NOTE

Employee Benefits

The Company participates in the Pentegra Defined Benefit Plan for Financial Institutions (Pentegra DB Plan), a noncontributory multi-employer defined benefit pension plan covering Bank employees who were hired prior to

2002

that met minimum service requirements. Effective

September 1, 2002,

this plan was frozen and closed to new participants but employees that were already in the plan at the time it was frozen continue to accrue benefits. The Pentegra DB Plan's Employer Identification Number is

5645888

and the Plan number is

333.

There are

collective bargaining agreements that require contributions to the Pentegra DB Plan, and there is

funding improvement or rehabilitation plan as part of the Pentegra DB Plan. The Company's policy is to fund accrued pension costs and the employer contributions paid and expensed for the years ended

December 31, 2020,

2019

and

2018

were

$0.3

million,

$0.3

million and

$0.1

million, respectively. The Company's contributions to the Pentegra DB Plan were

not

more than

of total contributions to the Plan. Funded status (market value of plan assets divided by the funding target) as of

July 1

for the

2020,

2019

and

2018

plan years were

85.26%,

87.67%

and

89.86%,

respectively.

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

$19,500

for

2020,

$19,000

for

2019

and

$18,500

for

2018,

with additional “catch up” contributions allowed for employees over

years of age. 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

2020,

2019

and

2018.

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

2020,

2019

and

2018.

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

$0.4

million for

2020,

and

$0.5

million for

2019

and

2018.

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:

	2020			2019			2018
Shares held by participants beginning of the year		346,097			340,237			357,135
Shares allocated to participants		24,377			24,317			24,317
Shares distributed to participants		(10,631	)		(18,457	)		(41,215	)
Shares held by participants end of year		359,843			346,097			340,237

Unreleased shares beginning of the year		206,795			231,112			255,429
Shares released during year		(24,377	)		(24,317	)		(24,317	)
Unreleased shares end of year		182,418			206,795			231,112
Total ESOP shares end of year		542,261			552,892			571,349
Fair value of unreleased shares at December 31	$	3,137,590			4,344,763			4,534,417

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, 2020

there were

34,229

vested options outstanding under the

2009

Plan. These options expire

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

$11.21

and had a grant date fair value of

$4.04.

All restricted stock awards previously granted under the

2009

Plan have vested as of

December 31, 2020.

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 the 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, 2020,

there were

options outstanding under the

2017

Plan. There were

21,484

shares of restricted stock previously granted to employees and directors under the

2017

Plan that remained unvested at

December 31, 2020.

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, 2017		0			14,881			49,229		$	9.25		22,820		$	4.04
Options Exercised		0			0			(15,000	)
Vested		0			(7,541	)		0					(11,410	)
December 31, 2018		0			7,340			34,229		$	11.21		11,410		$	4.04
Vested		0			(4,238	)		0					(11,410	)
December 31, 2019		0			3,102			34,229		$	11.21		0
Vested		0			(3,102	)		0					0
December 31, 2020		0			0			34,229		$	11.21		0

2017 Plan
December 31, 2017		415,292			2,280			0			N/A		0
Granted January 23, 2018		(10,044	)		6,696			0										3
Granted April 24, 2018		(792	)		528			0										1
Vested		0			(2,280	)		0					0
December 31, 2018		404,456			7,224			0			N/A		0
Granted January 22, 2019		(12,971	)		8,647			0										3
Granted April 23, 2019		(2,514	)		1,676			0										1
Vested		0			(2,760	)		0					0
December 31, 2019		388,971			14,787			0			N/A		0
Granted January 28, 2020		(10,650	)		7,100			0										3
Granted April 23, 2020		(9,000	)		6,000			0										2
Granted April 28, 2020		(3,579	)		2,386			0										1
Vested		0			(8,789	)		0					0
December 31, 2020		365,742			21,484			0			N/A		0

Total all plans		365,742			21,484			34,229		$	11.21		0

The following table summarizes information about stock options outstanding at

December 31, 2020:

Date of Grant	Exercise Price		Number Outstanding		Weighted Average Remaining Contractual Life in Years		Number Exercisable		Number Unexercisable
January 26, 2016	$	11.21		34,229		5.1		34,229		0
				34,229				34,229		0

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

2020,

2019

2018.