SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------------------------------------------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OF 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OF 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 classes of
common stock as of the latest practicable date.
Class Outstanding at November 5 , 1999
- ------------------------------- --------------------------------
Common stock, $0.01 par value 4,923,527
1
HMN FINANCIAL, INC.
CONTENTS
PART I - FINANCIAL INFORMATION
Page
----
Item 1: Financial Statements (unaudited)
Consolidated Balance Sheets at
September 30, 1999 and December 31, 1998 3
Consolidated Statements of Income for the
Three Months Ended and Nine Months Ended
September 30, 1999 and 1998 4
Consolidated Statements of Comprehensive Income for the
Three Months and Nine Months Ended September 30, 1999 and 1998 5
Consolidated Statement of Stockholders' Equity
for the Nine Month Period Ended September 30, 1999 5
Consolidated Statements of Cash Flows for
the Nine Months Ended September 30, 1999 and 1998 6-7
Notes to Consolidated Financial Statements 8
Item 2: Management's Discussion and Analysis of Financial
Condition and Results of Operations 16
Item 3: Quantitative and Qualitative Disclosures about Market Risk
Discussion included in Item 2 under Market Risk 21
PART II - OTHER INFORMATION
Item 1: Legal Proceedings 29
Item 2: Changes in Securities 29
Item 3: Defaults Upon Senior Securities 29
Item 4: Submission of Matters to a Vote of Security Holders 29
Item 5: Other Information 29
Item 6: Exhibits and Reports on Form 8-K 29
Signatures 30
2
PART I - FINANCIAL STATEMENTS
HMN FINANCIAL, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(unaudited)
ASSETS September 30, December 31,
1999 1998
--------------- --------------
Cash and cash equivalents $ 6,530,090 20,960,957
Securities available for sale:
Mortgage-backed and related securities
(amortized cost $106,920,399 and
$144,320,926) 105,227,647 143,146,165
Other marketable securities
(amortized cost $81,785,937 and
$38,657,193) 78,811,596 38,478,623
--------------- -------------
184,039,243 181,624,788
--------------- -------------
Loans held for sale
4,991,440 13,094,528
Loans receivable, net 458,103,984 447,455,052
Accrued interest receivable 3,870,249 3,952,763
Federal Home Loan Bank stock, at cost 10,620,000 9,837,900
Mortgage servicing rights, net 1,090,097 1,005,693
Real estate, net 0 10,602
Premises and equipment, net 8,558,032 8,382,136
Investment in limited partnerships 2,761,016 2,437,246
Goodwill 4,206,006 4,341,033
Core deposit intangible 1,084,913 1,259,245
Prepaid expenses and other assets 830,345 295,829
Deferred tax assets 842,726 0
------------- -------------
Total assets $ 687,528,141 694,657,772
============= =============
Liabilities and Stockholders' Equity
Deposits $ 404,555,026 433,868,907
Federal Home Loan Bank advances 211,900,000 185,400,000
Other borrowed money 0 2,500,000
Accrued interest payable 1,535,217 1,086,013
Advance payments by borrowers for taxes
and insurance 856,332 657,089
Accrued expenses and other liabilities 2,934,592 2,700,424
------------- -------------
Total liabilities 621,781,167 626,212,433
------------- -------------
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; issued shares 9,128,662 91,287 91,287
Additional paid-in capital 59,662,969 59,739,020
Retained earnings, subject to certain
restrictions 67,183,853 63,424,378
Accumulated other comprehensive income (loss) (2,868,974) (837,838)
Unearned employee stock ownership plan shares (5,560,181) (5,705,152)
Unearned compensation restricted stock awards (137,230) (276,867)
Treasury stock, at cost 4,195,908 and
3,835,058 shares (52,624,750) (47,989,489)
------------- -------------
Total stockholders' equity 65,746,974 68,445,339
------------- -------------
Total liabilities and stockholders' equity $ 687,528,141 694,657,772
============= =============
See accompanying notes to consolidated financial statements.
3
HMN FINANCIAL, INC. AND SUBSIDIARIES
Consolidated Statements of Income
(unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
1999 1998 1999 1998
------------------------- -----------------------
Interest Income:
Loans receivable $8,763,166 8,905,981 26,170,227 26,346,061
Securities available
for sale:
Mortgage-backed and
related 1,629,729 2,188,930 5,254,159 6,566,267
Other marketable 1,243,901 952,855 3,039,680 3,138,830
Cash equivalents 34,826 90,067 166,057 362,014
Other 163,131 158,825 468,038 430,383
---------- ---------- ---------- ----------
Total interest income 11,834,753 12,296,658 35,098,161 36,843,555
---------- ---------- ---------- ----------
Interest expense:
Deposits 4,423,942 5,613,824 13,567,222 17,038,627
Federal Home Loan Bank
advances 2,811,197 2,625,181 7,949,955 7,164,278
Other borrowed money 0 0 7,207 0
---------- ---------- ---------- ----------
Total interest expense 7,235,139 8,239,005 21,524,384 24,202,905
---------- ---------- ---------- ----------
Net interest income4,599,614 4,057,653 13,573,777 12,640,650
Provision for loan losses 45,000 85,000 195,000 235,000
---------- ---------- ---------- ----------
Net interest income
after provision
for loan losses 4,554,614 3,972,653 13,378,777 12,405,650
---------- ---------- ---------- ----------
Non-interest income:
Fees and service charges 246,200 127,220 565,197 405,596
Mortgage servicing fees 94,180 127,113 270,888 340,082
Securities gains (losses),
net (14,685) 348,025 148,085 1,982,104
Gain on sales of loans 358,073 518,570 1,637,747 1,236,706
Earnings (loss) in limited
partnerships (29,297) (2,676,458) 333,297 (3,614,071)
Other 166,592 128,341 384,916 403,265
---------- ---------- ---------- ----------
Total non-interest
income (loss) 821,063 (1,427,189) 3,340,130 753,682
---------- ---------- ---------- ----------
Non-interest expense:
Compensation and benefits 1,539,214 1,581,907 4,503,030 5,314,221
Occupancy 423,182 361,191 1,239,249 1,083,951
Federal deposit insurance
premiums 72,608 72,608 217,824 219,047
Advertising 73,386 124,067 227,227 353,020
Data processing 173,344 167,003 534,892 505,561
Amortization of mortgage
servicing rights, net of
valuation adjustments
and servicing costs 92,254 414,089 409,233 690,651
Other 596,829 515,839 1,764,845 1,766,736
---------- ---------- ---------- ----------
Total non-interest
expense 2,970,817 3,236,704 8,896,300 9,933,187
---------- ---------- ---------- ----------
Income (loss) before
income tax expense 2,404,860 (691,240) 7,822,607 3,226,145
Income tax expense (benefit) 909,900 (257,000) 3,009,300 1,213,000
---------- ---------- ---------- ----------
Net income (loss) $ 1,494,960 (434,240) 4,813,307 2,013,145
========== ========== ========== ==========
Basic earnings (loss)
per share $0.35 (0.09) 1.09 0.40
========== ========== ========== ==========
Diluted earnings (loss)
per share $0.33 (0.09) 1.05 0.37
========== ========== ========== ==========
See accompanying notes to consolidated financial statements.
4
HMN FINANCIAL, INC. AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income
(unaudited)
Three Months Ended September 30,
1999 1998
--------------------- -----------------------
Net income (loss) $ 1,494,960 (434,240)
Other comprehensive income,
net of tax:
Unrealized gains (losses)
on securities:
Unrealized holding gains
(losses) arising during
period (790,608) (1,063,613)
Less: reclassification
adjustment for gains (losses)
included in net income (9,027) 213,939
--------- ---------
Other comprehensive income
(loss) (781,581) (1,277,552)
--------- ---------
Comprehensive income (loss) $ 713,379 (1,711,792)
========= =========
Nine Months Ended September 30,
1999 1998
----------------------- ---------------------
Net income (loss) $ 4,813,307 2,013,145
Other comprehensive income,
net of tax:
Unrealized gains (losses)
on securities:
Unrealized holding gains
(losses) arising during
period (1,940,105) (314,587)
Less: reclassification
adjustment for gains
included in net income 91,031 1,218,447
----------- ----------
Other comprehensive income (loss) (2,031,136) (1,533,034)
---------- ---------
Comprehensive income (loss) $ 2,782,171 480,111
========== =========
See accompanying notes to consolidated financial statements.
HMN FINANCIAL, INC. AND SUBSIDIARIES
Consolidated Statement of Stockholders' Equity
For the Nine Month Period Ended September 30, 1999
(unaudited)
Accumulated
Additional Other
Common Paid-In Retained Comprehensive
Stock Capital Earnings Income (Loss)
--------------------------------------------------------
Balance,
December 31, 1998 $ 91,287 59,739,020 63,424,378 (837,838)
Net income 4,813,307
Treasury stock purchases
Other comprehensive income
(loss) (2,031,136)
Tax benefits of restricted
stock awards 26,743
Employee stock options
exercised (163,455)
Tax benefit of exercised
stock options 11,929
Amortization of restricted
stock awards
Restricted stock awards
cancelled
Dividends paid (1,053,832)
Earned employee stock
ownership plan shares 48,732
--------- ----------- ---------- -----------
Balance,
September 30, 1999 $ 91,287 59,662,969 67,183,853 (2,868,974)
========= =========== ========== ===========
Unearned
Employee
Stock Unearned
Ownership Compensation Total
Plan Restricted Treasury Stockholders'
Shares Stock Awards Stock Equity
--------------------------------------------------------
Balance,
December 31, 1998 $ (5,705,152) (276,867) (47,989,489) 68,445,339
Net income 4,813,307
Treasury stock purchases (5,037,630) (5,037,630)
Other comprehensive income
(loss) (2,031,136)
Tax benefits of restricted
stock awards 26,743
Employee stock options
exercised 411,898 248,443
Tax benefit of exercised
stock options 11,929
Amortization of restricted
stock awards 130,108 130,108
Restricted stock awards
cancelled 9,529 (9,529) 0
Dividends paid (1,053,832)
Earned employee stock
ownership plan shares 144,971 193,703
----------- -------- ----------- ----------
Balance,
September 30, 1999 $ (5,560,181) (137,230) (52,624,750) 65,746,974
=========== ======== =========== ==========
See accompanying notes to consolidated financial statements.
5
HMN FINANCIAL, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(unaudited)
Nine Months Ended
September 30,
1999 1998
---------------------------------
Cash flows from operating activities:
Net income $ 4,813,307 2,013,145
Adjustments to reconcile net income to
cash provided by operating activities:
Provision for loan losses 195,000 235,000
Depreciation 573,285 455,195
Amortization of (discounts) premiums, net 28,484 (99,108)
Amortization of deferred loan fees (523,090) (469,874)
Amortization of goodwill 135,027 135,477
Amortization of core deposit intangible 174,332 215,271
Amortization of other purchase accounting
adjustments 30,433 582,961
Amortization of mortgage servicing rights
and net valuation adjustments 377,514 642,457
Capitalized mortgage servicing rights (461,919) (188,977)
Increase (decrease) in deferred income taxes (228,099) 255,000
Securities gains, net (148,085) (1,982,104)
Gain on sales of real estate 0 (21,777)
Gain on sales of loans (1,637,747) (1,236,706)
Proceeds from sale of loans held for sale 150,721,591 108,788,891
Disbursements on loans held for sale (138,985,731) (110,984,572)
Principal collected on loans held for sale 1,099 0
Amortization of restricted stock awards 130,108 177,185
Amortization of unearned ESOP shares 144,971 276,441
Earned employee stock ownership shares
priced above original cost 48,732 218,777
Decrease in accrued interest receivable 82,514 134,205
Increase in accrued interest payable 449,204 334,662
Equity (earnings) loss of limited partnerships(333,297) 3,614,071
Increase in other assets (534,516) (483,054)
Increase (decrease) in other liabilities 945,642 (541,372)
Other, net 33,925 (10,223)
---------- -----------
Net cash provided by operating activities 16,032,684 2,060,971
---------- -----------
Cash flows from investing activities:
Proceeds from sales of securities available
for sale 14,744,724 119,137,787
Principal collected on securities available
for sale 40,060,482 27,152,425
Proceeds collected on maturity of securities
available for sale 21,331,000 32,674,876
Purchases of securities available for sale (72,580,007) (165,638,598)
Proceeds from sales of loans receivable 220,605 3,252,274
Purchases of mortgage servicing rights 0 (550,532)
Purchase of interest in limited partnerships 0 (181,125)
Purchase of Federal Home Loan Bank stock (782,100) (1,971,600)
Net increase in loans receivable (21,840,511) (30,936,923)
Proceeds from sale of real estate 16,625 152,415
Purchases of premises and equipment (749,181) (2,071,196)
Decrease in due to stockholders of
Marshalltown Financial Corporation (10,716) (3,507,270)
---------- -----------
Net cash used by investing activities (19,589,079) (22,487,467)
---------- -----------
Cash flows from financing activities:
Decrease in deposits (29,230,696) (20,838,371)
Purchase of treasury stock (5,037,630) (15,685,962)
Increase in unearned ESOP shares 0 (1,476,000)
Stock options exercised 248,443 119,707
Dividends to stockholders (1,053,832) (584,459)
Fractional shares purchased from stock split 0 (1,716)
Proceeds from Federal Home Loan Bank advances 81,800,000 125,500,000
Repayment of Federal Home Loan Bank advances (55,300,000) (68,571,438)
Increase (decrease) in other borrowed money (2,500,000) 100,000
Increase (decrease) in advance payments by
borrowers for taxes and insurance 199,243 (23,893)
---------- -----------
Net cash provided (used) by financing
activities (10,874,472) 18,537,868
---------- -----------
Decrease in cash and cash equivalents (14,430,867) (1,888,628)
Cash and cash equivalents, beginning of period 20,960,957 9,364,635
---------- -----------
Cash and cash equivalents, end of period $ 6,530,090 7,476,007
========== ===========
Supplemental cash flow disclosures:
Cash paid for interest $ 21,075,180 23,868,243
Cash paid for income taxes 2,704,000 1,724,441
6
Supplemental noncash flow disclosures:
SBA certificates transferred from loans
to securities available for sale $ 2,528,442 0
Loans securitized and transferred to
securities available for sale 6,913,219 1,930,846
Loans transferred to loans held for sale 2,028,211 1,172,718
Transfer of loans to real estate 0 17,105
See accompanying notes to consolidated financial statements.
7
HMN FINANCIAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
September 30, 1999 and 1998
(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. As of April 30, 1999 MSL was
dissolved and its assets were transferred to the Bank in exchange for the stock
of MSL. 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 a mortgage banking
and mortgage brokerage facility located in 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. Results of
operations for MSL are included through April 30, 1999, the date of its
dissolution. 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 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 and nine month periods ended
September 30, 1999 are 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
8
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 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 Financial Accounting Standards Board issued SFAS No.
137 which deferred the required adoption of SFAS No. 133 to fiscal years
starting after June 15, 2000. HMN is anticipating that it will adopt SFAS No.
133 in the first quarter of 2001. HMN is currently researching the impact on
its financial condition and results of operations of adopting SFAS No. 133.
Effective January 1, 1999 HMN adopted FASB issued SFAS No. 134, ACCOUNTING FOR
MORTGAGE-BACKED SECURITIES RETAINED AFTER THE SECURITIZATION OF MORTGAGE LOANS
HELD FOR SALE BY A MORTGAGE BANKING ENTERPRISE, which amended SFAS No. 65 to
require that after the securitization of mortgage loans held for sale, an
entity engaged in mortgage banking activities classify the resulting mortgage-
backed securities or other retained interests based on its ability and intent
to sell or hold those investments. The adoption of SFAS No. 134 in the first
quarter of 1999 did not have a material impact on HMN's financial condition or
the results of its operations.
9
(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 losses for the third quarter of 1999 were
$1,286,000, the income tax benefit would have been $495,000 and therefore, the
net loss was $791,000. The gross reclassification adjustment for the third
quarter of 1999 was $(15,000), the income tax benefit would have been $6,000
and therefore, the net reclassification adjustment was $9,000. The gross
unrealized holding losses for the third quarter of 1998 were $1,730,000, the
income tax benefit would have been $666,000 and therefore, the net loss was
$1,064,000. The gross reclassification adjustment for the third quarter of
1998 was $348,000, the income tax expense would have been $134,000 and
therefore, the net reclassification adjustment was $214,000.
The gross unrealized holding losses for the nine month period ended September
30, 1999 were $3,166,000, the income tax benefit would have been $1,226,000 and
therefore, the net loss was $1,940,000. The gross reclassification adjustment
for the first nine months of 1999 was $148,000, the income tax expense would
have been $57,000 and therefore, the net gain was $91,000. The gross
unrealized holding losses for the first nine months of 1998 were $568,000, the
income tax benefit would have been $253,000 and therefore, the net loss was
$315,000. The gross reclassification adjustment for the first nine months of
1998 was $1,982,000, the income tax expense would have been $764,000 and
therefore, the net reclassification adjustment was $1,218,000.
(5) CASH DIVIDEND
On October 26, 1999 HMN's Board of Directors announced a cash dividend of $0.08
per share, payable on December 10, 1999 to stockholders of record on November
23, 1999.
(6) INVESTMENT IN MORTGAGE SERVICING RIGHTS
A summary of mortgage servicing activity is as follows:
- ---------------------------------------------------------------------
1999 1998
----------------- ----------------
Mortgage servicing rights
Balance, beginning of year $ 1,117,193 845,517
Originations 461,919 188,977
Purchases 0 550,532
Amortization (438,969) (568,702)
------------ ----------
Balance, September 30, 1,140,143 1,016,324
------------ ----------
Valuation reserve
Balance, beginning of year (111,500) (64,512)
Additions 0 (165,583)
Reductions 61,454 91,828
------------ ----------
Balance, September 30, (50,046) (138,267)
------------ ----------
Mortgage servicing rights, net $ 1,090,097 878,057
============ ==========
Fair value of mortgage servicing
rights $ 1,250,000 878,057
============ ==========
- ---------------------------------------------------------------
10
All of the loans being serviced were single family loans serviced for FNMA
under the mortgage-backed security program or the individual loan sale program.
The following is a summary of the risk characteristics of the loans being
serviced at September 30, 1999.
- ------------------------------------------------------------------------------
Weighted Weighted
Loan Average Average
Principal Interest Remaining Number
Balance Rate Term Of Loans
----------------------------------------------
Original term 30 year fixed rate $48,721,824 7.42% 331 736
Original term 15 year fixed rate 66,175,900 6.74% 163 1,159
Seven year balloon 842,700 6.97% 342 8
Adjustable rate 8,572,900 7.42% 334 69
- -------------------------------------------------------------------------------
(7) INVESTMENT IN LIMITED PARTNERSHIPS
Investments in limited partnerships were as follows:
- ----------------------------------------------------------------------
September 30, December 31,
Primary partnership activity 1999 1998
- ---------------------------------- -------------- ------------
Mortgage servicing rights $ 2,046,939 1,622,519
Common stock of financial institutions 367,476 415,189
Low to moderate income housing 346,601 399,538
----------- -----------
$ 2,761,016 2,437,246
=========== ===========
- ----------------------------------------------------------------------
During the third quarter of 1999, HMN's proportionate revenue from a mortgage
servicing partnership (which included the reduction of previously established
impairment reserves of $135,000) was $40,000, its proportionate share of losses
from the common stock investments in financial institutions was $62,000 and it
recognized $7,000 of losses from the low income housing partnerships. During
1999, HMN anticipates receiving low income housing credits totaling $80,000, of
which $20,000 were credited to current income tax benefits in the third quarter
of 1999. During the third quarter of 1998, HMN's proportionate share of losses
from the mortgage servicing partnership was $2,486,000, its proportionate share
of losses from common stock investments in financial institutions was $190,000
and it did not recognize any revenue or loss from the low income housing
partnerships.
During the nine month period ended September 30, 1999, HMN's proportionate
revenue from a mortgage servicing partnership (which included the reduction of
previously established impairment reserves of $632,000) was $424,000, its
proportionate share of losses from the common stock investments in financial
institutions was $48,000 and it recognized $43,000 of losses from the low
income housing partnerships. During 1999, HMN anticipates receiving low income
housing credits totaling $80,000, of which $60,000 were credited to current
income tax benefits in the nine month period ended September 30, 1999. During
the nine month period ended September 30, 1998, HMN's proportionate share of
losses from the mortgage servicing partnership was $3,547,000, its
proportionate share of losses from common stock investments in financial
institutions was $67,000 and it did not recognize any revenue or loss from the
low income housing partnerships.
11
(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 Nine Months ended
September 30, September 30,
1999 1998 1999 1998
----------------------- ------------------------
Weighted average number of
common shares outstanding
used in basic earnings per
common share calculation 4,269,133 5,038,496 4,399,444 5,038,496
Net dilutive effect of:
Options 201,673 0 185,251 358,514
Restricted stock awards 13,630 0 20,019 54,344
---------- --------- --------- --------
Weighted average number of
shares outstanding adjusted
for effect of dilutive
securities 4,484,436 5,038,496 4,604,714 5,451,354
========== ========== ========= =========
Net income (loss) available to
common shareholders $ 1,414,960 (434,240) 4,813,307 2,013,145
Basic earnings per common
share $ 0.35 (0.09) 1.09 0.40
Diluted earnings per
common share $ 0.33 (0.09) 1.05 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 condition. 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 September 30, 1999, that the Bank meets
all capital adequacy requirements to which it is subject.
Management believes that based upon the Bank's capital calculations at
September 30, 1999 and other conditions consistent with the Prompt Corrective
Actions Provisions of the OTS regulations, the Bank would be categorized as
well capitalized.
On September 30, 1999 the Bank's tangible assets and adjusted total assets were
$666.3 million and its risk-weighted assets were $367.5 million. The following
table presents the Bank's capital amounts and ratios at September 30, 1999 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
---------------------- ---------------------------
Percent of Percent of
(IN THOUSANDS) Amount Assets <F1> Amount Assets<F1>
--------- ------------ ----------- ------------
Bank stockholder's equity $ 47,889
Plus:
Net unrealized loss on
certain securities
available for sale 2,083
Less:
Goodwill and other
intangibles 5,291
Excess mortgage
servicing rights 200
------
Tier I or core capital 44,481
------
Tier I capital to adjusted
total assets 6.68% $ 26,654 4.00%
Tier I capital to risk-
weighted assets 12.11% $ 14,690 4.00%
Less:
Equity investments & other
assets required to be
deducted (22)
Plus:
Allowable allowance for
loan losses 3,185
------
Risk-based capital $ 47,644 $ 29,401
======
Risk-based capital to risk-
weighted assets 12.96% 8.00%
To Be Well Capitalized
Under Prompt
Corrective Actions
Excess Capital Provisions
------------------------ -------------------------
Percent of Percent of
Amount Assets<F1> Amount Assets<F1>
---------- ------------- ----------- -------------
(in thousands)
Bank stockholder's equity $
Plus:
Net unrealized loss
on certain securities
available for sale
Less:
Goodwill and other
intangibles
Excess mortgage servicing
rights
Tier I or core capital
Tier I capital to adjusted
total assets $ 17,827 2.68% $ 33,317 5.00%
Tier I capital to risk-
weighted assets $ 29,791 8.11% $ 22,035 6.00%
Less:
Equity investments &
other assets required
to be deducted
Plus:
Allowable allowance for
loan losses
Risk-based capital $ 18,243 $ 36,751
Risk-based capital to risk-
weighted assets 4.96% 10.00%
<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.
- ----------------------------------------------------------------------------
The tangible capital of the Bank was in excess of the minimum 2% required at
September 30, 1999, but is not reflected in the table above.
(10) BUSINESS SEGMENTS
HMN's wholly owned subsidiaries, Home Federal Savings Bank and Mortgage
Services, Inc., have been identified as reportable operating segments in
accordance with the provisions of SFAS No. 131. MSI was deemed to be a segment
because it is a separate corporation which operates independently from the Bank
and it is not regulated by the Office of Thrift Supervision. MSI has been
segmented further into Mortgage Servicing Rights and Mortgage Banking
activities. The mortgage servicing segment owns servicing rights on loans
which have either been sold to FNMA or securitized into mortgage backed
instruments which were issued by FNMA. MSI receives a servicing fee which is
based upon the outstanding balance of the loan being serviced and pays a
subservicer a monthly fee to service the loan. MSI's mortgage banking activity
includes an origination function and it also purchases loans from other loan
originators. All loans acquired either by origination or by purchase are
intended to be resold in the secondary loan market.
Security Finance Corporation and HMN, the holding company, did not meet the
quantitative thresholds for determining reportable segments and therefore are
included in the 'Other' category.
HMN evaluates performance and allocates resources based on the segment's net
income or loss, return on average assets and return on average equity. The
segments follow generally accepted accounting principles as described in the
summary of significant accounting policies.
Each corporation is managed separately with its own president, who reports
directly to HMN's chief operating decision maker and board of directors.
13
The following table sets forth certain information about the reconciliations of
reported profit or loss and assets for each of HMN's reportable segments.
HMN Mortgage Services, Inc.
---------------------------
Mortgage Total
Home Federal Servicing Mortgage Reportable
(DOLLARS IN THOUSANDS) Savings Bank Rights Banking Segments
- -------------------------------------------------------------------------------
At or for the three months
ended September 30, 1999:
Interest income -
external customers $ 11,571 0 84 11,655
Non-interest income -
external customers 566 24 251 841
Earnings (loss) on limited
partnerships 33 0 0 33
Intersegment interest income 9 0 0 9
Intersegment non-interest income 86 0 0 86
Interest expense 7,235 0 85 7,320
Amortization of mortgage
servicing rights, net
valuation adjustments and
servicing code 56 36 0 92
Other non-interest expense 2,585 0 273 2,858
Income tax expense (benefit) 925 (4) (10) 911
Net income (loss) 1,419 (8) (13) 1,398
Total assets 669,719 217 4,942 674,878
Net interest margin 2.66 % NM NM NM
Return on average assets 0.84 % (13.61)% (0.92)% NM
Return on average realized
common equity 11.42 % (61.89)% (4.17)% NM
At or for the three months ended
September 30, 1998:
Interest income -
external customers $ 11,943 0 70 12,013
Non-interest income -
external customers 932 107 293 1,332
Earnings (loss) on limited
partnerships (2,883) 0 0 (2,883)
Intersegment interest income 13 0 0 13
Intersegment non-interest income 77 0 0 77
Interest expense 8,239 0 76 8,315
Amortization of mortgage
servicing rights, net
valuation adjustments and
servicing code 11 403 0 414
Other non-interest expense 2,528 0 251 2,779
Income tax expense (benefit) (277) (113) 14 (376)
Net income (loss) (494) (183) 22 (655)
Total assets 684,576 638 5,802 691,016
Net interest margin 2.22 % NM NM NM
Return on average assets (0.28) % (77.15)% 1.75% NM
Return on average realized
common equity (4.08) % (252.26)% 5.72% NM
Consolidated
(DOLLARS IN THOUSANDS) Other Eliminations Total
- ------------------------------------------------------------------------------
At or for the three months ended
September 30, 1999:
Interest income -
external customers $ 180 0 11,835
Non-interest income -
external customers 11 0 852
Earnings (loss) on limited
partnerships (63) 0 (30)
Intersegment interest income 117 (126) 0
Intersegment non-interest income 1,412 (1,498) 0
Interest expense 41 (126) 7,235
Amortization of mortgage
servicing rights, net
valuation adjustments and
servicing code 0 0 92
Other non-interest expense 107 (86) 2,879
Income tax expense (benefit) 0 0 911
Net income (loss) 1,509 (1,412) 1,495
Total assets 68,508 (55,858) 687,528
Net interest margin NM NM 2.75%
Return on average assets NM NM 0.86%
Return on average realized
common equity NM NM 8.55%
At or for the three months ended
September 30, 1998:
Interest income -
external customers $ 284 0 12,297
Non-interest income -
external customers 228 0 1,560
Earnings (loss) on limited
partnerships (73) 0 (2,956)
Intersegment interest income 175 (188) 0
Intersegment non-interest income (610) 533 0
Interest expense 112 (188) 8,239
Amortization of mortgage
servicing rights, net
valuation adjustments and
servicing code 0 0 414
Other non-interest expense 152 (77) 2,854
Income tax expense (benefit) 119 0 (257)
Net income (loss) (389) 610 (434)
Total assets 75,660 (60,407) 706,269
Net interest margin NM NM 2.35%
Return on average assets NM NM (0.24)%
Return on average realized
common equity NM NM (2.46)%
NM - Not meaningful
14
HMN Mortgage Services, Inc.
---------------------------
Mortgage Total
Home Federal Servicing Mortgage Reportable
(DOLLARS IN THOUSANDS) Savings Bank Rights Banking Segments
- -------------------------------------------------------------------------------
At or for the nine months
ended September 30, 1999:
Interest income -
external customers $ 34,260 0 256 34,516
Non-interest income -
external customers 2,027 79 846 2,952
Earnings (loss) on limited
partnerships 381 0 0 381
Intersegment interest
income 29 0 0 29
Intersegment non-interest
income 251 0 0 251
Interest expense 21,517 0 247 21,764
Amortization of mortgage
servicing rights, net
valuation adjustments and
servicing code 174 235 0 409
Other non-interest expense 7,502 0 855 8,357
Income tax expense (benefit) 2,969 (60) (2) 2,907
Net income (loss) 4,591 (96) 2 4,497
Total assets 669,719 217 4,942 674,878
Net interest margin 2.66 % NM NM NM
Return on average assets 0.92 % (46.02)% 0.03% NM
Return on average realized
common equity 12.41 % (142.35)% 0.11% NM
At or for the nine months ended
September 30, 1998:
Interest income -
external customers $ 35,617 0 178 35,795
Non-interest income -
external customers 1,721 300 690 2,711
Earnings (loss) on limited
partnerships (3,541) 0 0 (3,541)
Intersegment interest income 43 0 0 43
Intersegment non-interest income 230 0 0 230
Interest expense 24,203 0 185 24,388
Amortization of mortgage
servicing rights, net
valuation adjustments and
servicing code 23 668 0 691
Other non-interest expense 8,135 0 818 8,953
Income tax expense (benefit) 724 (141) (52) 531
Net income (loss) 760 (227) (83) 450
Total assets 684,576 638 5,802 691,016
Net interest margin 2.31 % NM NM NM
Return on average assets 0.15 % (31.62)% (2.60)% NM
Return on average realized
common equity 2.02 % (98.80)% (8.18)% NM
NM - Not meaningful
Consolidated
(DOLLARS IN THOUSANDS) Other Eliminations Total
- ------------------------------------------------------------------------------
At or for the nine months ended
September 30, 1999:
Interest income -
external customers $ 582 0 35,098
Non-interest income -
external customers 55 0 3,007
Earnings (loss) on
limited partnerships (48) 0 333
Intersegment interest income 340 (369) 0
Intersegment non-interest
income 4,547 (4,798) 0
Interest expense 129 (369) 21,524
Amortization of mortgage
servicing rights, net
valuation adjustments and
servicing code 0 0 409
Other non-interest expense 381 (251) 8,487
Income tax expense (benefit) 103 0 3,010
Net income (loss) 4,863 (4,547) 4,813
Total assets 68,508 (55,858) 687,528
Net interest margin NM NM 2.75%
Return on average assets NM NM 0.94%
Return on average realized
common equity NM NM 9.23%
At or for the nine months ended
September 30, 1998:
Interest income -
external customers $ 1,049 0 36,844
Non-interest income -
external customers 1,656 0 4,367
Earnings (loss) on limited
partnerships (73) 0 (3,614)
Intersegment interest income 430 (473) 0
Intersegment non-interest income 584 (814) 0
Interest expense 288 (473) 24,203
Amortization of mortgage
servicing rights, net
valuation adjustments and
servicing code 0 0 691
Other non-interest expense 519 (230) 9,242
Income tax expense (benefit) 682 0 1,213
Net income (loss) 2,147 (584) 2,013
Total assets 75,660 (60,407) 706,269
Net interest margin NM NM 2.46%
Return on average assets NM NM 0.38%
Return on average realized
common equity NM NM 3.47%
NM - Not meaningful
15
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 (LOSS)
HMN's net income for the third quarter of 1999 was $1.5 million, an increase of
$1.9 million, compared to a net loss of $434,000 for the third quarter of 1998.
Basic earnings per share were $0.35 for the quarter ended September 30, 1999,
an increase of $0.44 per share, from a loss of $0.09 basic earnings per share
for the same quarter of 1998. Diluted earnings per share were $0.33 for the
third quarter of 1999, an increase of $0.42 from a loss of $0.09 diluted
earnings per share for the third quarter of 1998.
HMN's net income for the nine month period ended September 30, 1999 was $4.8
million, an increase of $2.8 million, compared to $2.0 million for the same
nine month period in 1998. Basic earnings per share were $1.09 for the nine
month period ended September 30, 1999, an increase of $0.69 from $0.40 basic
earnings per share for the same nine month period of 1998. Diluted earnings
per share were $1.05 for the nine month period ended September 30, 1999, an
increase of $0.68 from $0.37 diluted earnings per share for the same nine month
period of 1998.
NET INTEREST INCOME
Net interest income for the third quarter of 1999 was $4.6 million, an increase
of $542,000, or 13.4%, compared to $4.1 million for the third quarter of 1998.
Interest income for the third quarter of 1999 was $11.8 million, a decrease of
$462,000, or 3.8%, compared to $12.3 million for the third quarter of 1998.
Interest income declined $495,000 primarily due to a $27.8 million decrease in
net average interest-earning assets from the third quarter of 1998 to the third
quarter of 1999, principally due to interest-earning assets being used to fund
deposit outflows and to purchase HMN's common stock under its stock repurchase
program. Interest income increased by $33,000 because
16
the yield earned on interest-earning assets increased from 7.05% for the quarter
ended September 30, 1998 to 7.07% for the quarter ended September 30, 1999,
primarily due to an increase in interest rates earned on loans receivable.
Interest expense was $7.2 million for the third quarter of 1999, a decrease of
$1.0 million, or 12.2%, compared to $8.2 million for the same quarter of 1998.
Interest expense decreased by $594,000 due to a net decrease of $45.5 million
in average outstanding deposits from the third quarter of 1998 to the third
quarter of 1999. Interest expense increased by $252,000 due to an increase of
$16.3 million in the average outstanding FHLB advances from the third quarter
of 1998 to the third quarter of 1999. FHLB advances were used to replace a
portion of the funds lost to deposit outflows. Interest expense decreased by
$662,000 primarily due to lower interest rates being paid on customer deposits
and advances from the FHLB. The average interest rate paid on average interest-
bearing liabilities was 4.69% during the third quarter of 1999, compared to
5.12% for the third quarter of 1998. HMN's margin was 2.75% for the third
quarter of 1999, an increase of 40 basis points, or 17.0%, from 2.35% for the
third quarter of 1998.
Net interest income for the nine month period ended September 30, 1999 was
$13.6 million, an increase of $933,000, or 7.4%, compared to $12.6 million for
the same nine month period of 1998. Interest income for the nine month period
ended in 1999 was $35.1 million, a decrease of $1.7 million, or 4.7%, compared
to $36.8 million for the same nine month period of 1998. Interest income
declined by $1.3 million due to a $25.3 million decrease in net average
interest-earning assets from the nine month period ended in 1998 to the same
period in 1999, principally due to interest-earning assets being used to fund
deposit outflows and to purchase HMN's common stock under its stock repurchase
program. Interest income decreased by $396,000 because the yield earned on
interest-earning assets for the nine month period decreased from 7.18% at
September 30, 1998 to 7.10% at September 30, 1999 primarily due to a decline in
interest rates earned on securities and cash equivalents. Interest expense was
$21.5 million for the nine month period ended September 30, 1999, a decrease of
$2.7 million, or 11.1%, compared to $24.2 million for the same nine month
period of 1998. Interest expense decreased by $1.8 million due to a net
decrease of $46.9 million in the average outstanding balance of deposits from
the nine month period ended September 30, 1998, compared to the same nine month
period of 1999. Interest expense increased by $1.1 million due to an increase
of $27.8 million in the average outstanding FHLB advances for the nine month
period ended September 30, 1998, compared to the same nine month period of
1999. FHLB advances were used to replace a portion of the funds lost to
deposit outflows. Interest expense decreased by $2.0 million primarily due to
lower interest rates being paid on customer deposits and advances from the
FHLB. The average interest rate paid on average interest-bearing liabilities
was 4.73% during the nine month period ended September 30, 1999, compared to
5.16% for the same nine month period of 1998. HMN's margin was 2.75% for the
nine month period ended September 30, 1999, an increase of 29 basis points, or
11.8%, from 2.46% for the same nine month period of 1998.
PROVISION FOR LOAN LOSSES
*The provision for loan losses for the third quarter ended September 30, 1999
was $45,000, a decrease of $40,000, or 47.1%, compared to $85,000 for the third
quarter of 1998. The provision for loan losses for the nine months ended
September 30, 1999 was $195,000, a decrease of $40,000, or 17.0%, compared to
$235,000 for the nine month period ended September 30, 1998. 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 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 conditions that resulted in
decreasing the third quarter of 1999 loan loss provision compared to the
provision for the third quarter of 1998. 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.
* This paragraph contains a forward-looking statement(s). Refer to information
regarding Forward-looking Information on page 26 of this discussion.
17
A reconciliation of HMN's allowance for loan losses is summarized as follows:
1999 1998
------------------ --------------
Balance at January 1, $ 3,041,486 2,748,219
Provision 195,000 235,000
Charge-offs (4,676) (18,599)
Recoveries 840 1,615
--------------- -------------
Balance at September 30, $ 3,232,650 2,966,235
=============== =============
NON-INTEREST INCOME
Non-interest income for the third quarter of 1999 was $821,000, an increase of
$2.2 million, or 157.5%, from a non-interest loss of $1.4 million for the same
quarter of 1998. The increase in non-interest income was principally due to a
$2.6 million decrease in losses from limited partnership interests and an
$119,000 increase in fees and service charges primarily related to deposit
accounts. The increase in non-interest income was partially offset by a
$363,000 decrease in securities gains (losses), net recognized on the sale of
securities and a $160,000 decrease in gains recognized on the sale of loans.
In the third quarter of 1998, HMN recognized a pretax charge of $2.5 million as
its proportionate share of an impairment reserve established on mortgage
servicing assets from its investment in a limited partnership. During the
third quarter of 1999, the number of single family mortgage loan refinancings
declined primarily due to a general increase in the interest rates charged on
mortgage loans. The decline in single family loan refinancings caused the loan
prepayment assumptions used to calculate the market value of mortgage servicing
assets to decline, which in turn caused the market value of mortgage servicing
assets to increase. The increase in the market value allowed HMN to reverse,
during the third quarter of 1999, $135,000 of previously established impairment
reserves. During the third quarter of 1999 interest rates in general were
increasing which reduced the opportunity to sell fixed rate securities at a
gain. During the third quarter of 1999 as a result of rising interest rates a
few securities were sold at a loss in order to improve the reinvestment yield
of the securities portfolio. Gain on the sale of loans decreased during the
third quarter of 1999 compared to the same quarter of 1998 partly due to
reduced loan production as a result of higher interest rates and also because
the Bank decided to retain in its portfolio certain fixed rate loans that in
previous quarters would have been sold in the secondary loan market.
Non-interest income for the nine month period ended September 30, 1999 was $3.3
million, an increase of $2.6 million, or 343.2%, from $754,000 for the same
nine month period of 1998. The increase in non-interest income was principally
due to a $3.9 million decrease in losses from limited partnerships, a $401,000
increase in gain recognized on the sale of loans and a $160,000 increase in
fees and service charges primarily related to deposit accounts. The increases
in non-interest income were partially offset by a $1.8 million decline in the
net gain recognized from the sale of securities and a $69,000 decrease in
mortgage servicing fees. During the first nine months of 1998, HMN recognized
a pretax charge of $3.5 million as its proportionate share of an impairment
reserve established on mortgage servicing assets from its investment in a
limited partnership. During the first nine months of 1999, the number of
single family mortgage loan refinancings declined primarily due to a general
increase in the interest rates charged on mortgage loans. The decline in
single family loan refinancings caused the loan prepayment assumptions used to
calculate the market value of mortgage servicing assets to decline, which in
turn caused the market value of mortgage servicing assets to increase. The
increase in the market value allowed HMN to reverse, during the nine month
period ended September 30, 1999, $632,000 of previously established impairment
reserves. Gain on the sale of loans increased by $401,000 due to more loans
being sold in 1999 than in 1998 and improved profitability on the sale of
certain loans. The net gain on the sale of securities for the nine months
ended September 30, 1999 was $148,000, a decline of $1.83 million from $1.98
million for the same nine month period of 1998. During the first nine months
of 1999 interest rates in general were increasing, which reduced the
opportunity to sell fixed rate securities at a gain.
NON-INTEREST EXPENSE
Non-interest expense was $3.0 million for the third quarter of 1999, a decrease
of $266,000, or 8.2%, from $3.2 million for the third quarter of 1998.
Compensation and benefit expense decreased by $43,000, primarily due to
18
reduced commissions paid on declining loan production and a reduction in the
cost of certain benefit plans. Non-interest expense declined by $322,000 due to
decreased amortization recorded on mortgage servicing assets and it decreased
by $51,000 due to a change in HMN's advertising emphasis from using direct
advertising media to employee sales incentives and other indirect approaches to
advertising. Occupancy expense increased by $62,000, primarily due to the
occupancy costs related to the new retail banking facility in Winona opening in
December 1998.
Non-interest expense was $8.9 million for the nine months ended September 30,
1999, a decrease of $1.0 million, or 10.4%, from $9.9 million for the same
period of 1998. Compensation and benefit expense decreased by $811,000,
primarily due to reduced compensation and benefits paid as a result of work
force reductions, commissions paid on declining loan production, a reduction
in the stock allocation formula for employee stock ownership participants and
cost savings in health benefits provided. HMN changed its advertising emphasis
from using direct advertising media to employee sales incentives and therefore
was able to reduce its advertising expense by $126,000. Non-interest expense
declined by $281,000 due to decreased amortization recorded on mortgage
servicing assets. The decreases in non-interest expense were partially offset
by a $155,000 increase in occupancy expense primarily related to new retail
banking facilities located in Spring Valley and Winona. The Spring Valley
location opened in late February of 1998 and the Winona location opened in
December of 1998, so only a portion of the occupancy costs for Spring Valley
and none of the occupancy costs for Winona were included in the occupancy costs
for 1998, whereas a full nine months of costs were included in the nine month
period ended September 30, 1999.
INCOME TAX EXPENSE
Income tax expense was $910,000 for the third quarter of 1999, an increase of
$1.2 million, from a tax benefit of $257,000 for the third quarter of 1998.
The increase is primarily due to an increase in taxable income between the two
quarters. Income tax expense was $3.0 million for the nine month period ended
September 30, 1999, an increase of $1.8 million, from $1.2 million for the same
nine month period in 1998. The increase is primarily due to an increase in
taxable income between the two nine month periods.
NON-PERFORMING ASSETS
The following table sets forth the amounts and categories of non-performing
assets in the Bank's portfolio at September 30, 1999 and December 31, 1998.
September 30, December 31,
(DOLLARS IN THOUSANDS) 1999 1998
--------------- ---------------
Non-Accruing Loans
One-to-four family real estate $ 183 317
Nonresidential real estate 0 73
Consumer 121 86
---- -----
Total 304 476
----- -----
Accruing loans delinquent 90
days or more 198 312
----- -----
Foreclosed Assets
Real estate:
One-to-four family 0 18
----- -----
Total non-performing assets $ 502 806
===== =====
Total as a percentage of total assets 0.07% 0.12%
===== =====
Total non-performing loans $ 502 788
===== =====
Total as a percentage of total
loans receivable, net 0.11% 0.18%
===== ======
Total non-performing assets at September 30, 1999 were $502,000, a decrease of
$304,000, from $806,000 at December 31, 1998. Non-accruing loans decreased by
$172,000, primarily related to one-to-four family real estate loans being
transferred to accruing loan status, nonresidential real estate being brought
current on late payments, the
19
sale of foreclosed assets and a net increase of $35,000 in non-accruing consumer
debt.
DIVIDENDS
During 1998 and 1999 HMN declared and paid dividends as follows:
Dividend Dividend
Record date Payable date per share Payout Ratio
- --------------- ------------------ ---------- ------------
May 27, 1998 June 12, 1998 $0.06 21.4 %
August 27, 1998 September 10, 1998 $0.06 42.9
December 1, 1998 December 15, 1998 $0.06 (66.7)
February 24, 1999 March 10, 1999 $0.08 21.6
May 26, 1999 June 10, 1999 $0.08 23.5
August 25, 1999 September 10, 1999 $0.08 21.6
On October 26, 1999 HMN's Board of Directors announced a cash dividend of $0.08
per share, payable on December 10, 1999 to stockholders of record on November
23, 1999. The annualized dividend payout ratio for the past four quarters was
22.7%. The dividend payout ratio is calculated by dividing dividends per share
by diluted earnings per share.
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.
LIQUIDITY
For the nine month period ended September 30, 1999, the net cash provided by
operating activities was $16.0 million. HMN collected $14.7 million from the
sale of securities; it collected $61.4 million in principal repayments or on
the maturity of securities during the period. HMN also collected $221,000 on
the sale of loans receivable during the period. It purchased $72.6 million of
securities, $782,000 of FHLB common stock and $749,000 of premises and
equipment. HMN also funded a net increase in loans receivable of $59.4
million. HMN had a net deposit outflow of $29.2 million, additional net
borrowing from the FHLB of $26.5 million and paid $2.5 million from other
sources. HMN paid $5.0 million to purchase 391,900 shares of its own common
stock during the first nine months of 1999 and it paid $1.1 million in
dividends to its stockholders.
*HMN has certificates of deposits with outstanding balances of $185.4 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 $19.0 million of FHLB advances which mature over the next 12 months
and $14.0 million of FHLB advances which mature in 2001 but have call features
which can be exercised by the FHLB on a semiannual basis starting in August or
September of 1999. 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 maturing or being called by the FHLB
during the next 12 month period.
* This paragraph contains a forward-looking statement(s). Refer to information
regarding Forward-looking Information on page 26 of this discussion.
20
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 September 30, 1999. 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 September 30, 1999.
* This paragraph contains a forward-looking statement(s). Refer to information
regarding Forward-looking Information on page 26 of this discussion.
21
Other than trading portfolio Market Value
---------------------------------------------------
(DOLLARS IN THOUSANDS)
Basis point change
in interest rates -200 -100 0 +100 +200
- -----------------------------------------------------------------------------
Cash equivalents $ 6,536 6,531 6,527 6,522 6,517
Securities available
for sale:
Fixed-rate CMOs 18,766 18,649 18,101 17,367 16,570
Variable-rate CMOs 85,618 86,828 85,253 82,566 79,178
Fixed-rate available
for sale mortgage-backed
and related securities 1,906 1,875 1,838 1,793 1,739
Variable-rate available
for sale mortgage-
backed and related
securities 49 48 46 45 45
Fixed-rate available for
sale other marketable
securities 96,558 94,134 91,016 86,872 83,477
Variable-rate available
for sale other
marketable securities 1,323 1,322 1,321 1,320 1,319
Fixed-rate loans held
for sale 4,999 4,995 4,991 4,987 4,983
Loans receivable, net:
Fixed-rate real
estate loans 286,535 281,815 274,298 265,513 256,611
Variable-rate real
estate loans 132,931 130,875 128,025 124,113 119,454
Fixed-rate other
loans 40,341 39,808 39,110 38,344 37,650
Variable-rate other
loans 25,344 25,130 25,101 25,074 25,046
Mortgage servicing
rights, net 406 813 1,250 1,420 1,562
Investment in limited
partnerships 659 1,112 2,761 6,372 7,023
------- ------- ------- ------- -------
Total market risk
sensitive assets 701,971 693,935 679,638 662,308 641,174
------- ------- ------- ------- -------
NOW deposits 31,854 31,827 31,801 31,774 31,748
Passbook deposits 34,551 33,109 31,782 30,558 29,424
Money market deposits 31,200 29,864 28,638 27,509 26,465
Certificate deposits 312,227 308,773 305,399 302,103 298,882
Fixed-rate Federal Home
Loan Bank advances 173,103 164,940 159,943 155,676 151,552
Variable-rate Federal
Home Loan Bank
advances 50,647 50,604 50,561 50,519 50,477
------- ------- ------- ------- -------
Total market risk
sensitive liabilities 633,582 619,117 608,124 598,139 588,548
------- ------- ------- ------- -------
Off-balance sheet
financial instruments:
Commitments to
extend credit 52 52 50 48 46
------- ------- ------- ------- -------
Net market risk $ 68,337 74,766 71,464 64,121 52,580
======= ======= ======= ======= =======
Percentage change from
current market value (4.38)% 4.62% 0.00% (10.27)% (26.42)%
======= ======= ======= ======= =======
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 44%, 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 18% and 54% 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
20%. FHLB advances
22
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 September 30,
1999 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 $ 21,683 3.09%
+100 21,416 1.82%
0 21,033 0.00%
-100 20,349 -3.25%
-200 19,337 -8.06%
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
*This paragraph contains a forward-looking statement(s). Refer to information
regarding Forward-looking Information on page 26 of this discussion.
23
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 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 September 30, 1999, using certain assumptions that are
described in more detail below:
- -----------------------------------------------------------------------------
Maturing or Repricing
----------------------------------------------------
Over 6
6 Months Months to Over 1-3 Over 3-5
(DOLLARS IN THOUSANDS) Or Less One Year Years Years
- -----------------------------------------------------------------------------
Cash equivalents $ 6,530 0 0 0
Securities available for sale:
Mortgage-backed and
related securities<F1> 89,640 4,762 8,495 934
Other marketable
securities 10,071 2,889 34,385 20,318
Loans held for sale, net 4,991 0 0 0
Loans receivable, net<F1><F2>
Fixed rate one-to-four
family 26,878 23,482 71,575 46,600
Adjustable rate
one-to-four family 17,306 17,620 29,091 37,675
Multi family 7,147 225 554 566
Fixed rate commercial
real estate 3,789 3,424 8,111 4,273
Adjustable rate commercial
real estate 7,557 1,572 3,222 4,689
Commercial business 6,617 3,025 7,352 2,797
Consumer loans 25,759 2,489 7,246 3,885
Federal Home Loan Bank stock 0 0 0 0
------- ------- -------- --------
Total interest-earning
assets 206,285 59,488 170,0311 21,737
------- ------- -------- --------
Non-interest checking 8,384 0 0 0
NOW accounts 23,506 0 0 0
Passbooks 3,573 3,573 10,289 6,585
Money market accounts 3,147 3,147 9,062 5,800
Certificates 118,856 66,589 90,227 28,729
Federal Home Loan Bank
advances 55,500 14,000 26,000 116,400
------- ------- -------- --------
Total interest-
bearing liabilities 212,966 87,309 135,578 157,514
------- ------- -------- --------
Interest-earning assets less
interest-bearing
liabilities $ (6,681) (27,821) 34,453 (35,777)
======= ======= ======== ========
Cumulative interest-rate
sensitivity gap $ (6,681) (34,502) (49) (35,826)
======= ======= ======== ========
Cumulative interest-rate
gap as a percentage of
total assets at
September 30, 1999 (0.10)% (5.02)% (0.01)% (5.21)%
======= ======= ======== ========
- -----------------------------------------------------------------------------
Maturing or Repricing
----------------------------------------------------
Over 5 No Stated
(DOLLARS IN THOUSANDS) Years Maturity Total
- -----------------------------------------------------------------------------
Cash equivalents $ 0 0 6,530
Securities available for sale:
Mortgage-backed and
related securities<F1> 3,089 0 106,920
Other marketable securities 5,536 8,587 81,786
Loans held for sale, net 0 0 4,991
Loans receivable, net<F1><F2>
Fixed rate one-to-four family 75,064 0 243,599
Adjustable rate
one-to-four family 228 0 101,920
Multi family 326 0 8,818
Fixed rate commercial
real estate 6,407 0 26,004
Adjustable rate commercial
real estate 0 0 17,040
Commercial business 505 0 20,296
Consumer loans 4,281 0 43,660
Federal Home Loan Bank stock 0 10,620 10,620
------- ------- --------
Total interest-earning
assets 95,436 19,207 672,184
------- ------- --------
Non-interest checking 0 0 8,384
NOW accounts 0 0 23,506
Passbooks 11,707 0 35,727
Money market accounts 10,309 0 31,465
Certificates 1,071 0 305,472
Federal Home Loan Bank advances 0 0 211,900
------- ------- --------
Total interest-bearing
liabilities 23,087 0 616,454
------- ------- --------
Interest-earning assets less
interest-bearing liabilities $ 72,349 19,207 55,730
======= ======= ========
Cumulative interest-rate
sensitivity gap $ 36,523 55,730 55,730
======= ======= ========
Cumulative interest-rate gap as a
percentage of total assets at
September 30, 1999 5.31 % 8.11 % 8.11 %
======= ======= ========
<FN>
<F1> 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.
<F2> Loans receivable are presented net of loans in process and deferred loan
fees.
</FN>
*This paragraph contains a forward-looking statement(s). Refer to information
regarding Forward-looking Information on page 26 of this discussion.
24
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 44%,
depending on the coupon and period to maturity. ARMs were assumed to prepay at
annual rates of between 11% and 31%, depending on coupon and the period to
maturity. GEM loans were assumed to prepay at annual rates of between 18% and
54% 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 20%. FHLB advances
were projected to be called at the first call date where the projected interest
rate on similar remaining term advances exceeded the interest rate on HMN's
callable advance.
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.
YEAR 2000
HMN has been actively engaged in managing the Year 2000 (Y2K) project since
September of 1997. HMN's management has consistently met the completion
deadlines for various phases of the project that were established by the
Federal Financial Institutions Examination Council (FFIEC) guidelines.
HMN has an extensive business recovery plan that addresses the procedures that
would be implemented in the event of certain types of disasters. A Y2K
Contingency Plan (the Plan) was developed by the Y2K Committee to document how
HMN would respond to the unique aspects of possible Y2K disruptions. The Plan
focuses on the core business processes of HMN and the systems that support
those processes in accordance with the FFIEC guidelines.
*In developing the Plan HMN inventoried its computer hardware, computer
software, third party vendors and its other non-computer equipment and assessed
whether the items were Y2K compliant. All non-compliant hardware was replaced
in either 1998 or 1999 at an aggregate cost of $102,000. The computer software
inventory indicated that certain programs were not compliant. Those software
programs were replaced during 1998 and 1999 at an aggregate cost of $80,000.
HMN has also tested computer software to determine that the software was Y2K
compliant. The assessment of non-computer equipment for Y2K compliance
indicated that HMN did not have any significant issues in this area.
*The majority of the Bank's loan and deposit data is supported by a third party
data processing center. Other third party providers support the automated
teller machines owned by the Bank and process the check clearings for the
Bank's negotiable order of withdrawal accounts ('checking accounts'). The Bank
is also reliant upon the Federal Home Loan Bank of Des Moines and the Federal
Reserve System to properly and efficiently conduct its business.
Notwithstanding the Bank's efforts, the failure of any of these third party
vendors to address their Y2K issues in a timely fashion may have an adverse
effect on the Bank's ability to conduct its business and/or process its
customers' transactions. The Bank's Y2K Committee has worked very closely with
its data processing center to ascertain that their software applications and
hardware will be Y2K compliant. The Y2K Committee is also monitoring the
progress that other key third party providers are making toward becoming Y2K
compliant. The Y2K Committee is not aware that either the data processing
center or any other key third party providers to the Bank will have issues
related to Y2K that will have an adverse effect on the Bank's ability to
conduct its business.
*This paragraph contains a forward-looking statement(s). Refer to information
regarding Forward-looking Information on page 26 of this discussion.
25
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 third quarter ended September 30,
1999 was $45,000, a decrease of $40,000, or 47.1%, compared to $85,000 for
the third quarter of 1998. The provision for loan losses for the nine
months ended September 30, 1999 was $195,000, a decrease of $40,000, or
17.0%, compared to $235,000 for the nine month period ended September 30,
1998. 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 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 conditions that resulted in
decreasing the third quarter of 1999 loan loss provision compared to the
provision for the third quarter of 1998. 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 $185.4
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 $19.0 million of FHLB advances which mature over the next 12
months and $14.0 million of FHLB advances which mature in 2001 but have
call features which can be exercised by the FHLB on a semiannual basis
starting in August or September of 1999. 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 maturing or being called by the FHLB during the
next 12 month period.
If circumstances exist which cause the maturing certificates of deposit to
become a liquidity problem then the advances which mature and or the
advances that would be called by the FHLB would also become a liquidity
problem.
26
MARKET RISK
HMN utilizes a model which uses the discounted cash flows from its
interest-earning assets and its interest-bearing liabilities to calculate
the current market value of those assets and liabilities. The model also
calculates the changes in market value of the interest-earning assets and
interest-bearing liabilities due to different interest rate changes. HMN
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 September 30, 1999. 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 September 30, 1999.
Interest rates could fluctuate in a range of more than 200 basis points up
or down from where the rates were on September 30, 1999 due to the
influence of many unforeseen factors not now known to HMN's management.
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 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
September 30, 1999 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.
The following (Maturing or Repricing) table sets forth the interest rate
risk sensitivity of HMN's assets and liabilities at September 30, 1999
using certain assumptions that are described in more detail below. 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.
YEAR 2000
In developing the Plan HMN inventoried its computer hardware, computer
software, third party vendors and its other non-computer equipment and
assessed whether the items were Y2K compliant. All non-compliant hardware
was replaced in either 1998 or 1999 at an aggregate cost of $102,000. The
computer software inventory indicated that certain programs were not
compliant. Those software programs were replaced during
27
1998 and 1999 at
an aggregate cost of $80,000. HMN has also tested computer software to
determine that the software was Y2K compliant. The assessment of non-
computer equipment for Y2K compliance indicated that HMN did not have any
significant issues in this area.
The majority of the Bank's loan and deposit data is supported by a third
party data processing center. Other third party providers support the
automated teller machines owned by the Bank and process the check
clearings for the Bank's negotiable order of withdrawal accounts
('checking accounts'). The Bank is also reliant upon the Federal Home
Loan Bank of Des Moines and the Federal Reserve System to properly and
efficiently conduct its business. Notwithstanding the Bank's efforts, the
failure of any of these third party vendors to address their Y2K issues in
a timely fashion may have an adverse effect on the Bank's ability to
conduct its business and/or process its customers' transactions. The
Bank's Y2K Committee has worked very closely with its data processing
center to ascertain that their software applications and hardware will be
Y2K compliant. The Y2K Committee is also monitoring the progress that
other key third party providers are making toward becoming Y2K compliant.
The Y2K Committee is not aware that either the data processing center or
any other key third party providers to the Bank will have issues related
to Y2K that will have an adverse effect on the Bank's ability to conduct
its business.
While HMN has inventoried and assessed its hardware, software and other
non computer equipment other unforeseen issues may come to light in the
future with the above mentioned items that would cause HMN to incur
additional costs in order to become Y2K compliant.
While HMN has identified and assessed the Y2K risks related to each of its
major third party vendors and providers, it is monitoring their activities
related to becoming Y2K compliant. It is still possible that the vendors
and providers may not be Y2K compliant and the Plan that HMN has developed
would not have anticipated the problem. An example of this situation
would be if all the telephone communication lines became inoperative
because of a Y2K issue on December 31, 1999, the Bank would not be able to
process its daily activity and servicing its customers would be difficult
without the communication lines for any extended period of time. It would
be difficult to have a contingency plan that would allow the Bank to
conduct its business without using the communication lines to transmit its
business activity.
28
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.
ITEM 6. Exhibits and Reports on Form 8-K.
(a) Exhibits. See Index to Exhibits on page 31 of this report.
29
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: 11 /15/99 /s/ Roger P. Weise
-------------------------
Roger P. Weise,
Chairman, President and
Chief Executive Officer
(Duly Authorized Officer)
Date: 11 /15/99 /s/ James B. Gardner
-------------------------
James B. Gardner,
Executive Vice President
(Principal Financial Officer)
30
HMN FINANCIAL, INC.
INDEX TO EXHIBITS
FOR FORM 10-Q
Reference Sequential
to Prior Page Numbering
Filing or Where Attached
Exhibit Exhibits Are
Number Located in
Regulation S-K Attached This Form 10-Q
Exhibit Number Document Hereto Report
- -------------- ------------------------------- --------- ---------------
3.1 Amended and Restated Articles of
Incorporation *1 N/A
3.2 Amended and Restated By-laws *2 N/A
4 Form of Common Stock Certificate *3 N/A
10.1 Extension of Employment Agreement *4 N/A
for Roger P. Weise dated May 25, 1999
10.2 Extension of Employment Agreement *4 N/A
for James B. Gardner dated May 25, 1999
11 Computation of Earnings Per Filed
Common Share 11 electronically
Filed
27 Financial Data Schedule 27 electronically
*1 Incorporated by reference to the same numbered exhibit 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 the same numbered exhibit to the
Company's Quarterly Report on Form 10-Q for the period ended
September 30, 1997 (File No. 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).
*4 Incorporated by reference to the same numbered exhibit to the
Company's Registration Statement on Form 10-Q for the period ended
June 30, 1999 (File No. 0-24100).
31