 North Carolina...... 11,819,254 2.9 Ohio................ 8,477,956 2.1 South Carolina...... 8,314,943 2.1 Tennessee........... 4,288,917 1.1 Wisconsin........... 20,130,423 5.0 Other states........ 7,118,538 1.8 ------------ ------- Total............. $402,684,807 100.0% ------------ ------- ------------ ------- - - -------------------------------------------------------------------------------
- - -------------------------------------------------- NOTE 6 ALLOWANCE FOR LOAN AND REAL ESTATE LOSSES The allowance for losses is summarized as follows:
Loans Real estate Total - - ------------------------------------------------------------------------------- Balance, December 31, 1994............ $1,893,143 36,997 1,930,140 Provision for losses............... 300,000 9,327 309,327 Charge-offs........................ (2,612) (11,324) (13,936) Recoveries......................... 133 0 133 ----------- -------- --------- Balance, December 31, 1995............ 2,190,664 35,000 2,225,664 Provision for losses............... 300,000 2,000 302,000 Charge-offs........................ (150,136) 0 (150,136) Recoveries......................... 57 0 57 Other.............................. 0 (35,000) (35,000) ----------- -------- --------- Balance, December 31, 1996............ 2,340,585 2,000 2,342,585 Provision for losses............... 300,000 18,000 318,000 MFC allowance for losses acquired . 122,500 0 122,500 Charge-offs........................ (22,691) (12,000) (34,691) Recoveries......................... 7,825 0 7,825 ----------- -------- --------- Balance, December 31, 1997............ $2,748,219 8,000 2,756,219 ----------- -------- --------- ----------- -------- --------- - - -------------------------------------------------------------------------------
NOTE 7 REAL ESTATE A summary of real estate at December 31 is as follows: - - --------------------------------------------------------------------------- 1997 1996 ----------------------- Real estate in judgement subject to redemption............................ $ 0 22,610 Real estate acquired through foreclosure.... 141,939 0 -------- ------ 141,939 22,610 Allowance for losses........................ 8,000 2,000 -------- ------ $133,939 20,610 -------- ------ -------- ------ - - ---------------------------------------------------------------------------
NOTE 8 PREMISES AND EQUIPMENT A summary of premises and equipment at December 31 is as follows:
- - --------------------------------------------------------------------------- 1997 1996 ------------------------- Land ......................................... $1,175,169 726,923 Office buildings and improvements............. 5,196,656 3,704,146 Furniture and equipment....................... 2,735,835 1,966,130 ---------- --------- 9,107,660 6,397,199 ---------- --------- Less accumulated depreciation................. 3,226,950 2,815,702 ---------- --------- $5,880,710 3,581,497 ---------- --------- ---------- --------- - - ---------------------------------------------------------------------------
During 1997 HMN purchased land totaling $392,700 in order to build new retail banking facilities in Spring Valley and Winona. During 1997 HMN spent $700,000 for construction in process on the two banking facilities. During 1998 HMN will spend approximately $2,200,000 to complete its building projects and provide the buildings with furniture and equipment. NOTE 9 ACCRUED INTEREST RECEIVABLE Accrued interest receivable at December 31 is summarized as follows:
- - ---------------------------------------------------------------------- 1997 1996 ------------------------ Securities available for sale............. $1,549,173 1,256,214 Securities held to maturity............... 0 41,730 Loans receivable ......................... 2,488,958 2,117,208 ---------- --------- $4,038,131 3,415,152 ---------- --------- ---------- --------- - - ----------------------------------------------------------------------
HMN FINANCIAL, INC. 37 NOTE 10 DEPOSITS Deposits and their weighted average interest rates at December 31 are summarized as follows:
- - -------------------------------------------------------------------------------------------------------------------------- 1997 1996 --------------------------------------- -------------------------------------- Weighted Percent of Weighted Percent of average rate Amount total average rate Amount total - - -------------------------------------------------------------------------------------------------------------------------- Noninterest checking.................... 0.00% $ 3,832,736 0.8% 0.00% $ 2,389,034 0.7% NOW accounts............................ 1.50 23,143,564 5.0 2.01 17,588,877 4.8 Passbooks............................... 2.62 36,198,890 7.6 2.50 30,070,326 8.3 Money market accounts................... 3.34 24,807,554 5.3 2.83 16,532,806 4.6 ------------ ----- ------------ ----- 87,982,744 18.7 66,581,043 18.4 ------------ ----- ------------ ----- Certificates: 3-3.99%................................. 726,629 0.2 425,284 0.1 4-4.99%................................. 24,155,281 5.2 22,552,550 6.2 5-5.99%................................. 162,916,038 34.9 168,040,084 46.4 6-6.99%................................. 178,847,401 38.3 76,703,716 21.2 7-7.99%................................. 11,627,046 2.5 28,077,048 7.7 Over 8.00%.............................. 1,092,549 0.2 97,219 0.0 ------------ ----- ------------ ----- Total certificates...................... 5.81 379,364,944 81.3 5.76 295,895,901 81.6 ------------ ----- ------------ ----- Total deposits.......................... 5.17 $467,347,688 100.0% 5.14 $362,476,944 100.0% ------------ ----- ------------ ----- ------------ ----- ------------ ----- - - --------------------------------------------------------------------------------------------------------------------------
At December 31, 1997 and 1996, HMN had $47,546,431 and $38,226,676, respectively, of deposit accounts with balances at $100,000 or more. Certificates had the following maturities at December 31:
- - ------------------------------------------------------------------------------------------------------ 1997 1996 ------------------------------------------------------------ Weighted Weighted Amount average Amount average REMAINING TERM TO MATURITY (in thousands) rate (in thousands) rate - - ------------------------------------------------------------------------------------------------------ 1-6 months.............................. $121,295 5.69% $ 92,495 5.38% 7-12 months............................. 138,235 5.86 71,077 5.95 13-36 months............................ 98,515 5.87 111,369 5.91 37-60 months............................ 21,320 5.92 20,955 6.02 ------- ------- $379,365 5.81 $295,896 5.76 ------- ------- ------- ------- - - ------------------------------------------------------------------------------------------------------
At December 31, 1997 mortgage loans and mortgage-backed and related securities with an amortized cost of approximately $42,579,000 and $2,328,000 of letters of credit from the Federal Home Loan Bank (FHLB) were pledged as collateral on deposits. Interest expense on deposits is summarized as follows for the years ended December 31:
- - -------------------------------------------------------------------------------------- 1997 1996 1995 ----------- ---------- ----------- NOW..................................... $ 257,261 323,311 311,359 Passbook................................ 762,923 760,083 759,167 Money Market............................ 490,223 500,811 547,412 Certificates............................ 17,545,757 17,365,732 16,960,806 ----------- ---------- ----------- $19,056,164 18,949,937 18,578,744 ----------- ---------- ----------- ----------- ---------- ----------- - - --------------------------------------------------------------------------------------
NOTE 11 FEDERAL HOME LOAN BANK ADVANCES Federal Home Loan Bank advances consisted of the following at December 31, 1997 and 1996:
- - ----------------------------------------------------------------------------------------------------- 1997 1996 ------------------------ ---------------------------- YEAR OF MATURITY Amount Rate Amount Rate - - ----------------------------------------------------------------------------------------------------- 1997.................................... $ 46,428,568 5.52 1998.................................... $ 43,250,021 5.85% 1,250,021 6.55 1999.................................... 15,000,000 5.42 5,000,000 5.16 2000.................................... 24,000,000 5.97 19,000,000 6.00 2001.................................... 19,000,000 5.86 24,000,000 5.51 2002.................................... 16,000,000 5.61 0 0.00 2003.................................... 10,400,000 5.89 10,400,000 5.89 ------------ ------------ $127,650,021 5.80 $106,078,589 5.64 ------------ ------------ ------------ ------------ - - -----------------------------------------------------------------------------------------------------
Certain advances have call provisions which allow the FHLB to request that the advance be paid back prior to its maturity date. At December 31, 1997 all advances maturing in 2001 have semiannual call features which start in 1998 and $10,000,000 of the advances maturing in 2002 have quarterly call features which start in 1998. At December 31, 1997 and 1996 the Bank had an undrawn open line of credit for $5,000,000 from the FHLB. At December 31, 1997 the advances, the open line of credit, and $2,328,000 of letters of credit from the FHLB were collateralized by the Bank's FHLB stock and mortgage loans with unamortized principal balances of approximately $375,000,000. The Bank has the ability to draw additional borrowings of $150,000,000 based upon the mortgage loans that are currently pledged subject to a requirement to purchase FHLB stock. 38 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 12 INCOME TAXES Income tax expense for the years ended December 31 is as follows:
- - ---------------------------------------------------------------------------------------------------------------------------------- 1997 1996 1995 ------------------------------------------ Current: Federal ............................................................................ $2,425,591 1,838,158 2,152,628 State .............................................................................. 758,814 561,442 660,222 --------- --------- --------- Total current..................................................................... 3,184,405 2,399,600 2,812,850 --------- --------- --------- Deferred: Federal ............................................................................ 65,395 83,833 439,945 State .............................................................................. 18,200 26,567 128,105 --------- --------- --------- Total deferred ................................................................... 83,595 110,400 568,050 --------- --------- --------- $3,268,000 2,510,000 3,380,900 --------- --------- --------- --------- --------- --------- - - ----------------------------------------------------------------------------------------------------------------------------------
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:
- - --------------------------------------------------------------------------------------------------------------------------------- 1997 1996 1995 ---------------------------------------- Federal expected income tax expense................................................. $3,007,934 $2,306,677 3,060,434 Items affecting federal income tax: State income taxes, net of federal income tax benefit............................ 512,829 388,086 520,296 ---------- ---------- --------- Other, net........................................................................ (252,763) (184,763) (199,830) ---------- ---------- --------- 3,268,000 $2,510,000 3,380,900 ---------- ---------- --------- ---------- ---------- --------- - - ---------------------------------------------------------------------------------------------------------------------------------
The tax effects of temporary differences that give rise to the deferred tax assets and deferred tax liabilities are as follows at December 31:
- - ----------------------------------------------------------------------------------------------------------------------------- 1997 1996 --------------------------- Deferred tax assets: Allowances for loan and real estate losses................................................. $ 1,096,900 947,200 Discounts on assets and liabilities acquired from MFC...................................... 343,400 0 Deferred loan fees......................................................................... 185,900 377,100 Deferred compensation and pension costs.................................................... 143,250 172,500 Restricted stock awards.................................................................... 46,400 0 Loan servicing assets...................................................................... 20,800 0 Net unrealized loss on market value adjustment to securities available for sale............ 0 406,600 --------- --------- Total gross deferred tax assets........................................................... 1,836,650 1,903,400 Valuation allowance........................................................................ 0 0 --------- --------- Net deferred tax assets................................................................... 1,836,650 1,903,400 --------- --------- Deferred tax liabilities: Tax bad debt reserve over base year........................................................ 1,540,600 1,462,000 Mark up on assets acquired from MFC........................................................ 1,341,600 0 Net unrealized gain on market value adjustment to securities available for sale............ 793,000 0 FHLB stock................................................................................. 463,100 359,700 Deferred loan fees and costs............................................................... 334,500 250,600 Premises and equipment basis difference.................................................... 333,817 106,600 Other...................................................................................... 144,733 26,200 Unamortized discount on loan sale.......................................................... 92,900 136,200 --------- --------- Total gross deferred tax liabilities...................................................... 5,044,250 2,341,300 --------- --------- Net deferred tax liabilities.............................................................. $(3,207,600) (437,900) --------- --------- --------- ---------
Retained earnings at December 31, 1997 included approximately $8,800,000 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. NOTE 13 EMPLOYEE BENEFITS Substantially all full-time employees of the Bank are included in a trusteed noncontributory retirement plan sponsored by the Financial Institutions Retirement Fund. The actuarial present value of accumulated plan benefits and net assets available for benefits relating to the Bank's employees is not available because such information is not accumulated for each participating institution. No contributions were required in 1997, 1996 or 1995 because the retirement plan is fully funded. The Bank's policy is to fund retirement plan costs accrued and there are no unfunded past service costs. For the years ended December 31, 1997, 1996 and 1995 the amounts charged to operating expenses were $5,700, $5,100 and $4,222, respectively. The Bank has a qualified, tax-exempt savings plan with a cash or deferred feature qualifying under Section 401(k) of the Internal Revenue Code (the 401(k) Plan). All employees who have attained age 21 and completed one month of employment are eligible to par- HMN FINANCIAL, INC. 39 ticipate provided they work at least 1,000 hours in each plan year. Participants are permitted to make salary reduction contributions to the 401(k) Plan of up to 12% of the participant's annual salary. Each participant's salary reduction is matched by the Bank in an amount equal to 25% of the participant's salary reduction up to a maximum contribution of 8%. Contributions above 8% are not matched by the Bank. Generally all participant and Bank contributions and earnings are fully and immediately vested. Effective January 1, 1997, for new employees the Bank's contributions are vested on a five year cliff basis. The Bank's matching contributions are expensed when made. The Bank's contributions to the 401(k) Plan were $47,800, $41,804 and $41,324 in 1997, 1996 and 1995, respectively. During 1994 HMN adopted an Employee Stock Ownership Plan (the ESOP) which met the requirements of Section 4975(e)(7) of the Internal Revenue Code and Section 407(d)(6) of the Employee Retirement Income Security Act of 1974, as amended (ERISA), and, as such the ESOP was empowered to borrow in order to finance purchases of the common stock of HMN. The ESOP borrowed $6,085,770 from HMN to purchase 608,577 shares of common stock of HMN on the date of the conversion. The ESOP debt requires quarterly payments of principal plus interest at 7.52%. HMN has committed to make quarterly contributions to the ESOP necessary to repay the loan including interest. HMN contributed $689,636, $713,656, and $735,383 to the ESOP, respectively, during 1997, 1996 and 1995. As the debt is repaid, ESOP shares which were initially pledged as collateral for its debt, are committed to be released from collateral and allocated to active employees, based on the proportion of debt service paid in the year. HMN 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, HMN reports compensation expense equal to the current market price of the shares, and the shares become outstanding for earnings per share computations. ESOP compensation benefit expense was $885,208, $634,702 and $566,395, respectively, for 1997, 1996 and 1995. 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:
- - ------------------------------------------------------------------------------------- 1997 1996 1995 -------- -------- ------- Shares allocated beginning of year..................... 108,421 74,962 33,989 Shares allocated during year............ 38,426 39,763 40,973 Shares distributed to participants...................... (1,985) (5,361) 0 Unreleased shares....................... 455,428 493,852 533,615 -------- -------- ------- Total ESOP shares....................... 600,290 603,216 608,577 -------- -------- ------- -------- -------- ------- Fair value of unreleased shares at December 31................ $14,801,410 8,951,067 8,537,840 - - -------------------------------------------------------------------------------------
In June of 1995, HMN as part of a Recognition and Retention Plan (RRP) awarded 84,486 shares of restricted common stock to its officers and directors. The shares vest over a five year period and were issued from treasury stock. Compensation and benefit expense related to the RRP was $231,600, $231,048 and $116,700 for 1997, 1996 and 1995. In April 1997, 2,000 shares of restricted common stock were awarded to a director. Those shares vest over a five year period beginning in 1998. In June 1995, HMN adopted its only stock option plan, the 1995 Stock Option and Incentive Plan (the SOP). During 1995, options exercisable for 547,713 shares of HMN common stock were granted to certain officers and directors at an exercise price of $13.81 per share. The options vest over a five year period and may be exercised within 10 years of the grant date. In December 1996, options exercisable for 1,000 shares of common stock were granted to officers at an exercise price of $18.125. In April 1997, options for 12,000 shares of common stock were granted to a director at an exercise price of $19.50. The fair value of the options granted were $9.12, $8.32 and $6.73 for 1997, 1996 and 1995, respectively. A summary of stock option activity under the SOP is detailed as follows:
- - -------------------------------------------------------------------------------------------------------------------------------- Weighted Options average available for Options exercise grant outstanding price ---------------------------------------------- December 31, 1994............................................................... 0 0 Plan adopted.................................................................... 608,577 Granted June 21, 1995........................................................... (547,713) 547,713 $13.810 -------- ------- ------ December 31, 1995............................................................... 60,864 547,713 13.810 Exercised....................................................................... (4,699) 13.810 Forfeited....................................................................... 12,172 (12,172) 13.810 Granted December 11, 1996....................................................... (1,000) 1,000 18.125 -------- ------- ------ December 31, 1996............................................................... 72,036 531,842 13.818 Granted April 22, 1997.......................................................... (12,000) 12,000 19.500 Exercised....................................................................... (9,042) 13.810 -------- ------- ------ December 31, 1997............................................................... 60,036 534,800 $13.946 -------- ------- ------ -------- ------- ------ - - --------------------------------------------------------------------------------------------------------------------------------
The following table summarizes information about stock options outstanding at December 31, 1997: Options Outstanding Options Exercisable
Weighted average Exercise Number remaining contractual price outstanding life in years Number Price - - -------------------------------------------------------------------------------------------- $13.810 521,800 7.4 202,305 $13.81 18.125 1,000 8.9 200 18.125 19.500 12,000 9.3 ------- 534,800 ------- ------- - - --------------------------------------------------------------------------------------------
HMN 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 plan. 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. Had compensation cost for HMN's stock-based plan been determined in accordance with the fair value method recommended by SFAS No. 123, HMN's net income and earnings per share would have been reduced to the pro forma amounts indicated below: 40 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - ----------------------------------------------------------------------------- 1997 1996 1995 ------------------------------------------ Net income: As reported................ $5,578,866 4,274,349 5,620,377 Pro forma.................. 4,839,907 3,085,217 4,728,898 Earnings per common share: As reported: Basic................... $ 1.51 0.99 1.10 Diluted................. 1.41 0.96 1.09 Pro forma: Basic................... 1.31 0.71 0.93 Diluted................. 1.23 0.70 0.91 - - ----------------------------------------------------------------------------
The above disclosed pro forma effects of applying SFAS No. 123 to compensation costs, may not be representative of the effects on reported pro forma net income for future years. The fair value for each option grant for the SOP is estimated on the date of the grant using the Option Designer Model. The model incorporates the following assumptions:
- - ---------------------------------------------------------------------------- 1997 1996 1995 ---------------------------------------- Risk-free interest rate....... 6.80% 6.21% 6.28% Expected life................. 10 YEARS 10 years 10 years Expected volatility........... 18.00% 18.00% 20.00% Expected dividends............ NONE None None - - ----------------------------------------------------------------------------
NOTE 14 SAIF ASSESSMENT The Deposit Insurance Fund Act of 1996 (DIFA) was enacted on September 30, 1996. DIFA addressed the inadequate funding of the Savings Association Insurance Fund (SAIF). In order to recapitalize the SAIF, DIFA imposed a one-time assessment on all thrift institutions. The Bank's assessment was a pretax charge of $2,351,563 and was recognized in the third quarter of 1996. DIFA also addressed the funding for the Financing Corp. (FICO) bonds. Thrifts will pay 6.4 basis points per $100 of deposits from January 1, 1997 to December 31, 1999. From January 1, 2000 until the FICO bonds are retired in 2019, the estimated assessment to retire the FICO bonds is expected to be 2.5 basis points per $100 of deposits. NOTE 15 STOCKHOLDERS' EQUITY HMN was incorporated for the purpose of becoming the savings and loan holding company of the Bank in connection with the Bank's conversion from a federally chartered mutual savings bank to a federally chartered stock savings bank, pursuant to a Plan of Conversion adopted on February 10, 1994. HMN commenced on May 23, 1994, a Subscription and Community Offering of its shares in connection with the conversion of the Bank (the Offering). The Offering was closed on June 22, 1994, and the conversion was consummated on June 29, 1994, with the issuance of 6,085,775 shares of HMN's common stock at a price of $10 per share. Total proceeds from the conversion of $59,178,342 net of costs relating to the conversion of $1,679,408, have been recorded as common stock and additional paid-in capital. HMN received all of the capital stock of the Bank in exchange for 50% of the net proceeds of the conversion. Starting in 1995 and continuing throughout 1997, with Board authorization and approval from the Office of Thrift Supervision (OTS), HMN purchased 298,334 shares during 1997, 869,785 shares during 1996, and 868,336 shares during 1995 of its own common stock from the open market for $5,988,450, $14,364,754 and $12,509,667, respectively. The shares were placed in treasury stock. In June of 1995, 84,486 shares were issued out of treasury stock for restricted stock Retention and Recognition Plan awards. Refer to Note 1 for disclosure of a potential stock split which is subject to approval of the stockholders of HMN at their April 28, 1998 annual meeting. HMN's certificate of incorporation authorized 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 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 account holder 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 account holders are reduced subsequent to the conversion, based on an annual determination of such balance. The liquidation account of MFC was absorbed by the Bank as a result of the acquisition. The Bank may not declare or pay a cash dividend to HMN in excess of 100% of its net income to date during the current calendar year plus the amount that would reduce by one-half the Bank's surplus capital ratio at the beginning of the calendar year without prior notice to the OTS. 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 16 FEDERAL HOME LOAN BANK INVESTMENT, REGULATORY LIQUIDITY 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 is carried at cost, in the Federal Home Loan Bank of Des Moines. In addition, the Bank is required to maintain cash and other liquid assets in an amount equal to 4% of its deposit accounts and other obligations due within one year. The Bank has met these requirements as of December 31, 1997. The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on HMN's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulations to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the following table) of Tangible, Core, and Risk-based capital (as defined in the regulations) to total assets (as defined). Management believes, as of December 31, 1997, that the Bank meets all capital adequacy requirements to which it is subject. HMN FINANCIAL, INC. 41 Management believes that based upon the Bank's capital calculations at December 31, 1997 and other conditions consistent with the Prompt Corrective Actions Provisions of the OTS regulations, the Bank would be categorized as well capitalized. At December 31, 1997 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:
- - --------------------------------------------------------------------------------------------------------- Actual Required -------------------------- ----------------------------- Percent of Percent of (IN THOUSANDS) Amount Assets (1) Amount Assets (1) - - ---------------------------------------------------------------------------------------------------------- Bank stockholder's equity............... $61,081 Plus: Net unrealized loss on certain securities available for sale.................. (375) Less: Goodwill and other intangibles....... 6,047 Excess mortgage servicing rights..... 510 ------- Tangible capital........................ 54,149 8.20% $ 9,909 1.50% ------- Tangible capital to adjusted total assets .............. 8.20% Core capital (Tier I)................... 54,149 8.20% 19,818 3.00% Tier I capital to risk-weighted assets.............................. 17.85% Less: Equity investments and other assets required to be deducted....... 266 Plus: Allowable allowance for loan losses .... 2,747 -------- Risk-based capital...................... $56,630 18.66% $24,274 8.00% -------- -------- - - ----------------------------------------------------------------------------------------------------------------- To Be Well Capitalized Under Prompt Corrective Actions Excess Capital Provisions ------------------------- ---------------------------- Percent of Percent of (IN THOUSANDS) Amount Assets (1) Amount Assets (1) - - ----------------------------------------------------------------------------------------------------------- Bank stockholder's equity............... Plus: Net unrealized loss on certain securities available for sale.................. Less: Goodwill and other intangibles....... Excess mortgage servicing rights..... Tangible capital........................ $44,240 6.70% Tangible capital to adjusted total assets .............. $33,029 5.00% Core capital (Tier I)................... 34,331 5.20% Tier I capital to risk-weighted assets 18,205 6.00% Less: Equity investments and other assets required to be deducted..... Plus: Allowable allowance for loan losses .... Risk-based capital...................... $32,356 10.66% $30,342 10.00%
(1) Based upon the Bank's adjusted total assets for the purpose of the tangible and core capital ratios and risk-weighted assets for the purpose of the risk-based capital ratio. - - ------------------------------------------------------------------------------- NOTE 17 FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK The Bank is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit. 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 Bank. The Bank's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit is represented by the contract amount of these commitments. The Bank uses the same credit policies in making commitments as it does for on-balance sheet instruments.
- - ----------------------------------------------------------------------------------------------------------- Contract amount ------------------------------- (IN THOUSANDS) 1997 1996 - - ----------------------------------------------------------------------------------------------------------- Financial instruments whose contract amount represents credit risk: Commitments to extend credit .............................. $53,681 24,524 Commitment of counter party to purchase loans........................................ 2,201 0 Financial instruments whose contract amount represents interest rate risk: Commitment to purchase limited partnership interest in mortgage loan servicing rights................. 181 2,120 - - ------------------------------------------------------------------------------------------------------------
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 real estate and personal property. Commitments of counter party to purchase loans represents commitments to sell loans to FNMA and are entered into in the normal course of business by the Bank. NOTE 18 FAIR VALUE OF FINANCIAL INSTRUMENTS SFAS No. 107, DISCLOSURES ABOUT FAIR VALUES OF FINANCIAL INSTRUMENTS, requires disclosure of estimated fair values of HMN'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, 1997, and 1996 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 HMN'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. 42 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The estimated fair value of HMN'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, --------------------------------------------------------------------------- 1997 1996 ---------------------------------- -------------------------------------- Carrying Estimated Contract Carrying Estimated Contract (IN THOUSANDS) amount fair value amount amount fair value amount - - -------------------------------------------------------------------------------------------------------------------------- Financial assets: Cash and cash equivalents................ $ 9,365 9,365 10,584 10,584 Securities available for sale............ 205,859 205,859 175,830 175,830 Securities held to maturity.............. 0 0 2,806 2,906 Loans held for sale...................... 2,287 2,287 739 739 Loans receivable, net.................... 442,069 456,012 349,022 358,039 Federal Home Loan Bank stock............. 7,432 7,432 5,434 5,434 Accrued interest receivable.............. 4,038 4,038 3,415 3,415 Financial liabilities: Deposits................................. 467,348 464,670 362,477 358,215 Federal Home Loan Bank advances.......... 127,650 127,147 106,079 105,484 Accrued interest payable................. 1,365 1,365 1,543 1,543 Off-balance sheet financial instruments: Commitments to extend credit............. 0 50 53,681 0 16 24,524 - - ---------------------------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS The carrying amount of cash and cash equivalents approximates their fair value. SECURITIES AVAILABLE FOR SALE AND SECURITIES HELD TO MATURITY The fair values of securities are based upon quoted market prices. LOANS HELD FOR SALE The fair value 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 HMN as of December 31, 1997 and 1996 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 HMN'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. ACCRUED INTEREST PAYABLE The carrying amount of accrued interest payable approximates its fair value since it is short-term in nature. FEDERAL HOME LOAN BANK ADVANCES The fair values of advances payable 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, 1997 and 1996 for borrowings of similar remaining maturities. COMMITMENTS TO EXTEND CREDIT The fair value of commitments to extend credit is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counter parties. HMN FINANCIAL, INC. 43 NOTE 19 HMN FINANCIAL, INC. FINANCIAL INFORMATION (PARENT COMPANY ONLY) The parent company's principal assets are its investment in the Bank and securities. The following are the condensed financial statements for the parent company only as of December 31, 1997 and 1996 and for the years ended December 31, 1997, 1996 and 1995.
1997 1996 1995 - - ----------------------------------------------------------------------------------------------------------------------------------- CONDENSED BALANCE SHEET ASSETS: Cash and cash equivalents......................................................... $ 944,925 3,655,598 Securities available for sale..................................................... 14,287,978 10,187,092 Loans receivable from subsidiaries................................................ 7,050,570 7,334,000 Investment in subsidiaries........................................................ 62,278,302 61,458,395 Investment in limited partnership................................................. 480,871 0 Accrued interest receivable....................................................... 67,883 215,959 Prepaid expenses and other assets................................................. 11,615 17,950 ----------- ----------- Total assets................................................................... $85,122,144 82,868,994 ----------- ----------- ----------- ----------- LIABILITIES AND STOCKHOLDERS' EQUITY: Accrued expenses and other liabilities............................................ $ 651,734 769,550 ----------- ----------- Total liabilities.............................................................. 651,734 769,550 ----------- ----------- Serial preferred stock............................................................ 0 0 Common stock...................................................................... 60,858 60,858 Additional paid-in capital........................................................ 59,729,090 59,428,768 Retained earnings................................................................. 60,224,253 54,645,387 Net unrealized loss on securities available for sale.............................. 1,129,818 (598,045) Unearned employee stock option plan shares........................................ (4,554,280) (4,938,520) Unearned compensation restricted stock awards..................................... (600,668) (793,289) Treasury stock, at cost, 1,941,407 and 1,651,615 shares........................... (31,518,661) (25,705,715) ----------- ----------- Total stockholders' equity..................................................... 84,470,410 82,099,444 ----------- ----------- Total liabilities and stockholders' equity........................................ $85,122,144 82,868,994 ----------- ----------- ----------- ----------- CONDENSED STATEMENT OF INCOME Interest income................................................................... $ 1,071,818 1,105,218 1,474,107 Interest expense.................................................................. (13,515) (4,943) (1,083) Securities gains, net............................................................. 644,278 229,002 53,058 Equity in earnings of subsidiaries................................................ 4,512,080 3,565,441 4,755,138 Equity in earnings of limited partnership......................................... (19,129) 0 0 Compensation and benefits......................................................... (17,494) (17,233) (21,775) Occupancy......................................................................... (6,604) (6,868) (6,353) Advertising....................................................................... (159) (670) (276) Data processing................................................................... (1,355) (1,271) (1,200) Other............................................................................. (477,030) (475,127) (380,039) ----------- ----------- ---------- Income before income tax expense............................................... 5,692,890 4,393,549 5,871,577 Income tax expense................................................................ 114,024 119,200 251,200 ----------- ----------- ---------- Net income....................................................................... $ 5,578,866 4,274,349 5,620,377 ----------- ----------- ---------- CONDENSED STATEMENT OF CASH FLOWS Cash flows from operating activities: Net income....................................................................... $ 5,578,866 4,274,349 5,620,377 Adjustments to reconcile net income to cash provided by operating activities: Equity in earnings of subsidiaries............................................ (4,512,080) (3,565,441) (4,755,138) Equity in earnings of limited partnership..................................... 19,129 0 0 Amortization of premiums (discounts), net..................................... (349) 9,727 (21,328) Securities gains, net......................................................... (644,278) (229,002) (53,058) Provision for deferred income taxes........................................... (800) (1,400) (2,500) Earned employee stock ownership shares priced above original cost............. 298,237 141,135 93,267 Decrease in restricted stock awards........................................... 231,621 231,048 116,700 Decrease in unearned ESOP shares.............................................. 384,240 397,630 409,730 (Increase) decrease in accrued interest receivable............................ 148,076 (63,071) 76,510 Increase (decrease) in accrued expenses and other liabilities................. (165,370) 172,831 (81,860) Decrease (increase) in other assets........................................... 6,335 143,321 (75,550) Other, net.................................................................... 65,035 9,737 0 ----------- ----------- ---------- Net cash provided by operating activities.................................. 1,408,662 1,520,864 1,327,150 ----------- ----------- ---------- Cash flows from investing activities: Proceeds from sales of securities available for sale............................. 9,384,529 5,412,430 8,523,675 Principal collected on securities available for sale............................. 0 5,027,241 1,624,106 Proceeds collected on maturity of securities available for sale.................. 4,018,412 1,500,000 4,000,000 Purchases of securities available for sale....................................... (15,900,938) (5,449,176) (7,754,954) Purchase of Security Finance Corporation stock................................... 0 0 (388,762) Investment in Home Federal Savings Bank.......................................... (1,016,063) 0 0 Investment in HMN Mortgage Services, Inc......................................... (844,500) (250,000) 0 Investment in limited partnership................................................ (500,000) 0 0 Net increase (decrease) in loans receivable from subsidiaries.................... 283,430 (7,334,000) 0 ----------- ----------- ---------- Net cash provided (used) by investing activities.............................. (4,575,130) (1,093,505) 6,004,065 ----------- ----------- ---------- Cash flows from financing activities: Purchase of treasury stock....................................................... (6,350,950) (14,002,254) 12,509,667) Stock options exercised.......................................................... 56,745 52,363 0 Proceeds from dividends on Bank stock............................................ 6,750,000 15,600,000 4,000,000 ----------- ----------- ---------- Net cash provided (used) by financing activities.............................. 455,795 1,650,109 (8,509,667) ----------- ----------- ---------- Increase (decrease) in cash and cash equivalents.............................. (2,710,673) 2,077,468 (1,178,452) Cash and cash equivalents, beginning of year........................................ 3,655,598 1,578,130 2,756,582 ----------- ----------- ---------- Cash and cash equivalents, end of year.............................................. $ 944,925 3,655,598 1,578,130 ----------- ----------- ---------- ----------- ----------- ----------
44 INDEPENDENT AUDITOR'S REPORT [LOGO] THE BOARD OF DIRECTORS HMN FINANCIAL, INC. SPRING VALLEY, MINNESOTA We have audited the accompanying consolidated balance sheets of HMN Financial, Inc. and Subsidiaries (the Company) as of December 31, 1997 and 1996, and the related consolidated statements of income, stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 1997. 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 generally accepted auditing standards. 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 at December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1997, in conformity with generally accepted accounting principles. /S/ KPMG PEAT MARWICK LLP MINNEAPOLIS, MINNESOTA FEBRUARY 4, 1998, EXCEPT FOR NOTE 1, WHICH IS AS OF FEBRUARY 19, 1998 HMN FINANCIAL, INC. 45 SELECTED QUARTERLY FINANCIAL DATA
DECEMBER 31, SEPTEMBER 30, JUNE 30, (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) 1997 1997 1997 - - --------------------------------------------------------------------------------------------------------------------------------- Selected Operations Data (3 MONTHS ENDED): Interest income................................................................. $ 10,706 10,314 10,166 Interest expense................................................................ 6,857 6,464 6,297 -------- ------ ------ Net interest income............................................................ 3,849 3,850 3,869 Provision for loan losses....................................................... 75 75 75 -------- ------ ------ Net interest income after provision for loan losses............................ 3,774 3,775 3,794 -------- ------ ------ Noninterest income: Fees and service charges....................................................... 169 122 100 Securities gains, net.......................................................... 377 488 114 Gain on sales of loans......................................................... 135 117 64 Other noninterest income....................................................... 59 152 128 -------- ------ ------ Total noninterest income...................................................... 740 879 406 -------- ------ ------ Noninterest expense: Compensation and benefits...................................................... 1,484 1,432 1,359 Occupancy...................................................................... 264 245 232 Federal deposit insurance premiums............................................. 63 58 59 SAIF assessment................................................................ 0 0 0 Advertising.................................................................... 101 63 74 Data processing................................................................ 137 129 119 Provision for real estate losses............................................... 15 0 1 Other noninterest expense...................................................... 488 302 283 -------- ------ ------ Total noninterest expense..................................................... 2,552 2,229 2,127 -------- ------ ------ Income before income tax expense............................................... 1,962 2,425 2,073 Income tax expense.............................................................. 714 901 740 -------- ------ ------ -------- ------ ------ Net income..................................................................... $ 1,248 1,524 1,333 -------- ------ ------ -------- ------ ------ Basic earnings per share........................................................ $ 0.34 0.41 0.36 -------- ------ ------ -------- ------ ------ Diluted earnings per share...................................................... $ 0.31 0.38 0.34 -------- ------ ------ -------- ------ ------ Financial Ratios: Return on average assets(1)..................................................... 0.84% 1.06 0.95 Return on average equity(1)..................................................... 6.09 7.29 6.58 Average equity to average assets................................................ 14.36 14.55 14.55 Net interest margin(1)(2)....................................................... 2.60 2.76 2.83 (DOLLARS IN THOUSANDS) - - --------------------------------------------------------------------------------------------------------------------------------- Selected Financial Condition Data: Total assets.................................................................... $691,232 568,847 566,865 Securities available for sale: Mortgage-backed and related securities......................................... 135,936 111,117 115,016 Other marketable securities.................................................... 69,923 72,815 73,860 Securities held to maturity: Mortgage-backed and related securities......................................... 0 0 0 Other marketable securities.................................................... 0 0 0 Loans held for sale............................................................. 2,287 2,090 1,205 Loans receivable, net........................................................... 442,069 352,925 345,516 Deposits........................................................................ 467,348 366,682 365,385 Federal Home Loan Bank advances................................................. 127,650 112,007 114,364 Stockholders' equity............................................................ 84,470 84,619 81,798 - - ---------------------------------------------------------------------------------------------------------------------------------
(1) Annualized (2) Net interest income divided by average interest-earning assets. 46
MARCH 31, DECEMBER 31, SEPTEMBER 30, (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) 1997 1996 1996 - - ------------------------------------------------------------------------------------------------------------------------------ Selected Operations Data (3 MONTHS ENDED): Interest income................................................................. 9,903 10,111 10,014 Interest expense................................................................ 6,024 6,174 6,191 ----- ------ ------ Net interest income............................................................ 3,879 3,937 3,823 Provision for loan losses....................................................... 75 75 75 ----- ------ ------ Net interest income after provision for loan losses............................ 3,804 3,862 3,748 ----- ------ ------ Noninterest income: Fees and service charges....................................................... 96 105 95 Securities gains, net.......................................................... 271 68 192 Gain on sales of loans......................................................... 153 22 10 Other noninterest income....................................................... 178 129 115 ----- ------ ------ Total noninterest income...................................................... 698 324 412 ----- ------ ------ Noninterest expense: Compensation and benefits...................................................... 1,316 1,211 1,176 Occupancy...................................................................... 241 230 203 Federal deposit insurance premiums............................................. 59 163 212 SAIF assessment................................................................ 0 0 2,352 Advertising.................................................................... 78 79 77 Data processing................................................................ 125 121 119 Provision for real estate losses............................................... 2 2 0 Other noninterest expense...................................................... 294 341 256 ----- ------ ------ Total noninterest expense..................................................... 2,115 2,147 4,395 ----- ------ ------ Income before income tax expense............................................... 2,387 2,039 (235) Income tax expense.............................................................. 913 740 (90) ----- ------ ------ ----- ------ ------ Net income..................................................................... 1,474 1,299 (145) ----- ------ ------ ----- ------ ------ Basic earnings per share........................................................ 0.40 0.32 (0.04) ----- ------ ------ ----- ------ ------ Diluted earnings per share...................................................... 0.38 0.31 (0.04) ----- ------ ------ ----- ------ ------ Financial Ratios: Return on average assets(1)..................................................... 1.09 0.93 (0.10) Return on average equity(1)..................................................... 7.43 6.06 (0.67) Average equity to average assets................................................ 14.65 15.32 15.48 Net interest margin(1)(2)....................................................... 2.92 2.86 2.77 (DOLLARS IN THOUSANDS) - - ------------------------------------------------------------------------------------------------------------------------------ Selected Financial Condition Data: Total assets.................................................................... 553,021 554,732 565,385 Securities available for sale: Mortgage-backed and related securities......................................... 123,925 133,355 135,191 Other marketable securities.................................................... 56,224 42,475 52,516 Securities held to maturity: Mortgage-backed and related securities......................................... 0 1,806 2,338 Other marketable securities.................................................... 0 1,000 1,000 Loans held for sale............................................................. 1,061 739 0 Loans receivable, net........................................................... 341,104 349,022 343,736 Deposits........................................................................ 364,123 362,477 363,963 Federal Home Loan Bank advances................................................. 105,721 106,079 101,833 Stockholders' equity............................................................ 78,772 82,099 83,669 - - ------------------------------------------------------------------------------------------------------------------------------ JUNE 30, MARCH 31, (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) 1996 1996 - - ------------------------------------------------------------------------------------------------------------ Selected Operations Data (3 MONTHS ENDED): Interest income................................................................. 9,944 9,795 Interest expense................................................................ 5,949 5,880 ----- ----- Net interest income............................................................ 3,995 3,915 Provision for loan losses....................................................... 75 75 ----- ----- Net interest income after provision for loan losses............................ 3,920 3,840 ----- ----- Noninterest income: Fees and service charges....................................................... 82 77 Securities gains, net.......................................................... 268 501 Gain on sales of loans......................................................... 1 6 Other noninterest income....................................................... 134 117 ----- ----- Total noninterest income...................................................... 485 701 ----- ----- Noninterest expense: Compensation and benefits...................................................... 1,099 1,106 Occupancy...................................................................... 195 197 Federal deposit insurance premiums............................................. 215 210 SAIF assessment................................................................ 0 0 Advertising.................................................................... 79 73 Data processing................................................................ 121 128 Provision for real estate losses............................................... 0 0 Other noninterest expense...................................................... 275 269 ----- ----- Total noninterest expense..................................................... 1,984 1,983 ----- ----- Income before income tax expense............................................... 2,421 2,558 Income tax expense.............................................................. 888 972 ----- ----- ----- ----- Net income..................................................................... 1,533 1,586 ----- ----- ----- ----- Basic earnings per share........................................................ 0.34 0.34 ----- ----- ----- ----- Diluted earnings per share...................................................... 0.33 0.33 ----- ----- ----- ----- Financial Ratios: Return on average assets(1)..................................................... 1.13 1.18 Return on average equity(1)..................................................... 6.77 6.91 Average equity to average assets................................................ 16.64 17.09 Net interest margin(1)(2)....................................................... 2.98 2.97 (DOLLARS IN THOUSANDS) - - ----------------------------------------------------------------------------------------------------------- Selected Financial Condition Data: Total assets.................................................................... 554,979 542,012 Securities available for sale: Mortgage-backed and related securities......................................... 148,706 163,273 Other marketable securities.................................................... 40,442 32,245 Securities held to maturity: Mortgage-backed and related securities......................................... 13,835 14,115 Other marketable securities.................................................... 999 3,227 Loans held for sale............................................................. 0 0 Loans receivable, net........................................................... 331,650 307,658 Deposits........................................................................ 363,195 368,393 Federal Home Loan Bank advances................................................. 101,053 72,493 Stockholders' equity............................................................ 87,263 90,879 - - -----------------------------------------------------------------------------------------------------------
HMN FINANCIAL, INC. 47 OTHER FINANCIAL DATA The following table sets forth the maximum month-end balance and average balance of FHLB advances.
- - --------------------------------------------------------------------------------------------------------------- Year Ended December 31, ---------------------------------------- (DOLLARS IN THOUSANDS) 1997 1996 1995 - - --------------------------------------------------------------------------------------------------------------- Maximum Balance: Federal Home Loan Bank advances............................ $128,007 106,436 74,534 Federal Home Loan Bank short-term borrowings............... 60,429 64,429 42,429 Average Balance: Federal Home Loan Bank advances............................ 112,500 89,656 65,069 Federal Home Loan Bank short-term borrowings............... 45,598 47,949 20,812 - - ---------------------------------------------------------------------------------------------------------------
The following table sets forth certain information as to the Bank's FHLB advances.
- - ---------------------------------------------------------------------------------------------------------------------------------- December 31, ------------------------------------------------------------------------------ 1997 1996 1995 ------------------------- ------------------- -------------------- Weighted Weighted Weighted Average Average Average (DOLLARS IN THOUSANDS) Amount Rate Amount Rate Amount Rate - - ---------------------------------------------------------------------------------------------------------------------------------- Federal Home Loan Bank short-term borrowings...... $ 43,250 5.85% 46,429 5.52% 33,429 6.05% Other Federal Home Loan Bank long-term advances... 84,400 5.77 59,650 5.74 35,448 5.91 -------- ------- ------- Total............................................. $127,650 5.80 106,079 5.64 68,877 5.98 -------- ------- ------- -------- ------- ------- - - -----------------------------------------------------------------------------------------------------------------------------------
Refer to Note 11 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. The common stock outstanding is 6,085,775 shares, of which 1,941,407 shares are in treasury stock at December 31, 1997. As of December 31, 1997, there are 800 stockholders of record and 1,500 estimated beneficial stockholders. The following table represents the stock price information for HMN Financial, Inc. as furnished by Nasdaq for each quarter starting in 1995 through December 31, 1997.
- - ------------------------------------------------------------------------------------------------------------ March 31, June 30, Sept. 29, Dec. 29, March 29, June 28, Sept. 30, Dec. 31, March 31, 1995 1995 1995 1995 1996 1996 1996 1996 1997 ------------------------------------------------------------------------------------------ High.......... $13.50 14.00 15.62 16.00 14.62 16.50 16.00 18.12 24.75 Low .......... 12.37 13.25 14.62 15.12 14.62 16.00 16.00 18.00 18.00 Close ........ 12.75 13.62 15.25 16.00 14.62 16.50 16.00 18.12 20.05 - - ------------------------------------------------------------------------------------------------------------ - - --------------------------------------------- June 30, Sept. 30, Dec. 31, 1997 1997 1997 ---------------------------- High.......... 24.38 26.00 32.50 Low .......... 18.63 21.88 24.25 Close ........ 23.00 24.75 32.50 - - ---------------------------------------------
48 CORPORATE AND SHAREHOLDER INFORMATION HMN FINANCIAL, INC. 101 North Broadway Spring Valley, MN 55975-0231 (507) 346-1100 ANNUAL MEETING The annual meeting of shareholders will be held on Tuesday, April 28, 1998 at 10:00 a.m. (Central Time) at the Best Western Apache Hotel, 1517 16th St. S.W., Rochester, Minnesota. LEGAL COUNSEL Faegre & Benson LLP 2200 Norwest Center 90 South Seventh St. Minneapolis, MN 55402-3901 INDEPENDENT AUDITORS KPMG Peat Marwick LLP 4200 Norwest Center 90 South Seventh St. Minneapolis, MN 55402-3900 INVESTOR INFORMATION AND FORM 10-K Additional information and HMN's Form 10-K, filed with the Securities and Exchange Commission, is available without charge upon request from: HMN Financial, Inc. Attn: Investor Relations 101 North Broadway Spring Valley, MN. 55975-0231 TRANSFER AGENT & REGISTRAR Inquiries regarding change of address, transfer requirements, and lost certificates should be directed to the transfer agent. First National Bank of Boston c/o Boston Equiserve P.O. Box 8040 Boston, MA 02266-8040 (617) 575-3170 DIRECTORS ROGER P. WEISE CHAIRMAN OF THE BOARD PRESIDENT AND CHIEF EXECUTIVE OFFICER JAMES B. GARDNER EXECUTIVE VICE PRESIDENT AND CHIEF FINANCIAL OFFICER IRMA R. RATHBUN RETIRED VICE PRESIDENT OF HOME FEDERAL SAVINGS BANK M.F. SCHUMANN LICENSED PUBLIC ACCOUNTANT SCHUMANN, GRANAHAN, HESSE & WILSON LTD. TIMOTHY R. GEISLER MANAGER, CORPORATE TAX UNIT MAYO CLINIC, ROCHESTER, MN DUANE D. BENSON EXECUTIVE DIRECTOR MINNESOTA BUSINESS PARTNERSHIP EXECUTIVE OFFICERS ROGER P. WEISE PRESIDENT AND CHIEF EXECUTIVE OFFICER JAMES B. GARDNER EXECUTIVE VICE PRESIDENT AND CHIEF FINANCIAL OFFICER DWAIN C. JORGENSEN VICE PRESIDENT AND CONTROLLER SUSAN K. KOLLING SENIOR VICE PRESIDENT ROXANNE M. HELLICKSON VICE PRESIDENT AND CORPORATE SECRETARY TIMOTHY P. JOHNSON VICE PRESIDENT AND TREASURER BRANCH OFFICES ALBERT LEA 143 West Clark Street Albert Lea, MN 56007 (507) 377-3330 AUSTIN 201 Oakland Avenue West Austin, MN 55912 (507) 433-2355 LACRESCENT 208 South Walnut LaCrescent, MN 55947 (507) 895-4090 MARSHALLTOWN 303 West Main Street Marshalltown, IA 50158 (515) 754-6000 29 South Center St. Marshalltown, IA 50158 (515) 754-6040 ROCHESTER Crossroads Shopping Center Rochester, MN 55901 (507) 289-4025 1110 6th Street NW Rochester, MN 55901 (507) 285-1707 SPRING VALLEY 715 North Broadway Spring Valley, MN 55975 (507) 346-7345 TOLEDO 119 West High St. Toledo, IA 52342 (515) 484-5141 WINONA 4th and Center Winona, MN 55987 (507) 454-4912 EDEN PRAIRIE Mortgage Banking Office 9973 Valley View Road Eden Prairie, MN 55344 (612) 914-7440 BROOKLYN PARK Mortgage Banking Office 7101 Northland Circle, Suite 105 Brooklyn Park, MN 55427 (612) 533-2500 HMN FINANCIAL, INC. AND HOME FEDERAL SAVINGS BANK ARE HEADQUARTERED IN SPRING VALLEY, MINNESOTA. HOME FEDERAL SAVINGS BANK OPERATES SEVEN FULL-SERVICE BANKING FACILITIES IN SOUTHERN MINNESOTA AND THREE IN IOWA. IN ADDITION, THE COMPANY HAS MORTGAGE BANKING OFFICES IN EDEN PRAIRIE AND BROOKLYNPARK, SUBURBS OF MINNEAPOLIS, MINNESOTA. TABLE OF CONTENTS FINANCIAL HIGHLIGHTS........................................................ 1 PRESIDENT'S LETTER TO SHAREHOLDERS AND CUSTOMERS............................ 2 GROWING WITH OUR COMMUNITIES................................................ 4 GROWING OUR FACILITIES TO MEET CUSTOMER NEEDS .............................. 8 CORPORATE VALUES............................................................ 9 FIVE-YEAR CONSOLIDATED FINANCIAL HIGHLIGHTS ................................11 MANAGEMENT'S DISCUSSION AND ANALYSIS........................................12 CONSOLIDATED FINANCIAL STATEMENTS ..........................................27 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS..................................31 AUDITORS' REPORT............................................................45 SELECTED QUARTERLY FINANCIAL DATA ..........................................46 OTHER FINANCIAL DATA........................................................48 COMMON STOCK INFORMATION....................................................48 CORPORATE AND SHAREHOLDER INFORMATION....................... INSIDE BACK COVER DIRECTORS AND OFFICERS...................................... INSIDE BACK COVER EX-21 4 EXHIBIT 21 Subsidiaries of Registrant Exhibit 21
Date and % of Voting Shares, Partnership Interests, Voting Year & Trust Certificates, State Capital Description of Name & Address Inc. Contributions Activity -------------- ------ ------------------ ------------------- Home Federal Savings Bank 1934 6/29/94 Federally Chartered 101 North Broadway MN HMN owns 100% of Stock Savings Bank Spring Valley, MN 55975 voting shares Osterud Insurance Agency, Inc. 1983 Bank owns 100% Offers credit life 101 North Broadway MN and annuity products Spring Valley, MN 55975 to the Bank's customers and others MSL Financial Corporation 1983 Bank owns 100% Offered annuity 101 North Broadway IA products to Spring Valley, MN 55975 Marshalltown Financial Security Finance Corporation 1929 12/29/95 Corporation invests 101 North Broadway MN HMN owns 100% of in securities and Spring Valley, MN 55975 voting shares loans HMN Mortgage Services, Inc. 1996 7/08/96 Mortgage Banking/ 9973 Valley View Road MN HMN owns 100% of Brokerage Office Eden Prairie, MN 55344 voting shares
EX-23 5 EXHIBIT 23 KPMG Peat Marwick LLP 4200 Norwest Center 90 South Seventh Street Minneapolis, MN 55402 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS The Board of Directors HMN Financial, Inc.: We consent to incorporation by reference of our report dated February 4, 1998, except for Note 1, which is as of February 19, 1998, relating to the consolidated balance sheets of HMN Financial, Inc. as of December 31, 1997 and 1996, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1997, which report appears in the December 31, 1997 Annual Report on Form 10-K of HMN Financial, Inc. in the following Registration Statements of HMN Financial, Inc.: Nos. 33-88228, 33-94388, and 33-94386 on Form S-8. /s/ KPMG Peat Marwick LLP KPMG PEAT MARWICK LLP Minneapolis, Minnesota March 26, 1998 56 EX-27.1 6 EXHIBIT 27.1
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED BALANCE SHEET AT DECEMBER 31, 1997 AND THE CONSOLIDATED STATEMENT OF INCOME FOR THE YEAR ENDED DECEMBER 31, 1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STAEMENTS. 1,000 YEAR DEC-31-1997 JAN-01-1997 DEC-31-1997 9,365 205,859 447,104 2,748 0 262,803 9,453 3,572 691,232 366,426 0 0 0 61 84,409 691,232 0 43,813 0 34,666 0 300 0 8,847 3,268 0 0 0 0 5,579 1.51 1.41
EX-27.2 7 EXHIBIT 27.2
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED BALANCE SHEETS AT SEPTEMBER 30, JUNE 30, AND MARCH 31, 1997 AND THE CONSOLIDATED STATEMENTS OF INCOME FOR THE NINE, SIX, AND THREE MONTHS ENDED SEPTEMBER 30, JUNE 30, AND MARCH 31, 1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 9-MOS 6-MOS 3-MOS DEC-31-1997 DEC-31-1997 DEC-31-1997 JAN-01-1997 JAN-01-1997 JAN-01-1997 SEP-30-1997 JUN-30-1997 MAR-31-1997 9,636 11,570 12,754 183,932 188,876 180,148 357,569 347,996 344,588 2,554 2,479 2,423 0 0 0 187,891 178,569 178,137 7,334 7,088 6,867 3,104 2,997 2,906 568,847 566,865 553,021 285,847 272,474 263,353 0 0 0 0 0 0 0 0 0 61 61 61 84,558 81,737 78,711 568,847 566,865 553,021 0 0 0 32,366 21,173 10,602 0 0 0 25,256 16,563 8,139 0 0 0 225 150 75 0 0 0 6,885 4,460 8,388 2,554 1,654 913 0 0 0 0 0 0 0 0 0 0 0 0 4,331 2,807 1,474 1.17 .76 .40 1.10 .72 .38
EX-27.3 8 EXHIBIT 27.3
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED BALANCE SHEETS AT DECEMBER 31, SEPTEMBER 30, JUNE 30, AND MARCH 31, 1996 AND THE CONSOLIDATED STATEMENTS OF INCOME FOR THE TWELVE, NINE, SIX, AND THREE MONTHS ENDED DECEMBER 31, SEPTEMBER 30, JUNE 30, AND MARCH 31, 1996 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 YEAR 9-MOS 6-MOS 3-MOS DEC-31-1996 DEC-31-1996 DEC-31-1996 DEC-31-1996 JAN-01-1996 JAN-01-1996 JAN-01-1996 JAN-01-1996 DEC-31-1996 SEP-30-1996 JUN-30-1996 MAR-31-1996 10,584 17,397 5,942 9,376 178,636 191,044 203,981 212,859 352,103 346,002 333,989 309,922 2,341 2,266 2,339 2,264 0 0 0 0 202,634 215,988 227,103 171,669 6,397 6,258 6,174 6,112 2,816 2,714 2,636 2,550 554,732 565,385 554,979 542,012 259,882 252,827 250,594 242,148 0 0 0 0 0 0 0 0 0 0 0 0 61 61 61 61 82,039 83,608 87,202 90,818 554,732 565,385 554,979 542,012 0 0 0 0 41,787 31,353 20,926 10,497 0 0 0 0 34,703 26,382 15,796 7,863 0 0 0 0 300 225 150 75 0 0 0 0 6,784 4,745 4,980 2,559 2,510 1,770 1,860 972 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 4,274 2,975 3,120 1,587 .99 .68 .69 .34 .96 .66 .67 .33
EX-27.4 9 EXHIBIT 27.4
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED BALANCE SHEET AT DECEMBER 31, 1995 AND THE CONSOLIDATED STATEMENTS OF INCOME FOR THE TWELVE MONTHS ENDED DECEMBER 31, 1995 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 YEAR DEC-31-1995 JAN-01-1997 DEC-31-1995 4,335 207,292 317,292 2,191 0 215,499 6,105 2,460 537,949 253,583 0 0 0 61 91,626 537,949 0 39,326 0 30,025 0 300 0 9,001 3,381 0 0 0 0 5,620 1.10 1.09
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