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, 1998
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) FOR THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
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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 8, 1998
- -------------------------------------- ----------------------------
Common stock, $0.01 par value 5,909,052*
*Gives effect to a 50% stock dividend to be distributed on May 22, 1998 to
holders of record on May 8, 1998.
HMN FINANCIAL, INC.
CONTENTS
PART I - FINANCIAL INFORMATION
Page
Item 1: Financial Statements (unaudited)
Consolidated Balance Sheets at
March 31, 1998 and December 31, 1997 3
Consolidated Statements of Income for the
Three Months Ended March 31, 1998 and 1997 4
Consolidated Statement of Comprehensive Income for the
Three Months Ended March 31, 1998 and 1997 5
Consolidated Statement of Stockholders' Equity
for the Three Month Period Ended March 31, 1998 5
Consolidated Statements of Cash Flows for
the Three Months Ended March 31, 1998 and 1997 6-7
Notes to Consolidated Financial Statements 8-13
Item 2: Management's Discussion and Analysis of Financial
Condition and Results of Operations 14-22
Item 3: Quantitative and Qualitative Disclosures about
Market Risk Discussion included in Item 2
under Market Risk 17
PART II - OTHER INFORMATION
Item 1: Legal Proceedings 23
Item 2: Changes in Securities 23
Item 3: Defaults Upon Senior Securities 23
Item 4: Submission of Matters to a Vote of
Security Holders 23
Item 5: Other Information 23
Item 6: Exhibits and Reports on Form 8-K 23
Signatures 24
2
PART I - FINANCIAL STATEMENTS
HMN FINANCIAL, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(unaudited)
March 31, December 31,
ASSETS 1998 1997
----------- -----------
Cash and cash equivalents. . . . . . . .$ 21,267,061 9,364,635
Securities available for sale:
Mortgage-backed and related securities
(amortized cost $137,263,165
and $135,598,404). . . . . . . . . 137,473,527 135,935,482
Other marketable securities
(amortized cost $80,170,535 and
$68,356,926) . . . . . . . . . . . 81,648,096 69,923,477
----------- -----------
219,121,623 205,858,959
----------- -----------
Loans held for sale. . . . . . . . . . . 8,317,565 2,287,265
Loans receivable, net. . . . . . . . . . 450,209,710 442,068,600
Federal Home Loan Bank stock, at cost. . 8,488,000 7,432,200
Real estate, net . . . . . . . . . . . . 75,177 133,939
Premises and equipment, net. . . . . . . 6,515,713 5,880,710
Accrued interest receivable. . . . . . . 3,870,744 4,038,131
Investment in limited partnerships . . . 6,222,467 5,989,399
Goodwill . . . . . . . . . . . . . . . . 4,476,510 4,500,873
Core deposit intangible. . . . . . . . . 1,474,516 1,546,273
Mortgage servicing rights. . . . . . . . 1,096,724 781,005
Prepaid expenses and other assets. . . . 982,545 1,349,521
----------- -----------
Total assets . . . . . . . . . . .$ 732,118,355 691,231,510
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY .
Deposits . . . . . . . . . . . . . . . .$ 466,998,386 467,347,688
Federal Home Loan Bank advances. . . . . 167,292,879 127,650,021
Accrued interest payable . . . . . . . . 2,104,569 1,365,064
Advance payments by borrowers for
taxes and insurance . . . . . . . . . 862,984 786,619
Accrued expenses and other liabilities . 5,967,389 6,056,356
Due to stockholders of Marshalltown
Financial Corporation. . . . . . . . . 192,890 3,555,352
Due to brokers . . . . . . . . . . . . . 3,745,250 0
----------- -----------
Total liabilities. . . . . . . . . 647,164,347 606,761,100
----------- -----------
Commitments and contingencies
Stockholders' equity:
Serial preferred stock: authorized
500,000 shares; issued and
outstanding none. . . . . . . . . . 0 0
Common stock ($.01 par value):
authorized 11,000,000 shares;
issued 9,128,662 shares . . . . . . 91,287 91,287
Additional paid-in capital. . . . . . 59,800,424 59,698,661
Retained earnings, subject to certain
restrictions. . . . . . . . . . . . 61,887,608 60,224,253
Accumulated other comprehensive
income. . . . . . . . . . . . . . . 1,031,926 1,129,818
Unearned employee stock ownership
plan shares . . . . . . . . . . . . (5,799,632) (4,554,280)
Unearned compensation restricted stock
awards. . . . . . . . . . . . . . . (538,944) (600,668)
Treasury stock, at cost 2,912,110
shares. . . . . . . . . . . . . . . (31,518,661) (31,518,661)
----------- -----------
Total stockholders' equity . . . . 84,954,008 84,470,410
----------- -----------
Total liabilities and stockholders'
equity . . . . . . . . . . . . . .$ 732,118,355 691,231,510
=========== ===========
See accompanying notes to consolidated financial statements.
3
HMN FINANCIAL, INC. AND SUBSIDIARIES
Consolidated Statements of Income
(unaudited)
Three Months Ended
March 31,
1998 1997
-------------------------------
Interest Income:
Loans receivable. . . . . . . . . . . . . $ 8,642,372 6,908,242
Securities available for sale:. . . . . .
Mortgage-backed and related . . . . . . 2,218,698 2,189,210
Other marketable. . . . . . . . . . . . 956,472 585,242
Securities held to maturity:. . . . . . .
Mortgage-backed and related . . . . . . 0 33,400
Other marketable. . . . . . . . . . . . 0 10,032
Cash equivalents. . . . . . . . . . . . . 161,324 82,160
Other . . . . . . . . . . . . . . . . . . 122,334 94,961
----------- -----------
Total interest income. . . . . . . . . 12,101,200 9,903,247
----------- -----------
Interest expense:. . . . . . . . . . . . . .
Deposits. . . . . . . . . . . . . . . . . 5,703,524 4,572,798
Federal Home Loan Bank advances . . . . . 2,084,466 1,451,400
----------- -----------
Total interest expense . . . . . . . . 7,787,990 6,024,198
----------- -----------
Net interest income . . . . . . . 4,313,210 3,879,049
Provision for loan losses. . . . . . . . . . 75,000 75,000
----------- -----------
Net interest income after
provision for loan losses. . . . 4,238,210 3,804,049
----------- -----------
Non-interest income: . . . . . . . . . . . .
Fees and service charges. . . . . . . . . 201,756 96,412
Securities gains, net . . . . . . . . . . 896,447 270,917
Gain on sales of loans. . . . . . . . . . 366,244 153,450
Other . . . . . . . . . . . . . . . . . . 197,722 177,515
----------- -----------
Total non-interest income. . . . . . . 1,662,169 698,294
----------- -----------
Non-interest expense:. . . . . . . . . . . .
Compensation and benefits . . . . . . . . 1,852,480 1,315,987
Occupancy . . . . . . . . . . . . . . . . 364,721 241,147
Federal deposit insurance premiums. . . . 73,831 58,977
Advertising . . . . . . . . . . . . . . . 92,981 78,137
Data processing . . . . . . . . . . . . . 174,055 124,529
Provision for real estate losses. . . . . 0 2,000
Other . . . . . . . . . . . . . . . . . . 695,956 293,665
----------- -----------
Total non-interest expense . . . . . . 3,254,024 2,114,442
----------- -----------
Income before income tax expense . . . 2,646,355 2,387,901
Income tax expense . . . . . . . . . . . . . 983,000 913,421
----------- -----------
Net income . . . . . . . . . . . . . . $ 1,663,355 1,474,480
=========== ===========
Basic earnings per share . . . . . . . . . . $ 0.31 0.27
=========== ===========
Diluted earnings per share . . . . . . . . . $ 0.28 0.25
=========== ===========
See accompanying notes to consolidated financial statements.
4
HMN FINANCIAL, INC.
Consolidated Statements of Comprehensive Income
(unaudited)
Three Months Ended March 31,
1998 1997
------------------------ ---------------------
Net income $ 1,663,355 1,474,480
Other comprehensive income,
net of tax:
Unrealized gains (losses) on
securities:
Unrealized holding gains
(losses) arising during
period 452,347 (747,358)
Less: reclassification
adjustment for gains
included in net income (550,239) (161,282)
-------- --------
Other comprehensive income (97,892) (908,640)
--------- -------
Comprehensive income $ 1,565,463 565,840
========= =======
See accompanying notes to consolidated financial statements.
HMN FINANCIAL, INC. AND SUBSIDIARIES
Consolidated Statement of Stockholders' Equity
For the Three Months Ended March 31, 1998
(unaudited)
Accumulated
Additional Other
Common Paid-in Retained Comprehensive
Stock Capital Earnings Income
---------------------------------------------------------
Balance,
December 31, 1997 $ 91,287 59,698,661 60,224,253 1,129,818
Net income 1,663,355
Other
comprehensive
income (97,892)
Amortization of
restricted stock
awards
Shares purchased
for employee
stock ownership
plan
Earned employee
stock
ownership plan
shares 101,763
----------- ----------- ----------- -----------
Balance,
March 31, 1998 $ 91,287 59,800,424 61,887,608 1,031,926
=========== =========== =========== ===========
Unearned
Employee
Stock Unearned
Ownership Compensation Total
Plan Restricted Treasury Stockholders'
Shares Stock Awards Stock Equity
--------------------------------------------------------
Balance,
December 31, 1997 $(4,554,280) (600,668) (31,518,661) 84,470,410
Net income 1,663,355
Other comprehensive
income (97,892)
Amortization of
restricted stock
awards
61,724 61,724
Shares purchased
for employee
stock ownership
plan (1,361,595) (1,361,595)
Earned employee
stock ownership
plan shares 116,243 218,006
----------- --------- ----------- ------------
Balance,
March 31, 1998 $ (5,799,632) (538,944) (31,518,661) 84,954,008
=========== ============ =========== ============
See accompanying notes to consolidated financial statements.
5
HMN FINANCIAL, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(unaudited)
Three Months Ended
March 31,
1998 1997
----------------------
Cash flows from operating activities:
Net income $ 1,663,355 1,474,480
Adjustments to reconcile net income to cash
provided by operating activities:
Provision for loan losses 75,000 75,000
Depreciation 144,845 102,879
Amortization of (discounts) premiums, net (20,916) (46,804)
Amortization of deferred loan fees (148,028) (87,139)
Amortization of goodwill 45,159 0
Amortization of core deposit intangible 71,757 0
Amortization of loans and deposits mark to
market on MFC 184,119 0
Amortization of mortgage servicing rights 137,110 0
Provision for deferred income taxes 90,000 128,200
Securities gains, net (896,447) (270,917)
Gain on sales of real estate (2,768) 0
Gain on sales of loans (366,244) (153,450)
Proceeds from sale of loans held for sale 34,212,150 867,032
Disbursements on loans held for sale (28,386,755) (276,008)
Amortization of restricted stock awards 61,724 57,174
Amortization of unearned ESOP shares 116,243 96,060
Earned employee stock ownership shares priced
above original cost 101,763 59,237
Decrease in accrued interest receivable 167,387 497,246
Increase (decrease) in accrued interest payable 739,505 (66,175)
Equity earnings of limited partnership (51,943) (73,824)
Decrease (increase) in other assets 481,381 (705,413)
Increase in other liabilities (61,153) 552,087
Other, net (105,926) 33,052
---------- ----------
Net cash provided by operating activities 8,251,318 2,390,917
---------- ----------
Cash flows from investing activities:
Proceeds from sales of securities available
for sale 61,083,048 15,902,046
Principal collected on securities available
for sale 6,290,945 2,949,425
Proceeds collected on maturity of securities
available for sale 6,100,000 14,650,000
Purchases of securities available for sale (82,365,386) (33,086,600)
Proceeds from sales of securities held to
maturity 0 348,871
Principal collected on securities held
to maturity 0 240,441
Proceeds collected on maturity of securities
held to maturity 0 1,000,000
Proceeds from sales of loans receivable 1,965,018 19,210,058
Purchases of mortgage servicing rights (356,744) 0
Purchase of interest in limited partnerships (181,125) (1,216,875)
Purchase of Federal Home Loan Bank stock (1,055,800) (193,100)
Net increase in loans receivable (21,711,768) (16,873,204)
Proceeds from sale of real estate 50,574 0
Purchases of premises and equipment (779,848) (482,836)
Decrease in due to shareholders of
Marshalltown Financial Corporation (3,362,462) 0
---------- ----------
Net cash provided by investing activities (34,323,548) 2,448,226
---------- ----------
Cash flows from financing activities:
Increase (decrease) in deposits (268,567) 1,645,716
Purchase of treasury stock 0 (4,109,637)
Increase in unearned ESOP shares (1,361,595) 0
Payments to ESOP trustee to purchase
additional HMN shares (114,405) 0
Proceeds from Federal Home Loan Bank advances 62,500,000 36,000,000
Repayment of Federal Home Loan Bank advances (22,857,142) (36,357,142)
Increase in advance payments by borrowers for
taxes and insurance 76,365 280,461
---------- ----------
Net cash provided (used) by financing
activities 37,974,656 (2,540,602)
---------- ----------
Increase in cash and cash equivalents 11,902,426 2,170,341
Cash and cash equivalents, beginning of period 9,364,635 10,583,717
---------- ----------
Cash and cash equivalents, end of period $ 21,267,061 12,754,058
========== ==========
6
Supplemental cash flow disclosures:
Cash paid for interest $ 7,048,485 6,090,373
Cash paid for income taxes 175,000 148,500
Supplemental noncash flow disclosures:
Loans securitized and transferred to
securities available for sale $ 0 4,781,034
Securities held to maturity transferred to
securities available for sale 0 1,295,147
Loans transferred to loans held for sale 11,495,290 897,559
Transfer of loans to real estate 0 94,164
Securities purchased with liability due
to broker 3,745,250 0
Due to stockholders of Marshalltown
Financial, Inc. 192,890 0
See accompanying notes to consolidated financial statements.
7
HMN FINANCIAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(unaudited)
March 31, 1998 and 1997
(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 two wholly owned
subsidiaries, Osterud Insurance Agency, Inc. (OAI) and MSL Financial
Corporation (MSL), which offer financial planning products and services. HMN
has two other wholly owned subsidiaries, Security Finance Corporation (SFC)
and HMN Mortgage Services, Inc. (MSI). SFC invests in commercial loans and
commercial real-estate loans located throughout the United States which were
originated by third parties. MSI operates mortgage banking and mortgage
brokerage facilities located in Eden Prairie and Brooklyn Park, Minnesota.
The consolidated financial statements included herein are for HMN, SFC, MSI,
the Bank and the Bank's wholly owned subsidiaries, OAI and MSL. All
significant intercompany accounts and transactions have been eliminated in
consolidation.
(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
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, 1998 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
Effective January 1, 1998 HMN adopted Statement of Financial Accounting
Standards ("SFAS") No. 130, REPORTING COMPREHENSIVE INCOME. The statement
establishes standards for reporting and display of comprehensive income and
its components in a full set of general-purpose financial statements. The
statement requires that all items that are required to be recognized under
accounting standards as components of comprehensive income be disclosed in
the financial statements. 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 1998 were
$681,000, the income tax expense would have been $228,000 and therefore, the
net gain was $452,000. The gross reclassification adjustment for the first
quarter of 1998 was $896,000, the income tax expense would have been $346,000
and therefore, the net reclassification adjustment was $550,000. The gross
unrealized holding losses for the first quarter of 1997 were $1,321,000, the
income tax benefit would have been $574,000 and therefore, the net loss was
$747,000. The gross reclassification adjustment for the first quarter of
1997 was $271,000, the income tax expense would have been $110,000 and
therefore, the net reclassification adjustment was $161,000.
8
In February 1998, the FASB issued SFAS No. 132, EMPLOYERS' DISCLOSURES ABOUT
PENSIONS AND OTHER POSTRETIREMENT BENEFITS which revises employers'
disclosures about pension and other Postretirement benefit plans. It does
not change the measurement or recognition of those plans. It standardizes
the disclosure requirements for pensions and other Postretirement benefits to
the extent practicable, requires additional information on changes in the
benefit obligation and fair values of plan assets that will facilitate
financial analysis, and eliminates certain disclosures that are no longer as
useful as they were when FASB Statements No. 87, EMPLOYERS' ACCOUNTING FOR
PENSIONS, No. 88, EMPLOYERS' ACCOUNTING FOR SETTLEMENT AND CURTAILMENTS OF
DEFINED BENEFIT PENSION PLANS AND FOR TERMINATION BENEFITS, and No. 106,
EMPLOYERS' ACCOUNTING FOR POSTRETIREMENT BENEFITS OTHER THAN PENSIONS, were
issued. SFAS No. 132 suggests combined formats for presentation of pension
and other postretirement benefit disclosures. It is effective for fiscal
years beginning after December 15, 1997. Restatement of disclosures for
earlier periods provided for comparative purposes is required unless the
information is not readily available. Adopting the disclosure requirements
of SFAS No. 132 will not have a material impact on HMN's financial condition
or the results of its operations.
(4) STOCK SPLIT
In February of 1998 HMN authorized a three-for-two stock split in the form of
a fifty percent stock dividend subject to stockholder approval to increase
HMN's authorized common stock from 7.0 million shares to 11.0 million shares.
At the annual meeting on April 28, 1998 the stockholders approved the
increase in authorized common stock. The Board of Directors then declared
that the stock dividend will be distributed on May 22, 1998 to stockholders
of record on May 8, 1998.
The stock split increased HMN's outstanding common shares from 6,085,775 to
9,128,662 shares. Stockholders' equity has been restated to give retroactive
effect to the stock split for all periods presented by reclassifying from
additional paid-in capital to common stock the par value of the additional
shares arising from the stock split. In addition all references in the
Consolidated Financial Statements and Notes thereto to number of shares, per-
share amounts, stock option data and market prices of HMN's common stock have
been restated giving retroactive recognition to the stock split.
The Board also announced a cash dividend of $0.06 per share, payable on June
12, 1998 to stockholders of record on May 27, 1998.
(5) MERGERS AND ACQUISITIONS
On December 5, 1997 HMN, through its wholly owned subsidiary, Home Federal,
completed its merger (the Merger) with Marshalltown Financial Corporation
(MFC) pursuant to a merger agreement dated July 1, 1997. The aggregate
consideration per the merger agreement was $24.8 million, consisting of $23.7
million for 1.35 million outstanding shares of MFC stock, or $17.51 per
share, and $1.1 million for the outstanding MFC options. HMN owned 60,000
shares of MFC stock with a historical cost of $1.0 million which were
cancelled upon the completion of the merger.
The following Unaudited Pro Forma Condensed Combined Consolidated Statements
of Income for the three months ended March 31, 1997 combine HMN's income
statement with MFC's income statement. The statement is presented as if the
Merger had been effective at the beginning of the period presented, after
giving effect to certain pro forma adjustments described in the accompanying
notes.
The Unaudited Pro Forma Condensed Combined Financial Information and notes
thereto (the Information) reflect the application of the purchase method of
accounting for the Merger. Under this method, the assets acquired and
liabilities assumed from MFC and its subsidiaries are recorded at their fair
market values on the date of the Merger. The amount of the purchase price in
excess of the fair market value of the tangible and identifiable intangible
assets acquired less the fair market value of the liabilities assumed is
recorded as goodwill. Certain historical information of the consolidated MFC
has been reclassified to conform to HMN's financial statement presentation.
The Information is not necessarily indicative of the results of future
operations of the combined entity or the actual results that would have been
achieved had the Merger of MFC been consummated prior to the period
indicated.
9
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENTS OF INCOME
Three months ended March 31, 1997
Pro Forma
---------------------------
HMN MFC Adjustments Combined
--------- ---------- ---------- -----------
Total interest income $ 9,903,247 2,200,332 (501,075)(1)(2) 11,602,504
Total interest expense 6,024,198 1,364,688 96,893 (3)(4) 7,485,779
---------- ---------- ---------- ----------
Net interest income 3,879,049 835,644 (597,968) 4,116,725
Provision for loan losses 75,000 2,500 77,500
Non-interest income 698,294 36,874 735,168
Non-interest expense 2,114,442 593,036 123,561 (5)(6) 2,831,039
---------- ---------- ---------- ----------
Income before income tax
expense 2,387,901 276,982 (721,529) 1,943,354
Income tax expense 913,421 33,904 (247,718) 699,607
---------- ---------- ---------- ----------
Net income $1,474,480 243,078 (473,811) 1,243,747
========== ========== ========== ==========
Basic earnings per share $ 0.27 0.17 0.22
Diluted earnings per share $ 0.25 0.17 0.21
Weighted average shares
outstanding:
Basic 5,550,215 1,411,475 5,550,215
Diluted 5,888,815 1,469,290 5,888,815
Pursuant to the Merger and consistent with GAAP, certain adjustments were
recorded, primarily to accrue for specific, identified costs related to the
merger of MFC. The amounts of the Merger related costs are subject to
revisions as economic conditions change or as more information becomes
available.
HMN expects to achieve operating cost savings primarily through reductions in
staff and the consolidation of certain functions such as data processing,
investments and other back office operations at MFC. The operating cost
savings are expected to be achieved in various amounts at various times
during the years subsequent to the acquisition of MFC and not ratably over,
or at the beginning or end of, such periods. No adjustment has been
reflected in the Unaudited Pro Forma Condensed Combined Consolidated
Statement of Income for the three months ended March 31, 1997 for the
anticipated cost savings.
(1) Represents amortization of MFC mark-to-market adjustments
under the purchase method of accounting for loans.
(2) Represents amortization of MFC mark-to-market adjustments
under the purchase method of accounting for securities, and
the forgone interest income resulting from the planned sale of
$15.8 million of securities.
(3) Represents amortization of MFC mark-to-market adjustments
under the purchase method of accounting for deposits.
(4) Represents the net interest cost of borrowing $10.0 million to
fund the MFC acquisition.
(5) Represents amortization of goodwill and core deposit
intangible.
(6) Represents the additional depreciation on premises and
equipment related to the MFC mark-to-market adjustments.
10
(6) 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,
1998 1997
-----------------------------
Weighted average number of common shares
outstanding used in basic earnings per
common share calculation . . . . . . . . 5,447,501 5,550,215
Net dilutive effect of:
Options . . . . . . . . . . . . . . . . . 403,037 255,093
Restricted stock awards . . . . . . . . . 61,395 83,507
--------- ---------
Weighted average number of shares
outstanding adjusted for effect of
dilutive securities . . . . . . . . . . . 5,911,933 5,888,815
========= =========
Income available to common shareholders. . $1,663,355 1,474,480
Basic earnings per common share. . . . . . $0.31 0.27
Diluted earnings per common share. . . . . $0.28 0.25
The earnings per share calculations reflected above are presented as if the
split had been completed at the beginning of each period presented for the
weighted average number of shares outstanding for each period.
(7) EMPLOYEE BENEFITS
During 1994 HMN adopted an Employee Stock Ownership Plan (the ESOP) which met
the requirements of Section 4975(e)(7) of the Internal Revenue Code and
Section 407(d)(6) of the Employee Retirement Income Security Act of 1974, as
amended (ERISA), and, as such the ESOP was empowered to borrow in order to
finance purchases of the common stock of HMN. The ESOP borrowed $6,085,770
from HMN to purchase 912,865 post stock split shares of common stock of HMN
on the date of the conversion. The ESOP debt requires quarterly payments of
principal plus interest at 7.52%. HMN has committed to make quarterly
contributions to the ESOP necessary to repay the loan including interest.
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. During the first quarter of 1998 HMN loaned $1,476,000 to the
ESOP to purchase additional shares of HMN stock. The stock purchased by the
ESOP will be used to provide a benefit to the employees that were added as
the result of the MFC Merger.
In June of 1995, HMN as part of a Recognition and Retention Plan (RRP)
awarded 126,729 post stock split shares of restricted common stock to its
officers and directors. The shares vest over a five year period and were
issued from treasury stock. In April 1997, 3,000 post stock split shares of
restricted common stock were awarded to a director. Those shares vest over a
five year period beginning in 1998. At March 31, 1998 there are 73,062 post
stock split shares that vest over the next four years.
In June 1995, HMN adopted its only stock option plan, the 1995 Stock Option
and Incentive Plan (the SOP). During 1995, options exercisable for 821,569
post stock split shares of HMN common stock were granted to certain officers
and directors at an exercise price of $9.21 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 post stock split shares of
common stock were granted to officers at an exercise price of $12.08. In
April
11
1997, options for 18,000 post stock split shares of common stock were granted
to a director at an exercise price of $13.00.
A summary of stock option activity under the SOP on a post stock split basis
is detailed as follows:
- ---------------------------------------------------------------------------
<CATION>
Weighted
Options average
available for Options exercise
grant outstanding price
---------- ----------- -------
December 31, 1997 90,054 802,200 $9.30
Exercised 0
---------- ----------- -------
March 31, 1998 90,054 802,200 $9.30
========== =========== =======
The following table summarizes information about stock options on a post
split basis outstanding at March 31, 1998:
- -----------------------------------------------------------------------------
Options Outstanding Options Exercisable
--------------------------------------------------- ----------------------
Weighted average
Exercise Number remaining contractual
price outstanding life in years Number Price
------------- ----------- --------------------- --------- ---------
$9.21 782,700 7.1 303,458 $9.21
12.08 1,500 8.6 300 12.08
13.00 18,000 9.0 3,600 13.00
-------- --------
802,200 307,358
======== ========
- -----------------------------------------------------------------------------
(8) 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.
Quantitative measures established by regulations to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth in the
following table) of Tangible, Tier I (Core), and Risk-based capital (as
defined in the regulations) to adjusted total assets and risk-weighted assets
(as defined). Management believes, as of March 31, 1998, 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, 1998 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, 1998 the Bank's tangible assets and adjusted total assets were
$691,231,000 and its risk-weighted assets were $321,833,000. The following
table presents the Bank's capital amounts and ratios at Mach 31, 1998 for
actual capital, required capital and excess capital including ratios in order
to qualify as being well capitalized under the Prompt Corrective Actions
regulations.
12
Required to be
Adequately
Actual Capitalized
--------------------- ----------------------
(in thousands) Amount Percent Amount Percent
---------- ---------- ---------- ----------
Bank stockholder's equity $ 52,193
Plus:
Net unrealized loss (gain)
on certain securities
available for sale (466)
Less:
Goodwill and other
intangibles 5,951
Excess mortgage
servicing rights 539
---------
Tier I or core capital 45,237 $27,649
---------
Tier I capital to
adjusted total assets
6.54% 4.00%
Tier I capital to risk-
weighted assets
14.06%
Less:
Equity investments and
other assets required to
be deducted (263)
Plus:
Allowable allowance for
loan losses 2,819
----------
Risk-based capital $47,793 $25,747
==========
Risk-based capital to risk-
weighted assets
14.85% 8.00%
To Be Well
Capitalized Under
Prompt Corrective
Excess Capital Actions Provisions
(in thousands) Amount Percent Amount Percent
---------- ---------- ---------- ----------
Bank stockholder's equity $
Plus:
Net unrealized loss (gain)
on certain securities
available for sale
Less:
Goodwill and other
intangibles
Excess mortgage
servicing rights
Tier I or core capital $17,588
Tier I capital to
adjusted total assets
2.54% 5.00%
Tier I capital to risk-
weighted assets 6.00%
Less:
Equity investments and
other assets required
to be deducted
Plus:
Allowable allowance for
loan losses
Risk-based capital $22,046
Risk-based capital to risk-
weighted assets 6.85% 10.00%
The tangible capital of the Bank was in excess of the minimum 2% required at
March 31, 1998 but is not reflected in the table above.
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 and establishment of a
provision for loan losses.
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 1998 was $1.7 million, an increase
of $189,000, or 12.8%, compared to $1.5 million for the first quarter of
1997. Net income increased by $434,000 due to an increase in net interest
income and by $964,000 due to increased non-interest income. The increased
income was partially off-set by a $1.1 million increase in non-interest
expense. Basic earnings per share was $0.31 for the quarter ended March 31,
1998, an increase of $0.04 per share, or 14.8%, from $0.27 basic earnings per
share for the same quarter of 1997. Diluted earnings per share was $0.28 per
share for the first quarter of 1998, an increase of $0.03, or 12.0% from
$0.25 diluted earnings per share for the first quarter of 1997.
In February of 1998 HMN announced that its Board of Directors had authorized
a three-for-two stock split in the form of a fifty percent stock dividend
subject to stockholder approval at the annual meeting of stockholders held on
April 28, 1998 to increase HMN's authorized common stock from 7.0 million
shares to 11.0 million shares. At the annual meeting the stockholders
approved the increase in authorized common stock. The Board of Directors then
declared that the split will be distributed on May 22, 1998 to shareholders
of record on May 8, 1998. The financial statements included in this Form 10-
Q have been presented assuming that the stock split had taken place on March
31, 1998 as required by generally accepted accounting principles. Earnings
per share calculations were based upon post split weighted average
outstanding share information.
NET INTEREST INCOME
Net interest income for the first quarter of 1998 was $4.3 million an
increase of $434,000, or 11.2%, compared to $3.9 million for the first
quarter of 1997. Interest income for the first quarter of 1998 was $12.1
million, an increase of $2.2 million, or 22.2%, compared to $9.9 million for
the first quarter of 1997. Interest income increased primarily due to the
interest-bearing assets that were acquired from the Marshalltown Financial
Corporation (MFC) merger which occurred on December 5, 1997 and the
additional
14
interest-bearing assets which were purchased with the $39.6 million of net
additional Federal Home Loan Bank of Des Moines (FHLB) advances which were
taken out during the first quarter of 1998. The average outstanding balances
for interest-bearing assets increased by $98.7 million for loans receivable,
$30.1 million for the securities portfolio, and $8.3 million for other
interest bearing assets. The increase in average outstanding interest
earning assets caused interest income to increase by $2.45 million and was
partially off-set by a decline in interest income of $253,000 caused by
declining yields on interest bearing assets.
Interest expense was $7.8 million for the first quarter of 1998 an increase
of $1.8 million, or 29.3%, compared to $6.0 million for the same quarter of
1997. The increase in interest expense is primarily due to the additional
deposits as a result of the MFC merger and the additional net advances taken
out from the FHLB. The average outstanding deposits for the first quarter of
1998 was $99.4 million larger than the average outstanding deposits for the
same quarter in 1997 and therefore caused interest expense to increase by
$1.1 million. The average outstanding FHLB advances for the first quarter of
1998 was $44.2 million larger than the average outstanding FHLB advances for
the same quarter in 1997 and therefore caused interest expense to increase by
$633,000.
PROVISION FOR LOAN LOSSES
The provision for loan losses for the first quarter of 1998 and 1997 was
$75,000. The provision is the result of management's evaluation of the loan
portfolio, a historically low level of non-performing loans, minimal loan
charge-off experience, and its assessment of the general economic conditions
in the geographic area where properties securing the loan portfolio are
located. Management's evaluation did not reveal conditions that would cause
it to increase the provision for loan losses during 1998 compared to 1997.
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:
1998 1997
--------- ----------
Balance at January 1, $ 2,748,219 2,340,585
Provision 75,000 75,000
Recoveries 1,576 7,000
--------- ----------
Balance at March 31, $ 2,824,795 2,422,585
========= ==========
NON-INTEREST INCOME
Non-interest income was $1.7 million for the first quarter of 1998, an
increase of $964,000, or 138.0% compared to $698,000 for the first quarter of
1997. The increase in non-interest income is primarily due to $105,000
increase in fees earned related to mortgage banking activities and additional
fees on deposits as the result of the MFC merger, $626,000 increase in gain
on the sale of securities and a $213,000 increase in gain on the sale of
loans. The Bank and HMN Mortgage Services, Inc. (MSI) have increased their
mortgage banking activities during the first quarter of 1998 compared to the
first quarter of 1997 and therefore fee income related to mortgage banking
activities and gain on the sale of loans has increased substantially. A
favorable interest rate environment allowed HMN to sell many securities that
were in portfolio at a gain.
NON-INTEREST EXPENSE
Non-interest expense was $3.3 million for the first quarter of 1998, an
increase of $1.2 million, or 57.1%, compared to $2.1 million for the same
quarter of 1997. Compensation and benefit expense increased by $536,000
primarily due to an increase in HMN's work force as a result of the MFC
merger, increased staff added to the mortgage banking operations of MSI and
the Bank and normal annual compensation increases to Bank employees.
Occupancy costs increased by $124,000 due to three buildings added by the MFC
merger, the addition of a mortgage banking office in Brooklyn Park, Minnesota
and increased occupancy costs related to opening a new retail facility in
Spring Valley. Other non-interest expense increased by $402,000 due to
15
additional operating costs incurred related to the MFC merger, the mortgage
banking expansion in Brooklyn Park and amortization of goodwill and core
deposit intangibles of $117,000 related to the MFC merger.
INCOME TAX EXPENSE
Income tax expense was $983,000 for the first quarter of 1998 an increase of
$70,000 compared to $913,000 for the first quarter of 1997. The increase is
primarily due to an increase in taxable income between the two periods.
NON-PERFORMING ASSETS
The following table sets forth the amounts and categories of non-performing
assets in the Bank's portfolio at March 31, 1998 and December 31, 1997.
March 31, December 31,
(Dollars in Thousands) 1998 1997
---------- -----------
Non-Accruing Loans
One-to-four family real estate $ 297 177
Nonresidential real estate 78 79
Commercial business 14 0
Consumer 8 7
---- ----
Total 397 263
---- ----
Accruing loans delinquent 90
days or more 383 402
Foreclosed Assets
Real estate:
One-to-four family 83 142
---- ----
Total non-performing assets $863 $807
==== ====
Total as a percentage of total assets 0.12% 0.12%
==== ====
Total non-performing loans $780 $665
==== ====
Total as a percentage of total
loans receivable, net 0.17% 0.15%
==== ====
Total non-performing assets at March 31, 1998 were $863,000, an increase of
$56,000, from $807,000 at December 31, 1997. The net increase of $56,000 was
the result of an increase of non-accruing loans and the sale of foreclosed
residential homes.
DIVIDENDS
In February of 1998, the Board of Directors of HMN authorized a stock split
in the form of a 50% stock dividend subject to HMN stockholder approval of an
increase in the number of authorized shares of common stock from 7.0 million
to 11.0 million at the annual meeting of stockholders on April 28, 1998.
HMN also declared a cash dividend of $.06 per share, payable on June 12, 1998
to shareholders of record on May 27, 1998. The dividend will be approximately
$352,000.
LIQUIDITY
For the quarter ended March 31, 1998, the net cash provided by operating
activities was $8.3 million. HMN collected $61.1 million from the sale of
securities, it collected $12.4 million in principal repayments or on the
maturity of securities during the quarter. HMN also collected $2.0 million
on the sale of loans receivable during the quarter. It purchased $82.4
million of securities, funded a net increase in loans receivable of $21.7
million, purchased $1.1 million of FHLB stock and paid $3.6 million to the
MFC stockholders related to the MFC merger. HMN had additional net borrowing
from the FHLB of $39.4 million and loaned $1.48 million to its employee stock
ownership plan to repurchase HMN stock for the purpose of providing a benefit
to the employees added as a result of the MFC merger.
16
*HMN has certificates of deposits with outstanding balances of $263.9 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.
MARKET RISK
Market risk is the risk of loss from adverse changes in market prices and
rates. HMN's market risk arises primarily from interest rate risk inherent
in its investing, lending and deposit taking activities. Management actively
monitors and manages its interest rate risk exposure.
HMN's profitability is affected by fluctuations in interest rates. A sudden
and substantial increase in interest rates may adversely impact HMN's
earnings to the extent that the interest rates borne by assets and
liabilities do not change at the same speed, to the same extent, or on the
same basis. HMN monitors how its assets will mature or reprice in comparison
to how its liabilities will mature or reprice. The Maturity or Repricing
Table located in the Asset/Liability Management section of this report is
used as part of the monitoring process. HMN also monitors the projected
changes in net interest income that would 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, 1998.
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, 1998.
* This paragraph contains a forward-looking statement(s). Refer to
information regarding Forward-looking Information on page 21 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 equivalents $20,293 20,276 20,258 20,242 20,226
Fixed-rate CMOs 62,434 62,107 61,507 59,965 57,957
Variable-rate CMOs 59,773 60,535 61,984 60,651 58,315
Fixed-rate available for
sale mortgage-backed
and related securities 12,288 12,159 12,011 11,851 11,620
Variable-rate available
for sale mortgage-
backed and related
securities 2,023 1,997 1,982 1,969 1,951
Fixed-rate available for
sale other marketable
securities 89,459 86,200 83,018 79,970 77,064
Variable-rate available
for sale other marketable
securities 6,971 6,953 6,936 6,919 6,902
Fixed-rate loans held
for sale 8,331 8,324 8,317 8,310 8,303
Fixed-rate real estate
loans 337,024 334,400 325,524 314,007 302,020
Variable-rate real estate
loans 85,614 84,314 82,616 81,023 79,262
Fixed-rate other loans 18,059 17,890 17,695 17,504 17,316
Variable-rate other loans 38,079 38,084 38,140 38,209 38,241
------- ------- ------- ------- -------
Total market risk
sensitive assets 740,348 733,239 719,988 700,620 679,177
------- ------- ------- ------- -------
NOW deposits 22,961 22,942 22,923 22,904 22,885
Passbook deposits 36,076 34,511 33,077 31,757 30,538
Money market deposits 35,798 34,505 33,327 32,245 31,250
Certificate deposits 383,083 379,270 375,529 371,870 368,285
Fixed-rate Federal Home
Loan Bank advances 130,496 126,578 122,828 119,236 115,793
Variable-rate Federal
Home Loan Bank advances 44,148 44,062 43,976 43,890 43,805
------- ------- ------- ------- -------
Total market risk
sensitive liabilities 652,562 641,868 631,660 621,902 612,556
------- ------- ------- ------- -------
Off-balance sheet
financial instruments:
Commitments to extend
credit 42 42 41 40 38
------- ------- ------ ------ ------
Net market risk $ 87,828 91,413 88,369 78,758 66,659
======= ======= ======= ====== ======
Percentage change from
current market value (0.61)% 3.44% 0.00% (10.88)% (24.57)%
======= ======= ======= ======= ======
- --------------------------------------------------------------------------
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 31%, depending on the coupon and
period to maturity. Adjustable rate mortgages ("ARMs") were assumed to
prepay at annual rates of between 12% and 23%, depending on coupon and the
period to maturity. Growing Equity Mortgage (GEM) loans were assumed to
prepay at annual rates of between 17% and 38% depending on the coupon and the
period to maturity. Mortgage-backed securities and Collateralized Mortgage
Obligations (CMOs) were projected to have prepayments based upon the
underlying collateral securing the instrument. Certificate accounts were
assumed not to be withdrawn until maturity. Passbook and money market
accounts were assumed to decay at an annual rate of 20%.
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
18
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, 1998 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.
Rate Shock Net Interest Percentage
in Basis Points Income Change
---------------- ------------ ----------
+200 15,947 -1.24%
+100 16,122 -0.16%
0 16,148 0.00%
-100 15,956 -1.19%
-200 15,223 -5.73%
The preceding table was prepared utilizing the Model Assumptions regarding
prepayment and decay ratios which were determined by management based upon
their review of historical prepayment speeds and future prepayment
projections.
Certain shortcomings are inherent in the method of analysis presented in the
foregoing table. In the event of a change in interest rates, prepayment and
early withdrawal levels would likely deviate significantly from those assumed
in calculating the foregoing table. The ability of many borrowers to service
their debt may decrease in the event of a substantial increase in interest
rates and could impact net interest income.
In an attempt to manage its exposure to changes in interest rates, management
closely monitors interest rate risk. The Bank has an Asset/Liability
Committee consisting of executive officers which meets at least quarterly to
review the interest rate risk position and projected profitability. The
committee makes recommendations for adjustments to the asset liability
position of the Bank to the Board of Directors of the Bank. This committee
also reviews the Bank's portfolio, formulates investment strategies and
oversees the timing and implementation of transactions to assure attainment
of the Board's objectives in the most effective manner. In addition, the
Board reviews on a quarterly basis the Bank's asset/liability position,
including simulations of the effect on the Bank's capital of various interest
rate scenarios.
In managing its asset/liability mix, the Bank, at times, depending on the
relationship between long- and short-term interest rates, market conditions
and consumer preference, may place more emphasis on managing net interest
margin than on better matching the interest rate sensitivity of its assets
and liabilities in an effort to enhance net interest income. Management
believes that the increased net interest income resulting from a mismatch in
the maturity of its asset and liability portfolios can, during periods of
declining or stable interest rates, provide high enough returns to justify
the increased exposure to sudden and unexpected increases in interest rates.
To the extent consistent with its interest rate spread objectives, the Bank
attempts to reduce its interest rate risk and has taken a number of steps to
restructure its assets and liabilities. The Bank has primarily focused its
fixed rate one-to-four family residential lending program on loans with
contractual terms of 20 years or less. The Bank generally follows the
practice of selling all of its fixed rate single family loans with
*This paragraph contains a forward-looking statement(s). Refer to information
regarding Forward-looking Information on page 22 of this discussion.
19
contractual maturities of thirty years. At times, depending on its interest
rate sensitivity, the Bank may sell fixed rate single family loans with
shorter contractual maturities than thirty years in order to reduce interest
rate risk and record a gain on the sale of loans.
The following table sets forth the interest rate sensitivity of HMN's assets
and liabilities at March 31, 1998, using certain assumptions that are
described in more detail below:
- -----------------------------------------------------------------------------
Maturing or Repricing
---------------------------------------------------
Over 6
6 Months Months to Over 1-3
(Dollars in thousands) or Less One Year Years
- -----------------------------------------------------------------------------
Securities available for sale:
Mortgage-backed and
related securities<F1> $ 74,478 9,302 31,239
Other marketable securities 12,837 329 8,767
Securities held to maturity:
Mortgage-backed and
related securities<F1> 0 0 0
Other marketable securities 0 0 0
Loans held for sale, net 8,318 0 0
Loans receivable, net<F1><F2>
Fixed rate one-to-four
family<F3> 27,201 25,030 83,332
Adjustable rate
one-to-four family<F3> 29,083 20,077 17,590
Multi family 364 366 1,128
Fixed rate commercial real
estate 2,703 396 662
Adjustable rate commercial
real estate 5,512 2,095 720
Commercial business 2,109 715 1,636
Consumer loans 26,539 1,515 3,471
Federal Home Loan Bank stock 0 0 0
Cash equivalents 20,267 0 0
Total interest-earning
assets 209,411 59,825 148,545
Non-interest checking 7,558 0 0
NOW accounts 22,973 0 0
Passbooks 3,600 3,600 10,366
Money market accounts 2,694 2,694 7,762
Certificates 138,154 125,776 87,273
Federal Home Loan Bank advances 61,714 5,179 24,000
Total interest-bearing
liabilities 236,693 137,249 129,401
Interest-earning assets less
interest-bearing liabilities $ (27,282) (77,424) 19,144
Cumulative interest-rate
sensitivity gap $ (27,282) (104,706) (85,562)
Cumulative interest-rate gap
as a percentage of total
assets at March 31, 1998 (3.95)% (15.15)% (12.38)%
Cumulative interest-rate gap as a
percentage of interest-earning
assets at December 31, 1997 (6.36) (15.38)
<FN>
<FN1>Schedule prepared based upon the earlier of contractual maturity or
repricing date, if applicable, adjusted for scheduled repayments of principal
and projected prepayments of principal based upon experience.
<FN2> Loans receivable are presented net of loans in process and deferred
loan fees.
<FN3>Construction and development loans are all one-to-four family loans and
therefore have been included in the fixed rate one-to-four family and
adjustable rate one-to-four family lines.
</FN>
Over 3-5 Over 5 No Stated
(Dollars in thousands) Years Years Maturity Total
- -----------------------------------------------------------------------------
Securities available for sale:
Mortgage-backed and
related securities<F1>$ 13,600 8,644 0 137,263
Other marketable securities 30,410 15,577 12,251 80,171
Securities held to maturity:
Mortgage-backed and
related securities<F1> 0 0 0 0
Other marketable securities 0 0 0 0
Loans held for sale, net 0 0 0 8,318
Loans receivable, net<F1><F2>
Fixed rate one-to-four
family<F3> 59,697 115,189 0 310,449
Adjustable rate
one-to-four family<F3> 18,972 3,378 0 89,100
Multi family 506 522 0 2,886
Fixed rate commercial real
estate 195 42 0 3,998
Adjustable rate commercial
real estate 0 0 0 8,327
Commercial business 696 85 0 5,241
Consumer loans 1,534 (26) 0 33,033
Federal Home Loan Bank stock 0 0 8,488 8,488
Cash equivalents 0 0 0 20,267
Total interest-earning
assets 125,610 143,411 20,739 707,541
Non-interest checking 0 0 0 7,558
NOW accounts 0 0 0 22,973
Passbooks 6,635 11,795 0 35,996
Money market accounts 4,968 8,832 0 26,950
Certificates 19,884 2,434 0 373,521
Federal Home Loan Bank
advances 66,000 10,400 0 167,293
Total interest-bearing
liabilities 97,487 33,461 0 634,291
Interest-earning assets less
interest-bearing
liabilities $ 28,123 109,950 20,739 73,250
Cumulative interest-rate
sensitivity gap $ (57,439) 52,511 73,250 73,250
Cumulative interest-rate
gap as a percentage of
total assets at
March 31, 1998 (8.31)% 7.60 % 10.60 % 10.60%
Cumulative interest-rate gap
as a percentage of interest-
earning assets
at December 31, 1997
<FN>
<FN1> Schedule prepared based upon the earlier of contractual maturity or
repricing date, if applicable, adjusted for scheduled repayments of principal
and projected prepayments of principal based upon experience.
<FN2> Loans receivable are presented net of loans in process and deferred
loan fees.
<FN3>Construction and development loans are all one-to-four family loans and
therefore have been included in the fixed rate one-to-four family and
adjustable rate one-to-four family lines.
</FN>
20
The preceding table was prepared utilizing the Model Assumptions regarding
prepayment and decay ratios which were determined by management based upon
their review of historical prepayment speeds and future prepayment
projections. Fixed rate loans were assumed to prepay at annual rates of
between 7% to 31%, depending on the coupon and period to maturity. ARMs were
assumed to prepay at annual rates of between 12% and 23%, depending on coupon
and the period to maturity. GEM loans were assumed to prepay at annual rates
of between 17% and 38% depending on the coupon and the period to maturity.
Mortgage-backed securities and CMOs were projected to have prepayments based
upon the underlying collateral securing the instrument. Certificate accounts
were assumed not to be withdrawn until maturity. Passbook and money market
accounts were assumed to decay at an annual rate of 20%.
Certain shortcomings are inherent in the method of analysis presented in the
foregoing table. Although certain assets and liabilities may have similar
maturities and periods of repricing, they may react in different degrees to
changes in market interest rates. The interest rates on certain types of
assets and liabilities may fluctuate in advance of changes in market interest
rates, while interest rates on other types of assets and liabilities may lag
behind changes in market interest rates. Certain assets, such as adjustable-
rate mortgages, have features which restrict changes in interest rates on a
short-term basis and over the life of the asset. In the event of a change in
interest rates, prepayment and early withdrawal levels would likely deviate
significantly from those assumed in calculating the foregoing table. The
ability of many borrowers to service their debt may decrease in the event of
an interest rate increase.
Refer to Regulatory Capital Requirements above for a discussion of the Bank's
interest rate risk component.
FORWARD-LOOKING INFORMATION
The following statements within Management's Discussion and Analysis of
Financial Condition and Results of Operations contain forward-looking
statements and actual results may differ materially from the expectations
disclosed within this Discussion and Analysis. These forward-looking
statements are subject to risks and uncertainties, including those discussed
below. HMN assumes no obligations to publicly release results of any
revision or updates to these forward-looking statements to reflect future
events or unanticipated occurrences.
LIQUIDITY
HMN has certificates of deposit with outstanding balances of $263.9
million that come due during 1998. Based upon past experience
management anticipates that the majority of the deposits will renew for
another term. Any deposits which do not renew will be replaced with
deposits from other customers, or funded with advances from the FHLB, or
will be funded through the sale of securities. Management does not
anticipate that it will have a liquidity problem due to maturing
deposits.
Competitive pricing by other institutions, the desire of a competitor to
pay interest rates on deposits that are above the current rates paid by
HMN, or desire by customers to put more of their funds into
nontraditional bank products such as stocks and bonds could be
circumstances that would cause the maturing certificates to become a
liquidity problem
MARKET RISK
HMN believes that over the next twelve months interest rates could
conceivably fluctuate in a range of 200 basis points up or down from
where the rates were at March 31, 1998. 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.
Actual interest rates could fluctuate by more than 200 basis points up
or down from rates in effect on March 31, 1998 due to unanticipated
occurrences such as the start of another war in the gulf. Many Asian
countries are experiencing economic difficulties which may have a larger
impact on the economy of the United States than is currently anticipated
and thereby cause general interest rates to fluctuate by more than 200
basis points.
21
Certain shortcomings are inherent in the method of analysis in the table
presented in the Market Risk section above. The interest rates on
certain types of assets and liabilities may fluctuate in advance of
changes in market interest rates, while interest rates on other types of
assets and liabilities may lag behind changes in market interest rates.
The model assumes that the difference between the current interest rate
being earned or paid compared to a treasury instrument or other interest
rate index with a similar term to maturity (the Interest Spread) will
remain constant over the interest changes disclosed in the table.
Changes in Interest Spread could impact projected market value changes.
Certain assets, such as ARMs, have features which restrict changes in
interest rates on a short-term basis and over the life of the assets.
The market value of the interest-bearing assets which are approaching
their life time interest rate caps could be different from the values
disclosed in the table. In the event of a change in interest rates,
prepayment and early withdrawal levels may deviate significantly from
those assumed in calculating the foregoing table. The ability of many
borrowers to service their debt may decrease in the event of an interest
rate increase.
ASSET/LIABILITY MANAGEMENT
HMN's management reviews the impact that changing interest rates will
have on its net interest income projected for the twelve months
following March 31, 1998 to determine if its current level of
interest rate risk is acceptable. HMN's actual net interest income
caused by interest rate changes may differ from the amounts reflected in
the table which projects the estimated impact on net interest income of
immediate interest rate changes called rate shocks. HMN's actual
maturing and repricing results of its interest-earning assets and
interest-bearing liabilities may differ from the amounts reflected in
the gap table.
Certain shortcomings are inherent in the method of analysis presented in
each of the tables. In the event of a change in interest rates,
prepayment and early withdrawal levels would likely deviate
significantly from those assumed in calculating the foregoing 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.
22
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.
At its meeting held on April 28, 1998 the Board of Directors
passed a resolution amending the Certificate of Incorporation of
HMN Financial, Inc.. The Amended Certificate of Incorporation is
included as Exhibit 3(I). Since the Certificate of Incorporation
has not been previously filed in electronic format the complete
Amended Articles of Incorporation are included in this item.
ITEM 6. Exhibits and Reports on Form 8-K.
(a) Exhibits. See Index to Exhibits on page 25 of this report.
(b) Reports on Form 8-K - None.
23
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, 1998 /s/ Roger P. Weise
------------------- ------------------------
Roger P. Weise,
Chairman, President and
Chief Executive Officer
(Principal Executive Officer)
Date: May 14, 1998 /s/ James B. Gardner
------------------- ------------------------
James B. Gardner,
Executive Vice President
(Principal Financial Officer)
24
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
2 Plan of acquisition, reorganization,
arrangement, liquidation or succession. N/A N/A
3(a) Articles of Incorporation
Certificate of Incorporation as amended. 3(i) Filed
electronically
3(b) By-laws *3 N/A
Resolution to Amend By-laws of HMN Financial, Inc.
By-laws of HMN Financial, Inc. as amended
4 Instruments defining the rights of
security holders, Including indentures *1 N/A
5(a) Amendment to the Home Federal Savings *2 N/A
Bank Employees' Savings & Profit Sharing
Plan dated January 28, 1997.
5(b) Amendment to the Adoption Agreement for *2 N/A
Home Federal Savings Bank Employees'
Savings & Profit Sharing Plan and Trust
effective June 17, 1997.
11 Computation of Earnings Per Common Share 11 Filed
electronically
27 Financial Data Schedule 27 Filed
electronically
*1 Filed April 1, 1994, as exhibits to the Registrant's Form S-1
registration statement (Registration No. 33-77212) pursuant to the
Securities Act of 1933. All of such previously filed documents are
hereby incorporated herein by reference in accordance with Item 601
of Regulation S-K.
*2 Filed as an exhibit to Registrant's Form 10-Q for June 30, 1997 (file
no. 0-24100). All previously filed documents are hereby incorporated
by reference in accordance with Item 601 of Regulation S-K.
*3 Filed as an exhibit to Registrant's Form 10-Q for September 30, 1997
(file no. 0-24100). All previously filed documents are hereby
incorporated by reference in accordance with Item 601 of Regulation
S-K.
25