UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2005
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) FOR THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _________ to _________
Commission File Number 0-24100
HMN FINANCIAL, INC.
(Exact name of Registrant as specified in its Charter)
Delaware 41-1777397
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
1016 Civic Center Drive N.W., Rochester, MN 55901
(Address of principal executive offices) (ZIP Code)
Registrant's telephone number, including area code: (507) 535-1200
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 by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's common stock
as of the latest practicable date.
Class Outstanding at April 22, 2005
----- -----------------------------
Common stock, $0.01 par value 4,407,494
1
HMN FINANCIAL, INC.
CONTENTS
Page
-----
PART I - FINANCIAL INFORMATION
Item 1: Financial Statements (unaudited)
Consolidated Balance Sheets at March 31, 2005 and
December 31, 2004 3
Consolidated Statements of Income for the Three Months Ended
March 31, 2005 and 2004 4
Consolidated Statement of Stockholders' Equity for the Three
Month Period Ended March 31, 2005 5
Consolidated Statements of Cash Flows for the Three Months Ended
March 31, 2005 and 2004 6
Notes to Consolidated Financial Statements 7-13
Item 2: Management's Discussion and Analysis of Financial Condition and
Results of Operations 14-21
Item 3: Quantitative and Qualitative Disclosures about Market Risk
Discussion included in Item 2 under Market Risk 19
Item 4: Controls and Procedures 21
PART II - OTHER INFORMATION
Item 1: Legal Proceedings 22
Item 2: Unregistered Sales of Equity Securities and Use of Proceeds 22
Item 3: Defaults Upon Senior Securities 22
Item 4: Submission of Matters to a Vote of Security Holders 22
Item 5: Other Information 22
Item 6: Exhibits and Reports on Form 8-K 22
Signatures 23
2
PART I - FINANCIAL INFORMATION
ITEM 1 : FINANCIAL STATEMENTS
HMN FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
March 31, December 31,
2005 2004
------------ ------------
(unaudited)
ASSETS
Cash and cash equivalents ...................................... $ 39,340,351 34,298,394
Securities available for sale, at fair value:
Mortgage-backed and related securities
(amortized cost $9,058,730 and $9,509,377) ............... 8,470,270 9,150,871
Other marketable securities
(amortized cost $92,084,357 and $95,097,051) ............. 90,979,999 94,521,512
------------ -----------
99,450,269 103,672,383
------------ -----------
Loans held for sale ............................................ 1,510,373 2,711,760
Loans receivable, net .......................................... 813,244,220 783,213,262
Accrued interest receivable .................................... 4,482,087 3,694,133
Real estate, net ............................................... 1,058,859 140,608
Federal Home Loan Bank stock, at cost .......................... 8,697,600 9,292,800
Mortgage servicing rights, net ................................. 3,137,081 3,231,242
Premises and equipment, net .................................... 12,486,865 12,464,265
Investment in limited partnerships ............................. 160,548 168,258
Goodwill ....................................................... 3,800,938 3,800,938
Core deposit intangible, net ................................... 305,153 333,617
Prepaid expenses and other assets .............................. 2,371,321 2,638,681
Deferred tax asset ............................................. 1,280,600 1,012,700
------------ -----------
Total assets ................................................ $991,326,265 960,673,041
============ ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits ....................................................... $727,814,985 698,902,185
Federal Home Loan Bank advances ................................ 170,900,000 170,900,000
Accrued interest payable ....................................... 1,943,401 1,314,356
Customer escrows ............................................... 980,756 762,737
Accrued expenses and other liabilities ......................... 5,198,659 5,022,927
------------ -----------
Total liabilities ........................................... 906,837,801 876,902,205
------------ -----------
Commitments and contingencies
Stockholders' equity:
Serial preferred stock ($.01 par value):
Authorized 500,000 shares; issued and outstanding none ... 0 0
Common stock ($.01 par value):
Authorized 11,000,000; issued shares 9,128,662 ........... 91,287 91,287
Additional paid-in capital ..................................... 57,779,389 57,875,595
Retained earnings, subject to certain restrictions ............. 93,380,666 91,408,028
Accumulated other comprehensive loss ........................... (1,095,317) (604,446)
Unearned employee stock ownership plan shares .................. (4,495,943) (4,544,300)
Unearned compensation restricted stock awards .................. (302,408) 0
Treasury stock, at cost 4,721,168 and 4,708,798 shares ......... (60,869,210) (60,455,328)
------------ -----------
Total stockholders' equity .................................. 84,488,464 83,770,836
------------ -----------
Total liabilities and stockholders' equity ..................... $991,326,265 960,673,041
============ ===========
See accompanying notes to consolidated financial statements.
3
HMN FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
Three Months Ended
March 31,
------------------------
2005 2004
----------- ----------
Interest income:
Loans receivable .............................................. $13,333,019 11,491,264
Securities available for sale:
Mortgage-backed and related ................................ 89,768 118,864
Other marketable ........................................... 641,756 683,407
Cash equivalents .............................................. 52,269 26,298
Other ......................................................... 79,528 36,422
----------- ----------
Total interest income ...................................... 14,196,340 12,356,255
----------- ----------
Interest expense:
Deposits ...................................................... 3,702,631 2,930,034
Federal Home Loan Bank advances ............................... 1,822,691 2,188,955
----------- ----------
Total interest expense ..................................... 5,525,322 5,118,989
----------- ----------
Net interest income ........................................ 8,671,018 7,237,266
Provision for loan losses ........................................ 636,000 819,000
----------- ----------
Net interest income after provision for loan losses ........ 8,035,018 6,418,266
----------- ----------
Non-interest income:
Fees and service charges ...................................... 602,597 568,550
Mortgage servicing fees ....................................... 292,980 287,232
Gain on sales of loans ........................................ 293,316 412,369
Earnings (losses) in limited partnerships ..................... (7,710) (6,617)
Other ......................................................... 245,548 274,749
----------- ----------
Total non-interest income .................................. 1,426,731 1,536,283
----------- ----------
Non-interest expense:
Compensation and benefits ..................................... 2,774,104 2,528,478
Occupancy ..................................................... 995,254 884,602
Deposit insurance premiums .................................... 27,906 18,705
Advertising ................................................... 83,908 87,546
Data processing ............................................... 237,488 190,565
Amortization of mortgage servicing rights, net of valuation
adjustments ................................................ 239,033 253,449
Other ......................................................... 932,692 962,574
----------- ----------
Total non-interest expense ................................. 5,290,385 4,925,919
----------- ----------
Income before income tax expense ........................... 4,171,364 3,028,630
Income tax expense ............................................... 1,356,300 910,500
----------- ----------
Income before minority interest ............................ 2,815,064 2,118,130
Minority interest ................................................ 0 (2,331)
----------- ----------
Net income ................................................. $ 2,815,064 2,120,461
=========== ==========
Basic earnings per share ......................................... $ 0.74 0.54
=========== ==========
Diluted earnings per share ....................................... $ 0.70 0.52
=========== ==========
See accompanying notes to consolidated financial statements.
4
HMN FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE THREE MONTH PERIOD ENDED MARCH 31, 2005
(unaudited)
Accumulated
Additional Other
Common Paid-in Retained Comprehensive
Stock Capital Earnings Income (Loss)
------- ---------- ---------- -------------
Balance, December 31, 2004 $91,287 57,875,595 91,408,028 (604,446)
Net income 2,815,064
Other comprehensive income, net of tax:
Net unrealized losses on securities (490,871)
available for sale
Total comprehensive income
Purchase of treasury stock
Employee stock options exercised (228,013)
Tax benefits of exercised stock options 22,240
Unearned compensation restricted stock awards 15,616
Restricted stock awards cancelled (286)
Amortization of restricted stock awards
Dividends paid (842,426)
Earned employee stock ownership plan shares 94,237
------- ---------- ---------- ----------
Balance, March 31, 2005 $91,287 57,779,389 93,380,666 (1,095,317)
======= ========== ========== ==========
Unearned
Employee Unearned
Stock Compensation Total
Ownership Restricted Stock-
Plan Stock Treasury Holders'
Shares Awards Stock Equity
---------- ------------ ----------- ----------
Balance, December 31, 2004 (4,544,300) 0 (60,455,328) 83,770,836
Net income 2,815,064
Other comprehensive income, net of tax:
Net unrealized losses on securities (490,871)
available for sale ----------
Total comprehensive income 2,324,193
Purchase of treasury stock (972,000) (972,000)
Employee stock options exercised 252,900 24,887
Tax benefits of exercised stock options 22,240
Unearned compensation restricted stock awards (326,528) 310,912 0
Restricted stock awards cancelled 5,980 (5,694) 0
Amortization of restricted stock awards 18,140 18,140
Dividends paid (842,426)
Earned employee stock ownership plan shares 48,357 142,594
---------- -------- ----------- ----------
Balance, March 31, 2005 (4,495,943) (302,408) (60,869,210) 84,488,464
========== ======== =========== ==========
See accompanying notes to consolidated financial statements.
5
HMN FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
Three Months Ended
March 31,
--------------------------
2005 2004
------------ -----------
Cash flows from operating activities:
Net income ............................................. $ 2,815,064 2,120,461
Adjustments to reconcile net income to cash
provided by operating activities:
Provision for loan losses ........................... 636,000 819,000
Depreciation ........................................ 431,856 380,097
Amortization of discounts, net ...................... (143,378) (39,059)
Amortization of deferred loan fees .................. (208,343) (220,725)
Amortization of core deposit intangible ............. 28,464 28,464
Amortization of mortgage servicing rights ........... 239,033 253,449
Capitalized mortgage servicing rights ............... (144,872) (216,835)
Loss on sales of real estate ........................ (5,640) 0
Gain on sales of loans .............................. (293,316) (412,369)
Proceeds from sale of real estate ................... 39,141 0
Proceeds from sale of loans held for sale ........... 14,093,471 25,171,959
Disbursements on loans held for sale ................ (12,599,099) (23,108,118)
Amortization of restricted stock awards ............. 18,140 0
Amortization of unearned ESOP shares ................ 48,357 48,456
Earned employee stock ownership shares priced
above original cost .............................. 94,237 70,706
Increase in accrued interest receivable ............. (787,954) (354,723)
Increase in accrued interest payable ................ 629,045 128,704
Equity losses of limited partnerships ............... 7,710 6,617
Equity losses of minority interest .................. 0 (2,331)
Decrease in other assets ............................ 309,168 853,479
Increase (decrease) in other liabilities ............ 156,495 (1,797,891)
Other, net .......................................... 486 (140,775)
------------ -----------
Net cash provided by operating activities ........ 5,364,065 3,588,566
------------ -----------
Cash flows from investing activities:
Principal collected on securities available for sale ... 475,599 1,426,429
Proceeds collected on maturities of securities
available for sale .................................. 8,000,000 0
Purchases of securities available for sale ............. (4,991,400) (5,023,437)
Redemption of interest in limited partnership .......... 0 422,474
Purchases of Federal Home Loan Bank Stock .............. (973,500) (456,700)
Redemption of Federal Home Loan Bank Stock ............. 1,568,700 523,000
Net increase in loans receivable ....................... (31,416,483) (28,946,445)
Purchases of premises and equipment .................... (454,456) (657,479)
------------ -----------
Net cash used in investing activities ............... (27,791,540) (32,712,158)
------------ -----------
Cash flows from financing activities:
Increase in deposits ................................... 29,040,952 60,036,525
Purchase of treasury stock ............................. (972,000) (770,000)
Stock options exercised ................................ 24,887 27,647
Dividends to stockholders .............................. (842,426) (787,140)
Proceeds from Federal Home Loan Bank advances .......... 39,000,000 0
Repayment of Federal Home Loan Bank advances ........... (39,000,000) (5,000,000)
Increase (decrease) in customer escrows ................ 218,019 (21,378,159)
------------ -----------
Net cash provided by financing activities ........... 27,469,432 32,128,873
------------ -----------
Increase in cash and cash equivalents ............... 5,041,957 3,005,281
Cash and cash equivalents, beginning of period ............ 34,298,394 30,496,823
------------ -----------
Cash and cash equivalents, end of period .................. $ 39,340,351 33,502,104
============ ===========
Supplemental cash flow disclosures:
Cash paid for interest ................................. $ 4,896,277 4,990,285
Cash paid for income taxes ............................. 237,000 2,532,500
Supplemental noncash flow disclosures:
Transfer of loans to real estate ....................... 952,252 260,825
See accompanying notes to consolidated financial statements.
6
HMN FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
MARCH 31, 2005 AND 2004
(1) HMN FINANCIAL, INC.
HMN Financial, Inc. (HMN or the Company) is a stock savings bank holding company
that owns 100 percent of Home Federal Savings Bank (the Bank). The Bank has a
community banking philosophy and operates retail banking and loan production
facilities in Minnesota and Iowa. The Bank also provides highly personalized
financial services to a select group of individuals and businesses through Eagle
Crest Capital Bank, a division of the Bank, in Edina and Rochester, Minnesota.
The Bank has two wholly owned subsidiaries, Osterud Insurance Agency, Inc. (OAI)
which offers financial planning products and services and Home Federal Holding,
Inc. (HFH) which is the holding company for Home Federal REIT, Inc. (HFREIT)
which invests in real estate loans acquired from the Bank. HMN has another
wholly owned subsidiary, Security Finance Corporation (SFC) which acts as an
intermediary for the Bank in transacting like-kind property exchanges for Bank
customers. The Bank had an 80% owned subsidiary, Federal Title Services, LLC
(FTS), which performed mortgage title services for Bank customers. FTS stopped
accepting title orders in the third quarter of 2004 and was dissolved.
The consolidated financial statements included herein are for HMN, SFC, the Bank
and the Bank's consolidated entities as described above. 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 statement of
stockholders' equity and consolidated statements of cash flows in conformity
with generally accepted accounting principles. However, all normal recurring
adjustments which are, in the opinion of management, necessary for the fair
presentation of the interim financial statements have been included. The
statement of income for the three-month period ended March 31, 2005 is not
necessarily indicative of the results which may be expected for the entire year.
Certain amounts in the consolidated financial statements for prior periods have
been reclassified to conform with the current period presentation.
(3) NEW ACCOUNTING STANDARDS
In December 2004, the Financial Accounting Standards Board (FASB) issued a
revised SFAS No. 123, Share-Based Payment. This Statement is a revision of FASB
Statement No. 123, Accounting for Stock Based Compensation and requires that the
cost resulting from all share-based payment transactions be recognized in the
financial statements. It requires a public entity to measure the cost of
employee services received in exchange for an award of equity instruments based
on the grant-date fair value of the award. That cost will be recognized over the
period during which an employee is required to provide service in exchange for
the award. The Statement also requires that the notes to financial statements
disclose information to assist users of financial information to understand the
nature of share-based payment transactions and the effects of those transactions
on the financial statements. In April 2005, the effective date of this statement
was deferred until the beginning of the first annual period beginning after June
15, 2005. The Company does not expect the impact of adopting the revised SFAS
No. 123 in January of 2006 to be material on the Company's financial condition
and results of operations.
(4) DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
The Company has commitments outstanding to extend credit to future borrowers or
to purchase loans that had not closed prior to the end of the quarter which it
intends to sell. These commitments are referred to as its mortgage pipeline. As
commitments to originate or purchase loans enter the mortgage pipeline, the
Company generally enters into commitments to sell the mortgage pipeline into the
secondary market. The commitments to originate, purchase
7
or sell loans are derivatives. As a result of marking to market the mortgage
pipeline and the related commitments to sell for the period ended March 31,
2005, the Company recorded an increase in other assets of $41,477 and an
increase in other liabilities of $41,477.
The current commitments to sell loans held for sale are derivatives that do not
qualify for hedge accounting. As a result, these derivatives are marked to
market. The loans held for sale that are not hedged are recorded at the lower of
cost or market. The Company recorded a lower of cost or market adjustment of
$331 and an increase in other assets of $331 due to the mark to market
adjustment on the commitments to sell loans held for sale.
(5) 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 the Company is
comprised of unrealized gains and losses on securities available for sale. The
components of other comprehensive income and the related tax effects were as
follows:
For the period ended March 31,
---------------------------------------------------------------------------
(Dollars in thousands) 2005 2004
- ---------------------- ------------------------------------ ------------------------------------
Securities available for sale: Before tax Tax effect Net of tax Before tax Tax effect Net of tax
---------- ---------- ---------- ---------- ---------- ----------
Net unrealized gains (losses)
arising during the period $(759) (268) (491) 753 266 487
----- ---- ---- --- --- ---
Other comprehensive income $(759) (268) (491) 753 266 487
===== ==== ==== === === ===
(6) INVESTMENTS IN LIMITED PARTNERSHIPS
During the first quarter of 2005 the Company recognized $7,710 of losses on low
income housing partnerships. During 2005 the Company anticipates receiving low
income housing credits totaling $42,000 of which $10,500 were credited to
current income tax benefits.
During the first quarter of 2004, the Company recognized $7,420 of losses on low
income housing partnerships. During 2004, the Company received low-income
housing credits totaling $84,000, of which $21,000 were credited to current
income tax benefits in the first quarter.
(7) SECURITIES AVAILABLE FOR SALE
The following table shows the securities available for sale portfolio's gross
unrealized losses and fair value, aggregated by investment category and length
of time that individual securities have been in a continuous loss position, at
March 31, 2005. The Company has reviewed these securities and has concluded that
the unrealized losses are temporary and no other-than-temporary impairment has
occurred at March 31, 2005.
Less than twelve months Twelve months or more Total
----------------------- --------------------- --------------------
# of Fair Unrealized # of Fair Unrealized Fair Unrealized
(Dollars in thousands) Investments Value Losses Investments Value Losses Value Losses
- ---------------------- ----------- ------- ---------- ----------- ------ ---------- ------- ----------
Mortgage backed securities:
FHLMC 1 $ 26 0 1 $3,219 (291) $ 3,245 (291)
FNMA 2 931 (35) 1 3,857 (280) 4,788 (315)
Other marketable securities:
FNMA Debt 3 14,767 (190) 0 0 0 14,767 (190)
FHLMC Debt 2 9,840 (117) 0 0 0 9,840 (117)
FHLB Debt 12 62,555 (916) 0 0 0 62,555 (916)
--- ------- ------ --- ------ ---- ------- ------
Total temporarily impaired 20 $88,119 (1,258) 2 $7,076 (571) $95,195 (1,829)
securities === ======= ====== === ====== ==== ======= ======
8
(8) INVESTMENT IN MORTGAGE SERVICING RIGHTS
A summary of mortgage servicing activity is as follows:
Three months ended Twelve months ended Three months ended
March 31, 2005 December 31, 2004 March 31, 2004
------------------ ------------------- ------------------
Mortgage servicing rights
Balance, beginning of period .............. $3,231,242 3,447,843 3,447,843
Originations .............................. 144,872 844,806 216,835
Amortization .............................. (239,033) (1,061,407) (253,449)
---------- ---------- ---------
Balance, end of period .................... 3,137,081 3,231,242 3,411,229
---------- ---------- ---------
Valuation reserve ......................... 0 0 0
---------- ---------- ---------
Mortgage servicing rights, net ............ $3,137,081 3,231,242 3,411,229
========== ========== =========
Fair value of mortgage servicing rights ... $4,644,284 4,494,724 3,870,052
========== ========== =========
All of the loans being serviced were single family loans serviced for the
Federal National Mortgage Association (FNMA) under the mortgage-backed security
program or the individual loan sale program. The following is a summary of the
risk characteristics of the loans being serviced at March 31, 2005.
Weighted
Loan Principal Weighted Average Average Number of
Balance Interest Rate Remaining Term Loans
-------------- ---------------- -------------- ---------
Original term 30 year fixed rate $216,820,447 5.91% 339 1,905
Original term 15 year fixed rate 230,245,694 5.28% 158 2,825
Adjustable rate 8,322,874 4.98% 334 75
(9) INTANGIBLE ASSETS
The gross carrying amount of intangible assets and the associated accumulated
amortization at March 31, 2005 is presented in the table below. Amortization
expense for intangible assets was $267,497 for the period ended March 31, 2005.
Gross Unamortized
Carrying Accumulated Valuation Intangible
Amount Amortization Adjustment Assets
---------- ------------ ---------- -----------
Amortized intangible assets:
Mortgage servicing rights $4,591,213 (1,454,132) 0 3,137,081
Core deposit intangible 1,567,000 (1,261,847) 0 305,153
---------- ---------- --- ---------
Total $6,158,213 (2,715,979) 0 3,442,234
========== ========== === =========
The following table indicates the estimated future amortization expense for
amortized intangible assets:
Mortgage Core
Servicing Deposit
Rights Intangible Total
--------- ---------- -------
Year ended December 31,
2005 357,579 85,393 442,972
2006 469,636 113,857 583,493
2007 427,373 105,903 533,276
2008 332,291 0 332,291
2009 240,654 0 240,654
9
Projections of amortization are based on existing asset balances and the
existing interest rate environment as of March 31, 2005. The Company's actual
experience may be significantly different depending upon changes in mortgage
interest rates and other market conditions.
(10) EARNINGS PER SHARE
The following table reconciles the weighted average shares outstanding and the
income available to common shareholders used for basic and diluted EPS:
Three months ended March 31,
----------------------------
2005 2004
---------- ---------
Weighted average number of common shares outstanding
used in basic earnings per common share calculation 3,824,857 3,915,044
Net dilutive effect of:
Options 173,788 162,559
Restricted stock awards 7,014 0
---------- ---------
Weighted average number of shares outstanding
adjusted for effect of dilutive securities 4,005,659 4,077,603
========== =========
Income available to common shareholders $2,815,064 2,120,460
Basic earnings per common share $ 0.74 0.54
Diluted earnings per common share $ 0.70 0.52
(11) 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 the
Company's financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Bank must meet specific
capital guidelines that involve quantitative measures of the Bank's assets,
liabilities, and certain off-balance sheet items as calculated under regulatory
accounting practices. The Bank's capital amounts and classification are also
subject to qualitative judgments by the regulators about components, risk
weightings, and other factors. Quantitative measures established by regulations
to ensure capital adequacy require the Bank to maintain minimum amounts and
ratios (set forth in the following table) of Tier I or Core capital, and
Risk-based capital (as defined in the regulations) to total assets (as defined).
Management believes, as of March 31, 2005, that the Bank meets all capital
adequacy requirements to which it is subject.
Management believes that based upon the Bank's capital calculations at March 31,
2005 and other conditions consistent with the Prompt Corrective Actions
Provisions of the OTS regulations, the Bank would be categorized as well
capitalized.
On March 31, 2005 the Bank's tangible assets and adjusted total assets were
$985.3 million and its risk-weighted assets were $808.8 million. The following
table presents the Bank's capital amounts and ratios at March 31, 2005 for
actual capital, required capital and excess capital including ratios in order to
qualify as being well capitalized under the Prompt Corrective Actions
regulations.
10
To Be Well
Required to be Capitalized Under
Adequately Prompt Corrective
Actual Capitalized Excess Capital Actions Provisions
------------------- ------------------ ------------------ -------------------
Percent of Percent of Percent of Percent of
(dollars in thousands) Amount Assets(1) Amount Assets (1) Amount Assets(1) Amount Assets (1)
- ---------------------- ------- ---------- ------ ---------- ------ ---------- ------ ----------
Bank stockholder's equity .................... $80,508
Less:
Net unrealized losses on certain
securities available for sale........... 1,172
Goodwill and core deposit intangible....... (4,106)
Excess mortgage servicing rights........... (480)
-------
Tier I or core capital 77,094
-------
Tier I capital to adjusted total assets ... 7.82% 39,413 4.00% 37,681 3.82% 49,267 5.00%
Tier I capital to risk-weighted assets .... 9.53% 32,350 4.00% 44,744 5.53% 48,525 6.00%
Plus:
Allowable allowance for loan losses ....... 8,606
-------
Risk-based capital ........................... $85,700 64,700 21,000 80,876
=======
Risk-based capital to risk-weighted assets ... 10.60% 8.00% 2.60% 10.00%
(1) Based upon the Bank's adjusted total assets for the tangible and core
capital ratios and risk-weighted assets for the risk-based capital ratio.
The tangible capital of the Bank was in excess of the minimum 2% required at
March 31, 2005 but is not reflected in the table above.
(12) COMMITMENTS AND CONTINGENCIES
The Bank issued standby letters of credit which guarantee the performance of
customers to third parties. The standby letters of credit outstanding at March
31, 2005 were approximately $5.4 million, expire over the next two years, and
are collateralized primarily with commercial real estate mortgages. Since the
conditions under which the Bank is required to fund the standby letters of
credit may not materialize, the cash requirements are expected to be less than
the total outstanding commitments.
(13) STOCK-BASED COMPENSATION
The Company accounts for stock based compensation in accordance with Accounting
Principles Board (APB) Opinion No. 25 and related interpretations which measure
compensation cost using the intrinsic value method. Had compensation cost for
the Company's stock-based plan been determined in accordance with the fair value
method recommended by SFAS No. 123, the Company's net income and earnings per
share would have been adjusted to the pro forma amounts that follow:
11
Quarter Ended Quarter Ended
March 31, 2005 March 31, 2004
-------------- --------------
Net income:
As reported ................................................. $2,815,064 2,120,461
Deduct: Total stock-based employee compensation expense
determined under fair value method for all awards,
net of related tax effects ............................ 41,910 8,531
---------- ---------
Pro forma ................................................... $2,773,154 2,111,930
---------- ---------
Earnings per Common share:
As reported:
Basic .................................................... $ 0.74 0.54
Diluted .................................................. 0.70 0.52
Pro forma:
Basic .................................................... 0.73 0.54
Diluted .................................................. 0.70 0.52
(14) BUSINESS SEGMENTS
The Bank has been identified as a reportable operating segment in accordance
with the provisions of SFAS No. 131. SFC and HMN, the holding company, did not
meet the quantitative thresholds for determining reportable segments and
therefore are included in the "Other" category.
The Company evaluates performance and allocates resources based on the segments
net income or loss, return on average assets and return on average equity. Each
corporation is managed separately with its own officers and board of directors.
12
The following table sets forth certain information about the reconciliations of
reported profit or loss and assets for each of the Company's reportable
segments.
Home Federal Consolidated
(Dollars in thousands) Savings Bank Other Eliminations Total
- ---------------------- ------------ ------ ------------ ------------
AT OR FOR THE QUARTER ENDED MARCH 31, 2005:
Interest income - external customers .............. $ 14,186 10 0 14,196
Non-interest income - external customers .......... 1,434 0 0 1,434
Earnings (losses) on limited partnerships ......... (8) 0 0 (8)
Intersegment interest income ...................... 0 16 (16) 0
Intersegment non-interest income .................. 34 2,847 (2,881) 0
Interest expense .................................. 5,541 0 (16) 5,525
Amortization of mortgage servicing rights net of
valuation adjustments .......................... 239 0 0 239
Other non-interest expense ........................ 4,923 162 (34) 5,051
Income tax expense (benefit) ...................... 1,459 (103) 0 1,356
Net income ........................................ 2,848 2,814 (2,847) 2,815
Goodwill .......................................... 3,801 0 0 3,801
Total assets ...................................... 987,117 85,056 (80,847) 991,326
Net interest margin ............................... 3.78% NM NM 3.79%
Return on average assets (annualized) ............. 1.17% NM NM 1.18%
Return on average realized common equity
(annualized) ................................... 14.36% NM NM 13.22%
AT OR FOR THE QUARTER ENDED MARCH 31, 2004:
Interest income - external customers .............. $ 12,344 12 0 12,356
Non-interest income - external customers .......... 1,543 0 0 1,543
Earnings (losses) on limited partnerships ......... (8) 1 0 (7)
Intersegment interest income ...................... 0 8 (8) 0
Intersegment non-interest income .................. 69 2,152 (2,221) 0
Interest expense .................................. 5,127 0 (8) 5,119
Amortization of mortgage servicing rights net of
valuation adjustments .......................... 253 0 0 253
Other non-interest expense ........................ 4,588 154 (69) 4,673
Income tax expense (benefit) ...................... 1,010 (100) 0 910
Minority interest ................................. (2) 0 0 (2)
Net income ........................................ 2,153 2,119 (2,152) 2,120
Goodwill .......................................... 3,801 0 0 3,801
Total assets ...................................... 893,272 82,645 (76,192) 899,725
Net interest margin ............................... 3.46% NM NM 3.46%
Return on average assets (annualized) ............. 0.98% NM NM 0.96%
Return on average realized common equity
(annualized) ................................... 11.55% NM NM 10.21%
NM - Not meaningful
13
HMN FINANCIAL, INC.
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD-LOOKING INFORMATION
This quarterly report and other reports filed with the Securities and Exchange
Commission may contain "forward-looking" statements that deal with future
results, plans or performance. When used in this Form 10-Q, the words
"anticipates", "believes", "estimates", "expects", "intends" and similar
expressions, as they relate to the Company and its management, are intended to
identify such forward-looking statements. In addition, the Company's management
may make such statements orally to the media, or to securities analysts,
investors or others. Forward looking statements deal with matters that do not
relate strictly to historical facts. The Company's future results may differ
materially from historical performance and forward-looking statements about the
Company's expected financial results or other plans are subject to a number of
risks and uncertainties. These include but are not limited to possible
legislative changes and adverse economic, business and competitive developments
such as shrinking interest margins; deposit outflows; reduced demand for
financial services and loan products; changes in accounting policies and
guidelines, or monetary and fiscal policies of the federal government or tax
laws; changes in credit and other risks posed by the Company's loan and
investment portfolios; technological, computer-related or operational
difficulties; adverse changes in securities markets; results of litigation or
other significant uncertainties. For additional discussion of the risks and
uncertainties applicable to the Company, see the "Risk Factors" section of the
Company's Annual Report on Form 10-K for the year ended December 31, 2004.
GENERAL
The earnings of the Company are primarily dependant on the Bank's net interest
income, which is the difference between interest earned on its loans and
investments, and the interest paid on interest-bearing liabilities such as
deposits and Federal Home Loan Bank (FHLB) advances. The difference between the
average rate of interest earned on assets and the average rate paid on
liabilities is the "interest rate spread". Net interest income is produced when
interest-earning assets equal or exceed interest-bearing liabilities and there
is a positive interest rate spread. The Company's interest rate spread has been
enhanced by the increased level of commercial loans placed in portfolio and the
increased amount of lower rate deposits. Net interest income and net interest
rate spread 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. The Company's net income is also affected by the
generation of non-interest income, which consists primarily of gains or losses
from the sale of securities, gains from the sale of loans, and the generation of
fees and service charges on deposit accounts. The Bank incurs expenses in
addition to interest expense in the form of salaries and benefits, occupancy
expenses, provisions for loan losses and amortization and valuation adjustments
on mortgage servicing assets.
The earnings of financial institutions, such as the Bank, are significantly
affected by prevailing economic and competitive conditions, particularly changes
in interest rates, government monetary and fiscal policies, and regulations of
various regulatory authorities. Lending activities are influenced by the demand
for and supply of single family and commercial properties, competition among
lenders, the level of interest rates and the availability of funds. Mortgage
loan activity was down in the first quarter of 2005 when compared to the same
period of 2004 due to increases in mortgage interest rates, and we expect this
trend to continue. Deposit flows and costs of deposits are influenced by
prevailing market rates of interest on competing investments, account maturities
and the levels of personal income and savings. The interest rates charged by the
FHLB on advances to the Bank also have a significant impact on the Bank's
overall cost of funds.
CRITICAL ACCOUNTING POLICIES
Critical accounting policies are those policies that the Company's management
believes are the most important to understanding the Company's financial
condition and operating results. The Company has identified the following
policies as being critical because they require difficult, subjective, and/or
complex judgments that are inherently uncertain. Therefore, actual financial
results could differ significantly depending upon the estimates used.
14
Allowance for Loan Losses and Related Provision
The allowance for loan losses is based on periodic analysis of the loan
portfolio. In this analysis, management considers factors including, but not
limited to, specific occurrences of loan impairment, changes in the size of the
portfolios, national and regional economic conditions such as unemployment data,
loan portfolio composition, loan delinquencies, local construction permits,
development plans, local economic growth rates, historical experience and
observations made by the Company's ongoing internal audit and regulatory exam
processes. The allowance for loan losses is established for known problem loans,
as well as for loans which are not currently known to require specific
allowances. Loans are charged off to the extent they are deemed to be
uncollectible. The Company has established separate processes to determine the
adequacy of the loan loss allowance for its homogeneous and non-homogeneous loan
portfolios. The determination of the allowance for the non-homogeneous
commercial, commercial real estate, and multi-family loan portfolios involves
assigning standardized risk ratings and loss factors that are periodically
reviewed. The loss factors are estimated using a combination of the Company's
own loss experience and external industry data and are assigned to all loans
without identified credit weaknesses. The Company also performs an individual
analysis of impairment on each non-performing loan that is based on the expected
cash flows or the value of the assets collateralizing the loans. The
determination of the allowance on the homogeneous single-family and consumer
loan portfolios is calculated on a pooled basis with individual determination of
the allowance of all non-performing loans.
The adequacy of the allowance for loan losses is dependent upon management's
estimates of variables affecting valuation, appraisals of collateral,
evaluations of performance and status, and the amounts and timing of future cash
flows expected to be received on impaired loans. Such estimates, appraisals,
evaluations and cash flows may be subject to frequent adjustments due to
changing economic prospects of borrowers or properties. The estimates are
reviewed quarterly and adjustments, if any, are recorded in the provision for
loan losses in the periods in which the adjustments become known. The allowance
is allocated to individual loan categories based upon the relative risk
characteristics of the loan portfolios and the actual loss experience. The
Company increases its allowance for loan losses by charging the provision for
loan losses against income. The methodology for establishing the allowance for
loan losses takes into consideration probable losses that have been identified
in connection with specific loans as well as losses in the loan portfolio for
which specific reserves are not required. Although management believes that the
allowance for loan losses is maintained at an adequate amount to provide for
probable loan losses inherent in the portfolio as of the balance sheet dates,
future adjustments to the provision for loan losses may be necessary if
conditions differ substantially from those in the assumptions used to determine
the allowance for loan losses.
Mortgage Servicing Rights
The Company recognizes as an asset the rights to service mortgage loans for
others, which are referred to as mortgage servicing rights (MSRs). MSRs are
capitalized at the relative fair value of the servicing rights on the date the
mortgage loan is sold and are carried at the lower of the capitalized amount,
net of accumulated amortization, or fair value. MSRs are capitalized and
amortized in proportion to, and over the period of, estimated net servicing
income. Each quarter the Company evaluates its MSRs for impairment in accordance
with Statement of Financial Accounting Standard (SFAS) No. 140. Loan type and
interest rate are the predominant risk characteristics of the underlying loans
used to stratify the MSRs for purposes of measuring impairment. If temporary
impairment exists, a valuation allowance is established for any excess of
amortized cost over the current fair value through a charge to income. If the
Company later determines that all or a portion of the temporary impairment no
longer exists, a reduction of the valuation allowance is recorded as an increase
to income. The valuation of the MSRs is based on various assumptions including
the estimated prepayment speeds and default rates of the stratified portfolio.
Changes in the mix of loans, interest rates, prepayment speeds, or default rates
from the estimates used in the valuation of the mortgage servicing rights may
have a material effect on the amortization and valuation of MSRs. Although
management believes that the assumptions used and the values determined are
reasonable, future adjustments may be necessary if economic conditions differ
substantially from the economic conditions in the assumptions used to determine
the value of the MSRs. The Company does not formally hedge its MSRs because they
are hedged naturally by the Company's mortgage origination volume. Generally, as
interest rates rise, the origination volume declines and the value of MSRs
increases and as interest rates decline, the origination volume increases and
the value of MSRs decreases.
15
Income Taxes
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to temporary differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax basis. Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled. The effect
on deferred tax assets and liabilities of a change in tax rates is recognized in
income in the period that includes the enactment date. These calculations are
based on many complex factors including estimates of the timing of reversals of
temporary differences, the interpretation of federal and state income tax laws,
and a determination of the differences between the tax and the financial
reporting basis of assets and liabilities. Actual results could differ
significantly from the estimates and interpretations used in determining the
current and deferred income tax liabilities.
NET INCOME
The Company's net income for the first quarter of 2005 was $2.8 million, up
$695,000, or 32.8%, from net income of $2.1 million for the first quarter of
2004. Basic earnings per share for the first quarter of 2005 were $0.74, an
increase of $0.20, from $0.54 basic earnings per share for the same quarter of
2004. Diluted earnings per common share for the first quarter of 2005 were
$0.70, up $0.18, from $0.52 for the first quarter of 2004.
NET INTEREST INCOME
Net interest income was $8.7 million for the first quarter of 2005, an increase
of $1.4 million, or 19.8%, compared to $7.2 million for the first quarter of
2004. Interest income was $14.2 million for the first quarter of 2005, an
increase of $1.8 million, or 14.9%, from $12.4 million for the first quarter of
2004. Interest income increased primarily because of an increase in the average
interest-earning assets and because of a change in the mix of assets between the
periods. The increase in interest-earning assets was caused primarily by the
$109 million increase in the commercial loans between the periods. The increase
in interest income on commercial loans was partially offset by lower interest
income on the single-family loan and investment portfolios due to a decrease in
the outstanding balances and lower interest rates of these portfolios in the
first quarter of 2005 when compared to the same period in 2004. The yield earned
on interest-earning assets was 6.21% for the first quarter of 2005, an increase
of 30 basis points from the 5.91% yield for the first quarter of 2004.
Interest expense was $5.5 million for the first quarter of 2005, an increase of
$406,000, or 7.9%, compared to $5.1 million for the first quarter of 2004.
Interest expense increased because of the $116 million in deposit growth that
was experienced between the periods. The increase in interest expense caused by
the additional deposits was partially offset by a decrease in the average
interest rate paid on deposits. The decrease in the average interest rate
between the periods was primarily the result of lower interest rates paid on
certificates of deposit and FHLB advances. The average interest rate paid on
interest-bearing liabilities was 2.56% for the first quarter of 2005, a decrease
of 2 basis points from the 2.58% paid for the first quarter of 2004.
Net interest margin (net interest income divided by average interest earning
assets) for the first quarter of 2005 was 3.79%, an increase of 33 basis points,
compared to 3.46% for the first quarter of 2004.
PROVISION FOR LOAN LOSSES
The provision for loan losses is recorded to bring the allowance for loan losses
to a level deemed appropriate by management based on factors disclosed in the
critical accounting policy previously discussed. The provision for loan losses
was $636,000 for the first quarter of 2005, a decrease of $183,000, compared to
$819,000 for the first quarter of 2004. The provision for loan losses for the
first quarter of 2005 decreased despite the $14 million of additional loan
growth experienced in the quarter when compared to the same period in 2004. The
increase in the provision related to the additional loan growth was entirely
offset by a decrease in the provision due to fewer commercial loan risk rating
downgrades in the first quarter of 2005 when compared to the same period of
2004.
16
A reconciliation of the Company's allowance for loan losses is summarized as
follows:
2005 2004
---------- ---------
Balance at January 1, $8,995,892 6,939,602
Provision 636,000 819,000
Charge offs (271,737) (206,078)
Recoveries 33,420 4,381
---------- ---------
Balance at March 31, $9,393,575 7,556,905
========== =========
NON-INTEREST INCOME
Non-interest income was $1.4 million for the first quarter of 2005, a decrease
of $110,000, or 7.1%, from $1.5 million for the first quarter of 2004.
Non-interest income decreased $119,000 because of lower gains on sales of loans
due to the decreased mortgage loan activity in the first quarter of 2005 when
compared to the same period in 2004. Mortgage loan activity slowed in the first
quarter of 2005 due to the increase in mortgage interest rates from the first
quarter of 2004. Fees and service charges increased $34,000 between the periods
primarily due to increased business banking and debit card activity. Other
non-interest income decreased $29,000 primarily because of decreased revenues
from the sale of uninsured investment products.
NON-INTEREST EXPENSE
Non-interest expense was $5.3 million for the first quarter of 2005, an increase
of $364,000, or 7.4%, from $4.9 million for the first quarter of 2004.
Compensation expense increased $246,000 primarily because of increases in health
insurance costs and because of annual payroll cost increases. Occupancy expense
increased $111,000 due to the additional corporate office facilities occupied in
the first quarter of 2005 and because of an increase in amortization expense as
a result of various software upgrades between the periods. Data processing costs
increased $47,000 due to increases in the services provided by the Bank's third
party processor between the periods.
INCOME TAX EXPENSE
Income tax expense increased $446,000 between the periods due to increased
taxable income and an increased effective tax rate. The effective tax rate
increased from 30.0% in the first quarter of 2004 to 32.5% in the first quarter
of 2005 primarily because of changes in state tax allocations and a decrease in
tax exempt income as a percentage of income. The Company has a Real Estate
Investment Trust (REIT) and related company that acquire and hold mortgage
assets and other authorized investments to generate income. These entities are
consolidated with the Bank and are therefore included in the consolidated
financial statements of the Company. The REIT must meet specific provisions of
the Internal Revenue Code (IRC) to continue to qualify as a REIT. State laws may
also impose limitations or restrictions on the operations of the REIT and
related company. These laws are subject to change and are currently under review
in Minnesota. If these companies fail to meet any of the required provisions of
Federal and state tax laws or if the state tax laws change unfavorably, the
Company's tax expense would increase.
17
NON-PERFORMING ASSETS
The following table summarizes the amounts and categories of non-performing
assets in the Bank's portfolio at March 31, 2005 and December 31, 2004.
March 31, December 31,
(Dollars in Thousands) 2005 2004
- ---------------------- --------- ------------
Non-Accruing Loans:
One-to-four family real estate $ 686 $ 1,864
Commercial real estate 1,091 1,114
Consumer 313 472
Commercial business 261 261
------- -------
Total 2,351 3,711
------- -------
Accruing loans delinquent 90 days or more:
One-to-four family 1,154 628
Other assets 201 201
Foreclosed and Repossessed Assets:
One-to-four family real estate 1,059 141
Consumer 169 201
------- -------
Total non-performing assets $ 4,934 $ 4,882
======= =======
Total as a percentage of total assets 0.50% 0.51%
======= =======
Total non-performing loans $ 3,505 $ 4,339
======= =======
Total as a percentage of total loans receivable, net 0.43% 0.55%
======= =======
Allowance for loan loss to non-performing loans 267.99% 207.30%
======= ======
Total non-performing assets were $4.9 million at March 31, 2005, an increase of
$52,000, from $4.9 million at December 31, 2004. During the first quarter of
2005, the following activity occurred related to non-performing assets: $982,000
of previously performing loans were classified as non-performing, $1.2 million
in non-performing loans were foreclosed or repossessed, $268,000 in loans were
charged off as a loss, $91,000 in foreclosed assets were sold, and $645,000 in
loans were reclassified as performing.
DIVIDENDS
On April 26, 2005 the Company declared a cash dividend of $0.22 per share,
payable on June 8, 2005 to shareholders of record on May 20, 2005.
During the first quarter of 2005, the Company declared and paid dividends as
follows:
Record date Payable date Dividend per share Dividend Payout Ratio
----------- ------------- ------------------ ---------------------
February 18, 2005 March 7, 2005 $0.22 41.51%
The annualized dividend payout ratio for the past four quarters, ending with the
June 8, 2005 payment will be 35.34%.
The declaration of dividends are subject to, among other things, the Company'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 quarter ended March 31, 2005, the net cash provided by operating
activities was $5.4 million. The Company collected $8.5 million in principal
repayments and maturities on securities during the quarter. It purchased $5.0
million in securities and $454,000 in premises and equipment and paid out $31.4
million relating to an increase in net loans receivable. The Company had a net
increase in deposit balances of $29.0 million during the quarter, received
$25,000 related to the exercise of HMN stock options, paid $842,000 in dividends
to its shareholders and paid $972,000 to purchase treasury stock.
18
The Company has certificates of deposits with outstanding balances of $221.8
million that come due over the next 12 months. Based upon past experience
management anticipates that the majority of the deposits will renew for another
term. The Company believes that deposits which do not renew will be replaced
with deposits from other customers or brokers, or funded with advances from the
FHLB. Management does not anticipate that it will have a liquidity problem due
to maturing deposits.
The Company has $110.9 million of FHLB advances that mature beyond March 31,
2006 but have call features that can be exercised by the FHLB during the next 12
months. If the call features are exercised, the Company has the option of
requesting any advance otherwise available to it pursuant to the credit policy
of the FHLB. Since the Company has the ability to request another advance to
replace the advance that is being called, management does not anticipate that it
will have a liquidity problem due to advances being called by the FHLB during
the next 12 month period.
MARKET RISK
Market risk is the risk of loss from adverse changes in market prices and rates.
The Company'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.
The Company's profitability is affected by fluctuations in interest rates. A
sudden and substantial increase in interest rates may adversely impact the
Company'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. The Company monitors the projected changes in net interest income that
occur if interest rates were to suddenly change up or down. The Rate Shock Table
located in the Asset/Liability Management section of this report, which follows,
discloses the Company's projected changes in net interest income based upon
immediate interest rate changes called rate shocks.
The Company utilizes a model that 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. The Company believes that
over the next twelve months interest rates potentially could fluctuate in a
range of 200 basis points up or 100 basis points down from where the rates were
at March 31, 2005. The Company does not have a trading portfolio. The following
table discloses the projected changes in market value to the Company's
interest-earning assets and interest-bearing liabilities based upon incremental
100 basis point changes in interest rates from interest rates in effect on March
31, 2005.
Other than trading portfolio Market Value
(Dollars in thousands) ---------------------------------------
Basis point change in interest rates -100 0 +100 +200
- ------------------------------------ -------- ------- ------- -------
Total market risk sensitive assets ............ $987,022 980,588 969,972 957,603
Total market risk sensitive liabilities ....... 887,315 873,497 859,743 849,098
Off-balance sheet financial instruments ....... (190) 0 (50) (69)
-------- ------- ------- -------
Net market risk ............................... $ 99,897 107,091 110,279 108,574
======== ======= ======= =======
Percentage change from current market value ... (6.72)% 0.00% 2.98% 1.38%
======== ======= ======= =======
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 5% to 76%, depending on the note rate and the period to maturity.
Adjustable rate mortgages (ARMs) were assumed to prepay at annual rates of
between 10% and 33%, depending on the note rate and the period to maturity.
Growing Equity Mortgage (GEM) loans were assumed to prepay at annual rates of
between 5% and 52% depending on the note rate and the period to maturity.
Mortgage-backed securities and Collateralized Mortgage
19
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 accounts were assumed to decay at an annual rate of 30% and
money market accounts were assumed to decay at an annual rate of 40%.
Non-interest checking accounts were assumed to decay at an annual rate of 33%
and NOW accounts were assumed to decay at an annual rate of 29%. 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 the
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 a substantial
sustained interest rate increase.
ASSET/LIABILITY MANAGEMENT
The Company's management reviews the impact that changing interest rates will
have on its net interest income projected for the twelve months following March
31, 2005 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 $40,228,000 7.96%
+100 38,874,000 4.32%
0 37,263,000 0.00%
-100 36,020,000 (3.34)%
The preceding table was prepared utilizing the Model Assumptions regarding
prepayment and decay ratios which were determined by management based upon their
review of historical prepayment speeds and future prepayment projections
prepared by third parties.
Certain shortcomings are inherent in the method of analysis presented in the
foregoing table. In the event of a change in interest rates, prepayment and
early withdrawal levels would likely deviate significantly from those assumed in
calculating the foregoing table. The ability of many borrowers to service their
debt may decrease in the event of a substantial increase in interest rates and
could impact net interest income.
In an attempt to manage its exposure to changes in interest rates, management
closely monitors interest rate risk. The Bank has an Asset/Liability Committee
which meets frequently to discuss changes in the interest rate risk position and
projected profitability. The Committee makes adjustments to the asset liability
position of the Bank which are reviewed by 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,
each quarter the Board reviews the Bank's asset/liability position, including
simulations of the effect on the Bank's capital of various interest rate
scenarios.
In managing its asset/liability mix, the Bank, at times, depending on the
relationship between long- and short-term interest rates, market conditions and
consumer preference, may place more emphasis on managing net interest margin
than on better matching the interest rate sensitivity of its assets and
liabilities in an effort to enhance net interest income. Management believes
that the increased net interest income resulting from a mismatch in the
20
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 manage its interest rate risk and has taken a number of steps to
restructure its balance sheet in order to better match the maturities of its
assets and liabilities. The Bank has primarily focused its fixed rate
one-to-four family residential lending program on loans that are saleable to
third parties and only places fixed rate loans that meet certain risk
characteristics into its loan portfolio. The Bank does place into portfolio
adjustable rate single-family loans that reprice over a one, three or five-year
period. The Bank's commercial loan production has primarily been in adjustable
rate loans and the fixed rate commercial loans placed in portfolio have been
shorter-term loans, usually with maturities of five years or less, in order to
lower the Company's interest rate risk exposure.
ITEM 4: CONTROLS AND PROCEDURES
Evaluation of disclosure controls and procedures. As of the end of the period
covered by this report, the Company conducted an evaluation, under the
supervision and with the participation of the principal executive officer and
principal financial officer, of the Company's disclosure controls and procedures
(as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act
of 1934 (Exchange Act). Based on this evaluation, the principal executive
officer and principal financial officer concluded that the Company's disclosure
controls and procedures are effective to ensure that information required to be
disclosed by the Company in reports that it files or submits under the Exchange
Act is recorded, processed, summarized and reported within the time periods
specified in Securities and Exchange Commission rules and forms.
Changes in internal controls. There was no change in the Company's internal
controls over financial reporting during the Company's most recently completed
fiscal quarter that has materially affected, or is reasonably likely to
materially affect, the Company's internal controls over financial reporting.
21
HMN FINANCIAL, INC.
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings.
None.
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds.
(a) and (b) Not applicable
(c) Information Regarding Share Repurchases
(c) Total Number of
(a) Total Shares Purchased as (d) Maximum Number
Number of Part of Publicly of Shares that May Yet
Shares (b) Average Price Announced Plans or Be Purchased Under the
Period Purchased Paid per Share Programs Plans or Programs
- ------ --------- ----------------- ------------------- ----------------------
January 1 through January 31, 2005 20,000 $32.30 20,000 207,000
February 1 through February 28, 2005 10,000 32.60 10,000 197,000
March 1 through March 31, 2005 0 0 0 197,000
------ ------ ------
Total 30,000 $32.40 30,000
====== ====== ======
(1) On February 24, 2004, the Board of Directors authorized a repurchase
program for 350,000 shares of the Company's common stock. This program
expires on August 24, 2005.
ITEM 3. Defaults Upon Senior Securities.
Not applicable.
ITEM 4. Submission of Matters to a Vote of Security Holders.
None.
ITEM 5. Other Information.
None.
ITEM 6. Exhibits.
See Index to Exhibits on page 24 of this report.
22
SIGNATURES
Pursuant to the requirement of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HMN FINANCIAL, INC.
Registrant
Date: May 4, 2005 /s/ Michael McNeil
----------------------------------------
Michael McNeil,
President and Chief Executive Officer
(Principal Executive Officer)
(Duly Authorized Representative)
Date: May 4, 2005 /s/ Jon Eberle
----------------------------------------
Jon Eberle,
Chief Financial Officer
(Principal Financial Officer)
23
HMN FINANCIAL, INC.
INDEX TO EXHIBITS
FOR FORM 10-Q
Sequential
Reference Page Numbering
Regulation to Prior Where Attached
S-K Filing or Exhibits Are
Exhibit Exhibit Located in This
Number Document Attached Hereto Number Form 10-Q 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 including indentures *3 N/A
31.1 Rule 13a-14(a)/15d-14(a) Certification of CEO 31.1 Filed Electronically
31.2 Rule 13a-14(a)/15d14(a) Certification of CFO 31.2 Filed Electronically
32 Section 1350 Certification of CEO and CFO 32 Filed 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 Exhibit 3 to the Company's Current Report on Form
8-K dated February 22, 2005, filed on February 23, 2005 (File 0-24100).
*3 Incorporated by reference to the same numbered exhibit to the Company's
Registration Statement on Form S-1 dated April 1, 1994 (File No. 33-77212).
24