UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 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 incorporation (I.R.S. Employer Identification
or organization) 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 July 25, 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
June 30, 2005 and December 31, 2004............................................ 3
Consolidated Statements of Income for the
Three Months Ended and Six Months Ended June 30, 2005 and 2004................. 4
Consolidated Statement of Stockholders' Equity
for the Six Month Period Ended June 30, 2005................................... 5
Consolidated Statements of Cash Flows for
the Six Months Ended June 30, 2005 and 2004.................................... 6
Notes to Consolidated Financial Statements..................................... 7-14
Item 2: Management's Discussion and Analysis of Financial
Condition and Results of Operations............................................ 15-22
Item 3: Quantitative and Qualitative Disclosures about Market Risk
Discussion included in Item 2 under Market Risk................................ 20
Item 4: Controls and Procedures............................................................ 22
PART II - OTHER INFORMATION
Item 1: Legal Proceedings.................................................................. 23
Item 2: Unregistered Sales of Equity Securities and Use of Proceeds........................ 23
Item 3: Defaults Upon Senior Securities.................................................... 23
Item 4: Submission of Matters to a Vote of Security Holders................................ 23
Item 5: Other Information.................................................................. 24
Item 6: Exhibits........................................................................... 24
Signatures.................................................................................. 25
2
PART I - FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS
HMN FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
June 30, December 31,
2005 2004
------------- ------------
(unaudited)
ASSETS
Cash and cash equivalents.......................................... $ 24,516,684 34,298,394
Securities available for sale, at fair value:
Mortgage-backed and related securities
(amortized cost $8,506,330 and $9,509,377)..................... 8,219,664 9,150,871
Other marketable securities
(amortized cost $92,072,767 and $95,097,051).................. 91,052,866 94,521,512
------------- -----------
99,272,530 103,672,383
------------- -----------
Loans held for sale................................................ 4,289,583 2,711,760
Loans receivable, net.............................................. 819,939,562 783,213,262
Accrued interest receivable........................................ 4,129,442 3,694,133
Real estate, net................................................... 789,608 140,608
Federal Home Loan Bank stock, at cost.............................. 9,628,200 9,292,800
Mortgage servicing rights, net..................................... 2,962,515 3,231,242
Premises and equipment, net........................................ 12,326,990 12,464,265
Investment in limited partnerships................................. 154,048 168,258
Goodwill........................................................... 3,800,938 3,800,938
Core deposit intangible, net....................................... 276,689 333,617
Prepaid expenses and other assets.................................. 2,430,740 2,638,681
Deferred tax asset................................................. 1,144,300 1,012,700
------------- -----------
Total assets................................................... $ 985,661,829 960,673,041
============= ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits........................................................... $ 720,230,277 698,902,185
Federal Home Loan Bank advances.................................... 170,900,000 170,900,000
Accrued interest payable........................................... 1,904,438 1,314,356
Customer escrows................................................... 649,637 762,737
Accrued expenses and other liabilities............................. 5,419,330 5,022,927
------------- -----------
Total liabilities.............................................. 899,103,682 876,902,205
------------- -----------
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......................................... 57,867,348 57,875,595
Retained earnings, subject to certain restrictions................. 95,036,871 91,408,028
Accumulated other comprehensive loss............................... (845,366) (604,446)
Unearned employee stock ownership plan shares...................... (4,447,586) (4,544,300)
Unearned compensation restricted stock awards...................... (275,197) 0
Treasury stock, at cost 4,721,168 and 4,708,798 shares............. (60,869,210) (60,455,328)
------------- -----------
Total stockholders' equity..................................... 86,558,147 83,770,836
------------- -----------
Total liabilities and stockholders' equity......................... $ 985,661,829 960,673,041
============= ===========
See accompanying notes to consolidated financial statements.
3
HMN FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
---------------------------- ---------------------------
2005 2004 2005 2004
-------------- ---------- ---------- ----------
Interest income:
Loans receivable............................ $ 13,769,340 11,486,417 27,102,359 22,977,681
Securities available for sale:
Mortgage-backed and related.............. 84,288 92,428 174,056 211,292
Other marketable......................... 654,182 766,391 1,295,938 1,449,798
Cash equivalents............................ 175,671 40,042 227,940 66,340
Other....................................... 89,232 41,398 168,760 77,820
-------------- ---------- ---------- ----------
Total interest income.................... 14,772,713 12,426,676 28,969,053 24,782,931
-------------- ---------- ---------- ----------
Interest expense:
Deposits.................................... 4,199,791 2,894,319 7,902,422 5,824,353
Federal Home Loan Bank advances............. 1,826,501 2,165,680 3,649,192 4,354,635
-------------- ---------- ---------- ----------
Total interest expense................... 6,026,292 5,059,999 11,551,614 10,178,988
-------------- ---------- ---------- ----------
Net interest income...................... 8,746,421 7,366,677 17,417,439 14,603,943
Provision for loan losses...................... 907,000 447,000 1,543,000 1,266,000
-------------- ---------- ---------- ----------
Net interest income after provision
for loan losses........................ 7,839,421 6,919,677 15,874,439 13,337,943
-------------- ---------- ---------- ----------
Non-interest income:
Fees and service charges.................... 685,357 704,651 1,287,954 1,273,201
Mortgage servicing fees..................... 303,363 290,849 596,343 578,080
Securities gains, net....................... 0 1,361 0 1,361
Gains on sales of loans..................... 324,173 506,862 617,489 919,231
Earnings (losses) in limited partnerships... (6,500) (6,500) (14,210) (13,117)
Other....................................... 268,206 183,048 513,754 457,797
-------------- ---------- ---------- ----------
Total non-interest income................ 1,574,599 1,680,271 3,001,330 3,216,553
-------------- ---------- ---------- ----------
Non-interest expense:
Compensation and benefits................... 2,784,578 2,581,764 5,558,682 5,110,242
Occupancy................................... 1,041,460 871,170 2,036,714 1,755,772
Deposit insurance premiums.................. 34,619 27,794 62,525 46,499
Advertising................................. 105,765 87,850 189,673 175,396
Data processing............................. 245,351 228,721 482,839 419,286
Amortization of mortgage servicing
rights, net of valuation adjustments..... 271,089 302,184 510,122 555,633
Other....................................... 1,038,805 897,762 1,971,497 1,860,336
-------------- ---------- ---------- ----------
Total non-interest expense............... 5,521,667 4,997,245 10,812,052 9,923,164
-------------- ---------- ---------- ----------
Income before income tax expense......... 3,892,353 3,602,703 8,063,717 6,631,332
Income tax expense 1,392,900 1,105,500 2,749,200 2,016,000
-------------- ---------- ---------- ----------
Income before minority interest.......... 2,499,453 2,497,203 5,314,517 4,615,332
Minority interest.............................. 0 43 0 (2,288)
-------------- ---------- ---------- ----------
Net income............................... $ 2,499,453 2,497,160 5,314,517 4,617,620
============== ========== ========== ==========
Basic earnings per share....................... $ 0.65 0.65 1.39 1.19
============== ========== ========== ==========
Diluted earnings per share..................... $ 0.62 0.62 1.33 1.13
============== ========== ========== ==========
See accompanying notes to consolidated financial statements.
4
HMN FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE SIX-MONTH PERIOD ENDED JUNE 30, 2005
(unaudited)
Unearned
Accumulated Employee
Other Stock Unearned Total
Additional Comprehensive Ownership Compensation Stock-
Common Paid-in Retained Income Plan Restricted Treasury Holders'
Stock Capital Earnings (Loss) Shares Stock Awards Stock Equity
------- ---------- ---------- ------------- ---------- ------------ ----------- ----------
Balance, December 31, 2004 $91,287 57,875,595 91,408,028 (604,446) (4,544,300) 0 (60,455,328) 83,770,836
Net income 5,314,517 5,314,517
Other comprehensive income,
net of tax:
Net unrealized losses on
securities available for
sale (240,920) (240,920)
---------
Total comprehensive income 5,073,597
Purchase of treasury stock (972,000) (972,000)
Employee stock options
exercised (228,013) 252,900 24,887
Tax benefits of exercised
stock options 22,240 22,240
Unearned compensation
restricted stock awards 15,616 (326,528) 310,912 0
Restricted stock awards
cancelled (286) 5,980 (5,694) 0
Amortization of restricted
stock awards 45,351 45,351
Dividends paid (1,685,674) (1,685,674)
Earned employee stock
ownership plan shares 182,196 96,714 278,910
------- ---------- ---------- -------- ---------- -------- ----------- ----------
Balance, June 30, 2005 $91,287 57,867,348 95,036,871 (845,366) (4,447,586) (275,197) (60,869,210) 86,558,147
======= ========== ========== ======== ========== ======== =========== ==========
See accompanying notes to consolidated financial statements.
5
HMN FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
Six Months Ended
June 30,
-------------------------------
2005 2004
--------------- ------------
Cash flows from operating activities:
Net income..................................................................... $ 5,314,517 4,617,620
Adjustments to reconcile net income to cash provided by operating activities:
Provision for loan losses.................................................... 1,543,000 1,266,000
Depreciation................................................................. 867,160 777,836
Amortization of discounts, net............................................... (324,753) (109,254)
Amortization of deferred loan fees........................................... (373,394) (572,132)
Amortization of core deposit intangible...................................... 56,928 56,928
Amortization of mortgage servicing rights.................................... 510,122 555,633
Capitalized mortgage servicing rights........................................ (241,395) (443,307)
Securities gains, net........................................................ 0 (1,361)
Losses (gains) on sales of real estate....................................... (8,220) 19,810
Gains on sales of loans...................................................... (617,489) (919,231)
Proceeds from sale of real estate............................................ 364,978 256,735
Proceeds from sale of loans held for sale.................................... 36,598,189 50,943,298
Disbursements on loans held for sale......................................... (37,540,037) (47,263,609)
Amortization of restricted stock awards...................................... 45,351 0
Amortization of unearned ESOP shares......................................... 96,714 96,912
Earned employee stock ownership shares priced above original cost............ 182,196 143,982
Increase in accrued interest receivable...................................... (435,309) (68,414)
Increase in accrued interest payable......................................... 590,082 90,655
Equity losses of limited partnerships........................................ 14,210 13,117
Equity losses of minority interest........................................... 0 (2,288)
Decrease in other assets..................................................... 264,105 597,761
Increase (decrease) in other liabilities..................................... 343,993 (1,896,949)
Other, net................................................................... (3,647) (176,592)
--------------- -----------
Net cash provided by operating activities................................... 7,247,301 7,983,150
--------------- -----------
Cash flows from investing activities:
Proceeds from sales of securities available for sale........................... 0 10,119,950
Principal collected on securities available for sale........................... 1,064,052 3,152,402
Proceeds collected on maturities of securities available for sale.............. 8,000,000 0
Purchases of securities available for sale..................................... (4,991,400) (19,955,262)
Redemption of interest in limited partnership.................................. 0 422,474
Purchase of Federal Home Loan Bank Stock....................................... (1,904,100) (540,300)
Redemption of Federal Home Loan Bank Stock..................................... 1,568,700 606,500
Net increase in loans receivable............................................... (38,897,415) (34,996,464)
Purchases of premises and equipment............................................ (725,547) (1,122,647)
--------------- -----------
Net cash used by investing activities....................................... (35,885,710) (42,313,347)
--------------- -----------
Cash flows from financing activities:
Increase in deposits........................................................... 21,602,586 75,762,987
Purchase of treasury stock..................................................... (972,000) (2,180,650)
Stock options exercised........................................................ 24,887 27,634
Dividends to stockholders...................................................... (1,685,674) (1,558,203)
Proceeds from Federal Home Loan Bank advances.................................. 48,500,000 16,500,000
Repayment of Federal Home Loan Bank advances................................... (48,500,000) (21,500,000)
Decrease in customer escrows................................................... (113,100) (21,579,577)
--------------- -----------
Net cash provided by financing activities................................... 18,856,699 45,472,191
--------------- -----------
Increase (decrease) in cash and cash equivalents............................ (9,781,710) 11,141,994
Cash and cash equivalents, beginning of period.................................... 34,298,394 30,496,823
--------------- -----------
Cash and cash equivalents, end of period.......................................... $ 24,516,684 41,638,817
=============== ============
Supplemental cash flow disclosures:
Cash paid for interest......................................................... $ 10,961,532 10,088,333
Cash paid for income taxes..................................................... 3,642,000 4,554,500
Supplemental noncash flow disclosures:
Transfer of loans to real estate............................................... 1,006,259 434,960
See accompanying notes to consolidated financial statements.
6
HMN FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
JUNE 30, 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 six-month period ended June 30, 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 or purchased 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 or
7
sell loans are derivatives. As a result of marking to market the mortgage
pipeline and the related commitments to sell for the period ended June 30, 2005,
the Company recorded an increase in other assets of $66,046 and an increase in
other liabilities of $66,046.
The current commitments to sell loans held for sale are derivative instruments
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 $9,882, a decrease in other assets of $9,882, an increase in other
liabilities of $8,604 and a net loss in the gain on sales of loans of $8,604.
(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 three months ended June 30,
----------------------------------------------------------------------------------------
(Dollars in thousands) 2005 2004
- ------------------------------- ------------------------------------------ ------------------------------------------
Securities available for sale: Before tax Tax effect Net of tax Before tax Tax effect Net of tax
---------- ---------- ---------- ---------- ---------- ----------
Gross unrealized gains (losses)
arising during the period $ 386 136 250 (2,253) (795) (1,458)
Reclassification of net gains
included in net income 0 0 0 (1) 0 (1)
---------- ---------- ---------- ---------- ---------- ----------
Net unrealized gains (losses)
arising during the period 386 136 250 (2,254) (795) (1,459)
---------- ---------- ---------- ---------- ---------- ----------
Other comprehensive income $ 386 136 250 (2,254) (795) (1,459)
========== ========== ========== ========== ========== ==========
For the six months ended June 30,
----------------------------------------------------------------------------------------
(Dollars in thousands) 2005 2004
------------------------------------------ ------------------------------------------
Securities available for sale: Before tax Tax effect Net of tax Before tax Tax effect Net of tax
---------- ---------- ---------- ---------- ---------- ----------
Gross unrealized losses arising
during the period $ (373) (132) (241) (1,499) (529) (970)
Reclassification of net gains
included in net income 0 0 0 (1) 0 (1)
---------- ---------- ---------- ---------- ---------- ----------
Net unrealized losses arising
during the period (373) (132) (241) (1,500) (529) (971)
---------- ---------- ---------- ---------- ---------- ----------
Other comprehensive income $ (373) (132) (241) (1,500) (529) (971)
========== ========== ========== ========== ========== ==========
(6) INVESTMENT IN LIMITED PARTNERSHIPS
During the second quarter of 2005 the Company recognized $6,500 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 second quarter of 2004 the Company's proportionate gains from common
stock investments in financial institutions was $803 and it 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.
During the six month period ended June 30, 2005 the Company recognized $14,210
of losses on low income housing partnerships. During 2005, the Company
anticipates receiving low income housing credits totaling $42,000 of which
$21,000 were credited to current income tax benefits.
During the six month period ended June 30, 2004, the Company's proportionate
shares of gains from common stock investments in financial institutions was $803
and it recognized $13,920 of losses on low income housing partnerships. During
2004, the Company received low income housing credits totaling $84,000 of which
$42,000 were credited to current income tax benefits.
(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
8
position, at June 30, 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 June 30, 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 $ 25 0 1 $ 3,229 (149) $ 3,254 (149)
FNMA 1 43 0 1 3,778 (155) 3,821 (155)
Other marketable securities:
FNMA Debt 2 9,888 (84) 1 4,939 (55) 14,827 (139)
FHLMC Debt 2 9,875 (90) 0 0 0 9,875 (90)
FHLB Debt 4 22,823 (141) 8 39,984 (533) 62,807 (674)
Corporate equity 1 2,844 (117) 0 0 0 2,844 (117)
-- ------- ---- -- -------- ---- ------- ------
Total temporarily impaired
securities 11 $45,498 (432) 11 $ 51,930 (892) $97,428 (1,324)
== ======= ==== == ======== ==== ======= ======
(8) INVESTMENT IN MORTGAGE SERVICING RIGHTS
A summary of mortgage servicing activity is as follows:
Six Months ended Twelve Months ended Six Months ended
June 30, 2005 December 31, 2004 June 30, 2004
---------------- ------------------- ----------------
Mortgage servicing rights
Balance, beginning of period.............. $ 3,231,242 3,447,843 3,447,843
Originations.............................. 241,395 844,806 443,307
Amortization.............................. (510,122) (1,061,407) (555,634)
---------------- ---------- ---------
Balance, end of period.................... 2,962,515 3,231,242 3,335,516
---------------- ---------- ---------
Valuation reserve........................... 0 0 0
---------------- ---------- ---------
Mortgage servicing rights, net............ $ 2,962,515 3,231,242 3,335,516
================ ========== =========
Fair value of mortgage servicing rights... $ 4,053,626 4,494,724 5,033,869
================ ========== =========
All of the loans being serviced were single family loans serviced for FNMA under
either the mortgage-backed security or individual loan sale program. The
following is a summary of the risk characteristics of the loans being serviced
at June 30, 2005.
Weighted Weighted
Loan Principal Average Average Number of
Balance Interest Rate Remaining Term Loans
-------------- ------------- -------------- ---------
Original term 30 year fixed rate $ 214,967,030 5.90% 338 months 1,894
Original term 15 year fixed rate 221,660,092 5.28% 155 months 2,746
Adjustable rate 7,236,626 5.02% 330 months 67
(9) INTANGIBLE ASSETS
The gross carrying amount of intangible assets and the associated accumulated
amortization at June 30, 2005 is presented in the table below. Amortization
expense for intangible assets was $567,050 for the six-month period ended June
30, 2005.
Gross Unamortized
Carrying Accumulated Valuation Intangible
Amount Amortization Adjustment Assets
-------------- ------------ ---------- -----------
Amortized intangible assets:
Mortgage servicing rights $ 4,516,670 (1,554,155) 0 2,962,515
Core deposit intangible 1,567,000 (1,290,311) 0 276,689
-------------- ---------- -- ---------
Total $ 6,083,670 (2,844,466) 0 3,239,204
============== ========== == =========
9
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 218,257 56,929 275,186
2006 384,087 113,857 497,944
2007 305,979 105,903 411,882
2008 277,207 0 277,207
2009 250,951 0 250,951
Projections of amortization are based on existing asset balances and the
existing interest rate environment as of June 30, 2005. The Company's actual
experiences 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 June 30, Six Months Ended June 30,
--------------------------- -------------------------
2005 2004 2005 2004
------------ ------------ --------- ------------
Weighted average number of common shares
outstanding used in basic earnings per
common share calculation 3,829,413 3,870,299 3,827,147 3,892,672
Net dilutive effect of:
Options 160,855 173,845 167,321 177,374
Restricted stock awards 8,994 0 8,010 0
------------ --------- --------- ---------
Weighted average number of shares outstanding
adjusted for effect of dilutive securities 3,999,262 4,044,144 4,002,478 4,070,046
============ ========= ========= =========
Income available to common shareholders $ 2,499,453 2,497,160 5,314,517 4,617,620
Basic earnings per common share $ 0.65 0.65 1.39 1.19
Diluted earnings per common share $ 0.62 0.62 1.33 1.13
(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
in the regulations). Management believes, as of June 30, 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 June 30,
2005 and other conditions consistent with the Prompt Corrective Actions
Provisions of the OTS regulations, the Bank would be categorized as well
capitalized.
On June 30, 2005 the Bank's tangible assets and adjusted total assets were
$980.4 million and its risk-weighted assets were $818.1 million. The following
table presents the Bank's capital amounts and ratios at June 30, 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 Percent Percent Percent
(in thousands) of of of of
Amount Assets(1) Amount Assets (1) Amount Assets(1) Amount Assets(1)
------- --------- -------- ---------- -------- --------- ------- ---------
Bank stockholder's equity........ $83,326
Plus:
Net unrealized loss on certain
securities available for
sale......................... 687
Less:
Net unrealized losses on
certain securities available
for sale.....................
Goodwill and core deposit
intangibles.................. 4,078
Excess mortgage servicing
rights....................... 480
-------
Tier I or core capital 79,455
-------
Tier I capital to adjusted
total assets................. 8.10% $ 39,214 4.00% $ 40,241 4.10% $49,018 5.00%
Tier I capital to risk-weighted
assets....................... 9.71% $ 32,722 4.00% $ 46,733 5.71% $49,083 6.00%
Plus:
Allowable allowance for loan
losses....................... 8,883
-------
Risk-based capital............... $88,338 $ 65,444 $ 22,894 $81,805
=======
Risk-based capital to risk-
weighted assets................ 10.80% 8.00% 2.80% 10.00%
(1) 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.
In addition, the tangible capital of the Bank was in excess of the minimum 2%
required at June 30, 2005.
(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 June
30, 2005 were approximately $6.0 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 occur, 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 Six Months Ended Six Months Ended
June 30, 2005 June 30, 2004 June 30, 2005 June 30, 2004
------------- ------------- ---------------- ----------------
Net income:
As reported....................... $ 2,499,453 2,497,160 5,314,517 4,617,620
Deduct: Total stock-based
employee compensation expense
determined under fair value
based method for all awards, net
of related tax effects.......... 13,655 8,531 22,514 17,061
------------- --------- --------- ---------
Pro forma......................... 2,485,798 2,488,629 5,292,003 4,600,559
============= ========= ========= =========
Earnings per common share:
As reported:
Basic............................. $ 0.65 0.65 1.39 1.19
Diluted........................... 0.62 0.62 1.33 1.13
Pro forma:
Basic ............................ 0.65 0.64 1.38 1.18
Diluted........................... 0.62 0.62 1.33 1.13
(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 segment's
net income or loss, return on average assets and return on average equity. Each
corporation has 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
Savings Consolidated
(Dollars in thousands) Bank Other Eliminations Total
- ---------------------- ----------- -------- ------------ ------------
AT OR FOR THE QUARTER ENDED JUNE 30, 2005:
Interest income - external customers............................. $ 14,749 24 0 14,773
Non-interest income - external customers......................... 1,582 0 0 1,582
Earnings (loss) on limited partnerships.......................... (7) 0 0 (7)
Intersegment interest income..................................... 0 0 0 0
Intersegment non-interest income................................. 33 2,533 (2,566) 0
Interest expense................................................. 6,026 0 0 6.026
Amortization of mortgage servicing rights,
net valuation adjustments...................................... 271 0 0 271
Other non-interest expense....................................... 5,120 164 (33) 5,251
Income tax expense (benefit)..................................... 1,497 (104) 0 1,393
Minority interest................................................ 0 0 0 0
Net income....................................................... 2,535 2,498 (2,533) 2,500
Goodwill......................................................... 3,801 0 0 3,801
Total assets..................................................... 981,979 87,156 (83,473) 985,662
Net interest margin.............................................. 3.70% NM NM 3.70%
Return on average assets......................................... 1.02% NM NM 1.01%
Return on average realized common equity......................... 12.20% NM NM 11.41%
AT OR FOR THE QUARTER ENDED JUNE 30, 2004:
Interest income - external customers............................. $ 12,415 12 0 12,427
Non-interest income - external customers......................... 1,687 0 0 1,687
Earnings (loss) on limited partnerships.......................... (7) 0 0 (7)
Intersegment interest income..................................... 0 1 (1) 0
Intersegment non-interest income................................. 39 2,544 (2,583) 0
Intersegment loan loss provision................................. 0 0 0 0
Interest expense................................................. 5,061 0 (1) 5,060
Amortization of mortgage servicing rights, net valuation
adjustments.................................................... 302 0 0 302
Other non-interest expense....................................... 4,567 167 (39) 4,695
Income tax expense (benefit)..................................... 1,213 (107) 0 1,106
Minority interest................................................ 0 0 0 0
Net income....................................................... 2,544 2,497 (2,544) 2,497
Goodwill......................................................... 3,801 0 0 3,801
Total assets..................................................... 909,610 81,679 (77,191) 914,098
Net interest margin.............................................. 3.46% NM NM 3.45%
Return on average assets......................................... 1.13% NM NM 1.12%
Return on average realized common equity......................... 13.31% NM NM 12.06%
NM - Not meaningful
13
Home Federal
(Dollars in thousands) Savings Bank Other Eliminations Consolidated Total
- ------------------------------------------------ ------------ ------ ------------ ------------------
AT OR FOR THE SIX MONTHS ENDED JUNE 30, 2005:
Interest income - external customers.......... $ 28,935 34 0 28,969
Non-interest income - external customers...... 3,016 0 0 3,016
Loss on limited partnerships.................. (14) 0 0 (14)
Intersegment interest income.................. 0 16 (16) 0
Intersegment non-interest income.............. 67 5,380 (5,447) 0
Interest expense.............................. 11,568 0 (16) 11,552
Amortization of mortgage servicing rights,
net valuation adjustments................... 510 0 0 510
Other non-interest expense.................... 10,043 326 (67) 10,302
Income tax expense (benefit).................. 2,956 (207) 0 2,749
Minority interest............................. 0 0 0 0
Net income.................................... 5,383 5,312 (5,380) 5,315
Goodwill .................................... 3,801 0 0 3,801
Total assets.................................. 981,979 87,156 (83,473) 985,662
Net interest margin........................... 3.74% NM NM 3.75%
Return on average assets...................... 1.10% NM NM 1.09%
Return on average realized common equity...... 13.24% NM NM 12.29%
AT OR FOR THE SIX MONTHS ENDED JUNE 30, 2004:
Interest income - external customers.......... $ 24,759 24 0 24,783
Non-interest income - external customers...... 3,230 0 0 3,230
Earnings (loss) on limited partnerships....... (14) 1 0 (13)
Intersegment interest income.................. 0 9 (9) 0
Intersegment non-interest income.............. 108 4,696 (4,804) 0
Interest expense.............................. 10,188 0 (9) 10,179
Amortization of mortgage servicing rights,
net valuation adjustments.................. 556 0 0 556
Other non-interest expense.................... 9,154 321 (108) 9,367
Income tax expense (benefit).................. 2,223 (107) 0 2,116
Minority interest............................. (2) 0 0 (2)
Net income.................................... 4,698 4,516 (4,696) 4,518
Goodwill...................................... 3,801 0 0 3,801
Total assets.................................. 909,610 81,679 (77,191) 914,098
Net interest margin........................... 3.46% NM NM 3.46%
Return on average assets...................... 1.06% NM NM 1.04%
Return on average realized common equity...... 12.50% NM NM 11.14%
NM - Not meaningful
14
ITEM 2:
HMN FINANCIAL, INC.
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. Single
family mortgage loan activity was down in the first six months of 2005 when
compared to the same period of 2004 due to a decline in refinancing activity,
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
15
are inherently uncertain. Therefore, actual financial results could differ
significantly depending upon the estimates used.
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
16
origination volume declines and the value of MSRs increases and as interest
rates decline, the origination volume increases and the value of MSRs decreases.
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 was $2.5 million for the second quarter of 2005 the
same net income as the second quarter of 2004. Basic earnings per share for the
second quarter of 2005 were $0.65, unchanged from the same quarter of 2004.
Diluted earnings per common share for the second quarter of 2005 were $0.62,
unchanged from the second quarter of 2004.
Net income was $5.3 million for the six month period ended June 30, 2005, an
increase of $697,000, or 15.1%, compared to $4.6 million for the six month
period ended June 30, 2004. Basic earnings per share were $1.39 for the six
months ended June 30, 2005, an increase of $0.20 per share, or 16.8%, from $1.19
for the same six month period in 2004. Diluted earnings per share for the six
month period in 2005 were $1.33, up $0.20, or 17.7%, from $1.13 for the same
period in 2004.
NET INTEREST INCOME
Net interest income was $8.7 million for the second quarter of 2005, an increase
of $1.3 million, or 18.7%, compared to $7.4 million for the second quarter of
2004. Interest income was $14.8 million for the second quarter of 2005, an
increase of $2.4 million, or 18.9%, from $12.4 million for the same period in
2004. Interest income increased primarily because of an increase in 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
$108 million increase in the average outstanding balance of commercial loans
between the periods due to the Company's continued focus on originating
commercial loans. 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 average outstanding balances and
lower interest rates of these portfolios in the second quarter of 2005 when
compared to the same period of 2004. The lower interest rate on these portfolios
is the result of higher interest earning assets maturing or being paid off
between the periods. The yield earned on interest-earning assets was 6.25% for
the second quarter of 2005, an increase of 43 basis points from the 5.82% yield
for the second quarter of 2004.
Interest expense was $6.0 million for the second quarter of 2005, an increase of
$966,000, or 19.1%, compared to $5.1 million for the second quarter of 2004.
Interest expense increased primarily because of the $84 million increase in the
average outstanding balance of deposits and advances between the periods due to
an increase in transaction and brokered deposits and because of a 225 basis
point increase in the federal funds rate between the periods that resulted in
higher interest rates on deposits. Increases in the federal funds rate, which is
the rate that banks charge other banks for short term loans, generally increase
the rates banks pay for deposits. The average rate paid on interest-bearing
liabilities was 2.70% for the second quarter of 2005, an increase of 20 basis
points from the 2.50% paid for the second quarter of 2004.
Net interest margin (net interest income divided by average interest earning
assets) for the second quarter of 2005 was 3.70%, an increase of 25 basis
points, compared to 3.45% for the second quarter of 2004.
Net interest income was $17.4 million for the first six months of 2005, an
increase of $2.8 million, or 19.3%, from $14.6 million for the same period in
2004. Interest income was $29.0 million for the six month period ended June
17
30, 2005, an increase of $4.2 million, or 16.9%, from $24.8 million for the same
six month period in 2004. Interest income increased primarily because of an
increase in 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 $104 million increase in the average outstanding balance
of commercial loans between the periods due to the Company's continued focus on
originating commercial loans. 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 six months of 2005 when
compared to the same period in 2004. The yield earned on interest-earning assets
was 6.23% for the first six months of 2005, an increase of 36 basis points from
the 5.87% yield for the same period of 2004.
Interest expense was $11.6 million for the six month period ended June 30, 2005,
an increase of $1.4 million, or 13.5%, compared to $10.2 million for the same
period of 2004. Interest expense increased primarily because of the $81 million
increase in the average outstanding balance of deposits and advances between the
periods and because of the 225 basis point increase in the federal funds rate
between the periods that resulted in higher interest rates on deposits.
Increases in the federal funds rate, which is the rate that banks charge other
banks for short term loans, generally increase the rates banks pay for deposits.
Interest expense increased $418,000 due to increased interest rates paid and
$954,000 due to the increase in interest-bearing liabilities between the
periods. The average interest rate paid on interest-bearing liabilities was
2.63% for the first six months of 2005, an increase of 9 basis points from the
2.54% paid for the first six months of 2004.
Net interest margin (net interest income divided by average interest earning
assets) for the first six months of 2005 was 3.75%, an increase of 29 basis
points, compared to 3.46% for the same period 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 policies previously discussed. The provision for loan losses
was $907,000 for the second quarter of 2005, an increase of $460,000, or 102.9%,
from $447,000 for the second quarter of 2004. The provision for loan losses was
$1.5 million for the six month period of 2005, an increase of $277,000, or
21.9%, from $1.3 million for the same six month period in 2004. The provision
for loan losses increased primarily because of increases in the allowance on
several commercial real estate loans totaling $8.0 million that were determined
to be impaired and classified as non-accruing during the first six months of
2005. Total non-performing assets were $12.5 million at June 30, 2005, an
increase of $7.6 million, or 155.5%, from $4.9 million at December 31, 2004.
Non-performing loans increased $7.0 million, foreclosed and repossessed assets
increased $630,000, and $352,000 in loans were charged off during the first six
months of 2005.
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 1,543,000 1,266,000
Charge-offs (351,625) (421,525)
Recoveries 35,621 8,720
------------ -----------
Balance at June 30, $ 10,222,888 $ 7,792,797
============ ===========
NON-INTEREST INCOME
Non-interest income was $1.6 million for the second quarter of 2005, a decrease
of $106,000, or 6.3%, from $1.7 million for the same period in 2004. Gain on
sales of mortgage loans originated by the Bank decreased $183,000 because of
decreased mortgage loan activity during the second quarter of 2005 when compared
to the same quarter in 2004. Other non-interest income increased $85,000 because
of increased revenues from the sale of uninsured investment products and
increased income relating to the rental of office space at an existing facility.
Non-interest income was $3.0 million for the first six months of 2005, a
decrease of $215,000, or 6.7%, from $3.2 million for the same period in 2004.
Gain on sales of loans decreased $302,000 due to the decreased mortgage loan
activity in the first six months of 2005 when compared to the same period of
2004. Other non-interest income increased $56,000 primarily because of increased
income relating to the rental of office space at an existing facility.
18
NON-INTEREST EXPENSE
Non-interest expense was $5.5 million for the second quarter of 2005, an
increase of $524,000, or 10.5%, from $5.0 million for the same period of 2004.
Compensation expense increased $203,000 because of annual payroll cost increases
and because of an increase in the number of employees. Occupancy expense
increased $170,000 primarily because of the additional corporate office
facilities occupied in the first quarter of 2005 and because of increased
amortization expense on various software upgrades that were implemented between
the periods. Other non-interest expense increased $141,000 primarily because of
a $125,000 charitable contribution expensed during the second quarter of 2005.
Non-interest expense was $10.8 million for the first six months of 2005, an
increase of $889,000, or 9.0%, from $9.9 million for the same period in 2004.
Compensation expense increased $448,000 primarily because of annual payroll cost
increases and because of an increase in the number of employees. Occupancy
expense increased $281,000 primarily because of the additional corporate office
facilities occupied in the first quarter of 2005 and because of an increase in
amortization expense relating to various software upgrades implemented between
the periods. Other non-interest expense increased $111,000 primarily because of
a $125,000 charitable contribution expensed during the second quarter of 2005.
INCOME TAX EXPENSE
Income tax expense was $1.4 million for the second quarter of 2005, an increase
of $287,000, compared to $1.1 million for the second quarter of 2004. Income tax
expense was $2.7 million, an increase of $733,000, or 36.4%, compared to $2.0
million for the first six months of 2004. Income tax expense increased due to
increased taxable income primarily related to a limited partnership investment.
The effective tax rate also increased because of a decrease in tax exempt income
as a percentage of total income. It is anticipated that the Company's 2005
effective tax rate will increase 2-3% in the third quarter due to recent tax law
changes.
NON-PERFORMING ASSETS
The following table sets forth the amounts and categories of non-performing
assets in the Bank's portfolio at June 30, 2005 and December 31, 2004
June 30, December 31,
(Dollars in thousands) 2005 2004
- ---------------------------------------------------- --------- ------------
Non-Accruing Loans:
One-to-four family real estate $ 139 1,864
Commercial real estate 9,084 1,114
Consumer 438 472
Commercial business 511 261
--------- ------------
Total 10,172 3,711
--------- ------------
Accruing Loans Delinquent 90 Days or More:
One-to-four family real estate 1,154 628
Other assets 178 201
Foreclosed and Repossessed Assets:
One-to-four family real estate 790 141
Consumer 181 201
--------- ------------
Total non-performing assets $ 12,475 $ 4,882
========= ============
Total as a percentage of total assets 1.27% 0.51%
========= ============
Total non-performing loans $ 11,326 $ 4,339
========= ============
Total as a percentage of total loans receivable, net 1.38% 0.55%
========= ============
Allowance for loan loss to non-performing loans 90.26% 207.30%
========= ============
Total non-performing assets were $12.5 million at June 30,2005, an increase of
$7.6 million, from $4.9 million at December 31, 2004. During the first six
months of 2005, the following activity occurred related to non-performing
assets: $9.6 million of previously performing loans were classified as
non-performing, $1.2 million in non-performing loans were foreclosed or
repossessed, $341,000 in loans were charged off as a loss, $445,000 in
foreclosed assets were sold, and $1.3 million in loans were reclassified as
performing.
19
DIVIDENDS
On July 26, 2005 the Company declared a cash dividend of $0.24 per share,
payable on September 9, 2005 to shareholders of record on August 26, 2005.
The Company has declared and paid dividends during 2005 as follows:
Record date Pay date Dividend per share Dividend Payout Ratio
- ----------------- ------------- ------------------ ---------------------
February 18, 2005 March 7, 2005 $0.22 41.51%
May 20, 2005 June 8, 2005 $0.22 31.43%
The annualized dividend payout ratio for the past four quarters, ending with the
September 9, 2005 payment will be 36.14%.
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, tax considerations, industry standards,
economic conditions, regulatory restrictions, general business practices and
other factors.
LIQUIDITY
For the six months ended June 30, 2005 the net cash provided by operating
activities was $7.2 million. The Company collected $8.0 million from the
maturities of securities and $1.1 million from principal repayments on
securities. It purchased securities available for sale of $5.0 million and
premises and equipment of $726,000. Net loans receivable increased by $38.9
million due to increased commercial loan production. The Company had a net
increase in deposit balances of $21.6 million and received $48.5 million in FHLB
advance proceeds. It paid out $48.5 million on FHLB advances and $113,000 on
customer escrows. The Company received $25,000 related to the exercise of HMN
stock options, paid $1.7 million in dividends to its shareholders and paid
$972,000 to purchase treasury stock.
The Company has certificates of deposits with outstanding balances of $211.8
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 that 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 which mature beyond June 30,
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. The Company also has $10.0 million of FHLB advances that will
mature during the next 12 months. Since the Company has the ability to request
another advance to replace the advance that is being called or is maturing,
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 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
20
interest rate changes. The Company believes that over the next twelve months
interest rates could fluctuate in a range of 200 basis points up or 200 basis
points down from where the rates were at June 30, 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 June 30, 2005.
Other than trading portfolio Market Value
-------------------------------------------------
(Dollars in thousands)
Basis point change in interest rates -200 -100 0 +100 +200
- -------------------------------------------------------- --------- ------- ------- ------- -------
Total market risk sensitive assets...................... $ 993,653 988,035 980,905 970,487 958,779
Total market risk sensitive liabilities................. 902,949 886,824 872,129 857,486 846,061
Off-balance sheet financial instruments................. 328 181 0 526 1,004
--------- ------- ------- ------- -------
Net market risk......................................... $ 90,376 101,030 108,776 112,475 111,714
========= ======= ======= ======= =======
Percentage change from current market value............. (16.92)% (7.12)% 0.00% 3.40% 2.70%
========= ======= ======= ======= =======
The preceding table was prepared utilizing the following assumptions (the Model
Assumptions) regarding prepayment and decay ratios that 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 75%, 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 28%, depending on the note rate and the period to maturity.
Growing Equity Mortgage loans were assumed to prepay at annual rates of between
25% and 53% depending on the note rate and the period to maturity.
Mortgage-backed securities and Collateralized Mortgage Obligations (CMOs) were
projected to have prepayments based upon the underlying collateral securing the
instrument and the related cash flow priority of the CMO tranche owned.
Certificate accounts were assumed not to be withdrawn until maturity. Passbook
accounts were assumed to decay at an annual rate of 31% and money market
accounts were assumed to decay at an annual rate of 49%. 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 June
30, 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 41,365,000 9.13%
+100 39,860,000 5.16%
0 37,903,000 0.00%
- -100 35,222,000 (7.07)%
- -200 32,090,000 (15.34)%
21
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 sustained increase in interest
rates which 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 to
enhance net interest income than on matching the interest rate sensitivity of
its assets and liabilities. Management believes that the increased net interest
income resulting from a mismatch in the maturity of its asset and liability
portfolios can, in certain situations, provide high enough returns to justify
the increased exposure to sudden and unexpected changes 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 its 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
manage 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
control 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 control over financial reporting.
22
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 Plans
Period Purchased Paid per Share Programs or Programs
- ------------------------------ --------- ----------------- ------------------- -----------------------------
April 1 through April 30, 2005 0 $0.00 0 197,000
May 1 through May 31, 2005 0 0.00 0 197,000
June 1 through June 30, 2005 0 0.00 0 197,000
-- ----- --
Total 0 $0.00 0
== ===== ==
(1) On July 26, 2005 the Board of Directors extended the existing repurchase
program for 197,000 shares of the Company's common stock until February
25, 2007.
ITEM 3. Defaults Upon Senior Securities.
Not applicable.
ITEM 4. Submission of Matters to a Vote of Security Holders.
The Annual Meeting of Stockholders of the Company was held on April 26,
2005 at 10:00 a.m.
The following is a record of the votes cast in the election of directors
of the Company:
Term expiring in 2008:
For Withhold
--------- --------
Allan R. DeBoer 3,655,277 108,833
Timothy R. Geisler 3,691,331 72,779
Karen L. Himle 3,694,499 69,611
There were 0 broker non-votes and 0 abstentions for each of the directors.
Accordingly the individuals named above were duly elected directors of the
Company for terms to expire as stated above.
The following is a record of the votes cast in respect of the proposal to ratify
the appointment of KPMG LLP as the Company's independent auditors for the fiscal
year ending December 31, 2005.
23
NUMBER PERCENTAGE OF
OF VOTES VOTES ACTUALLY CAST
--------- -------------------
FOR 3,733,242 99.18%
AGAINST 15,635 0.41%
ABSTAIN 15,233 0.40%
BROKER NON-VOTE 0 0.00%
Accordingly, the proposal described above was declared to be duly adopted by the
stockholders of the Company.
ITEM 5. Other Information.
None.
ITEM 6. Exhibits.
See Index to Exhibits on page 26 of this report
24
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: August 4, 2005 By: /s/ Michael McNeil
Michael McNeil,
President
(Duly Authorized Officer and
Principal Executive Officer)
Date: August 4, 2005 By: /s/ Jon Eberle
Jon Eberle,
Chief Financial Officer
(Principal Financial Officer)
25
HMN FINANCIAL, INC.
INDEX TO EXHIBITS
FOR FORM 10-Q
Reference Sequential
to Prior Page Numbering
Filing or Where Attached
Exhibit Exhibits Are
Regulation S-K Number Located in This
Exhibit Number Document Attached Hereto Form 10-Q Report
3.1 Amended and Restated Articles of Incorporation *1 N/A
3.2 Amended and Restated By-laws *2 N/A
4 Form of Common Stock *3 N/A
Including indentures
31.1 Rule 13a-14(a)/15d-14(a) Certification of CEO 31.1 Filed electronically
31.2 Rule 13a-14(a)/15d-14(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 to 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).
26