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FIVE-YEAR CONSOLIDATED FINANCIAL HIGHLIGHTS
Selected Operations Data:
| Year Ended December 31, | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2001 | 2000 | 1999 | 1998 | 1997 | |||||||
| (Dollars in thousands, except per share data) | |||||||||||
Total interest income | $ | 51,468 | 52,917 | 47,104 | 48,795 | 41,090 | ||||||
Total interest expense | 30,444 | 33,001 | 28,911 | 31,898 | 25,643 | |||||||
Net interest income | 21,024 | 19,916 | 18,193 | 16,897 | 15,447 | |||||||
Provision for loan losses | 1,150 | 180 | 240 | 310 | 300 | |||||||
Net interest income after provision for loan losses | 19,874 | 19,736 | 17,953 | 16,587 | 15,147 | |||||||
Fees and service charges | 1,563 | 1,297 | 848 | 518 | 440 | |||||||
Mortgage servicing fees | 470 | 341 | 335 | 337 | 47 | |||||||
Securities gains (losses), net | (671 | ) | (23 | ) | 122 | 2,799 | 1,250 | |||||
Gain on sales of loans | 2,934 | 1,216 | 1,932 | 2,177 | 469 | |||||||
Earnings (losses) in limited partnerships | (1,311 | ) | (121 | ) | 550 | (3,725 | ) | 220 | ||||
Other non-interest income | 599 | 613 | 506 | 524 | 296 | |||||||
Total non-interest income | 3,584 | 3,323 | 4,293 | 2,630 | 2,722 | |||||||
Other non-interest expense | 15,749 | 12,559 | 11,895 | 13,160 | 9,022 | |||||||
Total non-interest expense | 15,749 | 12,559 | 11,895 | 13,160 | 9,022 | |||||||
Income tax expense | 2,634 | 3,798 | 3,960 | 1,999 | 3,268 | |||||||
Income before minority interest | 5,075 | 6,702 | 6,391 | 4,058 | 5,579 | |||||||
Minority interest | (383 | ) | 0 | 0 | 0 | 0 | ||||||
Net income | $ | 5,458 | 6,702 | 6,391 | 4,058 | 5,579 | ||||||
Per common share and common share equivalents: | ||||||||||||
Basic | $ | 1.45 | 1.75 | 1.47 | 0.82 | 1.01 | ||||||
Diluted | 1.37 | 1.69 | 1.41 | 0.77 | 0.94 |
Selected Financial Condition Data:
| December 31, | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2001 | 2000 | 1999 | 1998 | 1997 | |||||||
| (Dollars in thousands, except per share data) | |||||||||||
Total assets | $ | 721,114 | 716,016 | 699,186 | 694,658 | 691,232 | ||||||
Securities available for sale | 119,895 | 139,206 | 173,477 | 181,625 | 205,859 | |||||||
Loans held for sale | 68,018 | 7,861 | 4,083 | 13,095 | 2,287 | |||||||
Loans receivable, net | 471,668 | 518,765 | 447,896 | 447,455 | 442,069 | |||||||
Deposits | 421,843 | 421,691 | 400,382 | 433,869 | 467,348 | |||||||
Federal Home Loan Bank advances | 217,800 | 221,900 | 229,400 | 185,400 | 127,650 | |||||||
Stockholders' equity | 72,161 | 66,626 | 64,561 | 68,445 | 84,470 | |||||||
Book value per share | 16.41 | 15.17 | 13.57 | 12.93 | 13.59 | |||||||
Tangible book value per share | 15.39 | 14.09 | 12.48 | 11.87 | 12.62 | |||||||
Number of full service offices | 12 | 11 | 10 | 10 | 10 | |||||||
Number of mortgage origination offices | 1 | 1 | 1 | 1 | 2 | |||||||
Key Ratios(1) | ||||||||||||
Stockholders' equity to total assets at year end | 10.01 | % | 9.31 | % | 9.23 | % | 9.85 | % | 12.22 | % | ||
Average stockholders' equity to average assets | 9.91 | 9.56 | 10.13 | 10.63 | 14.36 | |||||||
Return on stockholders' equity (ratio of net income to average equity) | 7.57 | 9.81 | 9.18 | 5.38 | 6.84 | |||||||
Return on assets (ratio of net income to average assets) | 0.75 | 0.94 | 0.93 | 0.57 | 0.98 | |||||||
Dividend payout ratio | 39.71 | 27.22 | 24.11 | 36.62 | 0.00 |
- (1)
- Average balances were calculated based upon amortized cost without the market value impact of SFAS 115.
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 its subsidiaries (HMN). This review should be read in conjunction with the consolidated financial statements and other financial data beginning on page 29.
General
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.
HMN's net income is significantly dependent on its net interest income, which is the difference between interest earned on its loans and investments (interest income), and the interest paid on interest-bearing liabilities such as deposits and Federal Home Loan Bank (FHLB) advances (interest expense). Net interest income is determined by (i) the difference between the yield earned on interest-earning assets and rates paid on interest-bearing liabilities (interest rate spread) and (ii) the relative amounts of interest-earning assets and interest-bearing liabilities. HMN's interest rate spread is affected by regulatory, economic and competitive factors that influence interest rates, loan demand and deposit flows. Net interest margin is calculated by dividing net interest income by the average interest-earning assets and is normally expressed as a percentage. Net interest income and net interest margin are affected by changes in interest rates, the volume and the mix of interest-earning assets and interest-bearing liabilities, and the level of non-performing assets. HMN's net income is also affected by the generation of non-interest income, which primarily consists of gains or losses from the sale of securities, gains from the sale of loans, service charges, fees, earnings or losses in limited partnership investments and other income. In addition, net income is also affected by the level of operating expenses, provisions made for loan losses, and amortization and valuation adjustments required on mortgage servicing assets.
The operations of financial institutions, including the Bank, are significantly affected by prevailing economic conditions, competition and the monetary and fiscal policies of governmental agencies. Lending activities are influenced by the demand for and supply of housing, competition among lenders, the level of interest rates and the availability of funds. Deposit flows and costs of deposits are influenced by prevailing market rates of interest primarily on competing investments, account maturities and the levels of personal income and savings in the market area of the Bank. The interest rates charged by the FHLB on advances to the Bank also have a significant impact on the Bank's overall cost of funds.
Critical Accounting Policies
Critical accounting policies are those policies that management believes are the most important to the portrayal of the company's financial condition and operating results that require difficult, subjective, or complex judgement. These judgements are often the result of the need to make estimates about the effect of matters that are inherently uncertain and therefore actual results could differ significantly from the estimates used. Management considers the following items to be the critical accounting policies of HMN.
Allowance for loan 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 that include loan impairment, changes in the size of the portfolios, general economic conditions, loan portfolio composition, and historical experience. The allowance for loan losses is established for known problem loans, as well as for loans which are not currently known to require specific allowances. Loans are charged off to the extent they are deemed to be uncollectible. The adequacy of the allowance for loan losses is dependent upon management's estimates of variables affecting valuation, appraisals of collateral, evaluations of performance and status, and the amounts and timing of future cash flows expected to be received on impaired loans. Such estimates, appraisals, evaluations and cash flows may be subject to frequent adjustments due to changing economic prospects of borrowers or properties. The estimates are reviewed periodically and adjustments, if any, are recorded in the provision for loan losses in the periods in which the adjustments become known. Although management believes that the allowance for loan losses is maintained at an amount considered adequate to provide for probable loan losses inherent in the portfolio, future adjustments may be necessary if conditions differ substantially from those in the assumptions used to determine the allowance for loan losses.
Mortgage Servicing Rights
Mortgage servicing rights are capitalized and amortized in proportion to, and over the period of, estimated net servicing income. HMN periodically evaluates its capitalized mortgage servicing rights for impairment. Loan type and note rate are the predominant risk characteristics of the underlying loans used to stratify capitalized mortgage servicing rights for purposes of measuring impairment. The valuation of the mortgage servicing rights is based on the estimated prepayment speeds and default rates of the stratified portfolio. Changes in the mix of loans, interest rates, prepayment speeds, or default rates from the estimates used in the valuation of the mortgage servicing rights may
12
have a material effect on the amortization and valuation of mortgage servicing rights. Although management believes that the assumptions used and the values determined are reasonable, future adjustments may be necessary if economic conditions differ substantially from the economic conditions in the assumptions used to determine the value of the servicing rights.
Investment in Limited Partnerships
HMN has investments in limited partnerships which invest in mortgage servicing assets, the common stock of other financial institutions and low to moderate income housing projects which generate tax credits for HMN. HMN generally accounts for the earnings or losses from the limited partnerships on the equity method with the exception of the limited partnership which invests in mortgage servicing assets. HMN adjusts its investment in this limited partnership recorded under the equity method for an amount that represents HMN's proportionate share of adjusting the mortgage servicing assets to the lower of amortized cost or appraised market value of the mortgage servicing assets.
Income Taxes
Deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. These calculations are based on many complex factors including estimates of the timing of reversals of temporary differences, the interpretation of Federal and State income tax laws, and a determination of the differences between the tax and the financial reporting basis of assets and liabilities. Actual results could differ significantly from the estimates and interpretations used in determining the current and deferred income tax liabilities.
Results of Operations
Net income for the year ended December 31, 2001 was $5.5 million, compared to $6.7 million for 2000 and $6.4 million for 1999. Basic earnings per share were $1.45 for the year ended December 31, 2001, compared to $1.75 for 2000 and $1.47 per share for 1999. Diluted earnings per share were $1.37 for the year ended December 31, 2001, compared to $1.69 for 2000 and $1.41 for 1999.
In comparing the year ended December 31, 2001 to the year ended December 31, 2000, net interest income increased by $1.1 million primarily due to an increase in the average outstanding balance of loans held for sale and lower interest rates being paid on FHLB advances and deposits. Non-interest income increased by $261,000 primarily due to increased fees and service charges. The $1.7 million increase in gains recognized on the sale of loans was entirely offset by a decrease of $1.2 million in earnings from limited partnerships, and an increase in losses on its securities portfolio of $648,000. Non-interest expense increased by $3.2 million primarily due to increased compensation, occupancy and other operating costs.
In comparing the year ended December 31, 2000 to the year ended December 31, 1999, net interest income increased by $1.7 million primarily due to an increase in the average outstanding balance of commercial and consumer loans. Non-interest income decreased by $970,000 primarily due to decreased gains recognized on the sale of loans and securities and losses recognized from investments in limited partnerships. Non-interest expense increased by $664,000 primarily due to increased compensation and occupancy expenses.
Return on average assets was 0.75%, 0.94% and 0.93%, for 2001, 2000 and 1999, respectively. Return on average equity was 7.57%, 9.81% and 9.18% for 2001, 2000 and 1999, respectively. The impact of recording the $1.2 million loss on a limited partnership investment caused the 2001 return on average assets to decline by 0.11% and the return on average equity to decline by 1.09%, while the impact of recording the $1.0 million impairment losses on securities caused the 2001 return on assets to decrease by 0.09% and the 2001 return on average equity to decrease by 0.88%.
Net Interest Income
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.
13
MANAGEMENT'S DISCUSSION AND ANALYSIS
| Year Ended December 31, | ||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2001 | 2000 | 1999 | ||||||||||||||||||||
| Average Outstanding Balance | Interest Earned/ Paid | Yield/ Rate | Average Outstanding Balance | Interest Earned/ Paid | Yield/ Rate | Average Outstanding Balance | Interest Earned/ Paid | Yield/ Rate | ||||||||||||||
| (Dollars in thousands) | ||||||||||||||||||||||
Interest-earning assets: | |||||||||||||||||||||||
Securities available for sale: | |||||||||||||||||||||||
Mortgage-backed and related securities | $ | 71,230 | 3,867 | 5.43 | % | $ | 93,565 | 6,695 | 7.15 | % | $ | 117,026 | 6,891 | 5.89 | % | ||||||||
Other marketable securities(1) | 38,106 | 2,248 | 5.90 | 73,947 | 4,659 | 6.30 | 68,882 | 4,262 | 6.17 | ||||||||||||||
Loans held for sale | 54,009 | 3,764 | 6.97 | 4,521 | 394 | 8.72 | 6,044 | 381 | 6.30 | ||||||||||||||
Loans receivable, net(2) | 503,063 | 40,806 | 8.11 | 498,359 | 40,116 | 8.05 | 453,040 | 34,711 | 7.66 | ||||||||||||||
Federal Home Loan Bank stock | 12,245 | 537 | 4.38 | 12,024 | 832 | 6.92 | 10,176 | 641 | 6.30 | ||||||||||||||
Other interest-earning assets including cash equivalents | 16,715 | 246 | 1.47 | 7,831 | 221 | 2.83 | 7,878 | 218 | 2.77 | ||||||||||||||
Total interest-earning assets | $ | 695,368 | 51,468 | 7.40 | $ | 690,247 | 52,917 | 7.67 | $ | 663,046 | 47,104 | 7.10 | |||||||||||
Interest-bearing liabilities: | |||||||||||||||||||||||
Non-interest checking | $ | 13,055 | 0 | 0.00 | % | $ | 8,834 | 0 | 0.00 | % | $ | 7,760 | 0 | 0.00 | % | ||||||||
NOW accounts | 33,457 | 380 | 1.13 | 27,001 | 311 | 1.15 | 24,337 | 239 | 0.98 | ||||||||||||||
Passbooks | 32,707 | 455 | 1.39 | 33,922 | 683 | 2.02 | 35,805 | 716 | 2.00 | ||||||||||||||
Money market accounts | 39,924 | 1,271 | 3.18 | 32,071 | 1,237 | 3.86 | 30,856 | 1,005 | 3.26 | ||||||||||||||
Certificate accounts | 299,336 | 16,472 | 5.50 | 304,540 | 16,901 | 5.55 | 313,472 | 15,966 | 5.09 | ||||||||||||||
Federal Home Loan | |||||||||||||||||||||||
Bank advances | 221,891 | 11,866 | 5.35 | 232,484 | 13,864 | 5.96 | 197,861 | 10,978 | 5.55 | ||||||||||||||
Other borrowed money | 0 | 0 | 0.00 | 57 | 5 | 8.04 | 88 | 7 | 8.21 | ||||||||||||||
Total interest-bearing liabilities | $ | 640,370 | 30,444 | 4.75 | $ | 638,909 | 33,001 | 5.17 | $ | 610,179 | 28,911 | 4.74 | |||||||||||
Net interest income | 21,024 | 19,916 | 18,193 | ||||||||||||||||||||
Net interest rate spread | 2.65 | % | 2.50 | % | 2.36 | % | |||||||||||||||||
Net earning assets | $ | 54,998 | $ | 51,338 | $ | 52,867 | |||||||||||||||||
Net interest margin | 3.02 | % | 2.89 | % | 2.74 | % | |||||||||||||||||
Average interest-earning assets to average interest-bearing liabilities | 108.59 | % | 108.04 | % | 108.66 | % | |||||||||||||||||
- (1)
- Tax exempt income was not significant; therefore, the yield was not presented on a tax equivalent basis. The tax exempt income was $70,702 for 2001, $35,521 for 2000 and $13,751 for 1999.
- (2)
- Calculated net of deferred loan fees, loan discounts, loans in process and loss reserve.
14
Net interest income for the year ended December 31, 2001 was $21.0 million, an increase of $1.1 million, or 5.6%, from $19.9 million for the year ended in 2000. Interest income for 2001 was $51.5 million, a decrease of $1.4 million, or 2.7%, compared to $52.9 million for 2000. Interest income decreased by $3.5 million due to a decrease in the average outstanding balance of securities available for sale during 2001 and it decreased by $1.7 million due to a decrease in the weighted average interest rate earned on the securities portfolio. These decreases were partially offset by an increase in interest income of $3.4 million on loans held for sale. During 2001 the Federal Reserve decreased the Federal Funds interest rate eleven times and interest rates on treasury instruments with maturities of two years and longer generally decreased. The Wall Street Journal prime rate decreased from approximately 9.50% at the beginning of 2001 to 4.75% at the end of 2001. As a result, loans with rates that were indexed to prime, such as commercial loans and consumer lines of credit, earned less interest income than loans that were indexed to treasury instruments.
Interest expense for the year ended December 31, 2001 was $30.4 million, a decrease of $2.6 million, or 7.7%, from $33.0 million for the year ended in 2000. The average outstanding balance on advances from the FHLB decreased by $10.6 million during 2001 which, along with lower interest rates paid on the FHLB advances, caused interest expense to decrease by $2.0 million. Due to the lowering rate environment during 2001, HMN paid lower rates on certificates of deposit which caused an outflow of certificates of deposit of $5.2 million. The effect of lower interest rates paid on less certificates of deposit resulted in a decrease in interest expense of $429,000.
Net interest income for the year ended December 31, 2000 was $19.9 million, an increase of $1.7 million, or 9.5%, from $18.2 million for the year ended in 1999. Interest income for 2000 was $52.9 million, an increase of $5.8 million, or 12.3%, compared to $47.1 million for 1999. Interest income increased by $3.6 million due to an increase in the average outstanding balance of loans receivable during 2000 and it increased by $1.8 million due to an increase in the weighted average interest rate earned on the loan portfolio. During 2000 HMN focused its efforts on originating and purchasing commercial real estate, commercial business, and consumer loans which generally have higher interest rates and shorter terms to maturity than single family residential loans.
Interest expense for the year ended December 31, 2000 was $33.0 million, an increase of $4.1 million, or 14.1%, from $28.9 million for the year ended in 1999. The average outstanding balance on advances from the FHLB increased by $34.6 million during 2000 which caused interest expense to increase by $2.9 million after taking into account the effect of increased interest rates being paid on FHLB advances. In order to reduce the outflow of deposits HMN paid higher rates on certificates of deposit, which also caused interest expense to increase by $935,000 after taking into account the impact of certificate of deposit outflow.
Net interest margin was 3.02%, 2.89% and 2.74% for the years ended December 31, 2001, 2000 and 1999, respectively. Average net earning assets were $55.0 million, $51.3 million and $52.9 million for the years ended December 31, 2001, 2000 and 1999, respectively. HMN has actively purchased its own common stock in the open market which reduced interest earning assets. During 2001, 2000 and 1999 HMN paid $1.6 million, $5.1 million and $7.3 million, respectively, to purchase its common stock in the open market. The common stock purchases were the principal reason for the decline in interest earning assets in 1999 and 2000. The increase in interest earning assets in 2001 is the result of net income exceeding stock repurchases and fixed asset additions.
The schedule on the following page 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 changes related to changes in outstanding balances and that due to the changes 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).
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MANAGEMENT'S DISCUSSION AND ANALYSIS
| Year Ended December 31, | ||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2001 vs. 2000 | 2000 vs. 1999 | |||||||||||||||||
| Increase (Decrease) Due to | | Increase (Decrease) Due to | | |||||||||||||||
| Total Increase (Decrease) | Total Increase (Decrease) | |||||||||||||||||
| Volume(1) | Rate(1) | Volume(1) | Rate(1) | |||||||||||||||
| (Dollars in thousands) | ||||||||||||||||||
Interest-earning assets: | |||||||||||||||||||
Securities available for sale: | |||||||||||||||||||
Mortgage-backed and related securities | $ | (1,406 | ) | (1,422 | ) | (2,828 | ) | $ | 2,724 | (2,920 | ) | (196 | ) | ||||||
Other marketable securities | (2,132 | ) | (279 | ) | (2,411 | ) | 311 | 86 | 397 | ||||||||||
Loans held for sale, net | 3,428 | (58 | ) | 3,370 | (28 | ) | 41 | 13 | |||||||||||
Loans receivable, net | 451 | 239 | 690 | 3,594 | 1,811 | 5,405 | |||||||||||||
Federal Home Loan Bank stock | 16 | (311 | ) | (295 | ) | 124 | 67 | 191 | |||||||||||
Other, including cash equivalents | 44 | (19 | ) | 25 | (1 | ) | 4 | 3 | |||||||||||
Total interest-earning assets | $ | 401 | (1,850 | ) | (1,449 | ) | $ | 6,724 | (911 | ) | 5,813 | ||||||||
Interest-bearing liabilities: | |||||||||||||||||||
NOW accounts | $ | 72 | (3 | ) | 69 | 28 | 44 | 72 | |||||||||||
Passbooks | (23 | ) | (205 | ) | (228 | ) | (39 | ) | 6 | (33 | ) | ||||||||
Money market accounts | 121 | (87 | ) | 34 | 41 | 191 | 232 | ||||||||||||
Certificates | (287 | ) | (142 | ) | (429 | ) | (437 | ) | 1,372 | 935 | |||||||||
Federal Home Loan Bank advances | (612 | ) | (1,386 | ) | (1,998 | ) | 2,021 | 865 | 2,886 | ||||||||||
Other borrowed money | (5 | ) | 0 | (5 | ) | (2 | ) | 0 | (2 | ) | |||||||||
Total interest-bearing liabilities | $ | (734 | ) | (1,823 | ) | (2,557 | ) | $ | 1,612 | 2,478 | 4,090 | ||||||||
Net interest income | $ | 21,024 | $ | 19,916 | |||||||||||||||
- (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, 2001 | ||||
---|---|---|---|---|---|
Weighted average yield on: | |||||
Securities available for sale: | |||||
Mortgage-backed and related securities | 4.02 | % | |||
Other marketable securities | 4.37 | ||||
Loans held for sale | 7.04 | ||||
Loans receivable, net | 7.89 | ||||
Federal Home Loan Bank advances | 4.00 | ||||
Other interest-earning assets | 1.38 | ||||
Combined weighted average yield on interest-earning assets | 6.92 | ||||
Weighted average rate on: | |||||
NOW accounts | 0.64 | % | |||
Passbooks | 0.75 | ||||
Money market accounts | 1.89 | ||||
Certificates | 4.52 | ||||
Federal Home Loan Bank stock | 4.75 | ||||
Combined weighted average rate on interest-bearing liabilities | 3.85 | ||||
Interest rate spread | 3.08 |
Provision For Losses on Loans
*The provision for losses on loans is considered a critical accounting policy of HMN. It is determined based on 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 could 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, 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
*This paragraph contains a forward-looking statement(s). Refer to information regarding Forward-looking Information on page 27 of this discussion.
16
provide for estimated 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 2001 was $1,150,000, compared to $180,000 for 2000 and $240,000 for 1999. The provision for loan losses increased in 2001 primarily due to the growth that was experienced in the commercial and consumer loan portfolios which generally require a larger provision due to the greater inherent credit risk of these loans. The provision also increased because of increases in specific commercial loan reserves of $382,000, as well as a slowing economy which resulted in more non accrual loans. 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, the provision was deemed adequate for each of the years in the three year period ended December 31, 2001. HMN incurred $517,000 of loan charge-offs during 2001 and it recovered $6,000 of loans previously charged-off. HMN incurred $312,000 of loan charge-offs during 2000 and it recovered $3,000 of loans previously charged-off. HMN incurred $9,800 of loan charge-offs during 1999 and it recovered $1,600 of loans previously charged-off. For more information on the allowance for loan losses refer to Notes 1 and 5 of the Notes to Consolidated Financial Statements.
Non-Interest Income
Non-interest income was $3.6 million for 2001, compared to $3.3 million for 2000 and $4.3 million for 1999. The following table presents certain components of non-interest income:
| Year Ended December 31, | Percentage Increase (Decrease) | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2001 | 2000 | 1999 | 2001/2000 | 2000/1999 | ||||||||
| (Dollars in thousands) | ||||||||||||
Fees and service charges | $ | 1,563 | 1,297 | 848 | 20.5 | % | 52.9 | % | |||||
Mortgage servicing fees | 470 | 341 | 335 | 37.8 | 1.8 | ||||||||
Securities gains (losses), net | (671 | ) | (23 | ) | 122 | (2,817.4 | ) | (118.9 | ) | ||||
Gain on sales of loans | 2,934 | 1,216 | 1,932 | 141.3 | (37.1 | ) | |||||||
Earnings (losses) in limited partnerships | (1,311 | ) | (121 | ) | 550 | (983.5 | ) | (122.0 | ) | ||||
Other non-interest income | 599 | 613 | 506 | (2.3 | ) | 21.1 | |||||||
Total non-interest income | $ | 3,584 | 3,323 | 4,293 | 7.9 | (22.6 | ) | ||||||
Fees and service charges earned for the year ended December 31, 2001 increased by $266,000 from fees and service charges earned in 2000, primarily due to increased fees and service charges on an increased number of deposit accounts. During 2001 HMN continued to concentrate on developing more retail and commercial checking account relationships which created more opportunities for fee income. The charges for some services were also increased during 2001. Fees and service charges earned for the year ended December 31, 2000 increased by $449,000 from fees and service charges earned in 1999, primarily due to increased fees and service charges on deposit accounts.
Mortgage servicing fees for the year ended December 31, 2001 increased by $129,000 from the mortgage servicing fees earned in 2000, primarily due to the increased number of single family loans that were serviced for others. During 2001 the lower interest rates caused loan originations and loan sales to increase significantly and the servicing rights on all of the loans sold by the Bank were retained. Mortgage servicing fees for the year ended December 31, 2000 increased $6,000 from the mortgage servicing fees earned in 1999. The increase was due to more mortgage servicing rights being capitalized than were amortized.
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 2001 interest rates in general were declining and the opportunity to sell investments at a gain was present, however, economic conditions caused HMN to recognize impairment losses totaling $1.0 million, which negated the gains recognized on securities that were sold. Management reviews the securities in its portfolio on a regular basis for impairment. As a result of these reviews, HMN recognized impairment losses of $610,000 on corporate debt securities because the underlying debtor corporations filed for bankruptcy. HMN also recognized a $410,000 impairment loss on a preferred stock whose decline in market value did not rebound as anticipated when interest rates decreased during 2001. During a portion of 2000 and throughout 1999 interest rates in general were rising and the opportunity to sell securities at a gain diminished.
Over the past three years, in order to reduce its interest rate risk and increase its other non-interest income, the Bank, which originates all of its 1-4 family loans at its retail facilities, sold many of its originated or refinanced fixed rate 1-4 family loans to FNMA. The mortgage banking business operated by Home Federal Mortgage Services, LLC (HFMS), and formerly operated by HMN Mortgage Services, Inc. (MSI), also sold the majority of their mortgage origination and loan brokerage activity. The lower interest rate environment in 2001 caused loan originations and brokerage activity to increase significantly. For the year ended December 31, 2001, HMN recognized $2.9 million of net gain on the sale of $724.2 million of primarily single family mortgage loans. The Bank accounted for $2.1 million of the
17
net gain on sale on $136.2 million of originated and refinanced loans sold. HFMS accounted for $842,000 of the net gain on sale on $588.1 million of loans. During 2001 HFMS brokered $349.6 million of loans from correspondent lenders at lower profit margins than its other brokerage and origination activity. The significant increase in loan volume from these correspondents resulted in pair off fees because loans were not delivered into their forward sales commitments on a timely basis. This resulted in a lower gain on sale of loans for HFMS as a percentage of loans sold. The lower profit margins coupled with the additional compensation costs relating to processing the increased loan volume resulted in HFMS generating a loss for 2001. Refer to Note 23 of the Notes to Consolidated Financial Statements for additional information relating to the results of operations for HFMS. For the year ended December 31, 2000, HMN recognized $1.2 million of net gain on the sale of $103.7 million of primarily single family mortgage loans. The Bank accounted for $752,000 of the net gain on the sale of loans and $31.6 million of the loans. For the year ended December 31, 1999, HMN recognized $1.9 million of net gains on the sale of $176.4 million of primarily single family mortgage loans. The Bank accounted for $995,000 of the net gain on sale and $46.5 million of the loans.
For the years ended December 31, 2001, 2000 and 1999, HMN recognized net losses of $1.3 million, $121,000 and net earnings of $550,000, respectively, from its limited partnership investments. A major portion of HMN's investment in limited partnerships resides in a partnership that owns mortgage servicing rights. HMN considers the valuation of mortgage servicing rights, and thus the investment in this limited partnership, to be a critical accounting policy that is subject to significant estimates. Generally, as interest rates rise the value of fixed rate mortgage servicing rights increases and as interest rates fall the value of mortgage servicing rights declines due to changes in the anticipated cash flows caused by prepayments on the loans being serviced. During 2001 and 2000 significant declines in interest rates on single family mortgages caused HMN to recognize a loss on its investment in the mortgage servicing limited partnership. During 1999 interest rates generally rose, which allowed HMN to reverse previously established impairment reserves and recognize earnings from its limited partnership investments. For more information on investments in limited partnerships refer to Notes 1 and 9 of the Notes to Consolidated Financial Statements.
Other non-interest income consists primarily of fees and commissions earned on the sale of financial planning products and services. For the year ended December 31, 2001 other non-interest income was $599,000, compared to $613,000 for 2000 and $506,000 for 1999. The changes in other non-interest income from 1999 to 2001 are principally due to changes in volume of sales.
Non-Interest Expense
Non-interest expense for the year ended December 31, 2001 was $15.7 million, compared to $12.6 million for the year ended in 2000 and $11.9 million for 1999. The following table presents the components of non-interest expense:
| Year Ended December 31, | Percentage Increase (Decrease) | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2001 | 2000 | 1999 | 2001/2000 | 2000/1999 | ||||||||
| (Dollars in thousands) | ||||||||||||
Compensation and benefits | $ | 7,915 | 6,391 | 6,052 | 23.8 | % | 5.6 | % | |||||
Occupancy | 2,239 | 1,891 | 1,571 | 18.4 | 20.4 | ||||||||
Federal deposit insurance premiums | 80 | 83 | 254 | (3.6 | ) | (67.3 | ) | ||||||
Advertising | 426 | 303 | 284 | 40.6 | 6.7 | ||||||||
Data processing | 964 | 790 | 719 | 22.0 | 9.9 | ||||||||
Amortization of mortgage servicing rights, net of valuation adjustments and servicing costs | 758 | 334 | 471 | 126.9 | (29.1 | ) | |||||||
Other | 3,367 | 2,767 | 2,544 | 21.7 | 8.8 | ||||||||
Total non-interest expense | $ | 15,749 | 12,559 | 11,895 | 25.4 | 5.6 | |||||||
The $3.2 million increase in non-interest expense from 2000 to 2001 was primarily due to a $1.5 million increase in compensation and benefit expense, which primarily resulted from commissions paid on the increased single family residential loan volume as well as additional staff to process the increased volume. Occupancy expense increased by $348,000 due to additional facilities maintained during 2001 including the new corporate headquarters in Rochester and a full year of depreciation on facilities opened or remodeled during 2000. Data processing increased by $174,000 due to the increased costs of various services offered to customers including Internet banking services. Advertising expenses increased $123,000 as a result of a more developed marketing plan, and other expenses increased by $600,000 primarily due to increases in fees for professional services and other operating costs. Amortization of mortgage servicing rights increased $424,000 from 2000 to 2001. Because of the lower interest rates in 2001 many loans that were being serviced by the Bank were refinanced. When a serviced loan was paid off, the remaining value of the servicing of that loan was recorded as additional amortization expense in the month in which the loan was repaid.
18
The $664,000 increase in non-interest expense from 1999 to 2000 was primarily due to a $248,000 charge to compensation and benefit expense which related to an early retirement program for an executive officer. Occupancy expense increased by $320,000 due to additional operating costs and depreciation on facilities that were remodeled throughout 2000 and software enhancements made during 2000. The $137,000 decrease in amortization of mortgage servicing rights from 1999 to 2000 was due to decreased amortization expense because of generally rising interest rates in 2000.
Income Taxes
HMN considers the calculation of current and deferred income taxes to be a critical accounting policy that is subject to significant estimates. Actual results could differ significantly from the estimates and interpretations used in determining the current and deferred income tax liabilities. During 2001 HMN recorded income tax expense of $2.6 million, compared to $3.8 million and $4.0 million for 2000 and 1999, respectively. The change in income tax expense between the years is primarily the result of changes in taxable income between the years. Refer to Note 1 and Note 14 of the Notes to Consolidated Financial Statements for additional information relating to income taxes.
Financial Condition
Loans Receivable, Net
The following table 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.
| December 31, | ||||||||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2001 | 2000 | 1999 | 1998 | 1997 | ||||||||||||||||||||||||
| Amount | Percent | Amount | Percent | Amount | Percent | Amount | Percent | Amount | Percent | |||||||||||||||||||
| (Dollars in thousands) | ||||||||||||||||||||||||||||
Real Estate Loans: | |||||||||||||||||||||||||||||
One-to-four family | $ | 215,448 | 44.73 | % | $ | 312,888 | 59.43 | % | $ | 344,674 | 70.95 | % | $ | 365,496 | 79.31 | % | $ | 395,668 | 87.58 | % | |||||||||
Multi-family | 14,369 | 2.98 | 12,090 | 2.30 | 8,489 | 1.75 | 4,719 | 1.02 | 2,717 | 0.60 | |||||||||||||||||||
Commercial | 70,768 | 14.69 | 61,654 | 11.71 | 43,894 | 9.04 | 28,990 | 6.29 | 10,572 | 2.34 | |||||||||||||||||||
Construction or development | 46,977 | 9.75 | 20,211 | 3.84 | 16,046 | 3.30 | 15,155 | 3.29 | 5,725 | 1.27 | |||||||||||||||||||
Total real estate | 347,562 | 72.15 | 406,843 | 77.28 | 413,103 | 85.04 | 414,360 | 89.91 | 414,682 | 91.79 | |||||||||||||||||||
Other Loans: | |||||||||||||||||||||||||||||
Consumer Loans: | |||||||||||||||||||||||||||||
Automobile | 6,624 | 1.38 | 6,363 | 1.21 | 4,532 | 0.94 | 2,897 | 0.63 | 2,437 | 0.54 | |||||||||||||||||||
Home equity line | 35,714 | 7.42 | 26,907 | 5.11 | 22,437 | 4.62 | 19,476 | 4.22 | 19,490 | 4.31 | |||||||||||||||||||
Home equity | 26,440 | 5.49 | 28,144 | 5.35 | 17,349 | 3.57 | 9,566 | 2.08 | 7,176 | 1.59 | |||||||||||||||||||
Mobile home | 5,456 | 1.13 | 4,921 | 0.93 | 791 | 0.16 | 58 | 0.01 | 26 | 0.01 | |||||||||||||||||||
Other | 4,897 | 1.02 | 4,561 | 0.87 | 3,127 | 0.64 | 2,803 | 0.61 | 2,736 | 0.60 | |||||||||||||||||||
Total consumer loans | 79,131 | 16.44 | 70,896 | 13.47 | 48,236 | 9.93 | 34,800 | 7.55 | 31,865 | 7.05 | |||||||||||||||||||
Commercial business loans | 54,940 | 11.41 | 48,760 | 9.25 | 24,435 | 5.03 | 11,695 | 2.54 | 5,226 | 1.16 | |||||||||||||||||||
Total other loans | 134,071 | 27.85 | 119,656 | 22.72 | 72,671 | 14.96 | 46,495 | 10.09 | 37,091 | 8.21 | |||||||||||||||||||
Total loans | 481,633 | 100.00 | % | 526,499 | 100.00 | % | 485,774 | 100.00 | % | 460,855 | 100.00 | % | 451,773 | 100.00 | % | ||||||||||||||
Less: | |||||||||||||||||||||||||||||
Loans in process | 4,692 | 2,953 | 2,771 | 7,997 | 4,562 | ||||||||||||||||||||||||
Unamortized discounts | 278 | 289 | 297 | 414 | 547 | ||||||||||||||||||||||||
Net deferred loan fees | 1,212 | 1,348 | 1,537 | 1,948 | 1,847 | ||||||||||||||||||||||||
Allowance for losses | 3,783 | 3,144 | 3,273 | 3,041 | 2,748 | ||||||||||||||||||||||||
Total loans receivable, net | $ | 471,668 | $ | 518,765 | $ | 477,896 | $ | 447,455 | $ | 442,069 | |||||||||||||||||||
19
M A N A G E M E N T ' S D I S C U S S I O N A N D A N A L Y S I S
*HMN established a commercial lending department in 1998 in order to facilitate a change in the mix of assets on its balance sheet. The purpose of changing the mix was to reduce interest rate risk and enhance performance by increasing its investment in shorter term and generally higher yielding commercial real estate and commercial business loans and reduce its investment in longer term one-to-four family real estate loans. HMN intends to continue to change its asset mix by continuing to originate more commercial real estate, commercial business and consumer loans while selling the majority of the newly originated one-to-four family loans with amortization terms of 20 years or longer.
The one-to-four family real estate loans were $215.4 million at December 31, 2001, a decrease of $97.5 million, or 31.1%, compared to $312.9 million at December 31, 2000. During 2001 loan prepayments increased as a result of the low interest rate environment and many loans that were in the portfolio at December 31, 2000 that were refinanced as conventional fixed rate loans during the year were sold to FNMA. The increased prepayments and the related loan sales were the principal cause of the decline in the one-to-four family loan portfolio.
The one-to-four family real estate loans were $312.9 million at December 31, 2000, a decrease of $31.8 million, or 9.2%, compared to $344.7 million at December 31, 1999. Loan production decreased in 2000 as a result of rising interest rates and because HMN stopped purchasing one-to-four family loans from a third party originator during 2000. HMN originated or purchased $140.3 million in one-to-four family loans from a third party originator during 2000, a decrease of $82.0 million, or 36.9%, compared to $222.3 million in one-to-four family loans during 1999. The reduced loan volume was the principal cause of the decline in the one-to-four family loan portfolio.
The one-to-four family real estate loans were $344.7 million at December 31, 1999, a decrease of $20.8 million, or 5.7%, compared to $365.5 million at December 31, 1998. Loan production decreased in 1999 as a result of rising interest rates. The reduced loan volume and the increased percentage of loans sold were the principal cause of the decline in the one-to-four family loan portfolio.
Commercial real estate loans were $70.8 million at December 31, 2001, an increase of $9.1 million, compared to $61.7 million at December 31, 2000. Commercial business loans were $54.9 million at December 31, 2001, an increase of $6.1 million, compared to $48.8 million at December 31, 2000. The continued emphasis on commercial real estate and commercial business loans resulted in the origination or purchase of commercial real estate loans totaling $18.3 million in 2001, compared to $18.2 million in 2000. Commercial business loans originated or purchased in 2001 were $48.2 million, compared to $42.4 million in 2000. The increased production was the principal reason for the increase in commercial real estate and commercial business loans in 2001.
Commercial real estate loans were $61.7 million at December 31, 2000, an increase of $17.8 million, compared to $43.9 million at December 31, 1999. Commercial business loans were $48.8 million at December 31, 2000, an increase of $24.4 million, compared to $24.4 million at December 31, 1999. Increased production was the principal reason for the increase in commercial real estate and commercial business loans in 2000.
Commercial real estate loans were $43.9 million at December 31, 1999, an increase of $14.9 million compared to $29.0 million at December 31, 1998. Commercial business loans were $24.4 million at December 31, 1999, an increase of $12.7 million compared to $11.7 million at December 31, 1998. The Bank was in the process of expanding its commercial loan and commercial deposit offerings in order to increase its investment in commercial real estate and commercial business loans.
Home equity line loans were $35.7 million at December 31, 2001, compared to $26.9 million at December 31, 2000, and $22.4 million at December 31, 1999. Due to the general decline in interest rates during 2001 many borrowers consolidated their debt into home equity lines and paid off closed end home equity loans when refinancing their first mortgage. Home equity loans were $26.4 million at December 31, 2001, compared to $28.1 million at December 31, 2000 and $17.3 million at December 31, 1999.
Allowances for Loan Losses
�� The determination of the allowance for loan losses and the related provision is considered to be a critical accounting policy that is subject to significant estimates. The current level of the allowance for loan losses is a result of management's assessment of the risks within the portfolio based on the information obtained through the credit evaluation process. HMN utilizes a risk-rating system on non-homogenous commercial real estate and commercial business loans that includes regular credit reviews to identify and quantify the risk in the commercial portfolio. The allowance for all loans is based on 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 the Office of Thrift Supervision (OTS) and other factors that, in management's judgement, deserve recognition. The allowance is allocated to individual loan categories based upon the relative risk characteristics of the loan portfolios and the actual loss experience. HMN increases its allowance for loan losses by charging the provision for loan losses against income. The methodology for establishing the allowance for loan losses takes into consideration probable losses that have been identified in connection with specific loans as well as losses in the loan portfolio for which specific
*This paragraph contains a forward-looking statement(s). Refer to information regarding Forward-looking Information on page 27 of this discussion.
20
reserves are not required. Management conducts quarterly reviews of the loan portfolio and evaluates the need to establish general allowances on the basis of these reviews.
*Management continues to actively monitor asset quality and to charge off loans against the allowance for loan losses when appropriate. Although management believes it uses the best information available to make determinations with respect to the allowance for loan losses, future adjustments may be necessary if economic conditions differ substantially from the economic conditions in the assumptions used to determine the size of the allowance for losses.
The allowance for loan losses was $3.8 million, or 0.79%, of total loans at December 31, 2001, compared to $3.1 million, or 0.60%, of total loans at December 31, 2000, $3.3 million, or 0.69%, of total loans at December 31, 1999, $3.0 million, or 0.68%, of total loans at December 31, 1998, and $2.7 million, or 0.62%, of total loans at December 31, 1997. The following table reflects the activity in the allowance for loan losses and selected statistics:
| December 31, | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2001 | 2000 | 1999 | 1998 | 1997 | |||||||||
| (Dollars in thousands) | |||||||||||||
Balance at the beginning of year | $ | 3,144 | 3,273 | 3,041 | 2,748 | 2,341 | ||||||||
Acquired allowance for loan losses | 0 | 0 | 0 | 0 | 122 | |||||||||
Provision for losses | 1,150 | 180 | 240 | 310 | 300 | |||||||||
Charge-offs: | ||||||||||||||
One-to-four family | 0 | 0 | (1 | ) | (2 | ) | (4 | ) | ||||||
Consumer | (170 | ) | (59 | ) | (9 | ) | (17 | ) | (7 | ) | ||||
Commercial business | (347 | ) | (253 | ) | 0 | 0 | (12 | ) | ||||||
Recoveries | 6 | 3 | 2 | 2 | 8 | |||||||||
Net charge-offs | (511 | ) | (309 | ) | (8 | ) | (17 | ) | (15 | ) | ||||
Balance at end of year | $ | 3,783 | 3,144 | 3,273 | 3,041 | 2,748 | ||||||||
Year end allowance for loan losses as a percent of year end gross loan balance | 0.79 | % | 0.60 | % | 0.69 | % | 0.68 | % | 0.62 | % | ||||
Ratio of net loan charge-offs to average loans outstanding | 0.10 | 0.06 | 0.00 | 0.00 | 0.01 | |||||||||
Allowance for loan losses as a percentage of total assets at year end | 0.52 | 0.44 | 0.47 | 0.44 | 0.40 |
The following table reflects the allocation of the allowance for loan losses:
| At December 31, | Allocations as a Percentage of Total Loan Outstanding by Type | ||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2001 | 2000 | 1999 | 1998 | 1997 | 2001 | 2000 | 1999 | 1998 | 1997 | ||||||||||||
| (Dollars in thousands) | |||||||||||||||||||||
Real estate loans: | ||||||||||||||||||||||
One-to-four family | $ | 215 | 302 | 527 | 544 | 560 | 44.73 | % | 59.43 | 70.95 | 79.31 | 87.58 | ||||||||||
Multi-family | 203 | 111 | 133 | 142 | 80 | 2.98 | 2.30 | 1.75 | 1.02 | 0.60 | ||||||||||||
Commercial | 903 | 802 | 533 | 797 | 198 | 14.69 | 11.71 | 9.04 | 6.29 | 2.34 | ||||||||||||
Construction or development | 560 | 408 | 231 | 455 | 172 | 9.75 | 3.84 | 3.30 | 3.29 | 1.27 | ||||||||||||
Consumer | 565 | 414 | 674 | 546 | 527 | 16.44 | 13.47 | 9.93 | 7.55 | 7.05 | ||||||||||||
Commercial business | 1,337 | 665 | 291 | 328 | 46 | 11.41 | 9.25 | 5.03 | 2.54 | 1.16 | ||||||||||||
Unallocated | 0 | 442 | 884 | 229 | 1,165 | 0.00 | 0.00 | 0.00 | 0.00 | 0.00 | ||||||||||||
Total | $ | 3,783 | 3,144 | 3,273 | 3,041 | 2,748 | 100.00 | % | 100.00 | 100.00 | 100.00 | 100.00 | ||||||||||
The allocated one-to-four family real estate allowance declined in recent years due to a decline in the one-to-four family loan portfolio.
The allocation of the allowance for loan losses increased from 2000 to 2001 for commercial, construction or development, multi-family real estate, consumer and commercial business loans because of the increase in the respective portfolios. The commercial business loan allocation also increased because of increases in specific reserves of $382,000.
*This paragraph contains a forward-looking statement(s). Refer to information regarding Forward-looking Information on page 27 of this discussion.
21
MANAGEMENT'S DISCUSSION AND ANALYSIS
Allowance for Real Estate Losses
Real estate properties acquired or expected to be acquired through loan foreclosures are initially recorded at the lower of the related loan balance, less any specific allowance for loss, or fair value less estimated selling costs. 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. There was no activity in the allowance for real estate losses during 2001 or 2000 and the balance of the allowance for real estate losses was zero at December 31, 2001. During 1999 there was a recapture of an $8,000 allowance that had been established in 1997.
Non-performing Assets
Non-performing assets (comprised of non-accrual loans, restructured loans, impaired securities, real estate acquired through foreclosure, and repossessed assets) totaled $3.8 million at December 31, 2001, compared to $1.6 million at December 31, 2000, $818,000 at December 31, 1999, $806,000 at December 31, 1998 and $807,000 at December 31, 1997. The increase from 2000 to 2001 is primarily the result of classifying $1.4 million of impaired securities as non-performing assets, increases in specific reserves on commercial business loans of $382,000, and an increase in non-accrual loans of $1.1 million due to a slowing economy. Non-performing assets had the following activity during 2001: charge-offs of $124,000, transfers in of $3,263,000 and transfers out due to performance of $990,000. Non-performing assets had the following activity during 2000: charge-offs of $8,000, transfers in of $1,128,000 and transfers out due to performance of $326,000. Non-performing assets had the following activity during 1999: sales of $18,000, transfers in of $423,000 and transfers out due to performance of $393,000. Non-performing assets had the following activity during 1998: sales of $142,000, transfers in of $389,000 and transfers out due to performance of $248,000. Non-performing assets are summarized in the following table:
| December 31, | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2001 | 2000 | 1999 | 1998 | 1997 | |||||||||
| (Dollars in thousands) | |||||||||||||
Non-accrual loans | $ | 2,159 | 1,012 | 342 | 476 | 263 | ||||||||
Accruing loans delinquent 90 days or more | 24 | 405 | 476 | 312 | 402 | |||||||||
Restructured loans | 0 | 0 | 0 | 0 | 0 | |||||||||
Other assets (impaired securities) | 1,390 | 0 | 0 | 0 | 0 | |||||||||
Foreclosed and repossessed assets | 188 | 195 | 0 | 18 | 142 | |||||||||
Total non-performing assets | $ | 3,761 | 1,612 | 818 | 806 | 807 | ||||||||
Non-performing assets as a percentage of total assets | 0.52 | % | 0.23 | % | 0.12 | % | 0.12 | % | 0.12 | % | ||||
Total non-performing loans | $ | 2,183 | 1,417 | 818 | 788 | 665 | ||||||||
Non-performing loans as a percentage of loans receivable, net | 0.46 | % | 0.27 | % | 0.17 | % | 0.18 | % | 0.15 | % | ||||
Allowance for loan losses to non-performing loans | 173.29 | % | 221.87 | % | 400.29 | % | 385.79 | % | 413.17 | % |
The non-performing assets reflected above primarily consist of one-to-four family mortgage loans, consumer loans, commercial business loans, and impaired securities.
Mortgage Servicing Rights
HMN considers the capitalization and valuation of servicing rights to be a critical accounting policy that is subject to significant estimates. Servicing rights are valued quarterly by an unrelated third party specializing in the valuation of servicing rights and are reviewed by HMN. The assumptions used to value the mortgage servicing rights are based on loan types, note rates, default rates, and prepayment speeds, among other assumptions. Changes in the mix of loans, interest rates, default rates or prepayment speeds may have a material effect on the amortization and valuation of mortgage servicing rights. Although management believes that the assumptions used and the values determined are reasonable based upon current circumstances, adjustments may be necessary if future economic conditions differ substantially from the economic condition in the assumptions used to determine the value of the servicing rights. Refer to Note 1 and Note 7 of the Notes to Consolidated Financial Statements for additional information relating to mortgage servicing rights.
22
Contractual Obligations and Commercial Commitments
HMN has certain obligations and commitments to make future payments under contracts. At December 31, 2001, the aggregate contractual obligations (excluding bank deposits) and commercial commitments are as follows:
| Payments Due by Period | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|
| Total | Less than 1 Year | 1-3 Years | 4-5 Years | After 5 Years | |||||||
| (Dollars in thousands) | |||||||||||
Contractual Obligations: | ||||||||||||
Total borrowings | $ | 217,800 | 9,500 | 97,400 | 0 | 110,900 | ||||||
Unconditional contract obligations | 1,498 | 1,498 | 0 | 0 | 0 | |||||||
Annual rental commitments under non-cancellable operating leases | 1,590 | 433 | 644 | 503 | 10 | |||||||
$ | 220,888 | 11,431 | 98,044 | 503 | 110,910 | |||||||
Amount of Commitment-Expiration by Period | ||||||||||||
Other Commerical Commitments: | ||||||||||||
Commercial lines of credit | $ | 3,189 | 2,922 | 207 | 60 | 0 | ||||||
Commitments to lend | 38,744 | 13,670 | 559 | 11,280 | 13,235 | |||||||
Standby letters of credit | 1,240 | 1,041 | 199 | 0 | 0 | |||||||
$ | 43,173 | 17,633 | 965 | 11,340 | 13,235 | |||||||
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, 2001. Refer to Note 18 of the Notes to Consolidated Financial Statements for a table which reflects the Bank's capital compared to its capital requirements.
Dividends
During 2001 HMN declared and paid dividends as follows:
Record date | Payable date | Dividend per share | Dividend payout ratio | |||||
---|---|---|---|---|---|---|---|---|
February 22, 2001 | March 8, 2001 | $ | 0.12 | 29.27 | % | |||
May 24, 2001 | June 11, 2001 | $ | 0.12 | 30.00 | % | |||
August 28, 2001 | September 11, 2001 | $ | 0.14 | 43.75 | % | |||
November 23, 2001 | December 12, 2001 | $ | 0.14 | 28.00 | % |
On January 22, 2002 HMN declared a cash dividend of $0.14 per share payable on March 7, 2002 to holders of record on February 21, 2002. The annualized dividend payout ratio for the past four quarters was 31.90%.
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 capital requirements, tax considerations, industry standards, economic conditions, regulatory restrictions, general business practices and other factors. Refer to Note 17 of the Notes to Consolidated Financial Statements for information on regulatory limitations on dividends from the Bank to HMN and more information on dividends.
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 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.
*This paragraph contains a forward-looking statement(s). Refer to information regarding Forward-looking Information on page 27 of this discussion.
23
MANAGEMENT'S DISCUSSION AND ANALYSIS
The primary investing activities are the origination or purchase of loans and the purchase of securities. Principal and interest payments on mortgages and securities along with the proceeds from the sale of loans held for sale are the primary sources 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.
The primary financing activity is the attraction of retail deposits. The Bank also obtains funds by utilizing brokered certificates of deposit. The Bank has the ability to borrow additional funds from the FHLB by pledging additional securities or loans. Refer to Note 12 of the Notes to Consolidated Financial Statements for more information on additional advances that could be drawn upon based upon existing collateral levels with the FHLB. Information on outstanding advance maturities and related early call features was also included in Note 12.
*HMN anticipates that its liquidity requirements for 2002 will be similar to the cash flows it experienced in 2001 with the following exceptions: expenditures for premises and equipment are anticipated to be $1.6 million which is less than the 2001 expenditures; net increase in loans receivable is anticipated to be $54 million; and the funds provided from deposits and/or FHLB advances will be in the range of $50 to $55 million.
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, 2001 were $23.0 million, an increase of $8.6 million, compared to $14.4 million at December 31, 2000. Net cash used by operating activities during 2001 was $49.9 million. HMN conducted the following major investing activities during 2001: proceeds from the sale of securities available for sale were $19.1 million, principal received on payments and maturities of securities available for sale were $37.8 million, purchases were $34.5 million of securities available for sale, proceeds of sales of loans receivable were $12,000, and net decrease in loans receivable which was due primarily to principal repayments of $44.2 million. HMN spent $2.4 million for the purchase of equipment and updating its premises, and received $317,000 from the sale of real estate. Net cash provided by investing activities during 2001 was $64.6 million. HMN conducted the following major financing activities during 2001: purchase of treasury stock of $1.6 million, received $646,000 from exercise of HMN common stock options, paid $1.9 million in dividends to HMN stockholders, proceeds from FHLB advances of $267.7 million and repayments of FHLB advances totaled $271.8 million. Net cash used by financing activities was $6.1 million.
*HMN has certificates of deposit with outstanding balances of $187.1 million that mature during 2002. 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 a combination of other customers or brokered deposits. FHLB advances or the sale of securities could also be used to replace unanticipated outflows of deposits. Management does not anticipate that it will have a liquidity problem due to maturing deposits.
*HMN has $9.5 million of FHLB advances which mature in 2002 and it has $25.0 million of FHLB advances with maturities beyond 2002 which have call features that may be exercised by the FHLB during 2002. If the call features are exercised, HMN has the option of requesting any advance otherwise available to it pursuant to the Credit Policy of the FHLB. Since HMN has the ability to request another advance to replace the advance that is being called, management does not anticipate that it will have a liquidity problem due to advances being called by the FHLB during 2002.
*The Credit Policy of the FHLB may change such that the current collateral pledged to secure the advances is no longer acceptable or the formulas for determining the excess pledged collateral may change and the Bank may not have additional collateral to pledge to secure the existing advances could cause the FHLB advances to become a liquidity problem during 2002.
On July 24, 2001, HMN's Board of Directors authorized the extension of the stock repurchase program to August 22, 2002. The plan authorized HMN to repurchase up to 344,800 shares of HMN's common stock in the open market. At December 31, 2001 there remained 244,800 shares approved to be purchased under the plan.
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.
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
*This paragraph contains a forward-looking statement(s). Refer to information regarding Forward-looking Information on page 27 of this discussion.
24
move in the same direction or to the same extent as the prices of goods and services.
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 the projected changes in net interest income that occur if interest rates were to suddenly change up or down. TheRate Shock Table located 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.
*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 100 basis points down from where the rates were at December 31, 2001. 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, 2001.
| Market Value | ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
Other than trading portfolio Basis point change in interest rates | |||||||||||
-100 | 0 | +100 | +200 | ||||||||
| (Dollars in thousands) | ||||||||||
Cash and cash equivalents | $ | 23,009 | 23,019 | 22,975 | 22,958 | ||||||
Securities available for sale: | |||||||||||
Fixed-rate CMOs | 7,661 | 7,611 | 7,561 | 7,513 | |||||||
Variable-rate CMOs | 53,654 | 54,595 | 55,184 | 55,189 | |||||||
Fixed-rate available for sale mortgage-backed and related securities | 2,531 | 2,454 | 2,370 | 2,288 | |||||||
Variable-rate available for sale mortgage-backed and related securities | 1,583 | 1,570 | 1,558 | 1,544 | |||||||
Fixed-rate available for sale other marketable securities | 54,935 | 53,551 | 52,215 | 50,914 | |||||||
Variable-rate available for sale other marketable securities | 117 | 114 | 111 | 111 | |||||||
Federal Home Loan Bank stock | 12,234 | 12,245 | 12,213 | 12,203 | |||||||
Fixed-rate loans held for sale | 69,220 | 68,018 | 64,460 | 63,439 | |||||||
Loans receivable, net: | |||||||||||
Fixed-rate real estate loans | 212,666 | 207,563 | 201,420 | 195,294 | |||||||
Variable-rate real estate loans | 126,931 | 124,487 | 122,059 | 119,680 | |||||||
Fixed-rate other loans | 87,948 | 86,749 | 84,923 | 83,281 | |||||||
Variable-rate other loans | 76,646 | 75,551 | 73,158 | 71,467 | |||||||
Mortgage servicing rights, net | 1,021 | 1,904 | 2,497 | 2,744 | |||||||
Investment in limited partnerships | 1,103 | 1,524 | 1,931 | 2,073 | |||||||
Total market risk sensitive assets | 731,259 | 720,955 | 704,635 | 690,698 | |||||||
Deposits: | |||||||||||
NOW accounts | 59,369 | 59,369 | 59,369 | 59,369 | |||||||
Passbooks | 32,739 | 32,739 | 32,739 | 32,739 | |||||||
Money market accounts | 44,006 | 44,006 | 44,006 | 44,006 | |||||||
Certificates | 293,339 | 290,649 | 287,965 | 285,388 | |||||||
Federal Home Loan Bank advances: | |||||||||||
Fixed-rate advances | 193,908 | 187,453 | 183,291 | 180,263 | |||||||
Variable-rate advances | 37,535 | 37,427 | 37,401 | 37,374 | |||||||
Total market risk sensitive liabilities | 660,896 | 651,643 | 644,771 | 639,139 | |||||||
Off-balance sheet financial instruments: | |||||||||||
Commitments to extend credit | 1,162 | (313 | ) | (1,163 | ) | (1,663 | ) | ||||
Commitments to sell or deliver loans | (2,954 | ) | 1,294 | 2,956 | 4,223 | ||||||
Interest rate swap | (183 | ) | (182 | ) | (182 | ) | (181 | ) | |||
Net market risk | $ | 72,338 | 68,513 | 58,253 | 49,180 | ||||||
Percentage change from current market value | 5.29 | % | 0.00 | % | (14.98 | )% | (28.22 | )% | |||
*This paragraph contains a forward-looking statement(s). Refer to information regarding Forward-looking Information on page 27 of this discussion.
25
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 7% to 38%, depending on the note rate and the period to maturity. Adjustable rate mortgages ("ARMs") were assumed to prepay at annual rates of between 11% and 28%, depending on the note rate and the period to maturity. Growing Equity Mortgage (GEM) loans were assumed to prepay at annual rates of between 12% and 43% depending on the note rate and the period to maturity. Mortgage-backed securities and Collateralized Mortgage Obligations (CMOs) were projected to have prepayments based upon the underlying collateral securing the instrument and the related cash flow priority of the CMO tranche owned. Certificate accounts were assumed not to be withdrawn until maturity. Passbook and money market accounts were assumed to decay at an annual rate of 20%. FHLB advances were projected to be called at the first call date where the projected interest rate on similar remaining term advances exceeded the interest rate on HMN's callable advance. Refer to Note 12 of the Notes to Consolidated Financial Statements for more information on call provisions of the FHLB advances.
*Certain shortcomings are inherent in the method of analysis presented in the foregoing table. The interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types of assets and liabilities may lag behind changes in market interest rates. The model assumes that the difference between the current interest rate being earned or paid compared to a treasury instrument or other interest index with a similar term to maturity (the "Interest Spread") will remain constant over the interest changes disclosed in the table. Changes in Interest Spread could impact projected market value changes. Certain assets, such as ARMs, have features 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 a substantial sustained 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, 2001 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 in Basis Points | Net Interest Income | Percentage Change | ||||
---|---|---|---|---|---|---|
+200 | $ | 23,414,000 | 5.36 | % | ||
+100 | 23,417,000 | 5.38 | % | |||
0 | 22,222,000 | 0.00 | % | |||
-100 | 19,184,000 | (13.67 | )% |
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 prepared by third parties.
*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. HMN has an Asset/Liability Committee which meets at least on a monthly basis to discuss changes made to 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
26
liabilities. The Bank has primarily focused its fixed rate one-to-four family residential lending program on loans that are saleable to third parties and will portfolio only certain fixed rate loans that meet certain risk characteristics. The Bank will portfolio adjustable rate loans which reprice over a one year, three year and five year period. At times, depending on its interest rate sensitivity, the Bank may sell seasoned 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.
Forward-looking Information
The following paragraphs 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.
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 estimated 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.
Loans Receivable, Net
HMN established a commercial lending department in 1998 in order to facilitate a change in the mix of assets on its balance sheet. The purpose of changing the mix was to reduce interest rate risk and enhance performance by increasing its investment in shorter term and generally higher yielding commercial real estate and commercial business loans and reduce its investment in longer term one-to-four family real estate loans. HMN intends to continue to change its asset mix by continuing to originate more commercial real estate, commercial business, and consumer loans while selling the majority of the newly originated one-to-four family loans with amortization terms of 20 years or longer.
Allowance for Loan Losses
Management continues to actively monitor asset quality and to charge off loans against the allowance for loan losses when appropriate. Although management believes it uses the best information available to make determinations with respect to the allowance for loan losses, future adjustments may be necessary if economic conditions differ substantially from the economic conditions in the assumptions used to determine the size of the allowance for losses.
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 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.
HMN anticipates that its liquidity requirements for 2002 will be similar to the cash flows it experienced in 2001 with the following exceptions: expenditures for premises and equipment are anticipated to be $1.6 million which is less than the 2001 expenditures; net increase in loans receivable is anticipated to be $54 million; and the deposits and/or FHLB advances will be in the range of $50 to $55 million.
The actual cash flows of HMN may be different than the anticipated cash flows discussed for 2002 due to unforeseen economic conditions or unanticipated events such as the desire of customers to close all of their accounts.
HMN has certificates of deposit with outstanding balances of $187.1 million that mature during 2002. 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 a combination of other customers or brokered deposits. FHLB advances or the sale of securities could also be used to replace unanticipated outflows of deposits. 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 the 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.
HMN has $9.5 million of FHLB advances which mature in 2002 and it has $25.0 million of FHLB
27
advances with maturities beyond 2002 which have call features that may be exercised by the FHLB during 2002. If the call features are exercised, HMN has the option of requesting any advance otherwise available to it pursuant to the Credit Policy of the FHLB. Since HMN has the ability to request another advance to replace the advance that is being called, management does not anticipate that it will have a liquidity problem due to advances being called by the FHLB during 2002.
The Credit Policy of the FHLB may change such that the current collateral pledged to secure the advances is no longer acceptable or the formulas for determining the excess pledged collateral may change and the Bank may not have additional collateral to pledge to secure the existing advances could cause the FHLB advances to become a liquidity problem during 2002.
Market Risk
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's actual market value changes for interest earnings 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. 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 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.
HMN believes that over the next twelve months interest rates could conceivably fluctuate in a range of 200 basis points up or 100 basis points down from where the rates were at December 31, 2001. HMN does not have a trading portfolio. The table in the Market Risk Section 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, 2001.
Actual interest rates could fluctuate by more than 200 basis points up or 100 basis points down from rates in effect on December 31, 2001 due to additional terroristic activity in the world. Many foreign countries have economies which may substantially impact the economy of the United States. Negative occurrences in foreign economies could cause general interest rates to fluctuate by more than 200 basis points up or 100 basis points down in the United States.
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, 2001 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.
Certain shortcomings are inherent in the method of analysis presented in the 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.
28
December 31, 2001 and 2000 | 2001 | 2000 | |||||
---|---|---|---|---|---|---|---|
ASSETS | |||||||
Cash and cash equivalents | $ | 23,019,553 | 14,416,861 | ||||
Securities available for sale: | |||||||
Mortgage-backed and related securities (amortized cost $65,878,534 and $76,199,237) | 66,229,732 | 75,379,719 | |||||
Other marketable securities (amortized cost $53,439,401 and $66,392,057) | 53,665,502 | 63,826,770 | |||||
119,895,234 | 139,206,489 | ||||||
Loans held for sale | 68,017,570 | 7,861,029 | |||||
Loans receivable, net | 471,667,772 | 518,765,209 | |||||
Accrued interest receivable | 3,508,828 | 4,311,747 | |||||
Federal Home Loan Bank stock, at cost | 12,245,000 | 12,245,000 | |||||
Mortgage servicing rights, net | 1,903,636 | 1,188,928 | |||||
Premises and equipment, net | 10,860,756 | 9,459,710 | |||||
Investment in limited partnerships | 1,523,650 | 2,838,364 | |||||
Goodwill | 3,800,938 | 3,980,974 | |||||
Core deposit intangible | 685,509 | 794,363 | |||||
Prepaid expenses and other assets | 3,985,625 | 947,201 | |||||
Total assets | $ | 721,114,071 | 716,015,875 | ||||
LIABILITIES AND STOCKHOLDERS' EQUITY | |||||||
Deposits | $ | 421,843,369 | 421,690,548 | ||||
Federal Home Loan Bank advances | 217,800,000 | 221,900,000 | |||||
Accrued interest payable | 1,017,456 | 1,575,521 | |||||
Advance payments by borrowers for taxes and insurance | 1,015,570 | 650,348 | |||||
Accrued expenses and other liabilities | 6,535,734 | 3,355,110 | |||||
Deferred tax liabilities | 976,900 | 218,700 | |||||
Total liabilities | 649,189,029 | 649,390,227 | |||||
Commitments and contingencies | |||||||
Minority interest | (236,309 | ) | 0 | ||||
Stockholders' equity: | |||||||
Serial preferred stock: ($.01 par value) Authorized 500,000 shares; issued and outstanding none | 0 | 0 | |||||
Common stock ($.01 par value): Authorized 11,000,000; issued shares 9,128,662 | 91,287 | 91,287 | |||||
Additional paid-in capital | 59,168,782 | 59,584,176 | |||||
Retained earnings, subject to certain restrictions | 76,956,978 | 73,380,588 | |||||
Accumulated other comprehensive income (loss) | 367,744 | (2,037,005 | ) | ||||
Unearned employee stock ownership plan shares | (5,124,746 | ) | (5,318,067 | ) | |||
Unearned compensation restricted stock awards | (7,350 | ) | (9,800 | ) | |||
Treasury stock, at cost 4,732,521 and 4,737,521 shares | (59,291,344 | ) | (59,065,531 | ) | |||
Total stockholders' equity | 72,161,351 | 66,625,648 | |||||
Total liabilities and stockholders' equity | $ | 721,114,071 | 716,015,875 | ||||
See accompanying notes to consolidated financial statements.
29
CONSOLIDATED STATEMENTS OF INCOME
Year ended December 31, 2001, 2000 and 1999 | 2001 | 2000 | 1999 | |||||||
---|---|---|---|---|---|---|---|---|---|---|
Interest income: | ||||||||||
Loans receivable | $ | 44,569,397 | 40,510,151 | 35,091,002 | ||||||
Securities available for sale: | ||||||||||
Mortgage-backed and related | 3,867,079 | 6,694,550 | 6,891,308 | |||||||
Other marketable | 2,248,383 | 4,658,871 | 4,262,344 | |||||||
Cash equivalents | 246,449 | 221,465 | 218,373 | |||||||
Other | 536,619 | 832,392 | 641,141 | |||||||
Total interest income | 51,467,927 | 52,917,429 | 47,104,168 | |||||||
Interest expense: | ||||||||||
Deposits | 18,578,348 | 19,132,506 | 17,925,739 | |||||||
Federal Home Loan Bank advances and other borrowed money | 11,865,682 | 13,868,974 | 10,985,256 | |||||||
Total interest expense | 30,444,030 | 33,001,480 | 28,910,995 | |||||||
Net interest income | 21,023,897 | 19,915,949 | 18,193,173 | |||||||
Provision for loan losses | 1,150,000 | 180,000 | 240,000 | |||||||
Net interest income after provision for loan losses | 19,873,897 | 19,735,949 | 17,953,173 | |||||||
Non-interest income: | ||||||||||
Fees and service charges | 1,563,031 | 1,297,014 | 848,249 | |||||||
Mortgage servicing fees | 470,081 | 340,935 | 334,603 | |||||||
Securities gains (losses), net | (670,958 | ) | (23,122 | ) | 122,395 | |||||
Gain on sales of loans | 2,934,317 | 1,215,702 | 1,932,164 | |||||||
Earnings (losses) in limited partnerships | (1,311,568 | ) | (120,922 | ) | 550,053 | |||||
Other | 598,625 | 613,275 | 505,546 | |||||||
Total non-interest income | 3,583,528 | 3,322,882 | 4,293,010 | |||||||
Non-interest expense: | ||||||||||
Compensation and benefits | 7,914,452 | 6,391,326 | 6,051,719 | |||||||
Occupancy | 2,239,152 | 1,890,947 | 1,571,333 | |||||||
Federal deposit insurance premiums | 79,714 | 83,233 | 254,198 | |||||||
Advertising | 426,357 | 303,046 | 283,886 | |||||||
Data processing | 963,958 | 789,995 | 718,468 | |||||||
Amortization of mortgage servicing rights, net of valuation adjustments and servicing costs | 758,352 | 333,692 | 471,105 | |||||||
Other | 3,366,698 | 2,766,382 | 2,543,983 | |||||||
Total noninterest expense | 15,748,683 | 12,558,621 | 11,894,692 | |||||||
Income before income tax expense | 7,708,742 | 10,500,210 | 10,351,491 | |||||||
Income tax expense | 2,634,385 | 3,797,900 | 3,960,500 | |||||||
Income before minority interest | 5,074,357 | 6,702,310 | 6,390,991 | |||||||
Minority interest | (383,259 | ) | 0 | 0 | ||||||
Net income | $ | 5,457,616 | 6,702,310 | 6,390,991 | ||||||
Basic earnings per share | $ | 1.45 | 1.75 | 1.47 | ||||||
Diluted earnings per share | $ | 1.37 | 1.69 | 1.41 | ||||||
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME | ||||||||||
Net income | $ | 5,457,616 | 6,702,310 | 6,390,991 | ||||||
Other comprehensive income (loss), net of tax: | ||||||||||
Unrealized gains on hedging valuation | 35,795 | 0 | 0 | |||||||
Less: minority interest in hedging valuation | 21,950 | 0 | 0 | |||||||
Net unrealized gains on hedging valuation | 13,845 | 0 | 0 | |||||||
Unrealized gains (losses) on securities: | ||||||||||
Unrealized holding gains (losses) arising during period | 1,988,754 | 1,136,524 | (2,274,666 | ) | ||||||
Less: reclassification adjustment for gains (losses) included in net income | (402,150 | ) | (14,214 | ) | 75,239 | |||||
Other comprehensive income (loss) | 2,404,749 | 1,150,738 | (2,349,905 | ) | ||||||
Comprehensive income | $ | 7,862,365 | 7,853,048 | 4,041,086 | ||||||
See accompanying notes to consolidated financial statements.
30
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years ended December 31, 2001, 2000 and 1999 | Common Stock | Additional Paid-In Capital | Retained Earnings | Accumulated Other Comprehensive Income (Loss) | Unearned Employee Stock Ownership Plan Shares | Unearned Compensation Restricted Stock Awards | Treasury Stock | Total Stockholders' Equity | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Balance, December 31, 1998 | $ | 91,287 | 59,739,020 | 63,424,378 | (837,838 | ) | (5,705,152 | ) | (276,867 | ) | (47,989,489 | ) | 68,445,339 | ||||||
Net income | 6,390,991 | 6,390,991 | |||||||||||||||||
Other comprehensive loss | (2,349,905 | ) | (2,349,905 | ) | |||||||||||||||
Treasury stock purchases | (7,271,668 | ) | (7,271,668 | ) | |||||||||||||||
Tax benefits of restricted stock awards | 26,743 | 26,743 | |||||||||||||||||
Employee stock options exercised | (183,098 | ) | 438,646 | 255,548 | |||||||||||||||
Tax benefit of exercised stock options | 27,636 | 27,636 | |||||||||||||||||
Amortization of restricted stock awards | 170,830 | 170,830 | |||||||||||||||||
Restricted stock awards cancelled | 9,529 | (9,529 | ) | 0 | |||||||||||||||
Earned employee stock ownership plan shares | 64,414 | 193,301 | 257,715 | ||||||||||||||||
Dividends paid | (1,392,361 | ) | (1,392,361 | ) | |||||||||||||||
Balance, December 31, 1999 | $ | 91,287 | 59,674,715 | 68,423,008 | (3,187,743 | ) | (5,511,851 | ) | (96,508 | ) | (54,832,040 | ) | 64,560,868 | ||||||
Net income | 6,702,310 | 6,702,310 | |||||||||||||||||
Other comprehensive income | 1,150,738 | 1,150,738 | |||||||||||||||||
Treasury stock purchases | (5,091,726 | ) | (5,091,726 | ) | |||||||||||||||
Tax benefits of restricted stock awards | 35,200 | 35,200 | |||||||||||||||||
Employee stock options exercised | (257,101 | ) | 858,235 | 601,134 | |||||||||||||||
Tax benefit of exercised stock options | 76,165 | 76,165 | |||||||||||||||||
Amortization of restricted stock awards | 86,708 | 86,708 | |||||||||||||||||
Earned employee stock ownership plan shares | 55,197 | 193,784 | 248,981 | ||||||||||||||||
Dividends paid | (1,744,730 | ) | (1,744,730 | ) | |||||||||||||||
Balance, December 31, 2000 | $ | 91,287 | 59,584,176 | 73,380,588 | (2,037,005 | ) | (5,318,067 | ) | (9,800 | ) | (59,065,531 | ) | 66,625,648 | ||||||
Net income | 5,457,616 | 5,457,616 | |||||||||||||||||
Other comprehensive income | 2,404,749 | 2,404,749 | |||||||||||||||||
Treasury stock purchases | (1,584,152 | ) | (1,584,152 | ) | |||||||||||||||
Employee stock options exercised | (712,140 | ) | 1,358,339 | 646,199 | |||||||||||||||
Tax benefit of exercised stock options | 191,695 | 191,695 | |||||||||||||||||
Tax benefits of restricted stock awards | 2,479 | 2,479 | |||||||||||||||||
Amortization of restricted stock awards | 2,450 | 2,450 | |||||||||||||||||
Earned employee stock ownership plan shares | 102,572 | 193,321 | 295,893 | ||||||||||||||||
Dividends paid | (1,881,226 | ) | (1,881,226 | ) | |||||||||||||||
Balance, December 31, 2001 | $ | 91,287 | 59,168,782 | 76,956,978 | 367,744 | (5,124,746 | ) | (7,350 | ) | (59,291,344 | ) | 72,161,351 | |||||||
See accompanying notes to consolidated financial statements.
31
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, 2001, 2000 and 1999 | 2001 | 2000 | 1999 | ||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
Cash flows from operating activities: | |||||||||||
Net income | $ | 5,457,616 | 6,702,310 | 6,390,991 | |||||||
Adjustments to reconcile net income to cash provided (used) by operating activities: | |||||||||||
Provision for loan losses | 1,150,000 | 180,000 | 240,000 | ||||||||
Depreciation | 1,037,897 | 896,741 | 757,695 | ||||||||
Amortization of (discounts) premiums, net | 107,719 | (73,113 | ) | 57,513 | |||||||
Amortization of deferred loan fees | (513,671 | ) | (212,200 | ) | (617,163 | ) | |||||
Amortization of goodwill | 180,036 | 180,024 | 180,035 | ||||||||
Amortization of core deposit intangible | 108,854 | 232,440 | 232,442 | ||||||||
Amortization of other purchase accounting adjustments | (10,210 | ) | (40,662 | ) | 29,123 | ||||||
Amortization of mortgage servicing rights and net valuation adjustments | 724,513 | 302,277 | 431,658 | ||||||||
Capitalized mortgage servicing rights | (1,458,322 | ) | (367,531 | ) | (549,639 | ) | |||||
Deferred income taxes | (821,600 | ) | 353,400 | 414,100 | |||||||
Securities losses (gains), net | 670,958 | 23,122 | (122,395 | ) | |||||||
Gain on sales of real estate | (17,293 | ) | 0 | 0 | |||||||
Gain on sales of loans | (2,934,317 | ) | (1,215,702 | ) | (1,932,164 | ) | |||||
Proceeds from sales of loans held for sale | 753,564,329 | 109,204,874 | 180,597,578 | ||||||||
Disbursements on loans held for sale | (809,722,094 | ) | (110,703,659 | ) | (167,022,259 | ) | |||||
Principal collected on loans held for sale | 179,020 | 38,601 | 1,099 | ||||||||
Amortization of restricted stock awards | 2,450 | 86,708 | 170,830 | ||||||||
Amortization of unearned ESOP shares | 193,321 | 193,784 | 193,301 | ||||||||
Earned employee stock ownership shares priced above original cost | 102,572 | 55,197 | 64,414 | ||||||||
Decrease (increase) in accrued interest receivable | 802,919 | (451,293 | ) | 92,309 | |||||||
Increase (decrease) in accrued interest payable | (558,065 | ) | 142,410 | 347,098 | |||||||
Equity (earnings) losses of limited partnerships | 1,311,568 | 120,922 | (550,053 | ) | |||||||
Equity losses of minority interest | (383,259 | ) | 0 | 0 | |||||||
Increase in other assets | (1,937,860 | ) | (112,976 | ) | (728,182 | ) | |||||
Increase in other liabilities | 2,890,551 | 870,222 | 623,010 | ||||||||
Other, net | (16,615 | ) | 7,367 | 23,448 | |||||||
Net cash (used) provided by operating activities | (49,888,983 | ) | 6,413,263 | 19,324,789 | |||||||
Cash flows from investing activities: | |||||||||||
Proceeds from sales of securities available for sale | 19,135,721 | 41,454,275 | 32,185,211 | ||||||||
Principal collected on securities available for sale | 24,062,724 | 9,198,142 | 42,684,941 | ||||||||
Proceeds collected on maturity of securities available for sale | 13,695,000 | 14,500,000 | 27,084,000 | ||||||||
Purchases of securities available for sale | (34,461,933 | ) | (17,958,537 | ) | (88,572,057 | ) | |||||
Proceeds from sales of loans receivable | 12,156 | 204,264 | 223,097 | ||||||||
Purchase of Federal Home Loan Bank stock | 0 | (775,000 | ) | (1,632,100 | ) | ||||||
Net decrease (increase) in loans receivable | 44,264,172 | (53,310,741 | ) | (42,190,734 | ) | ||||||
Proceeds from sale of real estate | 316,797 | 0 | 16,625 | ||||||||
Purchases of premises and equipment | (2,438,943 | ) | (1,826,017 | ) | (905,993 | ) | |||||
Net cash provided (used) by investing activities | 64,585,694 | (8,513,614 | ) | (31,107,010 | ) | ||||||
Cash flows from financing activities: | |||||||||||
Increase (decrease) in deposits | 334,938 | 21,364,898 | (33,375,878 | ) | |||||||
Purchase of treasury stock | (1,584,152 | ) | (5,091,726 | ) | (7,271,668 | ) | |||||
Stock options exercised | 646,199 | 601,134 | 255,548 | ||||||||
Dividends to stockholders | (1,881,226 | ) | (1,744,730 | ) | (1,392,361 | ) | |||||
Proceeds from Federal Home Loan Bank advances | 267,700,000 | 167,800,000 | 129,700,000 | ||||||||
Repayment of Federal Home Loan Bank advances | (271,800,000 | ) | (175,300,000 | ) | (85,700,000 | ) | |||||
Decrease in other borrowed money | 0 | 0 | (2,500,000 | ) | |||||||
Minority interest in mortgage services | 125,000 | 0 | 0 | ||||||||
Increase (decrease) in advance payments by borrowers for taxes and insurance | 365,222 | (163,744 | ) | 157,003 | |||||||
Net cash (used) provided by financing activities | (6,094,019 | ) | 7,465,832 | (127,356 | ) | ||||||
Increase (decrease) in cash and cash equivalents | 8,602,692 | 5,365,481 | (11,909,577 | ) | |||||||
Cash and cash equivalents, beginning of year | 14,416,861 | 9,051,380 | 20,960,957 | ||||||||
Cash and cash equivalents, end of year | $ | 23,019,553 | 14,416,861 | 9,051,380 | |||||||
Supplemental cash flow disclosures: | |||||||||||
Cash paid for interest | $ | 31,002,095 | 32,859,070 | 28,563,897 | |||||||
Cash paid for income taxes | 3,713,121 | 3,340,300 | 3,716,750 | ||||||||
Supplemental noncash flow disclosures: | |||||||||||
SBA certificates transferred from loans to securities available for sale | $ | 0 | 0 | 2,528,442 | |||||||
Loans securitized and transferred to securities available for sale | 0 | 11,129,146 | 6,913,219 | ||||||||
Loans transferred to loans held for sale | 2,172,128 | 1,095,640 | 2,662,480 | ||||||||
Transfer of loans to real estate | 86,123 | 244,258 | 0 | ||||||||
Transfer of real estate to loans | 0 | 50,140 | 0 |
See accompanying notes to consolidated financial statements.
32
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
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 subsidiaries, Osterud Insurance Agency, Inc. (OAI), doing business as Home Federal Investment Services and Home Federal Mortgage Services, LLC (HFMS). OAI is wholly owned by the Bank and offers financial planning products and services. HFMS is a mortgage banking and mortgage brokerage business located in Brooklyn Park, Minnesota. Prior to 2001 the business was operated as a wholly owned subsidiary of HMN and was known as HMN Mortgage Services, Inc. (MSI). In January 2001, HMN sold 100% of the MSI stock to the Bank. The Bank formed HFMS and merged MSI into HFMS. Effective February 1, 2001 the business sold a 49% membership interest in HFMS to two individuals. HMN has another wholly owned subsidiary, Security Finance Corporation (SFC). Prior to 2000, SFC invested in commercial loans and commercial real-estate loans located throughout the United States which were originated by third parties. During 2000 SFC sold many of its assets to the Bank and discontinued investing in commercial loans.
The consolidated financial statements included herein are for HMN, SFC, MSI, through January 31, 2001, the Bank and the Bank's subsidiaries, OAI and HFMS. All significant intercompany accounts and transactions have been eliminated in consolidation.
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.
Estimates that are particularly susceptible to change relate to the determination of the allowance for losses on loans and the valuation of mortgage servicing rights. In connection with the determination of the allowance for loan losses, management obtains independent appraisals for significant properties.
Management believes that the allowance for loan losses is adequate to cover probable losses inherent in the portfolio at the date of the balance sheet. While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the allowance for loan losses. Such agencies may require additions to the allowance based on their judgment about information available to them at the time of their examination.
Mortgage servicing rights are stratified by loan type and note rate and are valued quarterly using prepayment and default rate assumptions. While management believes that the assumptions used and the values determined are reasonable, future adjustments may be necessary if economic conditions differ substantially from the economic conditions in the assumptions used to determine the value of the mortgage servicing rights.
Cash 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. Declines in the value of securities available for sale that are considered other-than-temporary are recorded in noninterest income.
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 and recognized on trade date.
Loans Held for Sale Mortgage loans originated or purchased which are intended for sale in the secondary market are carried at the lower of cost or estimated market value in the aggregate. Net fees and costs associated with acquiring and/or originating loans held for sale are deferred and included in the basis of the loan in determining the gain or loss on the sale of the loans. Gains are recognized on settlement date. Net unrealized losses are recognized through a valuation allowance by charges to income.
Loans Receivable, Net Loans receivable, net are considered long-term investments and, accordingly, are carried at amortized cost. Loan origination fees received, net of certain loan origination costs, are deferred as an adjustment to the carrying value of the related loans, and are amortized into income using the interest method over the estimated life of the loans.
Premiums and discounts on loans are amortized into interest income using the interest method over the period to contractual maturity, adjusted for estimated prepayments.
The allowance for loan losses is maintained at an amount considered adequate by management to provide for probable loan losses inherent in the portfolio. The allowance for loan losses is based on periodic analysis of the loan portfolio by management. In this analysis, management considers factors including, but not limited
33
to, specific occurrences which include loan impairment, changes in the size of the portfolios, general economic conditions, loan portfolio composition and historical experience. The allowance for loan losses is established for known problem loans, as well as for loans which are not currently known to require specific allowances. Loans are charged off to the extent they are deemed to be uncollectible. The adequacy of the allowance for loan losses is dependent upon management's estimates of variables affecting valuation, appraisals of collateral, evaluations of performance and status, and the amounts and timing of future cash flows expected to be received on impaired loans. Such estimates, appraisals, evaluations and cash flows may be subject to frequent adjustments due to changing economic prospects of borrowers or properties. The estimates are reviewed periodically and adjustments, if any, are recorded in the provision for loan losses in the periods in which the adjustments become known.
Interest income is recognized on an accrual basis except when collectibility is in doubt. When loans are placed on a non-accrual basis, generally when the loan is 90 days past due, previously accrued but unpaid interest is reversed from income. Interest is subsequently recognized as income to the extent cash is received when, in management's judgment, principal is collectible.
All impaired loans, 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 for impairment on an individual basis.
Mortgage Servicing Rights Mortgage servicing rights are capitalized and amortized in proportion to, and over the period of, estimated net servicing income. HMN periodically evaluates its capitalized mortgage servicing rights for impairment. Loan type and note rate are predominant risk characteristics of the underlying loans used to stratify capitalized mortgage servicing rights for purposes of measuring impairment. Any impairment is recognized through a valuation allowance.
Real Estate, Net Real estate 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 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.
Investment in Limited Partnerships HMN has investments in limited partnerships which invest in mortgage servicing assets, the common stock of other financial institutions and low to moderate income housing projects which generate tax credits for HMN. HMN generally accounts for the earnings or losses from the limited partnerships on the equity method with the exception of the limited partnership which invests in mortgage servicing assets. HMN adjusts its investment in this limited partnership recorded under the equity method for an amount that represents HMN's proportionate share of adjusting the mortgage servicing assets to the lower of amortized cost or appraised market value of the mortgage servicing assets.
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 deposits run off. Management reviews intangible assets for impairment as events or circumstances indicate that the assets may not be recoverable. Effective January 1, 2002, HMN adopted Statement of Financial Accounting Standards (SFAS) No. 142,Goodwill and Other Intangible Assets, which requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead tested for impairment at least annually.
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 15, "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.
34
Earnings per Share Basic earnings per share (EPS) excludes dilution and is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential 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. Refer to Note 16 for disclosure of EPS calculations.
Comprehensive Income Comprehensive income is defined as the change in equity during a period from transactions and other events from nonowner sources. Comprehensive income is the total of net income and other comprehensive income, which for HMN is comprised of unrealized gains and losses on securities available for sale and unrealized gains on hedging valuations qualifying for cash flow hedge accounting treatment pursuant to SFAS No. 133.
Segment Information The amount of each segment item reported is the measure reported to the chief operating decision maker for purposes of making decisions about allocating resources to the segment and assessing its performance. Adjustments and eliminations made in preparing an enterprise's general-purpose financial statements and allocations of revenues, expenses and gains or losses are included in determining reported segment profit or loss if they are included in the measure of the segment's profit or loss that is used by the chief operating decision maker. Similarly, only those assets that are included in the measure of the segment's assets that is used by the chief operating decision maker is reported for that segment.
New Accounting Standards In July 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 141,Business Combinations, and SFAS No. 142,Goodwill and Other Intangible Assets. SFAS No. 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001 as well as all purchase method business combinations completed after June 30, 2001. SFAS No. 141 also specifies criteria intangible assets acquired in a purchase method business combination must meet to be recognized and reported apart from goodwill, noting that any purchase price allocable to an assembled workforce may not be accounted for separately. SFAS No. 142 requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead tested for impairment at least annually in accordance with the provisions of SFAS No. 142. SFAS No. 142 also requires that intangible assets with definite useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with SFAS No. 121,Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.
HMN adopted the provisions of SFAS No. 141 effective July 1, 2001 and adopted SFAS No. 142 effective January 1, 2002. Goodwill and intangible assets acquired in business combinations completed before July 1, 2001 continued to be amortized prior to the adoption of SFAS No. 142.
SFAS No. 141 requires that upon adoption of SFAS No. 142, HMN evaluate its existing intangible assets and goodwill that were acquired in a prior purchase business combination, and to make any necessary reclassifications in order to conform with the new criteria in SFAS No. 141 for recognition apart from goodwill. Upon adoption of SFAS No. 142, HMN will be required to reassess the useful lives and residual values of all intangible assets acquired in purchase business combinations, and make any necessary amortization period adjustments by the end of the first interim period after adoption. In addition, to the extent an intangible asset is identified as having an indefinite useful life, HMN will be required to test the intangible asset for impairment in accordance with the provisions of SFAS No. 142 within the first interim period. Any impairment loss will be measured as of the date of adoption and recognized as the cumulative effect of a change in accounting principle in the first interim period.
In connection with the transitional goodwill impairment evaluation, SFAS No. 142 will require HMN to perform an assessment of whether there is an indication that goodwill [and equity-method goodwill] is impaired as of the date of adoption. To accomplish this HMN must identify its reporting units and determine the carrying value of each reporting unit by assigning the assets and liabilities, including the existing goodwill and intangible assets, to those reporting units as of the date of adoption. HMN will then have up to six months from the date of adoption to determine the fair value of each reporting unit and compare it to the reporting unit's carrying amount. To the extent a reporting unit's carrying amount exceeds its fair value, an indication exists that the reporting unit's goodwill may be impaired and HMN must perform the second step of the transitional impairment test. In the second step, HMN must compare the implied fair value of the reporting unit's goodwill, determined by allocating the reporting unit's fair value to all of it assets (recognized and unrecognized) and liabilities in a manner similar to a purchase price allocation in accordance with SFAS No. 141, to its carrying amount, both of which would be measured as of the date of adoption. This second step is required to be completed as soon as possible, but no later than the end of the year of adoption. Any transitional impairment loss will be recognized as the cumulative effect of a change in accounting principle in HMN's income statement.
And finally, any unamortized negative goodwill and negative equity-method goodwill existing at the date SFAS No. 142 is adopted must be written off as the cumulative effect of a change in accounting principle.
On January 1, 2002, the adoption date, HMN had unamortized goodwill in the amount of $3,800,938, unamortized identifiable intangible assets in the amount of $685,509 and no unamortized negative goodwill, all of which will be subject to the transition provisions of SFAS No. 141 and 142. Amortization expense related to goodwill was $180,036 and $180,024 for the years ended December 31, 2001 and 2000, respectively. Because of the extensive effort needed to comply with adopting SFAS No. 141 and 142, it is
35
not practicable to reasonably estimate the impact of adopting these Statements on HMN's financial statements at the date of this report, including whether any transitional impairment losses will be required to be recognized as the cumulative effect of a change in accounting principle.
In August 2001, the FASB issued SFAS No. 144,Accounting for the Impairment of Disposal of Long-Lived Assets. This Statement supersedes FASB Statement No. 121,Accounting for the Impairment of Long-Lived Assets to Be Disposed Of, and the accounting and reporting provisions of APB Opinion No. 30,Reporting the Results of Operations—Reporting the Effects of Disposal of a Segment of a Business, And Extraordinary, Unusual and Infrequently Occurring Events and Transactions, for the disposal of a segment of a business (as previously defined in that Opinion). The Statement also amends Accounting Research Bulletin (ARB) No. 51,Consolidated Financial Statements, to eliminate the exception to consolidation for a subsidiary for which control is likely to be temporary. The Statement is effective for financial statements issued for fiscal years beginning after December 15, 2001. Management is currently studying the impact of adopting SFAS No. 144.
Derivative Financial Instruments HMN uses derivative financial instruments in order to manage the interest rate risk on residential loans held for sale and its commitments to extend credit for residential loans. HMN also uses interest rate swaps to manage interest rate risk. Derivative financial instruments include commitments to extend credit and forward mortgage loan sales commitments. See Note 20 for additional information concerning these derivative financial instruments.
Reclassifications Certain amounts in the consolidated financial statements for prior years have been reclassified to conform with the current year presentation.
NOTE 2 Other Comprehensive Income
The gross unrealized gains in hedging valuation for the year ended December 31, 2001 was $45,000, the income tax expense would have been $9,000 and therefore, the net gain was $36,000. The gross minority interest in hedging valuation for the year ended December 31, 2001 was $22,000. The net unrealized gains deferred to other comprehensive income was $14,000. There was no hedging valuation in the years ended December 31, 2000 and December 31, 1999. The gross unrealized holding gains on securities for the year ended December 31, 2001 were $3,291,000, the income tax expense would have been $1,302,000 and therefore, the net gain was $1,989,000. The gross reclassification adjustment for 2001 was $671,000, the income tax benefit would have been $269,000 and therefore, the net reclassification adjustment was $402,000. The gross unrealized holding gains on securities for the year ended December 31, 2000 were $1,886,000, the income tax expense would have been $749,000 and therefore, the net gain was $1,137,000. The gross reclassification adjustment for 2000 was $23,000, the income tax benefit would have been $9,000 and therefore, the net reclassification adjustment was $14,000. The gross unrealized holding losses for the year ended December 31, 1999 were $3,818,000, the income tax benefit would have been $1,543,000 and therefore, the net losses were $2,275,000. The gross reclassification adjustment for 1999 was $122,000, the income tax expense would have been $47,000 and therefore, the net reclassification adjustment was $75,000.
36
NOTE 3 Securities Available for Sale
A summary of securities available for sale at December 31, 2001 and 2000 is as follows:
| Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | ||||||
---|---|---|---|---|---|---|---|---|---|---|
December 31, 2001: | ||||||||||
Mortgage-backed securities: | ||||||||||
FHLMC | $ | 3,604,282 | 94,185 | 0 | 3,698,467 | |||||
FNMA | 256,482 | 4,730 | 0 | 261,212 | ||||||
GNMA | 63,051 | 1,932 | 0 | 64,983 | ||||||
Collateralized mortgage obligations: | ||||||||||
FHLMC | 22,018,460 | 82,623 | 81,587 | 22,019,496 | ||||||
FNMA | 26,577,974 | 144,767 | 50,611 | 26,672,130 | ||||||
Other | 13,358,285 | 155,159 | 0 | 13,513,444 | ||||||
65,878,534 | 483,396 | 132,198 | 66,229,732 | |||||||
Other marketable securities: | ||||||||||
U.S. Government and agency obligations | 35,304,271 | 210,087 | 9,456 | 35,504,902 | ||||||
Corporate debt | 9,545,532 | 96,109 | 0 | 9,641,641 | ||||||
Corporate equity | 8,589,598 | 63,744 | 134,383 | 8,518,959 | ||||||
53,439,401 | 369,940 | 143,839 | 53,665,502 | |||||||
$ | 119,317,935 | 853,336 | 276,037 | 119,895,234 | ||||||
December 31, 2000: | ||||||||||
Mortgage-backed securities: | ||||||||||
FHLMC | $ | 4,318,192 | 5,331 | 3,271 | 4,320,252 | |||||
FNMA | 266,853 | 0 | 7,973 | 258,880 | ||||||
GNMA | 81,328 | 0 | 865 | 80,463 | ||||||
Collateralized mortgage obligations: | ||||||||||
FHLMC | 24,111,859 | 7,885 | 362,508 | 23,757,236 | ||||||
FNMA | 29,927,398 | 16,268 | 440,393 | 29,503,273 | ||||||
Other | 17,493,607 | 78,682 | 112,674 | 17,459,615 | ||||||
76,199,237 | 108,166 | 927,684 | 75,379,719 | |||||||
Other marketable securities: | ||||||||||
U.S. Government and agency obligations | 37,802,316 | 12,682 | 1,227,343 | 36,587,655 | ||||||
Corporate debt | 16,234,831 | 25,709 | 526,849 | 15,733,691 | ||||||
Corporate equity | 12,354,910 | 236,914 | 1,086,400 | 11,505,424 | ||||||
66,392,057 | 275,305 | 2,840,592 | 63,826,770 | |||||||
$ | 142,591,294 | 383,471 | 3,768,276 | 139,206,489 | ||||||
Proceeds from securities available for sale which were sold during 2001 were $19,135,721, resulting in gross gains of $349,563 and gross losses of $521. The Company also recognized losses of $1,020,000 resulting from other than temporary impairment. Proceeds from securities available for sale which were sold during 2000 were $41,454,275, resulting in gross gains of $101,689 and gross losses of $124,811. Proceeds from securities available for sale which were sold during 1999 were $32,185,211, resulting in gross gains of $167,461 and gross losses of $45,066.
The following table indicates amortized cost and estimated fair value of securities available for sale at December 31, 2001, 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 Cost | Fair Value | ||||
---|---|---|---|---|---|---|
Due less than one year | $ | 69,888,320 | 70,297,278 | |||
Due after one year through five years | 39,447,052 | 39,677,880 | ||||
Due after five years through ten years | 1,190,971 | 1,197,940 | ||||
Due after ten years | 201,994 | 203,177 | ||||
No stated maturity | 8,589,598 | 8,518,959 | ||||
Total | $ | 119,317,935 | 119,895,234 | |||
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.
37
A summary of loans receivable at December 31 is as follows:
| 2001 | 2000 | |||||
---|---|---|---|---|---|---|---|
Residential real estate loans: | |||||||
1-4 family conventional | $ | 233,652,113 | 321,108,675 | ||||
1-4 family FHA | 488,510 | 1,032,120 | |||||
1-4 family VA | 271,356 | 548,499 | |||||
234,411,979 | 322,689,294 | ||||||
5 or more family | 21,786,780 | 17,152,215 | |||||
256,198,759 | 339,841,509 | ||||||
Commercial real estate: | |||||||
Lodging | 23,354,781 | 23,587,765 | |||||
Retail/office | 31,776,565 | 20,333,446 | |||||
Nursing home/health care | 34,229 | 3,466,000 | |||||
Land developments | 4,080,658 | 3,344,395 | |||||
Golf courses | 3,901,784 | 3,009,250 | |||||
Warehouse | 2,512,748 | 3,376,881 | |||||
Construction | 6,366,679 | 619,917 | |||||
Other | 19,335,460 | 9,264,108 | |||||
91,362,904 | 67,001,762 | ||||||
Other loans: | |||||||
Autos | 6,623,906 | 6,362,312 | |||||
Home equity line | 35,713,842 | 26,907,234 | |||||
Home equity | 26,439,557 | 28,144,157 | |||||
Other consumer | 2,497,502 | 2,951,519 | |||||
Commercial business | 54,940,192 | 48,759,903 | |||||
Savings | 594,330 | 695,190 | |||||
Mobile home | 5,456,362 | 4,920,549 | |||||
Other | 1,805,390 | 914,864 | |||||
134,071,081 | 119,655,728 | ||||||
Total loans | 481,632,744 | 526,498,999 | |||||
Less: | |||||||
Unamortized discounts | 278,161 | 288,828 | |||||
Net deferred loan fees | 1,211,438 | 1,348,618 | |||||
Allowance for losses | 3,783,112 | 3,143,746 | |||||
Loans in process | 4,692,261 | 2,952,598 | |||||
$ | 471,667,772 | 518,765,209 | |||||
Weighted average contractual interest rate | 7.64 | % | 8.17 | % | |||
Commitments to originate, fund or purchase loans | $ | 29,738,750 | 7,799,563 | ||||
Commitments to deliver loans to secondary market | 89,375,910 | 9,783,453 | |||||
Loans serviced for others | 234,911,618 | 147,905,114 |
Included in total commitments to originate or purchase loans are fixed rate loans aggregating approximately $27,435,250 and $1,355,960 as of December 31, 2001 and 2000, respectively. The interest rates on these commitments ranged from 5.50% to 8.00% at December 31, 2001 and from 7.00% to 10.25% at December 31, 2000.
At December 31, 2001 and 2000, loans on nonaccrual status totaled $2,159,228 and $1,011,662, respectively. Had the loans performed in accordance with their original terms throughout 2001, HMN would have recorded gross interest income of $207,330 for these loans. Interest income of $125,040 has been recorded on these loans for the year ended December 31, 2001.
At December 31, 2001 and 2000 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, 2001.
At December 31, 2001, 2000 and 1999, the recorded investment in loans that are considered to be impaired was $2,183,483, $1,416,916 and $817,743, respectively, for which the related allowance for credit losses was $637,233, $117,533 and $95,919, respectively. The average investment in impaired loans during 2001, 2000 and 1999 was $1,385,071, $869,168 and $709,903, respectively. For the years ended December 31, 2001, 2000 and 1999, HMN recognized interest income on impaired loans of $125,040, $68,447 and $41,485, respectively. All of the interest income that was recognized during 2001, 2000 and 1999 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 was $1,324,983, $476,815 and $616,735, at December 31, 2001, 2000 and 1999, respectively. During 2001 repayments on loans to executive officers and directors aggregated $302,869, loans originated aggregated $862,039, and loans added to the executive officer and director listing due to a change in status of the officer or director were $288,998. During 2000 repayments on loans to executive officers and directors were $55,131, new loans to executive officers and directors totaled $3,000, and loans removed from the executive officer listing due to change in status of the officer were $87,789.
At December 31, 2001, 2000 and 1999, HMN was servicing real estate loans for others with aggregate unpaid principal balances of approximately $234,911,618, $147,905,114 and $128,831,412, respectively.
HMN originates residential, commercial real estate and other loans primarily in southern Minnesota and Iowa. HMN has also purchased loans from a third party broker located in the Southeastern United States. At December 31, 2001 and 2000, HMN owned single family and multi-family residential loans located in the following states:
38
| 2001 | 2000 | ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|
| Amount | Percent of Total | Amount | Percent of Total | ||||||||
Alabama | $ | 6,067,456 | 2.4 | % | $ | 10,119,409 | 3.0 | % | ||||
California | 2,230,094 | 0.9 | 3,334,374 | 1.0 | ||||||||
Connecticut | 988,450 | 0.4 | 1,115,624 | 0.3 | ||||||||
Florida | 4,701,262 | 1.8 | 1,483,843 | 0.4 | ||||||||
Georgia | 29,548,729 | 11.5 | 45,384,328 | 13.4 | ||||||||
Illinois | 2,747,398 | 1.1 | 3,584,504 | 1.0 | ||||||||
Iowa | 15,874,165 | 6.2 | 22,339,473 | 6.6 | ||||||||
Maine | 1,395,209 | 0.5 | 2,144,840 | 0.6 | ||||||||
Massachusetts | 3,545,252 | 1.4 | 6,001,002 | 1.8 | ||||||||
Minnesota | 155,020,259 | 60.5 | 196,915,290 | 57.9 | ||||||||
New Hampshire | 1,218,104 | 0.5 | 1,908,595 | 0.6 | ||||||||
North Carolina | 13,181,582 | 5.1 | 18,603,691 | 5.5 | ||||||||
Ohio | 2,084,060 | 0.8 | 3,913,362 | 1.2 | ||||||||
South Carolina | 5,206,465 | 2.0 | 8,735,174 | 2.5 | ||||||||
Tennessee | 2,169,542 | 0.9 | 3,668,201 | 1.1 | ||||||||
Wisconsin | 8,030,367 | 3.1 | 8,067,458 | 2.4 | ||||||||
Other states | 2,190,365 | 0.9 | 2,522,341 | 0.7 | ||||||||
Total | $ | 256,198,759 | 100.0 | % | $ | 339,841,509 | 100.0 | % | ||||
Amounts under one million dollars are included in "Other states".
At December 31, 2001 and 2000, HMN owned commercial real estate loans located in the following states:
| 2001 | 2000 | ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|
| Amount | Percent of Total | Amount | Percent of Total | ||||||||
Alabama | $ | 1,778,301 | 1.9 | % | $ | 0 | 0.0 | % | ||||
Colorado | 1,740,529 | 1.9 | 1,754,703 | 2.6 | ||||||||
Iowa | 5,562,462 | 6.1 | 4,314,396 | 6.4 | ||||||||
Minnesota | 73,329,031 | 80.2 | 51,746,588 | 77.2 | ||||||||
Montana | 2,335,601 | 2.6 | 2,388,225 | 3.6 | ||||||||
Nebraska | 881,739 | 1.0 | 722,091 | 1.1 | ||||||||
New Mexico | 702,422 | 0.8 | 845,544 | 1.3 | ||||||||
Oregon | 1,268,194 | 1.4 | 1,326,419 | 2.0 | ||||||||
Texas | 3,689,143 | 4.0 | 3,813,942 | 5.7 | ||||||||
Wisconsin | 75,482 | 0.1 | 89,854 | 0.1 | ||||||||
Total | $ | 91,362,904 | 100.0 | % | $ | 67,001,762 | 100.0 | % | ||||
NOTE 5 Allowance for Loan and Real Estate Losses
The allowance for losses is summarized as follows:
Loans | Real estate | Total | |||||||
---|---|---|---|---|---|---|---|---|---|
Balance, December 31, 1998 | $ | 3,041,485 | 8,000 | 3,049,485 | |||||
Provision for losses | 240,000 | 0 | 240,000 | ||||||
Charge-offs | (9,792 | ) | (8,000 | ) | (17,792 | ) | |||
Recoveries | 1,618 | 0 | 1,618 | ||||||
Balance, December 31, 1999 | 3,273,311 | 0 | 3,273,311 | ||||||
Provision for losses | 180,000 | 0 | 180,000 | ||||||
Charge-offs | (312,455 | ) | 0 | (312,455 | ) | ||||
Recoveries | 2,890 | 0 | 2,890 | ||||||
Balance, December 31, 2000 | $ | 3,143,746 | 0 | 3,143,746 | |||||
Provision for losses | 1,150,000 | 0 | 1,150,000 | ||||||
Charge-offs | (516,337 | ) | 0 | (516,337 | ) | ||||
Recoveries | 5,703 | 0 | 5,703 | ||||||
Balance, December 31, 2001 | $ | 3,783,112 | 0 | 3,783,112 | |||||
NOTE 6 Accrued Interest Receivable
Accrued interest receivable at December 31 is summarized as follows:
| 2001 | 2000 | |||
---|---|---|---|---|---|
Securities available for sale | $ | 568,014 | 1,037,030 | ||
Loans receivable | 2,940,814 | 3,274,717 | |||
$ | 3,508,828 | 4,311,747 | |||
NOTE 7 Investment in Mortgage Servicing Rights
A summary of mortgage servicing activity is as follows:
| 2001 | 2000 | |||||
---|---|---|---|---|---|---|---|
Mortgage servicing rights | |||||||
Balance, beginning of year | $ | 1,188,928 | 1,148,774 | ||||
Originations | 1,458,321 | 367,531 | |||||
Amortization | (724,513 | ) | (327,377 | ) | |||
Balance, end of year | 1,922,736 | 1,188,928 | |||||
Valuation reserve | |||||||
Balance, beginning of year | 0 | (25,100 | ) | ||||
Additions | (19,100 | ) | 0 | ||||
Reductions | 0 | 25,100 | |||||
Balance, end of year | (19,100 | ) | 0 | ||||
Mortgage servicing rights, net | 1,903,636 | 1,188,928 | |||||
Fair value of mortgage servicing rights | $ | 1,939,000 | 1,476,000 | ||||
Mortgage servicing costs, which include professional services related to valuing mortgage servicing rights, were $14,739 and $31,415, respectively, in 2001 and 2000.
All of the loans being serviced were single family loans serviced for FNMA under the mortgage-backed security program or the individual loan sale program. The following is a summary of the risk characteristics of the loans being serviced at December 31, 2001:
| Loan Principal Balance | Weighted Average Interest Rate | Weighted Average Remaining Term | Number of Loans | |||||
---|---|---|---|---|---|---|---|---|---|
Original term 30 year fixed rate | $ | 100,642,000 | 7.23 | % | 338 | 1,159 | |||
Original term 15 year fixed rate | 125,597,000 | 6.55 | 163 | 1,845 | |||||
Seven year balloon | 122,000 | 7.07 | 315 | 2 | |||||
Adjustable rate | 3,374,000 | 7.28 | 303 | 26 |
39
A summary of real estate at December 31 is as follows:
| 2001 | 2000 | |||
---|---|---|---|---|---|
Real estate acquired through foreclosure | $ | 0 | 194,606 | ||
0 | 194,606 | ||||
Allowance for losses | 0 | 0 | |||
$ | 0 | 194,606 | |||
NOTE 9 Investment in Limited Partnerships
Investments in limited partnerships at December 31 were as follows:
Primary partnership activity | 2001 | 2000 | |||
---|---|---|---|---|---|
Mortgage servicing rights | $ | 991,941 | 2,257,941 | ||
Common stock of financial institutions | 265,955 | 285,524 | |||
Low to moderate income housing | 265,754 | 294,899 | |||
$ | 1,523,650 | 2,838,364 | |||
During 2001 HMN's proportionate loss from the mortgage servicing partnership was $1,266,000, its proportionate share of losses from the common stock investments in financial institutions was $19,568 and its proportionate loss on low income housing was $26,000. During 2001 HMN received low income housing credits totaling $84,000 which were credited to current income tax benefits.
During 2000 HMN's proportionate earnings from the mortgage servicing partnership was $35,848, its proportionate share of losses from the common stock investments in financial institutions was $130,053 and its proportionate loss on low income housing was $26,718. During 2000 HMN received low income housing credits totaling $84,000 which were credited to current income tax benefits. During 1999 HMN's proportionate earnings from the mortgage servicing partnership was $599,574, its proportionate share of earnings from the common stock investments in financial institutions was $387 and its proportionate loss on low income housing was $49,908. During 1999 HMN received low income housing credits totaling $84,000 which were credited to current income tax benefits.
NOTE 10 Premises and Equipment
A summary of premises and equipment at December 31 is as follows:
| 2001 | 2000 | |||
---|---|---|---|---|---|
Land | $ | 1,580,096 | 1,479,910 | ||
Office buildings and improvements | 8,375,777 | 7,615,356 | |||
Furniture and equipment | 7,737,924 | 6,159,587 | |||
17,693,797 | 15,254,853 | ||||
Less accumulated depreciation | 6,833,041 | 5,795,143 | |||
$ | 10,860,756 | 9,459,710 | |||
NOTE 11 Deposits
Deposits and their weighted average interest rates at December 31 are summarized as follows:
| 2001 | 2000 | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Weighted Average Rate | Amount | Percent of Total | Weighted Average Rate | Amount | Percent of Total | |||||||||
Noninterest checking | 0.00 | % | $ | 18,147,377 | 4.3 | % | 0.00 | % | $ | 12,922,925 | 3.1 | % | |||
NOW accounts | 0.64 | 40,226,061 | 9.5 | 1.50 | 33,067,936 | 7.8 | |||||||||
Passbooks | 0.75 | 32,738,309 | 7.8 | 2.00 | 32,741,841 | 7.7 | |||||||||
Money market accounts | 1.89 | 45,001,866 | 10.7 | 4.43 | 34,427,015 | 8.2 | |||||||||
136,113,613 | 32.3 | 113,159,717 | 26.8 | ||||||||||||
Certificates: | |||||||||||||||
1-1.99% | 2,784,991 | 0.7 | 0 | 0.0 | |||||||||||
2-2.99% | 34,924,430 | 8.3 | 244,204 | 0.1 | |||||||||||
3-3.99% | 64,330,025 | 15.2 | 15,883,674 | 3.8 | |||||||||||
4-4.99% | 64,096,795 | 15.2 | 38,420,432 | 9.1 | |||||||||||
5-5.99% | 35,908,810 | 8.5 | 52,713,635 | 12.5 | |||||||||||
6-6.99% | 70,282,159 | 16.6 | 159,764,813 | 37.9 | |||||||||||
7-7.99% | 13,402,546 | 3.2 | 41,504,073 | 9.8 | |||||||||||
Total certificates | 4.52 | 285,729,756 | 67.7 | 6.02 | 308,530,831 | 73.2 | |||||||||
Total deposits | 3.38 | $ | 421,843,369 | 100.0 | % | 5.02 | $ | 421,690,548 | 100.0 | % | |||||
At December 31, 2001 and 2000, HMN had $52,318,424 and $46,235,796, respectively, of certificate accounts with balances at $100,000 or more. At December 31, 2001 and 2000, HMN had $15,000,000 and $10,000,000 of certificate accounts, respectively, that had been acquired through a broker.
40
Certificates had the following maturities at December 31:
| 2001 | 2000 | |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
Remaining Term to Maturity | Amount (In Thousands) | Weighted Average Rate | Amount (In Thousands) | Weighted Average Rate | |||||||
1-6 months | $ | 141,450 | 5.13 | % | $ | 107,347 | 5.78 | % | |||
7-12 months | 45,670 | 3.50 | 94,639 | 6.13 | |||||||
13-36 months | 76,196 | 4.44 | 85,165 | 6.13 | |||||||
Over 36 months | 22,414 | 3.02 | 21,380 | 6.24 | |||||||
$ | 285,730 | 4.52 | $ | 308,531 | 6.02 | ||||||
At December 31, 2001 mortgage loans and mortgage-backed and related securities with an amortized cost of approximately $71,677,416 were pledged as collateral for certain deposits and $595,000 of letters of credit from the Federal Home Loan Bank (FHLB) were pledged as additional collateral on Bank deposits.
Interest expense on deposits is summarized as follows for the years ended December 31:
| 2001 | 2000 | 1999 | ||||
---|---|---|---|---|---|---|---|
NOW | $ | 315,149 | 310,503 | 239,216 | |||
Passbook | 454,628 | 683,613 | 715,707 | ||||
Money market | 897,875 | 1,237,646 | 1,004,910 | ||||
Certificates | 16,910,696 | 16,900,744 | 15,965,906 | ||||
$ | 18,578,348 | 19,132,506 | 17,925,739 | ||||
NOTE 12 Federal Home Loan Bank Advances
Federal Home Loan Bank advances consisted of the following at December 31, 2001 and 2000:
| 2001 | 2000 | |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
Year of Maturity | |||||||||||
Amount | Rate | Amount | Rate | ||||||||
2001 | 38,000,000 | 6.79 | % | ||||||||
2002 | $ | 9,500,000 | 4.42 | % | 9,500,000 | 6.16 | |||||
2003 | 64,400,000 | 3.47 | 54,400,000 | 6.44 | |||||||
2004 | 33,000,000 | 5.01 | 20,000,000 | 5.79 | |||||||
2008 | 90,000,000 | 5.40 | 90,000,000 | 5.40 | |||||||
2010 | 10,000,000 | 6.48 | 10,000,000 | 6.48 | |||||||
2011 | 10,900,000 | 4.81 | 0 | 0.00 | |||||||
217,800,000 | 4.75 | 221,900,000 | 6.01 | ||||||||
Lines of Credit | 0 | 0.00 | 0 | 0.00 | |||||||
$ | 217,800,000 | 4.75 | $ | 221,900,000 | 6.01 | ||||||
Many of the advances listed above have call provisions which allow the FHLB to request that the advance be paid back or refinanced at the rates then being offered by the FHLB. As of December 31, 2001, HMN had advances from the FHLB with the following call features:
Year of Maturity | Callable Quarterly in Year 2002 | Callable Quarterly in Year 2003 | Callable Quarterly in Year 2004 | Callable Quarterly in Year 2005 | |||||
---|---|---|---|---|---|---|---|---|---|
2004 | $ | 15,000,000 | 0 | 0 | 0 | ||||
2008 | 10,000,000 | 80,000,000 | 0 | 0 | |||||
2010 | 0 | 0 | 0 | 10,000,000 | |||||
2011 | 0 | 0 | 10,900,000 | 0 | |||||
$ | 25,000,000 | 80,000,000 | 10,900,000 | 10,000,000 | |||||
At December 31, 2001 the advances from the FHLB were collateralized by the Bank's FHLB stock and mortgage loans with unamortized principal balances of approximately $355,500,000 and securities with unamortized principal balances of approximately $10,500,000. The Bank has the ability to draw additional borrowings of $36,400,000 based upon the mortgage loans and securities that are currently pledged subject to a requirement to purchase FHLB stock.
NOTE 13 Other Borrowed Money
HMN had established a $2,500,000 revolving line of credit with a bank that was not drawn at December 31, 2001 or 2000. The line of credit matures September 30, 2002. The interest rate on the line floats with the Federal Funds Rate plus 250 basis points.
41
Income tax expense for the years ended December 31 is as follows:
| 2001 | 2000 | 1999 | ||||||
---|---|---|---|---|---|---|---|---|---|
Current: | |||||||||
Federal | $ | 2,773,200 | 2,663,500 | 2,751,700 | |||||
State | 682,785 | 781,000 | 794,700 | ||||||
Total current | 3,455,985 | 3,444,500 | 3,546,400 | ||||||
Deferred: | |||||||||
Federal | (638,000 | ) | 275,700 | 317,300 | |||||
State | (183,600 | ) | 77,700 | 96,800 | |||||
Total deferred | (821,600 | ) | 353,400 | 414,100 | |||||
$ | 2,634,385 | 3,797,900 | 3,960,500 | ||||||
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:
| 2001 | 2000 | 1999 | ||||||
---|---|---|---|---|---|---|---|---|---|
Federal expected income tax expense | $ | 2,751,300 | 3,570,100 | 3,519,500 | |||||
Items affecting federal income tax: | |||||||||
Dividend received deduction | (108,200 | ) | (92,400 | ) | (121,600 | ) | |||
Reduction of tax rate due to resolution of tax law | 0 | (200,400 | ) | 0 | |||||
State income taxes, net of federal income tax benefit | 329,500 | 568,600 | 587,200 | ||||||
Reduction of tax rate due to employee stock ownership plan dividends | (313,000 | ) | 0 | 0 | |||||
Low income housing credits | (84,000 | ) | (84,000 | ) | (84,000 | ) | |||
Other, net | 58,785 | 36,000 | 59,400 | ||||||
$ | 2,634,385 | 3,797,900 | 3,960,500 | ||||||
The tax effects of temporary differences that give rise to the deferred tax assets and deferred tax liabilities are as follows at December 31:
| 2001 | 2000 | ||||||
---|---|---|---|---|---|---|---|---|
Deferred tax assets: | ||||||||
Allowances for loan and real estate losses | $ | 1,504,500 | 1,250,200 | |||||
Investment in limited partnership | 118,900 | 0 | ||||||
Discounts on assets and liabilities acquired from MFC | 22,200 | 22,200 | ||||||
Deferred compensation and pension costs | 243,100 | 258,300 | ||||||
Restricted stock awards | 0 | 1,200 | ||||||
Mortgage loan servicing rights | 3,850 | 21,600 | ||||||
Impairment losses on securities available for sale | 407,700 | 0 | ||||||
Net unrealized loss on securities available for sale | 0 | 1,347,800 | ||||||
Total gross deferred tax assets | 2,300,250 | 2,901,300 | ||||||
Valuation allowance | 0 | 0 | ||||||
Net deferred tax assets | 2,300,250 | 2,901,300 | ||||||
Deferred tax liabilities: | ||||||||
Tax bad debt reserve over base year | 480,000 | 720,000 | ||||||
Premium on assets acquired from MFC | 273,600 | 317,200 | ||||||
Investment in limited partnership | 0 | 300,900 | ||||||
Net unrealized gain on market value adjustments to securities available for sale | 223,000 | 0 | ||||||
FHLB stock | 465,600 | 465,600 | ||||||
Deferred loan fees and costs | 437,400 | 370,700 | ||||||
Premises and equipment basis difference | 633,350 | 495,200 | ||||||
Originated mortgage servicing rights | 726,800 | 414,600 | ||||||
Other | 35,500 | 26,400 | ||||||
Unamortized discount on loan sale | 1,900 | 9,400 | ||||||
Total gross deferred tax liabilities | 3,277,150 | 3,120,000 | ||||||
Net deferred tax liabilities | $ | (976,900 | ) | (218,700 | ) | |||
Retained earnings at December 31, 2001 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 15 Employee Benefits
At December 31, 2001 substantially all full-time employees of the Bank are included in a trusteed noncontributory retirement plan sponsored by the Financial Institutions Retirement Fund (FIRF). The actuarial present value of accumulated plan benefits and net assets
42
available for benefits relating to the Bank's employees is not available at December 31, 2001 because such information is not accumulated for each participating institution. As of June 30, 2001, the FIRF valuation report reflected that the Bank was obligated to make contributions for the plan year ending June 30, 2002 totaling $155,000. Effective February 1, 2002, the Bank reduced the benefits provided in the plan so that the annual contribution required for that period would approximate $8,100. No contributions were required in 2000 or 1999 because the retirement plan was fully funded. For the years ended December 31, 2001, 2000 and 1999 the amounts charged to operating expenses were $700, $5,749 and $5,500, respectively.
HMN 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 are eligible to participate in the Plan. 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 HMN in an amount equal to 25% of the participant's salary reduction up to a maximum contribution of 8% of the participant's annual salary. Contributions above 8% are not matched by HMN. Generally all participant contributions and earnings are fully and immediately vested. HMN's matching contribution is made monthly but an employee must be employed by HMN on the last day of the plan year in order to vest the current year's employer match. Effective January 1, 1997, for new employees HMN's contributions are vested on a five year cliff basis in addition to the requirement of being employed at year end. HMN's matching contributions are expensed when made. HMN's contributions to the 401(k) Plan were $71,200, $60,700 and $63,400 in 2001, 2000 and 1999, respectively.
During 1994 HMN adopted an Employee Stock Ownership Plan (the ESOP) which met the requirements of Section (e)(7) of the Internal Revenue Code and Section 407 (d)(6) of the Employee Retirement Income Security Act of 1974, as amended (ERISA) and, as such the ESOP 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 912,866 shares of common stock in the initial public offering of HMN. In December of 1997 the Bank merged with Marshalltown Financial Corporation (MFC). As a result of the merger, in February 1998, the ESOP borrowed $1,476,000 to purchase 76,933 shares of HMN common stock to provide the employees from MFC with an ESOP benefit. The ESOP debt requires quarterly payments of principal plus interest at 7.52%. HMN has committed to make quarterly contributions to the ESOP necessary to repay the loan including interest. HMN contributed $525,224, $526,568 and $525,220 to the ESOP, respectively, during 2001, 2000 and 1999.
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 $365,921, $287,073 and $302,027, respectively, for 2001, 2000 and 1999.
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:
| 2001 | 2000 | 1999 | |||||
---|---|---|---|---|---|---|---|---|
Shares allocated to participants beginning of the year | $ | 246,710 | 245,294 | 246,721 | ||||
Shares allocated to participants | 24,317 | 24,382 | 24,317 | |||||
Shares purchased with dividends from allocated shares | 7,884 | 4,012 | 7,268 | |||||
Shares distributed to participants | (45,214 | ) | (26,978 | ) | (33,012 | ) | ||
Shares allocated to participants end of year | 233,697 | 246,710 | 245,294 | |||||
Unreleased shares beginning of the year | 669,064 | 693,446 | 717,763 | |||||
Shares released during year | (24,317 | ) | (24,382 | ) | (24,317 | ) | ||
Unreleased shares end of year | 644,747 | 669,064 | 693,446 | |||||
Total ESOP shares end of year | 878,444 | 915,774 | 938,740 | |||||
Fair value of unreleased shares at December 31 | $ | 9,987,131 | 8,739,648 | 7,801,268 |
In June of 1995, HMN as part of a Recognition and Retention Plan (RRP) awarded 126,729 shares of restricted common stock to its officers and directors. The shares vested over a five year period and were issued from treasury stock. In April 1997, 3,000 shares of restricted common stock were awarded to a director. Those shares vest over a five year period beginning in 1998. Compensation and benefit expense related to the restricted stock was $2,450, $86,708, and $170,830, respectively, for 2001, 2000 and 1999.
In June 1995, HMN adopted the 1995 Stock Option and Incentive Plan (the SOP). During 1995, options exercisable for 821,569 shares of HMN common stock were granted to certain officers and directors at an exercise price of $9.211 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 1,500 shares of common stock were granted to officers at an exercise price of $12.089. In April 1997, options for 18,000 shares of common stock were granted to a director at an exercise price of $13.007. In April 1999, options for 80,000 shares of common stock were granted to an officer and directors at an exercise price of $11.50. In April 2000, options for 30,000 shares were granted to directors at an exercise price of $11.25.
In March 2001, HMN adopted the HMN Financial, Inc. 2001 Omnibus Stock Plan (2001 Plan). The purpose of the 2001 Plan was to promote the interests of HMN and its stockholders by providing key personnel with an opportunity to acquire a proprietary interest in HMN and reward them for achieving a high level of corporate performance and thereby develop a stronger incentive to put forth maximum effort for the success and growth of HMN. The total number of shares of HMN common stock available for distribution under the 2001 Plan in either restricted stock or stock options is 400,000 subject to adjustment for future stock splits, stock dividends and similar changes to the capitalization of HMN. No awards were made pursuant to the 2001 Plan during 2001.
43
The fair value of the options granted under the SOP were $2.59, $4.11, $6.08, $5.55 and $4.49 for 2000, 1999, 1998, 1997 and 1995, respectively. A summary of stock option activity under the SOP is detailed as follows:
| Options available for grant | Options outstanding | Weighted average exercise price | |||||
---|---|---|---|---|---|---|---|---|
1995 Stock Option and Incentive Plan | ||||||||
December 31, 1998 | 111,799 | 727,246 | $ | 9.308 | ||||
Exercised | (49,516 | ) | 9.211 | |||||
Forfeited | 6,848 | (6,848 | ) | 9.211 | ||||
Granted April 27, 1999 | (80,000 | ) | 80,000 | 11.500 | ||||
December 31, 1999 | 38,647 | 750,882 | 9.549 | |||||
Exercised | (91,742 | ) | 9.211 | |||||
Forfeited | 750 | (750 | ) | 12.089 | ||||
Granted May 23, 2000 | (30,000 | ) | 30,000 | 11.250 | ||||
December 31, 2000 | 9,397 | 688,390 | 9.665 | |||||
Exercised | (171,271 | ) | 9.211 | |||||
Forfeited | 15,000 | (15,000 | ) | 11.500 | ||||
December 31, 2001 | 24,937 | 502,119 | 9.765 | |||||
2001 Omnibus Stock Plan | ||||||||
December 31, 2001 (potential award) | 400,000 | 0 | ||||||
The following table summarizes information about stock options outstanding at December 31, 2001:
Options Outstanding | Options Exercisable | |||||||||
---|---|---|---|---|---|---|---|---|---|---|
Exercise Price | Number outstanding | Weighted average remaining contractual life in years | Number | Price | ||||||
$ | 9.211 | 389,119 | 3.4 | 389,119 | $ | 9.211 | ||||
13.007 | 18,000 | 5.3 | 14,300 | 13.007 | ||||||
11.500 | 65,000 | 7.3 | 26,000 | 11.500 | ||||||
11.250 | 30,000 | 8.4 | 6,000 | 11.250 | ||||||
502,119 | 435,519 | |||||||||
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 adjusted to the pro forma amounts indicated below:
| 2001 | 2000 | 1999 | ||||||
---|---|---|---|---|---|---|---|---|---|
Net income: | |||||||||
As reported | $ | 5,457,616 | 6,702,310 | 6,390,991 | |||||
Pro forma | 5,464,421 | 6,508,031 | 6,169,114 | ||||||
Earnings per common share: | |||||||||
As reported: | |||||||||
Basic | $ | 1.45 | 1.75 | 1.47 | |||||
Diluted | 1.37 | 1.69 | 1.41 | ||||||
Pro forma: | |||||||||
Basic | 1.45 | 1.70 | 1.42 | ||||||
Diluted | 1.37 | 1.64 | 1.36 |
The preceding 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 incorporated the following assumptions for each year of grant:
| 2000 | 1999 | 1998 | 1997 | 1995 | ||||||
---|---|---|---|---|---|---|---|---|---|---|---|
Risk free interest rate | 6.49 | % | 5.59 | % | 6.80 | % | 6.21 | % | 6.28 | % | |
Expected life | 9 years | 9 years | 10 years | 10 years | 10 years | ||||||
Expected volarity | 15.60 | % | 30.00 | % | 18.00 | % | 18.00 | % | 20.00 | % | |
Expected dividends | 5.0 | % | 2.1 | % | None | None | None |
NOTE 16 Earnings per Share
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, | |||||||
---|---|---|---|---|---|---|---|---|
| 2001 | 2000 | 1999 | |||||
Weighted average number of common shares outstanding used in basic earnings per common share calculation | 3,761,115 | 3,831,353 | 4,340,551 | |||||
Net dilutive effect of: | ||||||||
Options | 212,854 | 137,568 | 181,930 | |||||
Restricted stock awards | 509 | 1,767 | 16,828 | |||||
Weighted average number of shares outstanding adjusted for effect of dilutive securities | 3,974,478 | 3,970,688 | 4,539,309 | |||||
Income available to common shareholders | $ | 5,457,616 | 6,702,310 | 6,390,991 | ||||
Basic earnings per common share | $ | 1.45 | 1.75 | 1.47 | ||||
Diluted earnings per common share | $ | 1.37 | 1.69 | 1.41 |
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NOTE 17 Stockholders' Equity
Starting in 1995 and continuing throughout 2001, HMN has repurchased its common stock in the open market. HMN purchased 105,200 shares during 2001, 439,000 shares during 2000 and 568,400 shares during 1999 for $1,584,152, $5,091,726 and $7,271,668, respectively. The shares were placed in treasury stock.
HMN declared and paid dividends as follows:
Record date | Payable date | Dividend per share | |||
---|---|---|---|---|---|
February 24, 1999 | March 10, 1999 | $ | 0.08 | ||
May 26, 1999 | June 10, 1999 | $ | 0.08 | ||
August 25, 1999 | September 10, 1999 | $ | 0.08 | ||
November 23, 1999 | December 10, 1999 | $ | 0.08 | ||
February 24, 2000 | March 10, 2000 | $ | 0.10 | ||
May 25, 2000 | June 12, 2000 | $ | 0.10 | ||
August 28, 2000 | September 11, 2000 | $ | 0.12 | ||
November 22, 2000 | December 11, 2000 | $ | 0.12 | ||
February 22, 2001 | March 8, 2001 | $ | 0.12 | ||
May 24, 2001 | June 11, 2001 | $ | 0.12 | ||
August 28, 2001 | September 11, 2001 | $ | 0.14 | ||
November 23, 2001 | December 12, 2001 | $ | 0.14 |
On January 22, 2002 HMN declared a cash dividend of $0.14 per share payable on March 7, 2002 to holders of record on February 21, 2002.
HMN's certificate of incorporation authorizes the issuance of up to 500,000 shares of preferred stock, but to date no shares have been issued.
In order to grant a priority to eligible accountholders in the event of future liquidation, the Bank, at the time of conversion established a liquidation account equal to its regulatory capital as of September 30, 1993. In the event of future liquidation of the Bank, an eligible accountholder who continues to maintain their deposit account shall be entitled to receive a distribution from the liquidation account. The total amount of the liquidation account will be decreased as the balance of eligible accountholders are reduced subsequent to the conversion, based on an annual determination of such balance.
The Bank may not declare or pay a cash dividend to HMN if the total amount of the dividends for the year exceeds the Bank's net income for the year plus the Bank's retained net income for the preceding two years without filing a capital distribution application with 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 18 Federal Home Loan Bank Investment and Regulatory Capital Requirements
The Bank, as a member of the Federal Home Loan Bank System, is required to hold a specified number of shares of capital stock, which is carried at cost, in the Federal Home Loan Bank of Des Moines. The Bank has met the requirements as of December 31, 2001.
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 Tier I or Core capital, and Risk-based capital (as defined in the regulations) to total assets (as defined). Management believes, as of December 31, 2001, that the Bank meets all capital adequacy requirements to which it is subject.
Management believes that based upon the Bank's capital calculations at December 31, 2001 and other conditions consistent with the Prompt Corrective Actions Provisions of the OTS regulations, the Bank would be categorized as well capitalized.
45
At December 31, 2001 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 To Be Adequately Capitalized | Excess Capital | To Be Well Capitalized Under Prompt Corrective Actions Provision | ||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Amount | Percent of Assets(1) | Amount | Percent of Assets(1) | Amount | Percent of Assets(1) | Amount | Percent of Assets(1) | ||||||||||||||
Bank stockholder's equity | $ | 60,213 | ||||||||||||||||||||
Plus: | ||||||||||||||||||||||
Net unrealized loss (gain) on certain securities available for sale and cash flow hedges | (393 | ) | ||||||||||||||||||||
Less: | ||||||||||||||||||||||
Goodwill and other intangibles | 4,486 | |||||||||||||||||||||
Excess mortgage servicing rights. | 99 | |||||||||||||||||||||
Tier I or core capital | 55,235 | |||||||||||||||||||||
Tier I capital to adjusted total assets | 7.81 | % | $ | 28,299 | 4.00 | % | $ | 26,936 | 3.81 | % | $ | 35,374 | 5.00 | % | ||||||||
Tier I capital to risk-weighted assets | 11.90 | % | $ | 18,561 | 4.00 | % | $ | 36,674 | 7.90 | % | $ | 27,842 | 6.00 | % | ||||||||
Plus: | ||||||||||||||||||||||
Allowable allowance for loan losses | 3,098 | |||||||||||||||||||||
Risk-based capital | $ | 58,333 | $ | 37,122 | $ | 21,211 | $ | 46,403 | ||||||||||||||
Risk-based capital to risk-weighted assets. | 12.57 | % | 8.00 | % | 4.57 | % | 10.00 | % |
- (1)
- Based upon the Bank's adjusted total assets for the purpose of the Tier I or core capital ratios and risk-weighted assets for the purpose of the risk-based capital ratio.
NOTE 19 Financial Instruments with Off-Balance Sheet Risk
HMN 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 HMN.
HMN'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. HMN uses the same credit policies in making commitments as it does for on-balance sheet instruments.
| Contract Amount | |||||
---|---|---|---|---|---|---|
| 2001 | 2000 | ||||
| (In Thousands) | |||||
Financial instruments whose contract amount represents credit risk: | ||||||
Commitments to extend credit | $ | 115,883 | 64,980 | |||
Commitment of counter party to purchase loans | 89,376 | 9,783 | ||||
Financial instruments whose contract amount represents interest rate risk: | ||||||
Interest rate swap | $ | 15,000 | 10,000 |
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.
Interest rate swaps are derivative instruments that involve the contractual exchange of fixed and floating rate interest payment obligations based on a notional principal amount. The contractual arrangement is made to enhance management of interest rate risk exposure caused by fluctuations in interest rates. In 2000, HMN entered into an interest rate swap with a notional amount of $10,000,000. The interest rate swap is used as a fair value hedge for a certificate of deposit.
NOTE 20 Derivative Instruments and Hedging Activities
HMN adopted SFAS No. 133,Accounting for Derivative Instruments and Hedging Activities, as amended, in the first quarter of 2001 when it had an outstanding interest rate swap of $10 million. A transition adjustment of $75,637 was recorded on January 1, 2001 as an increase to other assets and also as an increase to the related certificate of deposit. The swap for $10 million was called in July 2001, and HMN simultaneously called the certificate of deposit
46
relating to that swap. In July HMN entered into another interest rate swap for $15 million. Under the new interest rate swap, HMN pays interest based upon the three month London Inter-Bank Offer Rate (LIBOR) and receives interest payments based upon a fixed rate of 6.0% on a notional value of $15 million in a fair value hedge with no ineffectiveness. The hedge is offsetting a callable certificate of deposit for $15 million that was issued by HMN. At December 31, 2001 the interest rate swap had a market value adjustment of $182,117 which is included in other liabilities. The corresponding certificate of deposit was adjusted by the same amount and is reflected in deposits in the consolidated balance sheet of HMN. The interest rate swap was deemed to be totally effective and therefore no gain or loss was recorded in the income statement.
HMN originates and purchases single family residential loans for sale into the secondary market and enters into commitments to sell in order to mitigate the interest rate risk associated with holding the loans until they are sold. At the beginning of the second quarter of 2001, commitments to sell loans held for sale were designated as a cash flow hedge of a forecasted transaction and were accounted for in accordance with SFAS No. 133 with no ineffectiveness recognized in the income statement. The derivative recorded in the balance sheet is a consolidated number that is partially owned by a minority interest. At December 31, 2001, the carrying value of the derivatives were marked by a $44,795 increase in other assets, the deferred tax liability was $9,000, the minority interest amount was $21,950, and the unrealized gain in other comprehensive income was $13,845.
As the loans held for sale are ultimately sold, the gains currently in accumulated other comprehensive income will be reclassified into the gains and losses on sale of loans in the income statement. It is estimated that all the loans held for sale at December 31, 2001 will be sold in the next three months.
HMN has commitments outstanding to extend credit to future borrowers or to purchase loans that had not closed prior to the end of the year which it refers to as its mortgage pipeline. Most of the time, as commitments to originate or purchase loans enter the mortgage pipeline, HMN simultaneously enters into commitments to sell the mortgage pipeline into the secondary market in order to reduce the interest rate risk from when the loan is committed until it is sold. These commitments are freestanding derivatives. As a result of marking the mortgage pipeline and the related commitments to sell the loan to market for the year ended December 31, 2001, HMN recorded an increase to other assets of $294,388 and an increase to other liabilities of $294,388. The net impact on the income statement of recording these derivatives at fair value was zero. Some commitments to originate or purchase loans did not have a corresponding commitment to sell at December 31, 2001. The commitments were marked to market which resulted in an increase to other liabilities of $18,527 and a loss in the gains or losses on sales of loans of $18,527.
Loans held for sale include loans that do not qualify for hedge accounting. A significant portion of these loans have corresponding commitments to sell associated with them. As a result of marking these loans to the lower of cost or market and recording the commitment to sell at fair value, loans held for sale were reduced by $999,314 and other assets were increased by $999,314. The net impact on the income statement was zero. A portion of these loans did not have a commitment associated with them and the lower of cost or market adjustment resulted in a reduction of loans held for sale of $141,822 and a loss in gains or losses on sales of loans of $141,822.
NOTE 21 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, 2001 and 2000 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.
The estimated fair value of HMN's financial instruments are shown on the following page. Following the table, there is an explanation of the methods and assumptions used to estimate the fair value of each class of financial instruments.
47
| December 31, | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2001 | 2000 | ||||||||||||
| Carrying Amount | Estimated Fair Value | Contract Amount | Carrying Amount | Estimated Fair Value | Contract Amount | ||||||||
| (In Thousands) | |||||||||||||
Financial assets: | ||||||||||||||
Cash and cash equivalents | $ | 23,019 | 23,019 | 14,417 | 14,417 | |||||||||
Securities available for sale | 119,895 | 119,895 | 139,206 | 139,206 | ||||||||||
Loans held for sale | 68,018 | 68,018 | 7,861 | 7,861 | ||||||||||
Loans receivable, net | 471,668 | 494,350 | 518,765 | 527,635 | ||||||||||
Federal Home Loan Bank stock | 12,245 | 12,245 | 12,245 | 12,245 | ||||||||||
Accrued interest receivable | 3,509 | 3,509 | 4,312 | 4,312 | ||||||||||
Financial liabilities: | ||||||||||||||
Deposits | 421,843 | 426,763 | 421,691 | 421,675 | ||||||||||
Federal Home Loan Bank advances | 217,800 | 224,880 | 221,900 | 219,559 | ||||||||||
Accrued interest payable | 1,017 | 1,017 | 1,576 | 1,576 | ||||||||||
Off-balance sheet financial instruments: | ||||||||||||||
Commitments to extend credit | (313 | ) | (313 | ) | 115,883 | 0 | 63 | 64,980 | ||||||
Commitments to sell loans | 1,294 | 1,294 | 89,376 | 0 | 0 | 9,783 | ||||||||
Interest rate swap | (182 | ) | (182 | ) | 15,000 | 0 | 76 | 10,000 |
Cash and Cash Equivalents The carrying amount of cash and cash equivalents approximates their fair value.
Securities Available for Sale The fair values of securities were based upon quoted market prices.
Loans Held for Sale The fair 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, 2001 and 2000 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.
Federal Home Loan Bank Advances and Other Borrowed Money The fair values of advances and other borrowed money with fixed maturities are estimated based on discounted cash flow analysis using as discount rates the interest rates charged by the FHLB or Wells Fargo Bank Minnesota, N.A. at December 31, 2001 and 2000 for borrowings of similar remaining maturities.
Accrued Interest Payable The carrying amount of accrued interest payable approximates its fair value since it is short-term in nature.
Commitments to Extend Credit The fair value of commitments to extend credit for 2000 are estimated using the fees normally charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counter parties. The fair value of commitments to extend credit for 2001 are estimated using quoted market prices.
Interest Rate Swap The fair value of interest rate swaps is estimated based upon the present value of the anticipated cash flows that will be received from the interest rate swap, taking into account the existing spread between the fixed interest rate and the variable interest rate and the remaining time to the anticipated call date.
48
NOTE 22 HMN Financial, Inc. Financial Information (Parent Company Only)
The following are the condensed financial statements for the parent company only as of December 31, 2001 and 2000 and for the years ended December 31, 2001, 2000 and 1999.
| 2001 | 2000 | 1999 | |||||||
---|---|---|---|---|---|---|---|---|---|---|
Condensed Balance Sheets | ||||||||||
Assets: | ||||||||||
Cash and cash equivalents | $ | 2,910,068 | 56,829 | |||||||
Securities available for sale | 7,433,709 | 7,818,735 | ||||||||
Loans receivable from subsidiaries | 714,882 | 4,460,392 | ||||||||
Investment in subsidiaries | 60,390,180 | 54,215,145 | ||||||||
Investment in limited partnership | 265,955 | 285,524 | ||||||||
Accrued interest receivable | 119,827 | 208,810 | ||||||||
Prepaid expenses and other assets | 281,369 | 143,737 | ||||||||
Deferred tax asset | 220,700 | 325,700 | ||||||||
Total assets | $ | 72,336,690 | 67,514,872 | |||||||
Liabilities and Stockholders' Equity | ||||||||||
Other borrowed money | $ | 0 | 750,000 | |||||||
Accrued expenses and other liabilities | 175,339 | 139,224 | ||||||||
Total liabilities | 175,339 | 889,224 | ||||||||
Serial preferred stock | 0 | 0 | ||||||||
Common stock | 91,287 | 91,287 | ||||||||
Additional paid-in capital | 59,168,782 | 59,584,176 | ||||||||
Retained earnings | 76,956,978 | 73,380,588 | ||||||||
Net unrealized loss on securities available for sale | 367,744 | (2,037,005 | ) | |||||||
Unearned employee stock option plan shares | (5,124,746 | ) | (5,318,067 | ) | ||||||
Unearned compensation restricted stock awards | (7,350 | ) | (9,800 | ) | ||||||
Treasury stock, at cost, 4,737,521 and 4,370,285 shares | (59,291,344 | ) | (59,065,531 | ) | ||||||
Total stockholders' equity | 72,161,351 | 66,625,648 | ||||||||
Total liabilities and stockholders' equity | $ | 72,336,690 | 67,514,872 | |||||||
Condensed Statements of Income | ||||||||||
Interest income | $ | 651,478 | 802,647 | 962,179 | ||||||
Interest expense | (14,557 | ) | (34,443 | ) | (36,027 | ) | ||||
Securities gains (losses), net | (130,344 | ) | 0 | 42,547 | ||||||
Equity in earnings of subsidiaries | 5,282,142 | 6,592,861 | 5,997,933 | |||||||
Earnings (loss) in limited partnership | (19,568 | ) | (130,053 | ) | 387 | |||||
Other income | 0 | 3,073 | 9,658 | |||||||
Compensation and benefits | (48,601 | ) | (45,219 | ) | (16,480 | ) | ||||
Occupancy | (6,324 | ) | (6,132 | ) | (6,349 | ) | ||||
Advertising | 0 | 0 | (190 | ) | ||||||
Data processing | (2,722 | ) | (3,762 | ) | (1,323 | ) | ||||
Other | (458,788 | ) | (499,462 | ) | (450,344 | ) | ||||
Income before income tax expense | 5,252,716 | 6,679,510 | 6,501,991 | |||||||
Income tax expense (benefit) | (204,900 | ) | (22,800 | ) | 111,000 | |||||
Net income | $ | 5,457,616 | 6,702,310 | 6,390,991 | ||||||
Condensed Statements of Cash Flows | ||||||||||
Cash flows from operating activities: | ||||||||||
Net income | $ | 5,457,616 | 6,702,310 | 6,390,991 | ||||||
Adjustments to reconcile net income to cash provided (used) by operating activities: | ||||||||||
Equity in earnings of subsidiaries | (5,282,142 | ) | (6,592,861 | ) | (5,997,933 | ) | ||||
Equity in (earnings) loss in limited partnership | 19,568 | 130,053 | (387 | ) | ||||||
Amortization of discounts, net | 0 | 0 | (25,091 | ) | ||||||
Securities gains (losses), net | 130,344 | 0 | (42,547 | ) | ||||||
(Decrease) increase in provision for deferred income taxes | (171,800 | ) | (11,200 | ) | 200 | |||||
Earned employee stock ownership shares priced above original cost | 102,572 | 55,197 | 64,414 | |||||||
Decrease in restricted stock awards | 2,450 | 86,708 | 170,830 | |||||||
Decrease in unearned ESOP shares | 193,321 | 193,784 | 193,301 | |||||||
(Increase) decrease in accrued interest receivable | 88,983 | (65,756 | ) | 201,861 | ||||||
Increase in accrued expenses and other liabilities | 41,073 | 64,586 | 37,943 | |||||||
Decrease in other assets | 51,583 | 360,244 | 207,113 | |||||||
Other, net | 0 | (1 | ) | 54,379 | ||||||
Net cash provided by operating activities | 633,568 | 923,064 | 1,255,074 | |||||||
49
Cash flows from investing activities: | ||||||||||
Proceeds from sales of securities available for sale | $ | 3,634,968 | 0 | 655,104 | ||||||
Proceeds collected on maturity of securities available for sale | 0 | 0 | 4,931,000 | |||||||
Purchases of securities available for sale | (2,688,600 | ) | 0 | (5,834,479 | ) | |||||
Decrease of investments in subsidiaries | 1,096,972 | 548,462 | 0 | |||||||
Net decrease in loans receivable from subsidiaries | 3,745,510 | 302,239 | 7,672,001 | |||||||
Net cash provided by investing activities | 5,788,850 | 850,701 | 7,423,626 | |||||||
Cash flows from financing activities: | ||||||||||
Purchase of treasury stock | (1,584,152 | ) | (5,091,726 | ) | (7,271,668 | ) | ||||
Stock options exercised | 646,199 | 601,134 | 255,548 | |||||||
Dividends to stockholders | (1,881,226 | ) | (1,744,730 | ) | (1,392,361 | ) | ||||
Increase (decrease) in other borrowed money | (750,000 | ) | 750,000 | (3,525,000 | ) | |||||
Proceeds from dividends on Bank stock | 0 | 3,000,000 | 4,000,000 | |||||||
Net cash used by financing activities | (3,569,179 | ) | (2,485,322 | ) | (7,933,481 | ) | ||||
Increase (decrease) in cash and cash equivalents | 2,853,239 | (711,557 | ) | 745,219 | ||||||
Cash and cash equivalents, beginning of year | 56,829 | 768,386 | 23,167 | |||||||
Cash and cash equivalents, end of year | $ | 2,910,068 | 56,829 | 768,386 | ||||||
50
HMN's wholly owned subsidiary, Home Federal Savings Bank and its 51% owned subsidiary, Home Federal Mortgage Services, LLC (HFMS) have been identified as reportable operating segments in accordance with the provisions of SFAS No. 131. HFMS was deemed to be a segment because it is a separate corporation which operates independently from the Bank. HFMS has been segmented further into Mortgage Servicing Rights and Mortgage Banking activities. The mortgage servicing segment owns servicing rights on loans which have either been sold to FNMA or securitized into mortgage backed instruments which were issued by FNMA. HFMS receives a servicing fee which is based upon the outstanding balance of the loan being serviced and pays a subservicer a monthly fee to service the loan. HFMS's mortgage banking activity includes an origination function and it also purchases loans from other loan originators. All loans acquired either by origination or by purchase are intended to be resold in the secondary loan market.
Security Finance Corporation, Osterud Insurance Agency and HMN, the holding company, did not meet the quantitative thresholds for determining reportable segments and therefore are included in the "Other" category.
HMN evaluates performance and allocates resources based on the segment's net income or loss, return on average assets and return on average equity. The segments follow generally accepted accounting principles as described in the summary of significant accounting policies.
Each corporation is managed separately with its own president, who reports directly to either HMN's chief operating decision maker, or the board of directors.
The following table sets forth certain information about the reconciliations of reported profit or loss and assets for each of HMN's reportable segments.
51
| | Home Federal Mortgage Services, LLC | | | | | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Home Federal Savings Bank | Mortgage Servicing Rights | Mortgage Banking | Total Reportable Segments | Other | Eliminations | Consolidated Total | ||||||||||
| (Dollars in Thousands) | ||||||||||||||||
At or for the year ended December 31, 2001: | |||||||||||||||||
Interest income—external customers | $ | 47,583 | 0 | 3,457 | 51,040 | 428 | 0 | 51,468 | |||||||||
Non-interest income—external customers | 3,649 | 52 | 872 | 4,573 | 323 | 0 | 4,896 | ||||||||||
Earnings (losses) on limited partnerships | (1,292 | ) | 0 | 0 | (1,292 | ) | (20 | ) | 0 | (1,312 | ) | ||||||
Intersegment interest income | 2,800 | 0 | 0 | 2,800 | 225 | (3,025 | ) | 0 | |||||||||
Intersegment non-interest income (expense) | (246 | ) | 0 | 0 | (246 | ) | 5,282 | (5,036 | ) | 0 | |||||||
Interest expense | 30,553 | 0 | 2,900 | 33,453 | 16 | (3,025 | ) | 30,444 | |||||||||
Amortization of mortgage servicing rights and net valuation adjustments and servicing costs | 640 | 118 | 0 | 758 | 0 | 0 | 758 | ||||||||||
Other non-interest expense | 12,350 | 0 | 2,215 | 14,565 | 1,002 | (576 | ) | 14,991 | |||||||||
Income tax expense (benefit) | 2,880 | 0 | (28 | ) | 2,852 | (218 | ) | 0 | 2,634 | ||||||||
Minority interest | (383 | ) | 0 | 0 | (383 | ) | 0 | 0 | (383 | ) | |||||||
Net income (loss) | 5,304 | (66 | ) | (758 | ) | 4,480 | 5,438 | (4,460 | ) | 5,458 | |||||||
Total assets | 711,491 | 76 | 56,751 | 768,318 | 72,547 | (119,751 | ) | 721,114 | |||||||||
Net interest margin | 2.90 | % | NM | NM | NM | NM | NM | 3.02 | % | ||||||||
Return on average assets | 0.90 | (39.43 | )% | (1.37 | )% | NM | NM | NM | 0.75 | ||||||||
Return on average realized common equity | 11.39 | (1,122.38 | ) | (83.63 | ) | NM | NM | NM | 7.57 | ||||||||
At or for the year ended December 31, 2000: | |||||||||||||||||
Interest income—external customers | $ | 52,001 | 0 | 313 | 52,314 | 603 | 0 | 52,917 | |||||||||
Non-interest income—external customers | 2,801 | 60 | 568 | 3,429 | 15 | 0 | 3,444 | ||||||||||
Earnings (losses) on limited partnerships | 9 | 0 | 0 | 9 | (130 | ) | 0 | (121 | ) | ||||||||
Intersegment interest income | 30 | 0 | 0 | 30 | 282 | (312 | ) | 0 | |||||||||
Intersegment non-interest income | 387 | 0 | 0 | 387 | 6,593 | (6,980 | ) | 0 | |||||||||
Interest expense | 32,997 | 0 | 243 | 33,240 | 73 | (312 | ) | 33,001 | |||||||||
Amortization of mortgage servicing rights and net valuation adjustments and servicing costs | 260 | 73 | 0 | 333 | 0 | 0 | 333 | ||||||||||
Other non-interest expense | 11,046 | 0 | 1,004 | 12,050 | 563 | (387 | ) | 12,226 | |||||||||
Income tax expense (benefit) | 3,954 | (5 | ) | (147 | ) | 3,802 | (4 | ) | 0 | 3,798 | |||||||
Net income (loss) | 6,791 | (8 | ) | (219 | ) | 6,564 | 6,731 | (6,593 | ) | 6,702 | |||||||
Total assets | 702,767 | 180 | 5,599 | 708,576 | 67,379 | (59,939 | ) | 716,016 | |||||||||
Net interest margin | 2.81 | % | NM | NM | NM | NM | NM | 2.89 | % | ||||||||
Return on average assets | 0.95 | (5.67 | )% | (7.27 | )% | NM | NM | NM | 0.94 | ||||||||
Return on average realized common equity | 12.53 | (21.05 | ) | (27.00 | ) | NM | NM | NM | 9.81 | ||||||||
At or for the year ended December 31, 1999: | |||||||||||||||||
Interest income—external customers | $ | 46,013 | 0 | 307 | 46,320 | 784 | 0 | 47,104 | |||||||||
Non-interest income—external customers | 2,153 | 98 | 1,056 | 3,307 | 436 | 0 | 3,743 | ||||||||||
Earnings on limited partnerships | 550 | 0 | 0 | 550 | 0 | 0 | 550 | ||||||||||
Intersegment interest income | 29 | 0 | 0 | 29 | 413 | (442 | ) | 0 | |||||||||
Intersegment non-interest income | 395 | 0 | 0 | 395 | 5,998 | (6,393 | ) | 0 | |||||||||
Interest expense | 28,904 | 0 | 291 | 29,195 | 158 | (442 | ) | 28,911 | |||||||||
Amortization of mortgage servicing rights and net valuation adjustments and servicing costs | 229 | 242 | 0 | 471 | 0 | 0 | 471 | ||||||||||
Other non-interest expense | 9,856 | 0 | 1,121 | 10,977 | 810 | (364 | ) | 11,423 | |||||||||
Income tax expense (benefit) | 3,862 | (57 | ) | (20 | ) | 3,785 | 176 | 0 | 3,961 | ||||||||
Net income (loss) | 6,049 | (87 | ) | (29 | ) | 5,933 | 6,487 | (6,029 | ) | 6,391 | |||||||
Total assets | 683,400 | 222 | 4,235 | 687,857 | 67,389 | (56,060 | ) | 699,186 | |||||||||
Net interest margin | 2.66 | % | NM | NM | NM | NM | NM | 2.74 | % | ||||||||
Return on average assets | 0.91 | (33.11 | )% | (0.53 | )% | NM | NM | NM | 0.93 | ||||||||
Return on average realized common equity | 12.24 | (100.03 | ) | (1.70 | ) | NM | NM | NM | 9.18 |
NM—Not meaningful
52
The Board of Directors
HMN Financial, Inc.
Rochester, Minnesota:
We have audited the accompanying consolidated balance sheets of HMN Financial, Inc. and subsidiaries (the Company) as of December 31, 2001 and 2000, and the related consolidated statements of income, comprehensive income, stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 2001. 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 auditing standards generally accepted in the United States of America. 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, 2001 and 2000, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States of America.
Minneapolis, Minnesota
January 29, 2002
53
SELECTED QUARTERLY FINANCIAL DATA
| December 31, 2001 | September 30, 2001 | June 30, 2001 | ||||||
---|---|---|---|---|---|---|---|---|---|
| (Dollars in Thousands, Except Per Share Data) | ||||||||
Selected Operations Data(3 months ended): | |||||||||
Interest income | $ | 12,207 | 12,576 | 13,142 | |||||
Interest expense | 6,636 | 7,487 | 7,928 | ||||||
Net interest income | 5,571 | 5,089 | 5,214 | ||||||
Provision for loan losses | 400 | 300 | 300 | ||||||
Net interest income after provision for loan losses | 5,171 | 4,789 | 4,914 | ||||||
Noninterest income: | |||||||||
Fees and service charges | 432 | 417 | 363 | ||||||
Mortgage servicing fees | 142 | 114 | 107 | ||||||
Securities gains (losses), net | (410 | ) | 71 | (610 | ) | ||||
Gain on sales of loans | 219 | 592 | 1,272 | ||||||
Earnings (losses) in limited partnerships | (788 | ) | 105 | (325 | ) | ||||
Other noninterest income | 149 | 120 | 200 | ||||||
Total noninterest income | (256 | ) | 1,419 | 1,007 | |||||
Noninterest expense: | |||||||||
Compensation and benefits | 2,035 | 1,924 | 2,042 | ||||||
Occupancy | 631 | 528 | 515 | ||||||
Federal deposit insurance premiums | 19 | 20 | 20 | ||||||
Advertising | 132 | 95 | 114 | ||||||
Data processing | 254 | 239 | 241 | ||||||
Amortization of mortgage servicing rights and net valuation adjustments | 251 | 158 | 209 | ||||||
Other noninterest expense | 1,096 | 813 | 616 | ||||||
Total noninterest expense | 4,418 | 3,777 | 3,757 | ||||||
Income before income tax expense | 497 | 2,431 | 2,164 | ||||||
Income tax expense | 278 | 571 | 787 | ||||||
Income before minority interest | $ | 219 | 1,860 | 1,377 | |||||
Minority interest | $ | (353 | ) | (163 | ) | 105 | |||
Net income | $ | 572 | 2,023 | 1,272 | |||||
Basic earnings per share | $ | 0.15 | 0.53 | 0.34 | |||||
Diluted earnings per share | $ | 0.14 | 0.50 | 0.32 | |||||
Financial Ratios: | |||||||||
Return on average assets(1) | 0.31 | % | 1.12 | 0.70 | |||||
Return on average equity(1) | 3.08 | 11.06 | 7.11 | ||||||
Average equity to average assets | 9.91 | 9.84 | 9.69 | ||||||
Dividend payout ratio | 28.00 | 43.75 | 30.00 | ||||||
Net interest margin(1)(2) | 3.20 | 2.93 | 2.98 | ||||||
(Dollars in thousands) | |||||||||
Selected Financial Condition Data: | |||||||||
Total assets | $ | 721,114 | 721,427 | 731,345 | |||||
Securities available for sale: | |||||||||
Mortgage-backed and related securities | 69,230 | 68,585 | 72,453 | ||||||
Other marketable securities | 53,666 | 27,324 | 40,856 | ||||||
Loans held for sale | 68,018 | 66,650 | 46,608 | ||||||
Loans receivable, net | 471,668 | 499,543 | 503,476 | ||||||
Deposits | 421,843 | 429,414 | 412,439 | ||||||
Federal Home Loan Bank advances | 217,800 | 209,800 | 239,800 | ||||||
Stockholders' equity | 72,161 | 72,300 | 71,142 |
- (1)
- Annualized
- (2)
- Net interest income divided by average interest-earning assets.
54
March 31, 2001 | December 31, 2000 | September 30, 2000 | June 30, 2000 | March 31, 2000 | |||||
---|---|---|---|---|---|---|---|---|---|
13,543 | 13,692 | 13,526 | 13,039 | 12,661 | |||||
8,393 | 8,733 | 8,568 | 7,995 | 7,705 | |||||
5,150 | 4,959 | 4,958 | 5,044 | 4,956 | |||||
150 | 45 | 45 | 45 | 45 | |||||
5,000 | 4,914 | 4,913 | 4,999 | 4,911 | |||||
351 | 336 | 356 | 348 | 257 | |||||
107 | 90 | 95 | 77 | 79 | |||||
278 | 16 | (5 | ) | 35 | (69 | ) | |||
851 | 401 | 338 | 294 | 183 | |||||
(304 | ) | (199 | ) | (41 | ) | 82 | 37 | ||
130 | 191 | 121 | 181 | 126 | |||||
1,413 | 835 | 864 | 1,017 | 613 | |||||
1,913 | 1,724 | 1,482 | 1,488 | 1,696 | |||||
565 | 510 | 491 | 465 | 426 | |||||
21 | 21 | 21 | 21 | 21 | |||||
85 | 78 | 93 | 89 | 44 | |||||
230 | 211 | 203 | 191 | 185 | |||||
140 | 104 | 84 | 76 | 69 | |||||
842 | 940 | 623 | 619 | 590 | |||||
3,796 | 3,588 | 2,997 | 2,949 | 3,031 | |||||
2,617 | 2,161 | 2,780 | 3,067 | 2,493 | |||||
998 | 572 | 1,077 | 1,187 | 963 | |||||
1,619 | 1,589 | 1,703 | 1,880 | 1,530 | |||||
28 | 0 | 0 | 0 | 0 | |||||
1,591 | 1,589 | 1,703 | 1,880 | 1,530 | |||||
0.43 | 0.43 | 0.45 | 0.48 | 0.38 | |||||
0.40 | 0.41 | 0.44 | 0.47 | 0.37 | |||||
0.88 | 0.88 | 0.94 | 1.06 | 0.87 | |||||
9.18 | 9.26 | 9.91 | 11.07 | 9.00 | |||||
9.56 | 9.56 | 9.59 | 9.65 | 9.70 | |||||
29.27 | 27.27 | 25.53 | 27.03 | 27.78 | |||||
2.97 | 2.84 | 2.83 | 2.95 | 2.93 | |||||
730,490 | 716,016 | 722,157 | 716,209 | 705,704 | |||||
73,132 | 75,380 | 87,542 | 89,488 | 97,190 | |||||
42,361 | 63,827 | 70,664 | 67,290 | 69,479 | |||||
45,231 | 7,861 | 6,386 | 6,066 | 3,398 | |||||
519,307 | 518,765 | 506,831 | 505,280 | 486,632 | |||||
421,456 | 421,691 | 423,717 | 401,630 | 401,453 | |||||
231,800 | 221,900 | 227,900 | 244,900 | 233,900 | |||||
69,198 | 66,626 | 64,109 | 64,212 | 63,552 |
55
The following table sets forth the maximum month-end balance and average balance of FHLB advances.
| Year Ended December 31, | |||||||
---|---|---|---|---|---|---|---|---|
| 2001 | 2000 | 1999 | |||||
| (Dollars in Thousands) | |||||||
Maximum Balance: | ||||||||
Federal Home Loan Bank advances | $ | 240,900 | 244,900 | 230,900 | ||||
Federal Home Loan Bank short-term borrowings | 38,000 | 67,000 | 60,500 | |||||
Average Balance: | ||||||||
Federal Home Loan Bank advances | 221,890 | 232,862 | 197,861 | |||||
Federal Home Loan Bank short-term borrowings | 20,470 | 50,708 | 28,614 |
The following table sets forth certain information as to the Bank's FHLB advances.
| December 31, | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2001 | 2000 | 1999 | |||||||||||
| Amount | Weighted Average Rate | Amount | Weighted Average Rate | Amount | Weighted Average Rate | ||||||||
| (Dollars in Thousands) | |||||||||||||
Federal Home Loan Bank short-term borrowings | $ | 9,500 | 4.42 | % | 38,000 | 6.79 | % | 60,500 | 5.67 | |||||
Other Federal Home Loan Bank long-term advances | 208,300 | 4.76 | 183,900 | 5.85 | 168,900 | 5.53 | ||||||||
Total | $ | 217,800 | 4.75 | 221,900 | 6.01 | 229,400 | 5.57 | |||||||
Refer to Note 12 of the Notes to Consolidated Financial Statements for more information on the Bank's FHLB advances.
The common stock of HMN Financial, Inc. is listed on the Nasdaq Stock Market under the symbol: HMNF. The common stock outstanding is 9,128,662 shares of which 4,732,521 shares are in treasury stock at December 31, 2001. As of December 31, 2001 there were 742 stockholders of record and 871 estimated beneficial stockholders. The following table represents the stock price information for HMN Financial, Inc. as furnished by Nasdaq for each quarter starting in December 31, 2001 and regressing back to March 31, 1996.
| Dec. 31, 2001 | Sept. 28, 2001 | June 29, 2001 | March 30, 2001 | Dec. 29, 2000 | Sept. 29, 2000 | June 30, 2000 | March 31, 2000 | |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
HIGH | $ | 15.85 | 17.10 | 17.15 | 15.06 | 13.25 | 13.88 | 11.75 | 12.13 | ||||||||
LOW | 13.27 | 14.35 | 13.50 | 13.00 | 12.31 | 10.88 | 10.13 | 9.63 | |||||||||
CLOSE | 15.49 | 15.10 | 17.10 | 14.75 | 13.06 | 12.44 | 11.00 | 10.13 | |||||||||
Dec. 31, 1999 | Sept. 30, 1999 | June 30, 1999 | March 31, 1999 | Dec. 31, 1998 | Sept. 30, 1998 | June 30, 1998 | March 31, 1998 | ||||||||||
HIGH | $ | 12.75 | 13.50 | 13.13 | 13.50 | 14.75 | 16.06 | 20.67 | 21.33 | ||||||||
LOW | 10.88 | 11.88 | 10.50 | 11.38 | 10.38 | 13.25 | 15.50 | 17.50 | |||||||||
CLOSE | 11.25 | 12.25 | 11.63 | 11.38 | 11.75 | 14.50 | 15.88 | 20.00 | |||||||||
Dec. 31, 1997 | Sept. 30, 1997 | June 30, 1997 | March 31, 1997 | Dec. 31, 1996 | Sept. 30, 1996 | June 28, 1996 | March 29, 1996 | ||||||||||
HIGH | $ | 21.67 | 17.33 | 16.25 | 16.50 | 12.42 | 11.00 | 11.00 | 10.75 | ||||||||
LOW | 16.17 | 14.58 | 12.42 | 12.00 | 10.67 | 10.08 | 9.75 | 9.67 | |||||||||
CLOSE | 21.67 | 16.50 | 15.33 | 13.36 | 12.08 | 10.67 | 11.00 | 9.75 |
56
FIVE-YEAR CONSOLIDATED FINANCIAL HIGHLIGHTS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SELECTED QUARTERLY FINANCIAL DATA
OTHER FINANCIAL DATA
COMMON STOCK INFORMATION