UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) FOR THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _________ to _________
Commission File Number 0-24100
HMN FINANCIAL, INC.
---------------------
(Exact name of Registrant as specified in its Charter)
Delaware 41-1777397
-------------------------------- --------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
101 North Broadway, Spring Valley, Minnesota 55975-0231
- --------------------------------------------- ------------
(Address of principal executive offices) (ZIP Code)
Registrant's telephone number, including area code: (507) 346-1100
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes (X) No ( )
Indicate the number of shares outstanding of each of the issuer's common stock
as of the latest practicable date.
Class Outstanding at May 7, 2001
Common stock, $0.01 par value 4,423,819
HMN FINANCIAL, INC.
CONTENTS
PART I - FINANCIAL INFORMATION
Page
----
Item 1: Financial Statements (unaudited)
Consolidated Balance Sheets at
March 31, 2001 and December 31, 2000 3
Consolidated Statements of Income for the
Three Months Ended March 31, 2001 and 2000 4
Consolidated Statements of Comprehensive Income for the
Three Months Ended March 31, 2001 and 2000 5
Consolidated Statement of Stockholders' Equity
for the Three Month Period Ended March 31, 2001 5
Consolidated Statements of Cash Flows for
the Three Months Ended March 31, 2001 and 2000 6
Notes to Consolidated Financial Statements 7-13
Item 2: Management's Discussion and Analysis of Financial
Condition and Results of Operations 14-21
Item 3: Quantitative and Qualitative Disclosures about Market Risk
Discussion included in Item 2 under Market Risk 17
PART II - OTHER INFORMATION
Item 1: Legal Proceedings 22
Item 2: Changes in Securities 22
Item 3: Defaults Upon Senior Securities 22
Item 4: Submission of Matters to a Vote of Security Holders 22
Item 5: Other Information 22
Item 6: Exhibits and Reports on Form 8-K 22
Signatures 23
PART I - FINANCIAL STATEMENTS
HMN FINANCIAL, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(unaudited)
March 31, December 31,
Assets 2001 2000
------------- -------------
Cash and cash equivalents $ 14,737,067 14,416,861
Securities available for sale:
Mortgage-backed and related securities
(amortized cost $73,264,321 and $76,199,237) 73,131,964 75,379,719
Other marketable securities
(amortized cost $43,641,490 and $66,392,057) 42,361,365 63,826,770
----------- -----------
115,493,329 139,206,489
----------- -----------
Loans held for sale 45,231,319 7,861,029
Loans receivable, net 519,306,622 518,765,209
Accrued interest receivable 3,713,673 4,311,747
Federal Home Loan Bank stock, at cost 12,245,000 12,245,000
Mortgage servicing rights, net 1,239,195 1,188,928
Premises and equipment, net 9,684,159 9,459,710
Investment in limited partnerships 2,535,083 2,838,364
Goodwill 3,935,965 3,980,974
Core deposit intangible 761,324 794,363
Prepaid expenses and other assets 1,607,483 947,201
----------- -----------
Total assets $730,490,219 716,015,875
=========== ===========
Liabilities and Stockholders' Equity
Deposits $421,455,827 421,690,548
Federal Home Loan Bank advances 231,800,000 221,900,000
Accrued interest payable 1,296,817 1,575,521
Advance payments by borrowers for
taxes and insurance 1,101,964 650,348
Accrued expenses and other liabilities 4,480,358 3,355,110
Deferred tax liabilities 1,004,000 218,700
----------- -----------
Total liabilities 661,138,966 649,390,227
----------- -----------
Commitments and contingencies
Minority interest 152,879 0
Stockholders' equity:
Serial preferred stock: ($.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 59,420,263 59,584,176
Retained earnings, subject to
certain restrictions 74,606,456 73,380,588
Accumulated other comprehensive loss (849,982) (2,037,005)
Unearned employee stock ownership plan shares (5,269,710) (5,318,067)
Unearned compensation restricted stock awards (7,963) (9,800)
Treasury stock, at cost 4,714,843
and 4,737,521 shares (58,791,977) (59,065,531)
----------- -----------
Total stockholders' equity 69,198,374 66,625,648
----------- -----------
Total liabilities and stockholders' equity $730,490,219 716,015,875
=========== ===========
See accompanying notes to consolidated financial statements.
HMN FINANCIAL, INC. AND SUBSIDIARIES
Consolidated Statements of Income
(unaudited)
Three Months Ended
March 31,
2001 2000
----------------------------------
Interest Income:
Loans receivable $ 11,226,494 9,442,625
Securities available for sale:
Mortgage-backed and related 1,248,629 1,805,672
Other marketable 857,943 1,182,516
Cash equivalents 43,228 37,455
Other 165,886 192,762
----------- -----------
Total interest income 13,542,180 12,661,030
----------- -----------
Interest expense:
Deposits 5,061,602 4,336,621
Federal Home Loan Bank advances 3,330,364 3,368,660
----------- -----------
Total interest expense 8,391,966 7,705,281
----------- -----------
Net interest income 5,150,214 4,955,749
Provision for loan losses 150,000 45,000
----------- -----------
Net interest income after
provision for loan losses 5,000,214 4,910,749
----------- -----------
Non-interest income:
Fees and service charges 351,791 256,872
Mortgage servicing fees 106,774 79,243
Securities gains (losses), net 277,704 (68,761)
Gain on sales of loans 852,336 182,729
Earnings (loss) in limited partnerships (303,281) 36,989
Other 130,124 125,618
----------- -----------
Total non-interest income 1,415,448 612,690
----------- -----------
Non-interest expense:
Compensation and benefits 1,913,011 1,696,100
Occupancy 565,219 425,596
Federal deposit insurance premiums 20,803 21,451
Advertising 86,155 43,708
Data processing 230,826 185,421
Amortization of mortgage servicing rights,
net of valuation adjustments
and servicing costs 140,643 69,017
Other 842,618 589,632
----------- -----------
Total non-interest expense 3,799,275 3,030,925
----------- -----------
Income before income tax expense 2,616,387 2,492,514
Income tax expense 997,600 962,800
----------- -----------
Net income before minority interest $ 1,618,787 1,529,714
Minority interest 27,879 0
----------- -----------
Net income 1,590,908 1,529,714
=========== ===========
Basic earnings per share $ 0.43 0.38
=========== ===========
Diluted earnings per share $ 0.40 0.37
=========== ===========
See accompanying notes to consolidated financial statements.
HMN FINANCIAL, INC. AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income
(unaudited)
Three Months Ended March 31,
2001 2000
------------------- -----------------
Net income $ 1,590,908 1,529,714
Other comprehensive income
(losses), net of tax:
Unrealized gains (losses)
on securities:
Unrealized holding gains
(losses) arising during
period 1,357,734 (731,542)
Less: reclassification
adjustment for gains and
losses included in net
income 170,711 (42,269)
----------- -----------
Other comprehensive income (loss) 1,187,023 (689,273)
----------- ----------
Comprehensive income $ 2,777,931 840,441
=========== ==========
See accompanying notes to consolidated financial statements.
HMN FINANCIAL, INC. AND SUBSIDIARIES
Consolidated Statement of Stockholders' Equity
For the Three Months Ended March 31, 2001
(unaudited)
Additional Accumulated Other
Common Paid-in Retained Comprehensive
Stock Capital Earnings Loss
----------- ------------ ------------ --------------
Balance,
December 31, 2000 $ 91,287 59,584,176 73,380,588 (2,037,005)
Net income 1,590,908
Other comprehensive
income 1,187,023
Employee stock options
exercised (187,498)
Amortization of
restricted
stock awards
Dividends paid (365,040)
Earned employee
stock ownership
plan shares 23,585
---------- ------------ ------------ --------------
Balance,
March 31, 2001 $ 91,287 59,420,263 74,606,456 (849,982)
========== ============ ============ ==============
Unearned
Employee Stock Compensation Total
Ownership Restricted Treasury Stockholders'
Plan Shares Stock Awards Stock Equity
----------- ------------ ---------- -----------
Balance,
December 31, 2000 $(5,318,067) (9,800) (59,065,531) 66,625,648
Net income 1,590,908
Other comprehensive
income 1,187,023
Employee stock options
exercised 273,554 86,056
Amortization of
restricted
stock awards 1,837 1,837
Dividends paid (365,040)
Earned employee
stock ownership
plan shares 48,357 71,942
----------- ----------- ----------- ----------
Balance,
March 31, 2001 $(5,369,710) (7,963) (58,791,977) 69,198,374
=========== =========== =========== ==========
See accompanying notes to consolidated financial statements.
HMN FINANCIAL, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(unaudited)
Three Months Ended
March 31,
2001 2000
-------------- ---------------
Cash flows from operating activities:
Net income $ 1,590,908 1,529,714
Adjustments to reconcile net
income to cash provided (used)
by operating activities:
Provision for loan losses 150,000 45,000
Depreciation 243,694 204,711
Amortization of (discounts)
premiums, net (1,867) 25,070
Amortization of deferred loan fees (92,784) (96,990)
Amortization of goodwill 45,009 45,006
Amortization of core deposit intangible 33,039 58,110
Amortization of other purchase
accounting adjustments 3,171 (21,434)
Amortization of mortgage servicing
rights and net valuation adjustments 139,258 61,279
Capitalized mortgage servicing rights (194,575) (57,030)
Increase in deferred income taxes 62,500 103,500
Securities (gains) losses, net (277,704) 68,761
Gain on sales of loans (852,336) (182,729)
Proceeds from sales of
loans held for sale 141,878,210 19,473,383
Disbursements on loans held for sale (177,712,362) (18,365,757)
Principal collected on loans held
for sale 12,175 8,671
Amortization of restricted stock awards 1,837 41,516
Amortization of unearned ESOP shares 48,357 48,456
Earned employee stock ownership shares
priced above original cost 23,585 11,559
Decrease (increase) in accrued
interest receivable 598,074 (114,616)
Increase (decrease) in accrued
interest payable (278,704) 693,439
Equity (earnings) losses of
limited partnerships 303,281 (36,989)
Equity earnings of minority interest 27,879 0
Increase in other assets (523,256) (149,606)
Increase in other liabilities 1,060,897 1,021,221
Other, net 38,167 838
----------- -----------
Net cash provided (used) by
operating activities (33,673,547) 4,415,083
----------- -----------
Cash flows from investing activities:
Proceeds from sales of securities
available for sale 15,000,567 6,020,320
Principal collected on securities
available for sale 2,249,266 2,077,722
Proceeds collected on maturity of
securities available for sale 8,695,000 1,500,000
Purchases of securities available for sale 0 (986,500)
Proceeds from sales of loans receivable 0 105,464
Purchase of Federal Home Loan Bank stock 0 (320,000)
Net increase in loans receivable (1,359,467) (17,145,578)
Purchases of premises and equipment (468,143) (352,727)
----------- -----------
Net cash provided (used) by
investing activities 24,117,223 (9,101,299)
----------- -----------
Cash flows from financing activities:
Increase (decrease) in deposits (321,102) 1,098,879
Purchase of treasury stock 0 (1,603,694)
Stock options exercised 86,056 46,050
Dividends to stockholders (365,040) (396,494)
Proceeds from Federal Home Loan
Bank advances 76,400,000 46,900,000
Repayment of Federal Home Loan
Bank advances (66,500,000) (42,400,000)
Minority interest 125,000 0
Increase in advance payments by
borrowers for taxes and insurance 451,616 243,824
----------- -----------
Net cash provided by financing
activities 9,876,530 3,888,565
----------- -----------
Increase (decrease) in cash and
cash equivalents 320,206 (797,651)
Cash and cash equivalents, beginning of
period 14,416,861 9,051,380
----------- -----------
Cash and cash equivalents, end of period$ 14,737,067 8,253,729
=========== ===========
Supplemental cash flow disclosures:
Cash paid for interest $ 8,670,670 7,011,842
Cash paid for income taxes 442,000 190,000
Supplemental noncash flow disclosures:
Loans securitized and transferred to
securities available for sale 0 8,106,230
Loans transferred to loans held for sale 727,243 245,261
Transfer of loans to real estate 50,645 49,653
See accompanying notes to consolidated financial statements.
HMN FINANCIAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(unaudited)
March 31, 2001 and 2000
(1) HMN FINANCIAL, INC.
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 one wholly owned subsidiary,
Osterud Insurance Agency, Inc. (OAI) which offers financial planning products
and services. 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 Bank has another
subsidiary, Home Federal Mortgage Services, LLC (HFMS), which 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.
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.
(2) BASIS OF PREPARATION
The accompanying unaudited consolidated financial statements were prepared in
accordance with instructions for Form 10-Q and therefore, do not include all
disclosures necessary for a complete presentation of the consolidated balance
sheets, consolidated statements of income, consolidated statements of
comprehensive income, consolidated statement of stockholders' equity and
consolidated statements of cash flows in conformity with generally accepted
accounting principles. However, all adjustments consisting of only normal
recurring adjustments which are, in the opinion of management, necessary for
the fair presentation of the interim financial statements have been included.
The statement of income for the three month period ended March 31, 2001 is not
necessarily indicative of the results which may be expected for the entire
year.
Certain amounts in the consolidated financial statements for prior periods have
been reclassified to conform with the current period presentation.
(3) NEW ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards (SFAS) No. 133, ACCOUNTING FOR DERIVATIVE
INSTRUMENTS AND HEDGING ACTIVITIES, which establishes accounting and reporting
standards for derivative instruments, including certain derivative instruments
embedded in other contracts (collectively referred to as derivatives), and for
hedging activities. It requires that an entity recognize all derivatives as
either assets or liabilities in the statement of financial position and measure
those instruments at fair value. If certain conditions are met, a derivative
may be specifically designated as (a) a hedge of the exposure to changes in the
fair value of a recognized asset or liability or an unrecognized firm
commitment, (b) a hedge of the exposure to variable cash flows of a forecasted
transaction, or (c) a hedge of the foreign currency exposure of a net
investment in a foreign operation, an unrecognized firm commitment, an
available-for-sale
7
security, or a foreign-currency-denominated forecasted
transaction.
The accounting for changes in the fair value of a derivative (that is, gains
and losses) depends on the intended use of the derivative and the resulting
designation.
-For a derivative designated as hedging the exposure to changes in the
fair value of a recognized asset or liability or a firm commitment (referred to
as a fair value hedge), the gain or loss is recognized in earnings in the
period of change together with the offsetting loss or gain on the hedged item
attributable to the risk being hedged. The effect of that accounting is to
reflect in earnings the extent to which the hedge is not effective in achieving
offsetting changes in fair value.
-For a derivative designated as hedging the exposure to variable cash
flows of a forecasted transaction (referred to as a cash flow hedge), the
effective portion of the derivative's gain or loss is initially reported as a
component of other comprehensive income (outside earnings) and subsequently
reclassified into earnings when the forecasted transaction affects earnings.
The ineffective portion of the gain or loss is reported in earnings
immediately.
-For a derivative designated as hedging the foreign currency exposure of a
net investment in a foreign operation, the gain or loss is reported in other
comprehensive income (outside earnings) as part of the cumulative translation
adjustment. The accounting for a fair value hedge described above applies to a
derivative designated or an available-for-sale security. Similarly, the
accounting for a cash flow hedge described above applies to a derivative
designated as a hedge of the foreign currency exposure of a
foreign-currency-denominated forecasted transaction.
-For a derivative not designated as a hedging instrument, the gain or loss
is recognized in earnings in the period of change.
Under SFAS No. 133, an entity that elects to apply hedge accounting is required
to establish at the inception of the hedge the method it will use for assessing
the effectiveness of the hedging derivative and the measurement approach for
determining the ineffective aspect of the hedge. Those methods must be
consistent with the entity's approach to managing risk.
SFAS No. 133 precludes designating a nonderivative financial instrument as a
hedge of an asset, liability, unrecognized firm commitment, or forecasted
transaction except that a nonderivative instrument denominated in a foreign
currency may be designated as a hedge of the foreign currency exposure of an
unrecognized firm commitment denominated in a foreign currency or a net
investment in a foreign operation.
Originally SFAS No. 133 was effective for all fiscal quarters of fiscal years
beginning after June 15, 1999. Initial application should be as of the
beginning of an entity's fiscal quarter; on that date, hedging relationships
must be designated anew and documented pursuant to the provisions of SFAS No.
133. In June of 1999 the FASB issued SFAS No. 137 which deferred the required
adoption of SFAS No. 133 to fiscal years starting after June 15, 2000. In June
of 2000 the FASB issued SFAS No. 138 which addresses a limited number of issues
causing implementation difficulties for numerous entities that must apply
Statement No. 133 to their financial statements. SFAS No. 138 also amends
Statement No. 133 for decisions made by the FASB relating to the Derivatives
Implementation Group process. HMN adopted SFAS No. 133 in the first quarter
of 2001. HMN is using an interest rate swap, whereby it pays interest based
upon three month London Inter-Bank Offer Rate (LIBOR) and receives interest
payments based upon a fixed rate of 7.5% on a notional value of $10 million in
a fair value hedge with no ineffectiveness. The hedge is offsetting a callable
certificate of deposit for $10 million which was issued by HMN. A transition
adjustment of $75,637 was recorded on January 1, 2001 as a debit to other
assets and also as a credit to the related certificate of deposit. On March
31, 2001 the interest rate swap was marked to a market value of $86,381 which
is included in other assets and the corresponding certificate of deposit was
adjusted to the
8
same value 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 or securitize those loans
in order to mitigate the interest rate risk associated with holding the loans
until they are sold. The commitments to sell Loans Held for Sale were not
designated as hedging instruments during the first quarter of 2001, in
accordance with the requirements of SFAS No. 133, a loss of $84,861 relating
to those commitments was recognized as other non-interest expense during the
first quarter of 2001. HMN also had commitments outstanding to extend credit
to future borrowers or to purchase loans that had not closed prior to the end
of the quarter (mortgage pipeline). Simultaneously, HMN enters into
commitments to sell the loans in the mortgage pipeline into the secondary
market. In accordance with SFAS No. 133, on March 31, 2001, HMN recorded a
debit to Loans Held for Sale of $50,872, a credit to other liabilities of
$64,351, and an increase in other non-interest expense of $13,479 relating to
these commitments.
In September 2000, the FASB issued SFAS No. 140, ACCOUNTING FOR TRANSFERS AND
SERVICING OF FINANCIAL ASSETS AND EXTINGUISHMENTS OF LIABILITIES. It revises
the standards for accounting for securitizations and other transfers of
financial assets and collateral and requires certain disclosures, but it
carries over most of Statement 125's provisions without reconsideration. The
standards are based on consistent application of a financial-components
approach that focuses on control. Under that approach, after a transfer of
financial assets, an entity recognizes the financial and servicing assets it
controls and the liabilities it has incurred, derecognizes liabilities when
extinguished. SFAS No. 140 provides consistent standards for distinguishing
transfers of financial assets that are sales from transfers that are secured
borrowings.
SFAS No. 140 is effective for transfers and servicing of financial assets and
extinguishment of liabilities occurring after March 31, 2001. The Statement is
effective for recognition and reclassification of collateral and for
disclosures related to securitization transactions and collateral for fiscal
years ending after December 15, 2000. The Statement is to be applied
prospectively with certain exceptions. HMN adopted SFAS No. 140 for
recognitions and reclassification of collateral and for disclosures related to
securitization transactions and collateral on December 31, 2000. HMN will
adopt SFAS No. 140 for transfers and servicing of financial assets and
extinguishment of liabilities occurring after March 31, 2001. The impact of
adopting SFAS No. 140 on HMN's financial condition and its results of
operations will not be material.
(4) 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 entirely of unrealized gains and losses on securities available for
sale.
The gross unrealized holding gains for the first quarter of 2001 were $2.25
million, the income tax expense would have been $892,300 and therefore, the net
gain was $1.36 million. The gross reclassification adjustment for the first
quarter of 2001 was $277,700, the income tax expense would have been $107,000
and therefore, the net reclassification adjustment was $170,700. The gross
unrealized holding losses for the first quarter of 2000 were $1.2 million, the
income tax benefit would have been $452,500 and therefore, the net loss was
$731,500. The gross reclassification adjustment for the first quarter of 2000
was a loss of $68,800, the income tax benefit would have been $26,500 and
therefore, the net reclassification adjustment was a loss of $42,300.
(5) CASH DIVIDEND
On April 24, 2001 HMN's Board of Directors announced a cash dividend of $0.12
per share, payable on June 11, 2001 to stockholders of record on May 24, 2001.
9
(6) Investment in Mortgage Servicing Rights
A summary of mortgage servicing activity is as follows:
- --------------------------------------------------------------------------
March 31, 2001 December 31, 2000
------------------ -----------------
Mortgage servicing rights
Balance, beginning of period $ 1,188,928 1,148,774
Originations 194,575 367,531
Amortization (139,258) (327,377)
----------- -----------
Balance, March 31 1,244,245 1,188,928
----------- -----------
Valuation reserve
Balance, beginning of period 0 (25,100)
Additions (5,050) 0
Reductions 0 25,100
----------- -----------
Balance, March 31 (5,050) 0
----------- -----------
Mortgage servicing rights, net $ 1,239,195 1,188,928
=========== ===========
Fair value of mortgage servicing
rights $ 1,338,000 1,476,000
=========== ===========
- ---------------------------------------------------------------------------
All of the loans being serviced were single family loans serviced for the
Federal National Mortgage Association (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 March 31, 2001.
- ----------------------------------------------------------------------------
Weighted
Weighted Average Number
Loan Principal Average Remaining of
Balance Interest Rate Term Loans
------------ ------------- -------- -------
Original term 30 year
fixed rate $ 75,523,000 7.61% 332 976
Original term 15 year
fixed rate 71,890,000 6.85% 155 1,263
Seven year balloon 520,000 6.88% 328 6
Adjustable rate 4,779,000 8.26% 318 39
- -----------------------------------------------------------------------------
10
(7) INVESTMENT IN LIMITED PARTNERSHIPS
Investments in limited partnerships were as follows:
- -----------------------------------------------------------------------------
Primary partnership activity March 31, 2001 December 31, 2000
- -------------------------------- --------------- ------------------
Mortgage servicing rights $ 1,982,424 2,257,941
Common stock of financial institutions 264,259 285,524
Low to moderate income housing 288,400 294,899
----------- -----------
$ 2,535,083 2,838,364
=========== ===========
- -----------------------------------------------------------------------------
During the first quarter of 2001 HMN's proportionate loss from a mortgage
servicing partnership was $275,517, its proportionate share of losses from
common stock investments in financial institutions was $21,265 and it
recognized $6,499 of losses on low income housing partnerships. During 2001
HMN anticipates receiving low-income housing credits totaling $80,000, of which
$20,000 were credited to current income tax benefits.
During the first quarter of 2000 HMN's proportionate revenue from a mortgage
servicing partnership was $48,346, its proportionate share of losses from the
common stock investments in financial institutions was $4,139 and it recognized
$7,218 of losses on the low income housing partnerships. During 2000 HMN
received low-income housing credits totaling $80,000, of which $20,000 were
credited to current income tax benefits.
(8) 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:
Three months ended March 31,
2001 2000
----------------------------------
Weighted average number of common shares
outstanding used in basic earnings per
common share calculation 3,722,627 3,998,038
Net dilutive effect of:
Options 216,704 114,964
Restricted stock awards 735 1,953
---------- ----------
Weighted average number of shares outstanding
adjusted for effect of dilutive securities 3,940,066 4,114,955
========== ==========
Income available to common shareholders $ 1,590,908 1,529,714
Basic earnings per common share $ 0.43 0.38
Diluted earnings per common share $ 0.40 0.37
(9) REGULATORY CAPITAL
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.
11
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
March 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 March
31, 2001 and other conditions consistent with the Prompt Corrective Actions
Provisions of the OTS regulations, the Bank would be categorized as well
capitalized.
On March 31, 2001 the Bank's tangible assets and adjusted total assets were
$714.3 million and its risk-weighted assets were $462.7 million. The following
table presents the Bank's capital amounts and ratios at March 31, 2001 for
actual capital, required capital and excess capital including ratios in order
to qualify as being well capitalized under the Prompt Corrective Actions
regulations.
- -----------------------------------------------------------------------------
Required to be
Adequately
Actual Capitalized
----------------------- -----------------------
Percent of Percent of
Amount Assets <F1> Amount Assets <F1>
--------- ------------ --------- -------------
Bank stockholder's equity $ 55,433
Plus:
Net unrealized loss (gain)
on certain securities
available for sale 465
Minority interest in
consolidated subsidiaries 153
Less:
Goodwill and other
intangibles 4,697
Excess mortgage servicing
rights 198
------
Tier I or core capital 51,156
------
Tier I capital to adjusted
total assets 7.16% $ 28,571 4.0%
Tier I capital to risk-
weighted assets 11.06% $ 18,508 4.0%
Less:
Equity investments & other assets
required to be deducted 11
Plus:
Allowable allowance for
loan losses 3,067
------
Risk-based capital $ 54,212 $ 37,017
======
Risk-based capital to risk-
weighted assets 11.72% 8.0%
- ----------------------------------------------------------------------------
- ----------------------------------------------------------------------------
To Be Well Capitalized
Under Prompt
Corrective Actions
Excess Capital Provisions
----------------------- -----------------------
Percent of Percent of
Amount Assets <F1> Amount Assets <F1>
--------- -------------- --------- -------------
Bank stockholder's equity $
Plus:
Net unrealized loss (gain)
on certain securities
available for sale
Minority interest in
consolidated
subsidiaries
Less:
Goodwill and other
intangibles
Excess mortgage
servicing rights
Tier I or core capital
Tier I capital to
adjusted total assets $ 22,585 3.16% $ 35,714 5.0%
Tier I capital to risk-
weighted assets $ 32,648 7.06% $ 27,763 6.0%
Less:
Equity investments &
other assets
required to be deducted
Plus:
Allowable allowance for
loan losses
Risk-based capital $ 17,195 $ 46,271
Risk-based capital to risk-
weighted assets 3.72% 10.0%
<FN>
<F1>Based upon the Bank's adjusted total assets for the purpose of the
tangible and core capital ratios and risk-weighted assets for the purpose of
the risk-based capital ratio.
</FN>
- ----------------------------------------------------------------------------
The tangible capital of the Bank was in excess of the minimum 2% required at
March 31, 2001 but is not reflected in the table above.
(10) BUSINESS SEGMENTS
HMN's subsidiaries, Home Federal Savings Bank and MSI (through January 31,
2001), have been identified as reportable operating segments in accordance with
the provisions of SFAS 131. MSI and its successor through merger, Home Federal
Mortgage Services, LLC, were deemed to be a segment because its operations were
conducted independently from the Bank. MSI and HFMS, jointly called Mortgage
Services, have been segmented
12
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. Mortgage Services receives a servicing fee that is based upon
the outstanding balance of the loan being serviced and pays a subservicer a
monthly fee to service the loan. Mortgage Services' 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 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 segments net
income or loss, return on average assets and return on average equity. Each
corporation is managed separately with its own president, who reports directly
to HMN's chief operating decision maker, and 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.
Mortgage Services
---------------------------------
Mortgage Total
Home Federal Servicing Mortgage Reportable
(Dollars in thousands) Savings Bank Rights Banking Segments
- ---------------------------------------------------------------------------
At or for the quarter ended
March 31, 2001:
Interest income -
external customers $ 12,969 0 462 13,431
Non-interest income -
external customers 943 16 509 1,468
Earnings (loss) on
limited partnerships (282) 0 0 (282)
Intersegment interest
income 418 0 0 418
Intersegment non-interest
income 151 0 0 151
Interest expense 8,410 0 476 8,886
Amortization of mortgage
servicing rights
and net valuation adjustments 118 23 0 141
Other non-interest expense 3,153 1 500 3,654
Income tax expense (benefit) 928 0 (28) 900
Minority interest 28 0 0 28
Net income (loss) 1,412 (8) 23 1,427
Total assets 717,148 153 43,460 760,761
Net interest margin 2.95% NM NM NM
Return on average assets 0.80% (16.85)% 0.32% NM
Return on average realized
common equity 10.52%(218.00)% 8.24% NM
At or for the quarter ended
March 31, 2000:
Interest income -
external customers $ 12,421 0 48 12,469
Non-interest income -
external customers 452 22 100 574
Earnings (loss) on
limited partnerships 41 0 0 41
Intersegment interest income 0 0 0 0
Intersegment non-interest income 86 0 0 86
Interest expense 7,705 0 33 7,738
Amortization of mortgage
servicing rights and net
valuation adjustments 55 6 0 61
Other non-interest expense 2,691 8 247 2,946
Income tax expense (benefit) 981 3 (53) 931
Net income (loss) 1,523 5 (79) 1,449
Total assets 691,147 216 3,650 695,013
Net interest margin 2.85% NM NM NM
Return on average assets 0.89% 8.76% (10.68)% NM
Return on average realized
common equity 11.80% 21.35% (26.02)% NM
Consolidated
(Dollars in thousands) Other Eliminations Total
- ------------------------------------------------------------------------------
At or for the quarter ended
March 31, 2001:
Interest income -
external customers $ 111 0 13,542
Non-interest income -
external customers 250 0 1,718
Earnings (loss) on
limited partnerships (21) 0 (303)
Intersegment interest
income 88 (506) 0
Intersegment non-interest
income 1,401 (1,552) 0
Interest expense 12 (506) 8,392
Amortization of mortgage
servicing rights
and net valuation adjustments 0 0 141
Other non-interest expense 128 (124) 3,658
Income tax expense (benefit) 98 0 998
Minority interest 0 0 28
Net income (loss) 1,591 (1,427) 1,591
Total assets 69,944 (100,215) 730,490
Net interest margin NM NM 2.97%
Return on average assets NM NM 0.88%
Return on average realized
common equity NM NM 9.18%
At or for the quarter ended
March 31, 2000:
Interest income -
external customers $ 192 0 12,661
Non-interest income -
external customers 2 0 576
Earnings (loss) on
limited partnerships (4) 0 37
Intersegment interest income 63 (63) 0
Intersegment non-interest income 1,461 (1,547) 0
Interest expense 30 (63) 7,705
Amortization of mortgage
servicing rights and net
valuation adjustments 0 0 61
Other non-interest expense 110 (86) 2,970
Income tax expense (benefit) 32 0 963
Net income (loss) 1,542 (1,461) 1,530
Total assets 66,150 (55,459) 705,704
Net interest margin NM NM 2.93%
Return on average assets NM NM 0.87%
Return on average realized
common equity NM NM 9.00%
NM - Not meaningful
13
HMN FINANCIAL, INC.
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
HMN's net income is dependent primarily on its net interest income, which is
the difference between interest earned on its loans and investments and the
interest paid on interest-bearing liabilities. 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 from the sale of securities, gains from sale of loans, service charges,
fees and other income. In addition, net income is affected by the level of
operating expenses, provisions made for loan losses and impairment reserve
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 funds
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.
NET INCOME
HMN's net income for the first quarter of 2001 was $1.6 million, an increase of
$61,000, or 4%, compared to net income of $1.5 million for the first quarter of
2000. Basic earnings per share were $0.43 for the quarter ended March 31,
2001, an increase of $0.05 per share, from $0.38 basic earnings per share for
the same quarter of 2000. Diluted earnings per share were $0.40 for the first
quarter of 2001, an increase of $0.03 from $0.37 diluted earnings per share for
the first quarter of 2000. Earnings per share increased from the first quarter
of 2000 to the first quarter of 2001 due to an increase in net income and due
to HMN's treasury stock purchase program. The average number of outstanding
shares for the basic earnings per share calculation declined by 275,411 shares
from 3,998,038 at March 31, 2000, to 3,722,627 at March 31, 2001. The average
number of outstanding shares for the diluted earnings per share calculation
declined by 174,889 shares from 4,114,955 at March 31, 2000, to 3,940,066 at
March 31, 2001.
NET INTEREST INCOME
Net interest income for the first quarter of 2001 was $5.15 million, an
increase of $194,000, or 3.9%, compared to $4.96 million for the first quarter
of 2000. Interest income for the first quarter of 2001 was $13.5 million, an
increase of $881,000, or 7.0%, compared to $12.7 million for the first quarter
of 2000. The interest income increased by $376,000 due to a $22.4 million net
increase in average interest-earning assets from the first quarter of 2000 to
the first quarter of 2001. The increase in average interest-earning assets is
the result of HMN's emphasis on originating and/or purchasing commercial real
estate loans, commercial business loans and consumer loans which generally have
higher interest rates and shorter terms to maturity than fixed rate
single-family residential loans. Interest income increased by $501,000 because
the yield earned on interest-earning assets increased from the first quarter of
2000 to the first quarter of 2001. The yield earned on interest-earning assets
increased from 7.48% at March 31, 2000, to 7.81% at March 31, 2001.
14
Interest expense was $8.4 million for the first quarter of 2001, an increase of
$687,000, or 8.9%, compared to $7.7 million for the same quarter of 2000.
Interest expense on deposits increased by $609,000 due to increased interest
rates paid on certificates of deposit and by $116,000 due to an increase in the
average outstanding balance of deposits. The average interest rate paid on the
average interest-bearing liabilities was 5.27% during the first quarter of
2001, compared to 4.92% for the first quarter of 2000. Net interest margin
(net interest income divided by average interest earning assets) for the first
quarter of 2001 was 2.97%, an increase of 4 basis points, compared to 2.93% for
the first quarter of 2000.
PROVISION FOR LOAN LOSSES
*The provision for loan losses for the first quarter ended March 31, 2001 was
$150,000, an increase of $105,000, compared to $45,000 for the first quarter of
2000. The provision is the result of management's evaluation of the loan
portfolio, a historically low level of non-performing loans, a slight increase
in loan charge-off experience, and its assessment of the general economic
conditions in the geographic area where properties securing the loan portfolio
are located such as national and regional unemployment data, single family loan
delinquencies as reported separately by FNMA and the Federal Home Loan Mortgage
Corporation (FHLMC),local single family construction permits and local economic
growth rates. Management's evaluation of probable losses inherent in the loan
portfolio revealed that an increase in the provision for loan losses was
required in the first quarter of 2001 compared to the first quarter of 2000.
HMN will continue to monitor its allowance for losses as these conditions
dictate. Future economic conditions and other unknown factors will impact the
need for future provisions for loan losses. As a result, no assurances can be
given that increases in the allowance for loan losses will not be required
during future periods.
A reconciliation of HMN's allowance for loan losses is summarized as follows:
2001 2000
------------- -------------
Balance at January 1, $ 3,143,746 3,273,311
Provision 150,000 45,000
Charged off (3,978) 0
Recoveries 326 0
------------ -------------
Balance at March 31, $ 3,290,094 3,318,311
============ =============
NON-INTEREST INCOME
Non-interest income was $1.4 million for the first quarter of 2001, an increase
of $803,000, or 131%, from $613,000 for the first quarter of 2000. Non-interest
income increased by $670,000 due to an increase in gains recognized on the sale
of loans, $346,000 due to an increase in net gains recognized on the sale of
securities and by $95,000 due to increased fees and service charges on deposit
accounts. The increase in non-interest income was partially offset by a
decline of $340,000 in revenue from limited partnership investments. The
Federal Reserve substantially lowered interest rates during the first quarter
of 2001, which in turn caused interest rates on single family residential loans
to decline and allowed many home owners to refinance their home loans at lower
interest rates. The large number of home refinances allowed HMN to sell more
loans in the secondary market. The large number of home refinances also caused
the value of HMN's investment in a limited partnership which owns mortgage loan
servicing assets to decline in value because of anticipated increased
prepayments expected to be received on mortgage loan servicing assets.
NON-INTEREST EXPENSE
Non-interest expense was $3.8 million for the first quarter of 2001, an
increase of $768,000, or 25.4%, from $3.0 million for the first quarter of
2000. Compensation and benefits expense increased by $217,000, or 12.8%, due
to annual payroll increases and additional employees added to HMN's staff.
Occupancy expense increased by $140,000 due to additional operating costs
related to adding another branch, additional depreciation for remodeled
facilities and software improvements made during 2000. Amortization of
mortgage servicing rights, net of valuation adjustments and servicing costs
increased by $72,000 due to a change in the estimated time over which
* This paragraph contains a forward-looking statement(s). Refer to information
regarding Forward-looking Information on page 20 of this discussion
15
the servicing fees will be collected. Other non-interest expense increased by
$253,000 partially due to increased activity in mortgage banking operations.
INCOME TAX EXPENSE
Income tax expense was $998,000 for the first quarter of 2001, an increase of
$35,000 compared to $963,000 for the first quarter of 2000. The increase is
primarily due to an increase in taxable income between the two quarters.
NON-PERFORMING ASSETS
The following table sets forth the amounts and categories of non-performing
assets in the Bank's portfolio at March 31, 2001 and December 31, 2000.
March 31, December 31,
(Dollars in Thousands) 2001 2000
------------- -------------
Non-Accruing Loans
One-to-four family real estate $ 558 775
Commercial business 320 95
Consumer 302 142
------ ------
Total 1,180 1,012
------ ------
Accruing loans delinquent
90days or more 5 405
------ ------
Foreclosed Assets
Real estate:
One-to-four family 245 195
------ ------
Total non-performing assets $ 1,430 1,612
====== ======
Total as a percentage of total assets 0.20% 0.23%
====== ======
Total non-performing loans $ 1,185 $ 1,417
====== ======
Total as a percentage of total
loans receivable, net 0.23% 0.27%
====== ======
Total non-performing assets at March 31, 2001 were $1.4 million, a decrease of
$182,000, from $1.6 million at December 31, 2000. During the first quarter of
2001 the following activity occurred related to non-accruing loans: $596,000
of loans were transferred in, $54,000 were transferred out to foreclosed
assets, $367,000 were transferred out to performing loans and $4,000 were
charged off. During the same period $400,000 of accruing loans delinquent 90
days or more were transferred to performing status.
DIVIDENDS
On April 24, 2001 HMN declared a cash dividend of $.12 per share, payable on
June 11, 2001 to shareholders of record on May 24, 2001.
During the first quarter of 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 %
The annualized dividend payout ratio for the past four quarters, ending with
the June 11, 2001 payment will be 27.91%.
The declaration of dividends are subject to, among other things, HMN's
financial condition and results of operations, the Bank's compliance with its
regulatory capital requirements, including the fully phased-in capital
requirements, tax considerations, industry standards, economic conditions,
regulatory restrictions, general business practices and other factors.
16
LIQUIDITY
For the quarter ended March 31, 2001, the net cash used by operating activities
was $33.7 million. HMN collected $15.0 million from the sale of securities,
and $10.9 million in principal repayments or on the maturity of securities
during the quarter. It purchased premises and equipment of $468,000 and it
funded a net increase in loans receivable of $1.4 million. HMN had a net
decrease in deposit balances of $321,000 during the quarter. It received net
proceeds of $9.9 million from net additional advances from the FHLB and
$452,000 from increased advance payments from borrowers for taxes and
insurance. HMN received $125,000 from the sale of a minority interest in HFMS
and it also received $86,000 related to the exercise of HMN stock options. HMN
paid $365,000 in dividends to its shareholders.
*HMN has certificates of deposits with outstanding balances of $240.8 million
that come due over the next 12 months. Based upon past experience management
anticipates that the majority of the deposits will renew for another term. HMN
believes that deposits which do not renew will be replaced with deposits from
other customers, or funded with advances from the FHLB, or will be funded
through the sale of securities. Management does not anticipate that it will
have a liquidity problem due to maturing deposits.
*HMN has $25.0 million of FHLB advances which mature after 2003 but have call
features that can be exercised by the FHLB during the next 12 months. 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 the next 12 month period.
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. The Rate 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 down from where the rates were
at March 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 March 31, 2001.
* This paragraph contains a forward-looking statement(s). Refer to information
regarding Forward-looking Information on page 20 of this discussion.
17
- ---------------------------------------------------------------------------
Other than trading portfolio Market Value
----------------------------------------------
(Dollars in thousands)
Basis point change in
interest rates -200 -100 0 +100 +200
- ------------------------------------------------------------------------------
Cash and
cash equivalents $ 14,754 14,744 14,737 14,724 14,714
Securities available
for sale:
Fixed-rate CMOs 12,022 12,031 12,008 11,659 11,254
Variable-rate CMOs 56,319 56,110 56,429 56,742 56,275
Fixed-rate available for
sale mortgage-backed
and related securities 2,920 2,894 2,816 2,723 2,627
Variable-rate available for
sale mortgage- backed
and related securities 1,901 1,890 1,879 1,867 1,846
Fixed-rate available for
sale other marketable
securities 43,942 43,295 42,251 37,641 35,996
Variable-rate available for
sale other marketable
securities 111 111 110 110 110
Federal Home Loan
Bank stock 12,273 12,263 12,253 12,243 12,233
Fixed-rate loans held
for sale 47,596 46,844 45,231 43,590 42,766
Loans receivable, net:
Fixed-rate real
estate loans 255,164 251,780 246,187 238,708 231,040
Variable-rate real
estate loans 151,740 149,193 146,710 144,204 141,677
Fixed-rate other loans 54,704 54,438 53,788 52,399 51,224
Variable-rate
other loans 90,349 89,130 88,385 87,644 86,956
Mortgage servicing
rights, net 492 756 1,239 1,598 1,754
Investment in limited
partnerships 1,327 1,413 2,535 2,932 3,081
------- ------- ------- ------- -------
Total market risk
sensitive assets 745,614 736,892 726,558 708,784 693,553
------- ------- ------- ------- -------
NOW deposits 43,747 43,747 43,747 43,747 43,747
Passbook deposits 32,944 32,944 32,944 32,944 32,944
Money market deposits 39,348 39,348 39,348 39,348 39,348
Certificate deposits 315,571 312,499 309,500 304,258 303,717
Fixed-rate Federal Home
Loan Bank advances 195,311 186,347 178,523 176,263 174,046
Variable-rate Federal Home
Loan Bank advances 54,586 54,557 54,529 54,500 54,471
------- ------- ------- ------- -------
Total market risk
sensitive liabilities 681,507 669,442 658,591 651,060 648,273
------- ------- ------- ------- -------
Off-balance sheet
financial instruments:
Commitments to extend credit 4,576 3,108 0 (3,233) (4,806)
Commitments to sell or
deliver loans (7,150) (4,982) 0 4,682 6,875
------- ------ ------- ------- -------
Net market risk $ 66,681 66,324 67,967 56,275 43,211
======= ====== ======= ======= =======
Percentage change from
current market value (1.85)% 2.04% 0.00% (17.17)% (36.40)%
======= ====== ======= ======= ======
- ----------------------------------------------------------------------------
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 coupon and period
to maturity. Adjustable rate mortgages ("ARMs") were assumed to prepay at
annual rates of between 11% and 31%, depending on coupon and the period to
maturity. Growing Equity Mortgage (GEM) loans were assumed to prepay at annual
rates of between 17% and 47% depending on the coupon and the period to
maturity. Mortgage-backed securities and Collateralized Mortgage Obligations
(CMOs) were projected to have prepayments based upon the underlying collateral
securing the instrument 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
18
9%. 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.
*Certain shortcomings are inherent in the method of analysis presented in the
foregoing table. The interest rates on certain types of assets and liabilities
may fluctuate in advance of changes in market interest rates, while interest
rates on other types of assets and liabilities may lag behind changes in market
interest rates. The model assumes that the difference between the current
interest rate being earned or paid compared to a treasury instrument or other
interest index with a similar term to maturity (the "Interest Spread") will
remain constant over the interest changes disclosed in the table. Changes in
Interest Spread could impact projected market value changes. Certain assets,
such as ARMs, have features which restrict changes in interest rates on a
short-term basis and over the life of the assets. The market value of the
interest-bearing assets which are approaching their lifetime interest rate caps
could be different from the values disclosed in the table. In the event of a
change in interest rates, prepayment and early withdrawal levels may deviate
significantly from those assumed in calculating the foregoing table. The
ability of many borrowers to service their debt may decrease in the event of an
interest rate increase.
ASSET/LIABILITY MANAGEMENT
*HMN's management reviews the impact that changing interest rates will have on
its net interest income projected for the twelve months following March 31,
2001 to determine if its current level of interest rate risk is acceptable.
The following table projects the estimated annual impact on net interest income
of immediate interest rate changes called rate shocks. Table need updating!!
Rate Shock Net Interest Percentage
in Basis Point Income Change
-------------- ----------- -----------
+200 24,378,000 5.51%
+100 24,380,000 5.51%
0 23,106,000 0.00%
-100 20,749,000 (10.20)%
-200 18,991,000 (17.81)%
The preceding table was prepared utilizing the Model Assumptions regarding
prepayment and decay ratios which were determined by management based upon
their review of historical prepayment speeds and future prepayment projections.
*Certain shortcomings are inherent in the method of analysis presented in the
foregoing table. In the event of a change in interest rates, prepayment and
early withdrawal levels would likely deviate significantly from those assumed
in calculating the foregoing table. The ability of many borrowers to service
their debt may decrease in the event of a substantial increase in interest
rates and could impact net interest income.
In an attempt to manage its exposure to changes in interest rates, management
closely monitors interest rate risk. The Bank has an Asset/Liability Committee
consisting of executive officers which meets at least quarterly to review the
interest rate risk position and projected profitability. The committee makes
recommendations for adjustments to the asset liability position of the Bank to
the Board of Directors of the Bank. This committee also reviews the Bank's
portfolio, formulates investment strategies and oversees the timing and
implementation of transactions to assure attainment of the Board's objectives
in the most effective manner. In addition, the Board reviews on a quarterly
basis the Bank's asset/liability position, including simulations of the effect
on the Bank's capital of various interest rate scenarios.
In managing its asset/liability mix, the Bank, at times, depending on the
relationship between long- and short-term interest rates, market conditions and
consumer preference, may place more emphasis on managing net interest margin
than on better matching the interest rate sensitivity of its assets and
liabilities in an effort to enhance net interest income. Management believes
that the increased net interest income resulting from a mismatch in the
maturity of its asset and liability portfolios can, during periods of declining
or stable interest rates, provide high enough returns to justify the increased
exposure to sudden and unexpected increases in interest rates.
*This paragraph contains a forward-looking statement(s). Refer to information
regarding Forward-looking Information on page 20 of this discussion.
19
To the extent consistent with its interest rate spread objectives, the Bank
attempts to reduce its interest rate risk and has taken a number of steps to
restructure its assets and liabilities. The Bank has primarily focused its
fixed rate one-to-four family residential lending program on loans with
contractual terms of 20 years or less. The Bank generally follows the practice
of selling all of its fixed rate single family loans that conform to the
secondary market guidelines. HMN has focused its portfolio lending on the
origination of commercial loan products and consumer
loans which generally have shorter weighted average terms to maturity and/or
interest rates which adjust at least every three years. At times, depending on
its interest rate sensitivity, the Bank may sell fixed rate single family loans
with shorter contractual maturities than thirty years in order to reduce
interest rate risk and record a gain on the sale of loans.
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 LOAN LOSSES
The provision for loan losses for the first quarter ended March 31, 2001
was$150,000, an increase of $105,000, compared to $45,000 for the first
quarter of 2000. The provision is the result of management's evaluation
of the loan portfolio, a historically low level of non-performing loans, a
slight increase in loan charge-off experience, and its assessment of the
general economic conditions in the geographic area where properties
securing the loan portfolio are located 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 Mortgage Corporation (FHLMC),local single family construction permits
and local economic growth rates. Management's evaluation of probable
losses inherent in the loan portfolio revealed that an increase in the
provision for loan losses was required in the first quarter of 2001
compared to the first quarter of 2000. HMN will continue to monitor its
allowance for losses as these conditions dictate. Future economic
conditions and other unknown factors will impact the need for future
provisions for loan losses. As a result, no assurances can be given that
increases in the allowance for loan losses will not be required during
future periods.
LIQUIDITY
HMN has certificates of deposits with outstanding balances of $240.8
million that come due over the next 12 months. Based upon past experience
management anticipates that the majority of the deposits will renew for
another term. HMN believes that deposits which do not renew will be
replaced with deposits from other customers, or funded with advances from
the FHLB, or will be funded through the sale of securities. Management
does not anticipate that it will have a liquidity problem due to maturing
deposits. 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 $25.0 million of FHLB advances which mature after 2003 but have
call features that can be exercised by the FHLB during the next 12 months.
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
the next 12 month period.
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
20
also calculates the changes in market value of the interest-earning assets
and interest-bearing liabilities due to different interest rate changes.
HMN believes that over the next twelve months interest rates could
conceivably fluctuate in a range of 200 basis points up or down from where
the rates were at March 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 March 31, 2001.
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.
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 March
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 in the
Asset/Liability section 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
each of the tables. In the event of a change in interest rates,
prepayment and early withdrawal levels would likely deviate significantly
from those assumed in calculating the foregoing 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.
21
HMN FINANCIAL, INC.
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings.
None.
ITEM 2. Changes in Securities.
Not applicable.
ITEM 3. Defaults Upon Senior Securities.
Not applicable.
ITEM 4. Submission of Matters to a Vote of Security Holders.
None.
ITEM 5. Other Information.
None.
ITEM 6. Exhibits and Reports on Form 8-K.
(a) Exhibits. See Index to Exhibits on page 24 of this report.
(b) Reports on Form 8-K. None.
22
SIGNATURES
Pursuant to the requirement of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HMN FINANCIAL, INC.
Registrant
Date: May 14, 2001 /s/ Michael McNeil
Michael McNeil,
President
(Principal Executive Officer)
Date: May 14, 2001 /s/ Timothy P. Johnson
Timothy P. Johnson,
Chief Financial Officer
(Principal Financial Officer)
23
HMN FINANCIAL, INC.
INDEX TO EXHIBITS
FOR FORM 10-Q
Reference Sequential
to Prior Page Numbering
Filing or Where Attached
Exhibit Exhibits Are
Regulation S-K Number Located in This
Exhibit Number Document Attached Hereto Form 10-Q Report
3.1 Amended and Restated Certificate of
Incorporation *1 N/A
3.2 Amended and Restated By-laws *2 N/A
4 Form of Common Stock *3 N/A
Including indentures
11 Computation of Earnings
Per Common Share 11 Filed
electronically
*1 Incorporated by reference to Exhibit 3a to the Company's
Quarterly Report on Form 10-Q for the period ended March 31, 1998 (File No.
0-24100).
*2 Incorporated by reference to Exhibit 3b to the Company's
Quarterly Report on Form 10-Q for the period ended September 30, 1997 (File
0-24100).
*3 Incorporated by reference to the same numbered exhibit to the Company's
Registration Statement on Form S-1 dated April 1, 1994 (File No. 33-77212).
24