NOTE

Employee Benefits

All eligible full-time employees of the Bank that were hired prior to

2002

were included in a noncontributory retirement plan sponsored by the Financial Institutions Retirement Fund (FIRF). The Home Federal Savings Bank (Employer

#8006

) plan participates in the Pentegra Defined Benefit Plan for Financial Institutions (the Pentegra DB Plan). The Pentegra DB Plan’s Employer Identification Number is

5645888

and the Plan number is

333.

The Pentegra DB Plan operates as a multi-employer plan for accounting purposes under the Employee Retirement Income Security Act of

1974,

as amended (ERISA), and the Internal Revenue Code. There are

collective bargaining agreements in place that require contributions to the Pentegra DB Plan.

The Pentegra DB Plan is a single plan under Internal Revenue Code Section

413

(c) and, as a result, all of the assets stand behind all of the liabilities. Accordingly, under the Pentegra DB Plan, contributions made by a participating employer

may

be used to provide benefits to participants of other participating employers.

Effective

September 1, 2002,

the accrual of benefits for existing participants was frozen and

new enrollments have been permitted into the plan. The actuarial present value of accumulated plan benefits and net assets available for benefits relating to the Bank's employees was

not

available at

December 31, 2018

because such information is

not

accumulated for each participating institution. As of

June 30, 2018,

the Pentegra DB Plan valuation report reflected that the Bank was obligated to make a contribution totaling

$0.1

million which was paid and expensed in

2018.

Funded status (market value of plan assets divided by funding target) as of

July 1

for the

2018,

2017,

and

2016

plan years were

89.86%,

95.45%,

and

97.09%,

respectively. Market value of plan assets reflects contributions received through

June 30, 2018.

Total employer contributions made to the Pentegra DB Plan, as reported on Form

5500,

equal

$367.1

million,

$153.2

million, and

$163.1

for the plan years ended

June 30, 2017,

2016

and

2015,

respectively. The Bank’s contributions to the Pentegra DB Plan are

not

more than

of the total contributions to the Pentegra DB Plan. There is

funding improvement plan or rehabilitation plan as part of this multi-employer plan.

The following contributions were paid by the Bank during the fiscal years ending

December 31:

(Dollars in thousands)
2018			2017				2016
Date Paid	Amount		Date Paid		Amount		Date Paid	Amount
	$	0	01/06/2017	(1)	$	119		$	0
10/11/2018		26	10/15/2017			27	10/15/2016		33
12/27/2018		92	12/27/2017			99			0
Total	$	118			$	245		$	33

(

)

The contribution relates to the

2016

plan year and was accrued at

December 31, 2016.

The Company has a qualified, tax-exempt savings plan with a deferred feature qualifying under Section

401

(k) of the Internal Revenue Code (the

401

(k) Plan). All employees who have attained

years of age are eligible to participate in the

401

(k) Plan. Participants are permitted to make contributions to the

401

(k) Plan equal to the lesser of

50%

of their annual salary or the maximum allowed by law, which was

$18,500

for

2018

and

$18,000

for

2017

and

2016.

The Company matches

25%

of each participant’s contributions up to a maximum of

of their annual salary. Participant contributions and earnings are fully and immediately vested. The Company’s contributions are vested on a

three

year cliff basis, are expensed annually, and were

$0.2

million in

2018,

2017

and

2016.

The Company has adopted an Employee Stock Ownership Plan (the ESOP) that meets the requirements of Section

4975

(e)(

) of the Internal Revenue Code and Section

407

(d)(

) of ERISA and, as such, the ESOP is empowered to borrow in order to finance purchases of the common stock of HMN. The ESOP borrowed

$6.1

million from the Company to purchase

912,866

shares of common stock in the initial public offering of HMN in

1994.

As a result of a merger with Marshalltown Financial Corporation (MFC), the ESOP borrowed

$1.5

million in

1998

to purchase an additional

76,933

shares of HMN common stock to account for the additional employees and to avoid dilution of the benefit provided by the ESOP. The ESOP debt requires quarterly payments of principal plus interest at

7.52%.

The Company has committed to make quarterly contributions to the ESOP necessary to repay the loans including interest. The Company contributed

$0.5

million in

2018,

2017

and

2016.

As the debt is repaid, ESOP shares that were pledged as collateral for the debt are released from collateral based on the proportion of debt service paid in the year and then allocated to eligible employees. The Company accounts for its ESOP in accordance with ASU

718,

Employers' Accounting for Employee Stock Ownership Plans

. Accordingly, the shares pledged as collateral are reported as unearned ESOP shares in stockholders' equity. As shares are determined to be ratably released from collateral, the Company reports compensation expense equal to the current market price of the shares and the shares become outstanding for earnings per common share computations. ESOP compensation expense was

$0.5

million for

2018,

$0.4

million for

2017

and

$0.3

million for

2016.

All employees of the Bank are eligible to participate in the ESOP after they attain age

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

December 31:

	2018			2017			2016
Shares held by participants beginning of the year		357,135			339,870			334,277
Shares allocated to participants		24,317			24,317			24,377
Shares distributed to participants		(41,215	)		(7,052	)		(18,784	)
Shares held by participants end of year		340,237			357,135			339,870

Unreleased shares beginning of the year		255,429			279,746			304,123
Shares released during year		(24,317	)		(24,317	)		(24,377	)
Unreleased shares end of year		231,112			255,429			279,746
Total ESOP shares end of year		571,349			612,564			619,616
Fair value of unreleased shares at December 31	$	4,534,417			4,878,694			4,895,555

April 2009

the HMN Financial, Inc.

2009

Equity and Incentive Plan (

2009

Plan) was adopted by the Company. In

April 2017,

the

2009

Plan was superseded by the HMN Financial, Inc.

2017

Equity Incentive Plan (

2017

Plan) and options or restricted shares were

longer awarded from the

2009

Plan. As of

December 31, 2018

there were

22,819

vested and

11,410

unvested options outstanding under the

2009

Plan. These options expire

years from the date of grant and have an average exercise price of

$11.21.

There were also

7,340

shares of restricted stock previously granted to current employees under the

2009

Plan that as of

December 31, 2018

remained unvested.

The purpose of the

2017

Plan is to attract and retain the best available personnel for positions of responsibility with the Company, to provide additional incentives to them and align their interests with those of the Company’s stockholders, and to thereby promote the Company’s long-term business success.

375,000

shares of HMN common stock were initially available for distribution under the

2017

Plan in either restricted stock or options, subject to adjustment for future stock splits, stock dividends and similar changes to capitalization of the Company. Additionally, shares of restricted stock that are awarded are counted as

1.5

shares for purposes of determining the total shares available for issuance under the

2017

Plan. As of

December 31, 2018,

there were

options outstanding under the

2017

Plan. There were

7,224

shares of restricted stock previously granted to current employees under the

2017

Plan that remained unvested at

December 31, 2018.

A summary of activities under all plans for the past

three

years is as follows:

												Unvested options
	Shares Available For Grant			Unvested Restricted Shares Outstanding			Options Outstanding			Award Value/ Weighted Average Exercise Price		Number			Weighted Average Grant Date Fair Value		Vesting Period (in years)
2009 Plan
December 31, 2015		96,341			38,886			15,000		$	4.77		0
Granted January 26, 2016		(4,087	)		3,406			0			N/A		0				3
Granted January 26, 2016		(34,229	)		0			34,229			11.21		34,229		$	4.04	3
Granted April 26, 2016		(3,149	)		2,624			0			N/A		0				1
Vested		0			(24,320	)		0			N/A		0
December 31, 2016		54,876			20,596			49,229		$	9.25		34,229		$	4.04
Granted January 31, 2017		(11,164	)		9,303			0			N/A						3
Transferred to 2017 Plan		(43,712	)		0			0			N/A
Vested		0			(15,018	)		0			N/A		(11,409	)		4.04
December 31, 2017		0			14,881			49,229		$	9.25		22,820		$	4.04
Options Exercised		0			0			(15,000	)
Vested		0			(7,541	)		0			N/A		(11,410	)		4.04
December 31, 2018		0			7,340			34,229		$	11.21		11,410		$	4.04

2017 Plan
April 25, 2017		375,000			0			0
Granted May 5, 2017		(3,420	)		2,280			0			N/A						1
Transferred from 2009 Plan		43,712			0			0			N/A		0
December 31, 2017		415,292			2,280			0			N/A		0
Granted January 23, 2018		(10,044	)		6,696			0			N/A						3
Granted April 24, 2018		(792	)		528			0			N/A						1
Vested		0			(2,280	)		0			N/A		0
December 31, 2018		404,456			7,224			0			N/A		0

Total all plans		404,456			14,564			34,229		$	11.21		11,410		$	4.04

The following table summarizes information about stock options outstanding at

December 31, 2018:

(Dollars in thousands) Date of Grant	Exercise Price		Number Outstanding		Weighted Average Remaining Contractual Life in Years		Number Exercisable		Number Unexercisable		Unrecognized Compensation Expense		Weighted Average Years Over Which Unrecognized Compensation will be Recognized
January 26, 2016	$	11.21		34,229		7.1		22,819		11,410	$	1,165		0.1
				34,229				22,819		11,410	$	1,165

The Company will issue shares from treasury stock upon the exercise of outstanding options.

In accordance with ASC

718,

the Company recognizes compensation expense relating to stock options over the vesting period. The amount of the expense was determined under the fair value method. The fair value for each option grant is estimated on the date of the grant using the Black Scholes option valuation method. There were

options granted in

2018

2017.

The assumptions used in determining the fair value of the options granted during

2016

are as follows:

	2016
Risk-free interest rate		2.10	%
Expected life (in years)		10
Expected volatility		22.83	%
Expected dividends		0.00	%