UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
--------------------------
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
[NO FEE REQUIRED]
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
[NO FEE REQUIRED]
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 NO.)
101 NORTH BROADWAY, PO BOX 231 55975-0231
SPRING VALLEY, MINNESOTA (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (507) 346-1100
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, PAR VALUE $.01 PER SHARE
(TITLE OF CLASS)
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 twelve months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
requirements for the past 90 days. YES X NO
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K (Section 229.405 of this chapter) is not contained herein, and
will not be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. [X]
As of March 19, 1998, the Registrant had issued and outstanding 4,144,368
shares of the Registrant's Common Stock. The aggregate market value of the
voting stock held by non-affiliates of the Registrant as of March 19, 1998 was
$97.8 million. (The exclusion from such amount of the market value of the
shares owned by any person shall not be deemed an admission by the Registrant
that such person is an affiliate of the Registrant.)
DOCUMENTS INCORPORATED BY REFERENCE
Parts of the Registrant's Annual Report for the year ended December 31, 1997,
are incorporated by reference in Parts II and IV of this Form 10-K. Parts of
the Registrant's Proxy Statement dated March 30, 1998, are incorporated by
reference in Part III of this Form 10-K.
TABLE OF CONTENTS
PART I
PAGE
----
Item 1. Business . . . . . . . . . . . . . . . . . . . . . . 3
General . . . . . . . . . . . . . . . . . . . . . . 3
Lending Activities . . . . . . . . . . . . . . . . 4
Investment Activities . . . . . . . . . . . . . . 21
Sources of Funds . . . . . . . . . . . . . . . . 25
Other Information
Service Corporations . . . . . . . . . . . . . 29
Competition . . . . . . . . . . . . . . . . . 29
Employees . . . . . . . . . . . . . . . . . . 30
Executive Officers . . . . . . . . . . . . . . 30
Regulation . . . . . . . . . . . . . . . . . . . 30
Taxation . . . . . . . . . . . . . . . . . . . . 40
Item 2. Properties . . . . . . . . . . . . . . . . . . . . 42
Item 3. Legal Proceedings . . . . . . . . . . . . . . . . . 43
Item 4. Submission of Matters to a Vote of Security Holders 43
PART II
Item 5. Market for the Registrant's Common Stock and
Related Stockholder Matters . . . . . . . . . . . 43
Item 6. Selected Financial Data . . . . . . . . . . . . . . 43
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations . . . . . . . 43
Item 7A. Quantitative and Qualitative Disclosure About
Market Risk. . . . . . . . . . . . . . . . . . . . 43
Item 8. Financial Statements and Supplementary Data . . . . 44
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure . . . . . . . 44
PART III
Item 10. Directors and Executive Officers of the
Registrant . . . . . . . . . . . . . . . . . . . . 44
Item 11. Executive Compensation . . . . . . . . . . . . . . 44
Item 12. Security Ownership of Certain Beneficial Owners
and Management . . . . . . . . . . . . . . . . . . 44
Item 13. Certain Relationships and Related Transactions . . . 44
PART IV
Item 14. Exhibits, Financial Statement Schedules and
Reports on Form 8-K . . . . . . . . . . . . . . . 45
Signatures . . . . . . . . . . . . . . . . . . . . . . . . . 48
Index to Exhibits . . . . . . . . . . . . . . . . . . . . . . 49
2
PART I
ITEM 1. BUSINESS
GENERAL
HMN Financial, Inc. ("HMN" or the "Corporation"), was incorporated under
the laws of the State of Delaware in March 1994 for the purpose of becoming the
savings and loan holding company of Home Federal Savings Bank ("Home Federal" or
the "Bank") in connection with the Bank's conversion from a federally chartered
mutual savings bank to a federally chartered stock savings bank. Home Federal
has a community banking philosophy and operates retail banking facilities in
Minnesota and Iowa. The Bank has two wholly owned subsidiaries, Osterud
Insurance Agency, Inc. (OAI) and MSL Financial Corporation (MSL), which offer
financial planning products and services. HMN has two other wholly owned
subsidiaries, Security Finance Corporation (SFC) and HMN Mortgage Services, Inc.
(MSI). SFC invests in commercial loans and commercial real-estate loans located
throughout the United States which were originated by third parties. MSI
operates mortgage banking and mortgage brokerage facilities located in Eden
Prairie and Brooklyn Park, Minnesota.
On December 5, 1997 HMN, through its wholly owned subsidiary, the Bank,
completed its merger with Marshalltown Financial Corporation (MFC) pursuant
to a merger agreement dated July 1, 1997. Refer to Note 2 of the Notes to
Consolidated Financial Statements in the Annual Report for information on
assets acquired in the merger, HMN's Current Report on Form 8-K dated
December 5, 1997, filed on December 10, 1997 (file no. 0-24100) for a copy of
the merger agreement and HMN's Current Report on Form 8-K dated December 5,
1997, filed on February 11, 1998 (file no. 0-24100) for a copy of financial
statements of the acquired company and pro forma financial information.
As a community-oriented financial institution, HMN seeks to serve the
financial needs of communities in its market area. HMN's business involves
attracting deposits from the general public and using such deposits to originate
or purchase one-to-four family residential mortgage loans and, to a lesser
extent, consumer, construction, commercial real estate, commercial business and
multi-family loans. HMN also invests in mortgage-backed and related securities,
investment securities (consisting primarily of U.S. government and government
agency obligations) and other permissible investments. The executive offices of
HMN are located at 101 N. Broadway, PO Box 231, Spring Valley, Minnesota 55975-
0231. It's telephone number at that address is (507) 346-1100.
MARKET AREA
HMN serves the Minnesota counties of Fillmore, Freeborn, Houston, Mower,
Olmsted and Winona and portions of Steele, Dodge, Goodhue and Wabasha Counties,
Minnesota, through its main office located in Spring Valley, Minnesota and its
six branch offices located in Albert Lea, Austin, LaCrescent, Rochester and
Winona, Minnesota. The portion of HMN's market area consisting of Rochester and
the contiguous communities is composed of primarily urban and suburban
communities, while the balance of HMN's market area consists primarily of rural
areas and small towns. Primary industries in HMN's market area include
manufacturing, agriculture, health care, wholesale and retail trade, service
industries and education. Major employers include IBM, the Mayo Clinic, Hormel,
a food processing company, and various small industrial and other companies.
HMN's market area is also the home of Winona State University, Rochester
Community College, Austin Community College and several vocational/technical
schools.
HMN serves the Iowa counties of Marshall and Tama through its branch offices
located in Marshalltown and Toledo. Major industries in the area are Swift &
Company pork - processors, Fisher Controls Int. - valve and regulator
manufacturing, Lennox Industries - furnace and air conditioner manufacturing,
Iowa Veterans Home - hospital care, Marshall Community School District -
education, Marshall Medical & Surgical Center - hospital care and Meskwaki
Casino - gaming operation.
3
Based upon 1990 census information, the population of the six primary counties
in the Bank's market area was as follows: Fillmore - 20,800; Freeborn - 33,000;
Houston - 18,500; Mower - 37,300; Olmsted - 101,000; and Winona - 47,900. Based
upon 1990 U.S. Department of Commerce information, per capita income in these
six counties ranged from approximately $15,000 to $21,000.
Based upon 1990 census information, the population of Marshall County was
38,280 and the population of Tama County was 17,419. Based upon 1990 U.S.
Department of Commerce information, per capita income of the above mentioned
Iowa counties ranged from $11,300 to $12,800.
During the fourth quarter of 1996, HMN opened a mortgage banking office in
Edina, Minnesota which has subsequently moved to Eden Prairie. The office
primarily purchases loans from third party originators located in the seven
county metropolitan area of Minneapolis and St. Paul and sells the loans in the
secondary market or place the loans in HMN's loan portfolio. The new office
also purchases mortgage servicing rights from third parties for the purpose of
generating loan servicing income.
LENDING ACTIVITIES
GENERAL. Historically, the Bank originated 30-year, fixed-rate mortgage loans
secured by one-to-four family residences. Since 1979, in order to reduce its
vulnerability to changes in interest rates, the Bank has emphasized the
origination or purchase of mortgage loans having shorter terms to maturity or
repricing, such as 15-year, fixed-rate residential loans, Adjustable Rate
Mortgage loans ("ARMs") and Graduated Equity Mortgage loans ("GEMs"). Starting
in 1995 and throughout 1997 HMN offered a competitive home equity line of
credit. HMN also offers consumer loans and, to a lesser extent, construction,
commercial real estate, multi-family and commercial business loans. See "-
Originations, Purchases and Sales of Loans and Mortgage-Backed and Related
Securities."
4
LOAN PORTFOLIO COMPOSITION. The following information concerning the
composition of HMN's loan portfolio in dollar amounts and in percentages (before
deductions for loans in process, deferred fees and discounts and allowances for
losses) as of the dates indicated.
December 31,
-------------------------------------------------------------------------------------------------------
1997 1996 1995 1994 1993
------------------ ------------------ --------------------- ----------------- -----------------
(DOLLARS IN THOUSANDS) Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
-------- ------- -------- ------- ------- ------- -------- ------- -------- -------
REAL ESTATE LOANS:
One-to-four family . . . $395,668 87.58% $321,340 90.19% $292,497 90.62% $252,943 91.14% $233,009 92.18%
Multi-family . . . . . . 2,717 0.60 280 0.08 361 0.11 311 0.11 349 0.14
Commercial . . . . . . . 10,572 2.34 7,918 2.22 8,744 2.71 8,316 3.00 4,559 1.80
Construction or
development . . . . . 5,725 1.27 3,474 0.98 5,082 1.58 2,799 1.01 3,309 1.31
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Total real estate
loans . . . . . . . 414,682 91.79 333,012 93.47 306,684 95.02 264,369 95.26 241,226 95.43
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
OTHER LOANS:
Consumer loans:
Savings account . . . . 1,362 0.30 938 0.26 1,210 0.37 648 0.23 872 0.34
Education . . . . . . . 123 0.03 467 0.13 342 0.11 2,007 0.72 1,819 0.72
Automobile . . . . . . 2,438 0.54 566 0.16 671 0.21 520 0.19 681 0.27
Home equity line . . . 19,490 4.31 11,881 3.33 3,509 1.09 0 0.00 0 0.00
Home equity . . . . . . 7,176 1.59 5,927 1.67 7,997 2.47 7,716 2.78 5,604 2.22
Home improvement . . . 652 0.14 585 0.16 785 0.24 870 0.31 912 0.36
Other . . . . . . . . . 624 0.14 568 0.16 545 0.17 502 0.19 586 0.23
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Total consumer loans 31,865 7.05 20,932 5.87 15,059 4.66 12,263 4.42 10,474 4.14
Commercial business
loans . . . . . . . . 5,226 1.16 2,344 0.66 1,018 0.32 897 0.32 1,089 0.43
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Total other loans . . 37,091 8.21 23,276 6.53 16,077 4.98 13,160 4.74 11,563 4.57
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Total loans . . . 451,773 100.00% 356,288 100.00% 322,761 100.00% 277,529 100.00% 252,789 100.00%
------ ------ ------ ------ ------
------ ------ ------ ------ ------
LESS:
Loans in process . . . . 4,562 2,814 3,531 2,327 2,333
Unamortized discounts . 547 417 289 162 14
Net deferred loan fees . 1,847 1,695 1,899 2,147 2,507
Allowance for losses on
loans . . . . . . . . 2,748 2,340 2,191 1,893 1,489
-------- -------- -------- -------- --------
Total loans
receivable, net $442,069 $349,022 $314,851 $271,000 $246,446
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
5
The following table shows the composition of HMN's loan portfolio by
fixed and adjustable rate at the dates indicated.
December 31,
-------------------------------------------------------------------------------------------------
1997 1996 1995 1994 1993
---------------- ---------------- ---------------- ---------------- ----------------
(DOLLARS IN THOUSANDS) Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ ------- ------ ------- ------ -------
FIXED-RATE LOANS
Real estate:
One-to-four family
GEM . . . . . . . . . . . . $ 53,258 11.79% $ 48,831 13.71% $ 30,175 9.35% $ 24,769 8.93% $ 22,304 8.83%
Other . . . . . . . . . . . 256,263 56.72 187,519 52.63 181,401 56.20 168,272 60.63 171,503 67.84
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Total one-to-four family . 309,521 68.51 236,350 66.34 211,576 65.55 193,041 69.56 193,807 76.67
Multi-family . . . . . . . . 2,490 0.55 223 0.06 302 0.10 311 0.11 349 0.13
Commercial . . . . . . . . . 1,914 0.42 1,276 0.36 1,518 0.47 1,612 0.58 626 0.25
Construction or development . 3,180 0.71 2,970 0.83 4,848 1.50 1,008 0.37 2,800 1.11
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Total fixed-rate real
estate loans . . . . . . 317,105 70.19 240,819 67.59 218,244 67.62 195,972 70.62 197,582 78.16
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Consumer loans:
Savings . . . . . . . . . . . 1,362 0.30 938 0.26 1,210 0.37 648 0.23 872 0.34
Education . . . . . . . . . . 0 0.00 434 0.12 299 0.09 1,278 0.46 1,819 0.72
Automobile . . . . . . . . . 2,437 0.54 566 0.16 671 0.21 520 0.19 681 0.27
Home equity . . . . . . . . . 6,701 1.48 5,338 1.50 7,254 2.25 7,258 2.62 5,604 2.22
Home improvement . . . . . . 652 0.14 585 0.16 785 0.24 870 0.31 912 0.36
Other . . . . . . . . . . . . 612 0.14 568 0.16 545 0.17 502 0.18 586 0.23
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Total consumer loans . . . 11,764 2.60 8,429 2.36 10,764 3.33 11,076 3.99 10,474 4.14
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Commercial business loans . . 5,226 1.16 1,344 0.38 1,018 0.32 897 0.32 1,089 0.43
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Total other loans . . . . . 16,990 3.76 9,773 2.74 11,782 3.65 11,973 4.31 11,563 4.57
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Total fixed-rate loans . . 334,095 73.95 250,592 70.33 230,026 71.27 207,945 74.93 209,145 82.73
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
ADJUSTABLE-RATE LOANS
Real estate:
One-to-four family . . . . . 86,147 19.07 84,990 23.85 80,921 25.07 59,901 21.58 39,202 15.51
Multi-family . . . . . . . . 227 0.05 57 0.02 59 0.02 0 0.00 0 0.00
Commercial . . . . . . . . . 8,658 1.92 6,642 1.87 7,226 2.24 6,704 2.42 3,933 1.56
Construction or development . 2,545 0.56 504 0.14 234 0.07 1,792 0.64 509 0.20
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Total adjustable-rate real
estate loans . . . . . . 97,577 21.60 92,193 25.88 88,440 27.40 68,397 24.64 43,644 17.27
Consumer . . . . . . . . . . . 20,101 4.45 12,503 3.51 4,295 1.33 1,187 0.43 0 0.00
Commercial business loans . . 0 0.00 1,000 0.28 0 0.00 0 0.00 0 0.00
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Total adjustable-rate loans 117,678 26.05 105,696 29.67 92,735 28.73 69,584 25.07 43,644 17.27
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Total loans . . . . . . . . 451,773 100.00% 356,288 100.00% 322,761 100.00% 277,529 100.00% 252,789 100.00%
------ ------ ------ ------ ------
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
LESS
Loans in process . . . . . . . 4,562 2,814 3,531 2,327 2,333
Unamortized discounts . . . . 547 417 289 162 14
Net deferred loan fees . . . . 1,847 1,695 1,899 2,147 2,507
Allowance for losses on loans 2,748 2,340 2,191 1,893 1,489
-------- -------- -------- -------- --------
Total loans receivable, net $442,069 $349,022 $314,851 $271,000 $246,446
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
6
The following schedule illustrates the interest rate sensitivity of
HMN's loan portfolio at December 31, 1997. Loans which have adjustable or
renegotiable interest rates are shown as maturing in the period during which
the contract is due. Scheduled repayments of principal are reflected in the
year in which they are scheduled to be paid.
Real Estate
------------------------------------------------------
Multi-family and Commercial
One-to-four family Commercial Construction Consumer Business Total
------------------ ---------------- ---------------- ---------------- ----------------- ----------------
Weighted Weighted Weighted Weighted Weighted Weighted
Average Average Average Average Average Average
(DOLLARS IN Amount Rate Amount Rate Amount Rate Amount Rate Amount Rate Amount Rate
THOUSANDS) ------ -------- ------ -------- ------ -------- ------ -------- ------ -------- ------ --------
Due During
Years Ending
December 31,
------------
1998(1) . . . . . . $ 23,133 7.31% $ 738 7.66% $ 1,018 8.73% $ 4,102 8.95% $ 946 8.66% $29,937 7.63%
1999 . . . . . . . 23,470 7.24 1,004 7.95 46 7.91 2,065 8.74 908 8.46 27,493 7.42
2000 . . . . . . . 23,334 7.19 794 7.66 57 7.91 1,705 8.65 1,179 8.72 27,069 7.36
2001 and 2002 . . . 46,695 7.31 1,879 8.37 151 7.92 2,224 8.66 1,138 8.12 52,087 7.43
2003 to 2007 . . . 116,578 7.35 4,398 8.55 609 7.93 21,343 8.99 1,055 10.21 143,983 7.65
2008 to 2022 . . . 146,861 7.52 4,476 7.95 3,139 7.83 426 9.23 0 0.00 154,902 7.54
2023 and following. 15,597 7.46 0 0.00 705 8.08 0 0.00 0 0.00 16,302 7.49
-------- ------- ------- ------- ------ -------
$395,668 $13,289 $ 5,725 $31,865 $5,226 $451,773
-------- ------- ------- ------- ------ -------
-------- ------- ------- ------- ------ -------
- - --------------------
(1) Includes demand loans, loans having no stated maturity, overdraft loans
and education loans.
The total amount of loans due after December 31, 1999 which have
predetermined interest rates is $307.7 million, while the total amount of
loans due after such dates which have floating or adjustable interest rates
is $114.1 million. Construction or development loans for one-to-four family
dwellings totaled $3.3 million, multi-family totaled $1.0 million, and
non-residential totaled $1.4 million.
7
Under the Financial Institutions Reform, Recovery and Enforcement Act of
1989 ("FIRREA"), the aggregate amount of loans that the Bank is permitted to
make to any one borrower is generally limited to 15% of unimpaired capital
and surplus (25% if the security for such loan has a "readily ascertainable"
value or 30% for certain residential development loans). At December 31,
1997, based upon the 15% limitation, the Bank's regulatory loans-to-one
borrower limit was approximately $9.2 million. On the same date, the Bank
had no borrowers with outstanding balances in excess of this amount. At
December 31, 1997, the largest dollar amount outstanding to one borrower or
group of related borrowers was $960,000. This loan, which is secured by a
commercial office building in Des Moines, was performing in accordance with
its terms at December 31, 1997.
The Bank's Loan Committee is responsible for review and approval of all
loans over the FHLMC/FNMA conforming loan dollar limits (the Limit)
originated by the Bank. At December 31, 1997 the Limit was $214,600. Approval
of one member of the Loan Committee is required on all loans ranging from the
Limit to $500,000. Loans greater than $500,000 must be approved by the Board
of Directors of the Bank or its Executive Committee after review and
preliminary approval by the Loan Committee. All loans closed each month are
reviewed by the Board of Directors at the monthly meeting.
Under the Bank's loan policy, the loan officer processing an application
is responsible for ensuring that all documentation is obtained prior to the
submission of the application to the Loan Committee. In addition, the loan
officer verifies that the application meets the Bank's underwriting
guidelines described below. Also, each application is assigned to a
reviewing officer who reviews the file to assure its accuracy and
completeness. The Branch Manager or the designated underwriter has the
authority to approve all conforming loans up to the Limit.
All of the Bank's lending is subject to its written underwriting
standards and to loan origination procedures. Decisions on loan applications
are made on the basis of detailed applications and property valuations
(consistent with the Bank's appraisal policy) by the Bank's staff appraiser
or an independent appraiser. The loan applications are designed primarily to
determine the borrower's ability to repay. The more significant items on the
application are verified through use of credit reports, financial statements,
tax returns and/or confirmations. During 1997 the Bank introduced the Home
Credit Plus Program which relies on the credit score of the loan applicant
instead of income, asset and employment verification procedures. The Bank
also offers low or alternative documentation underwriting procedures which
conform to FNMA underwriting guidelines.
Generally, the Bank requires title insurance on its mortgage loans as
well as fire and extended coverage casualty insurance in amounts at least
equal to the principal amount of the loan or the value of improvements on the
property, depending on the type of loan. The Bank also requires flood
insurance to protect the property securing its interest when the property is
located in a flood plain.
ONE-TO-FOUR FAMILY RESIDENTIAL REAL ESTATE LENDING. The cornerstone of
HMN's lending program is the origination of loans secured by mortgages on
owner-occupied one-to-four family residences. At December 31, 1997, $395.7
million, or 87.58% of HMN's loan portfolio consisted of mortgage loans on
one-to-four family residences. At December 31, 1997, $282.7 million of the
residential loan portfolio was secured by properties located in HMN's market
area. HMN had $120.0 million of purchased one-to-four family loans in its
portfolio which were secured by properties located outside of its market area
(primarily located in the Midwestern United States or the Southeastern United
States). On December 5, 1997 the Bank merged with Marshalltown Financial
Corporation ("MFC"). The Loan Portfolio Composition table includes for
December 31, 1997 $62.9 million of one-to-four family residential loans, $2.3
of multi-family residential, $2.1 million of commercial real estate and $2.6
million of consumer loans which were acquired in the MFC merger.
8
Prior to 1979, the Bank originated for retention in its own portfolio
30-year fixed-rate loans secured by one-to-four family residential real
estate. Beginning in 1979, the Bank began to emphasize the origination of
fixed-rate loans with terms of 15 years or less for retention in its
portfolio. In addition, in 1982, the Bank began to originate ARMs, subject
to market conditions and consumer preference. Subsequently, the Bank also
began to emphasize GEM originations. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Asset/Liability
Management" in the Annual Report attached as Exhibit 13 hereto (the "Annual
Report").
HMN currently offers conventional fixed-rate loans with maximum terms of
up to 30 years although HMN generally sells originations of loans with terms
to maturity of 30 years. The interest rate on such loans is generally set
based on the FHLMC delivery rates, as well as, other competitive factors.
At December 31, 1997, HMN had $256.3 million of fixed-rate one-to-four family
loans (excluding GEM loans) or 56.72% of HMN's total loan portfolio with a
weighted average contractual term to maturity of 13.5 years.
HMN also offers one-year ARMs at a margin (generally 275 basis points)
over the yield on the Average Monthly One Year U.S. Treasury Constant
Maturity Index for terms of up to 30 years. The ARM loans currently offered
by HMN allow the borrower to select (subject to pricing) an initial period of
one year, three years, or five years between the loan origination and when
the first interest rate change occurs. Generally the ARMs provide for an up
to 200 basis point annual interest rate change cap and a lifetime cap
generally 600 basis points over or under the initial rate. Initial interest
rates offered on the ARM loans during 1997 ranged from 72 to 188 basis points
below the fully indexed loan rate. All borrowers are now qualified for the
loan at the fully indexed rate. See "-Delinquencies and Non-Performing
Assets." In the past, the Bank offered one-year ARMs with a margin of 200 to
235 basis points over a specified index and an average annual cap of 145
basis points. At December 31, 1997, one-to-four family ARMs totaled $86.1
million, or 19.07% of HMN's total loan portfolio.
HMN's originated ARMs do not permit negative amortization of principal,
do not contain prepayment penalties and generally are not convertible into
fixed-rate loans. HMN has $2.7 million of ARM loans purchased from a third
party which are convertible at borrower's option into fixed-rate loans. It
has an agreement with the third party to repurchase the ARM loans which
convert to fixed rates at a stipulated price.
The GEM loans carry required payments which increase after the first
year. Under the GEM loans, the monthly payments required for the first year
are established based on a 30-year amortization schedule. Depending upon the
program selected, the payments may increase in the succeeding years by
amounts ranging from 0% to 5%. Most of the GEM loans originated by HMN
provide for at least three annual payment increases over the first five years
of the loan. The increased payments required under GEM loans are applied to
principal and have the effect of shortening the term to maturity; the GEM
loans do not permit negative amortization. HMN currently offers two GEM
programs, one with a contractual maturity of approximately 17 years and one
with a contractual maturity of approximately 22 years. The GEMs are
generally priced based upon loans with similar contractual maturities. The
GEMs have been popular with consumers who anticipate future increases in
income and who desire an amortization schedule of less than 30 years. HMN
believes that GEMs may increase in popularity in the future if interest rates
rise and consumers are less easily able to afford the higher monthly payments
required by 15-year, fixed-rate loans.
HMN has also originated a limited number of fixed-rate loans with terms
up to 30 years which are insured by the Federal Housing Authority ("FHA"),
Veterans Administration ("VA") and Minnesota Home Finance Administration
("MHFA").
In underwriting one-to-four family residential real estate loans, HMN
evaluates both the borrower's ability to make principal, interest and escrow
payments, the value of the property that will secure the loan and debt to
income ratios. Properties securing one-to-four family residential real
estate loans made by HMN are appraised by independent fee appraisers or by
HMN's staff appraiser. HMN originates residential mortgage
9
loans with loan-to-value ratios of up to 95% for owner-occupied homes and up
to 70% for non-owner occupied homes; however, private mortgage insurance is
required to reduce HMN's exposure to 80% or less. HMN generally seeks to
underwrite its loans in accordance with secondary market standards.
HMN's residential mortgage loans customarily include due-on-sale clauses
giving it the right to declare the loan immediately due and payable in the
event that, among other things, the borrower sells or otherwise disposes of
the property subject to the mortgage and the loan is not repaid.
CONSTRUCTION LENDING. HMN makes construction loans to individuals for
the construction of their residences, and to a much lesser extent, to
builders for the construction of one-to-four family residences. It also
makes a very limited number of loans to builders for houses built on
speculation. The loan policy limits the total amount of construction loans
outstanding at one time to 2.0% of assets. At December 31, 1997, HMN had
$5.7 million of construction loans outstanding representing 1.3% of HMN's
total loan portfolio.
Almost all loans to individuals for the construction of their residences
are structured as permanent loans. Such loans are made on the same terms as
residential loans, except that during the construction phase, which typically
lasts up to seven months, the borrower pays interest only. The borrower also
pays a construction fee up to $800 at the time of origination. Residential
construction loans are underwritten pursuant to the same guidelines used for
originating residential loans on existing properties.
Construction loans to builders or developers of one-to-four family
residences generally carry terms of up to 15 years with a construction phase
of up to seven months. Such loans generally do not permit the payment of
interest from loan proceeds. At December 31, 1997, HMN had no construction
loans to builders or developers.
Construction loans to owner occupants are generally made in amounts of
up to 95% of the lesser of cost or appraised value, but no more than 85% of
the loan proceeds can be disbursed until the building is completed. The
loan-to-value ratios on loans to builders are limited to 70%. Prior to
making a commitment to fund a construction loan, HMN requires an appraisal of
the property and financial data and verification of income on the borrower.
It generally obtains personal guarantees for substantially all of its
construction loans to builders. Personal financial statements of guarantors
are also obtained as part of the loan underwriting process. All construction
loans have been located in HMN's market area.
Construction loans are obtained principally through continued business
from builders and developers who have previously borrowed from the Bank, as
well as referrals from existing customers and walk-in customers. The
application process includes a submission to the Bank of accurate plans,
specifications and costs of the project to be constructed. These items are
used as a basis to determine the appraised value of the subject property.
The nature of construction loans is such that they are more difficult to
evaluate and monitor. The risk of loss on a construction loan is dependent
largely upon the accuracy of the initial estimate of the property's value
upon completion of the project and the estimated cost (including interest) of
the project. If the estimate of value proves to be inaccurate, HMN may be
confronted, at or prior to the maturity of the loan, with a project having a
value which is insufficient to assure full repayment and/or the possibility
of having to make substantial investments to complete and sell the project.
Because defaults in repayment may not occur during the construction period it
may be difficult to identify problem loans at an early stage. In such cases,
HMN may be required to modify the terms of the loan.
COMMERCIAL REAL ESTATE AND MULTI-FAMILY LENDING. HMN originates
permanent commercial real estate and multi-family loans secured by properties
located in its market area. It also purchases commercial real estate loans
outside of its market area that are guaranteed by the Small Business
Administration ("SBA") or originated by other third parties. At December 31,
1997, HMN had $10.6 million in commercial real
10
estate loans, representing 2.3% of HMN's total loan portfolio, and $2.7
million in multi-family loans, or 0.6% of its total loan portfolio.
The commercial real estate and multi-family loan portfolio includes
loans secured by motels, apartment buildings, churches, small office
buildings, small business facilities, nursing homes and other non-residential
building properties primarily located in Minnesota or Iowa.
Permanent commercial real estate and multi-family loans are generally
originated for a maximum term of 15 years and generally have adjustable
interest rates. Prior to 1995 commercial real estate and multi-family loans
could have either a fixed interest rate or an adjustable interest rate.
Commercial real estate and multi-family loans are written in amounts of up to
70% of the lesser of the appraised value of the property or the purchase
price and must have a debt service coverage ratio of at least 125%. The debt
service coverage is the ratio of net cash from operations before payment of
debt to debt service. HMN does not originate construction loans secured by
commercial or multi-family real estate, but may purchase participation
interests in third party originated construction loans secured by commercial
or multi-family real estate.
Appraisals on properties serving commercial real estate and multi-family
loans originated by HMN are performed by independent appraisers prior to the
time the loan is made. Generally all appraisals on commercial and
multi-family real estate are reviewed by a member of the Bank's Loan
Committee. The Bank's underwriting procedures require verification of the
borrower's credit history, income and financial statements, banking
relationships, references and income projections for the property. It also
requires personal guarantees from the borrowers. In addition, HMN performs
an annual on-site inspection on collateral properties for loans with balances
in excess of $250,000.
At December 31, 1997, HMN's two largest commercial real estate loans
totaled $960,000 and $882,000. The first loan is secured by a commercial
office building located in Des Moines, Iowa and the second loan is secured by
a motel located in Rochester, Minnesota near the Mayo Clinic. Both of these
loans were performing at December 31, 1997.
Multi-family and commercial real estate loans generally present a higher
level of risk than loans secured by one-to-four family residences. This
greater risk is due to several factors, including the concentration of
principal in a limited number of loans and borrowers, the effects of general
economic conditions on income producing properties and the increased
difficulty of evaluating and monitoring these types of loans. Furthermore,
the repayment of loans secured by multi-family and commercial real estate is
typically dependent upon the successful operation of the related real estate
project. If the cash flow from the project is reduced (for example, if
leases are not obtained or renewed), the borrower's ability to repay the loan
may be impaired. At December 31, 1997, HMN had one commercial real estate
loan totaling $79,000 and no multi-family loans which were 90 days or more
delinquent.
CONSUMER LENDING. HMN originates a variety of different types of
consumer loans, including home equity loans (open-end and closed-end),
education, automobile, home improvement, deposit account and other loans for
household and personal purposes. At December 31, 1997, consumer loans
totaled $31.9 million, or 7.05% of total loans outstanding.
Consumer loan terms vary according to the type and value of collateral,
length of contract and creditworthiness of the borrower. HMN's consumer
loans are made at fixed and adjustable interest rates, with terms of up to 20
years for secured loans and up to three years for unsecured loans.
HMN's home equity loans are written so that the total commitment amount,
when combined with the balance of any other outstanding mortgage liens, may
not exceed 90% of the appraised value of the property. The closed-end home
equity loans are written with fixed or adjustable rates with terms of up to
15 years. The open-end home equity lines are written with an adjustable rate
with terms of up to 20 years, a 10 year
11
draw period which requires "interest only" payments and a 10 year repayment
period which fully amortizes the outstanding balance. The consumer may access
the open-end home equity line either by making a withdrawal at the Bank or
writing a check on the home equity line of credit account. At December 31,
1997, HMN's home equity loans totaled $7.2 million, or 1.6% of the total loan
portfolio and the home equity lines totaled $19.5 million, or 4.3% of the
total loan portfolio.
The underwriting standards employed by the Bank for consumer loans
include a determination of the applicant's payment history on other debts and
ability to meet existing obligations and payments on the proposed loan.
Although creditworthiness of the applicant is of primary consideration, the
underwriting process also includes a comparison of the value of the security,
if any, in relation to the proposed loan amount. Consumer loans may entail
greater credit risk than do residential mortgage loans, particularly in the
case of consumer loans which are unsecured or are secured by rapidly
depreciable assets, such as automobiles. In such cases, any repossessed
collateral for a defaulted consumer loan may not provide an adequate source
of repayment of the outstanding loan balance as a result of the greater
likelihood of damage, loss or depreciation. In addition, consumer loan
collections are dependent on the borrower's continuing financial stability,
and thus are more likely to be affected by adverse personal circumstances.
Furthermore, the application of various federal and state laws, including
bankruptcy and insolvency laws, may limit the amount which can be recovered
on such loans. At December 31, 1997, $44,000 of the consumer loan portfolio
was non-performing. There can be no assurance that delinquencies will not
increase in the future.
COMMERCIAL BUSINESS LENDING. In order to satisfy the demand for
financial services available to individuals and businesses in its market
area, HMN has maintained a portfolio of commercial business loans primarily
to small retail operations, small manufacturing concerns and professional
firms. Most of HMN's commercial business loans have terms ranging from six
months to five years and carry fixed interest rates. HMN's commercial
business loans generally include personal guarantees and are usually, but not
always, secured by business assets such as inventory, equipment, fixtures,
real estate and accounts receivables. The underwriting process for commercial
business loans includes consideration of the borrower's financial statements,
tax returns, projections of future business operations and inspection of the
subject collateral, if any. HMN has also purchased participation interests
in commercial business loans from third party originators. The underlying
collateral for the loans are generally equipment and generally have repayment
periods of less than ten years. At December 31, 1997, HMN had $5.2 million of
commercial business loans outstanding, or 1.3% of the total loan portfolio.
In addition, on that date, HMN had $20,000 of letters of credit outstanding.
Unlike residential mortgage loans, which generally are made on the basis
of the borrower's ability to make repayment from his or her employment and
other income, and which are secured by real property whose value tends to be
more easily ascertainable, commercial business loans are of higher risk and
typically are made on the basis of the borrower's ability to make repayment
from the cash flow of the borrower's business. As a result, the availability
of funds for the repayment of commercial business loans may be substantially
dependent on the success of the business itself. Further, the collateral
securing the loans may depreciate over time, may be difficult to appraise and
may fluctuate in value based on the success of the business. At December 31,
1997, there were no delinquent commercial business loans.
12
ORIGINATIONS, PURCHASES AND SALES OF LOANS AND MORTGAGE-BACKED AND RELATED
SECURITIES
Real estate loans are generally originated by HMN's staff of salaried
and commissioned loan officers. Loan applications are taken and processed in
all branch offices.
While HMN originates both fixed and adjustable-rate loans, its ability
to originate loans is dependent upon the relative customer demand for loans
in its market. Demand is affected by the interest rate environment. During
the last several years, the dollar volume of conventional fixed-rate,
one-to-four family loans has exceeded the dollar volume of GEMs and ARMs.
Currently, substantially all residential mortgage loans originated by the
Bank are retained in the loan portfolio except 30 year fixed rate loans.
In order to supplement loan demand in HMN's market area and
geographically diversify its loan portfolio, HMN purchases real estate loans
from selected sellers, with yields based upon current market rates. HMN
carefully reviews and underwrites all loans to be purchased to ensure that
they meet HMN's underwriting standards. The seller generally continues to
service these purchased loans. During 1997, HMN originated $70.3 million of
real estate and consumer loans and it purchased $67.2 million of single
family residential loans originated outside of its market area. The majority
of the purchased loans have interest rates that are fixed for a one, three or
five year period and then adjust annually thereafter or were 15 year fixed
rate loans. All purchased loans are reviewed to determine that each loan
meets certain underwriting requirements. Refer to Note 5 of the Notes to
Consolidated Financial Statements in the Annual Report for more information
on purchased loans.
HMN has substantial holdings of mortgage-backed and related securities
which are held, depending on the investment intent, in the "available for
sale" portfolio. During 1997, HMN purchased $3.4 million of mortgaged-backed
securities and $24.0 million of mortgage-related securities, primarily CMOs.
See "- Investment Activities." During the same period, HMN sold $67.9
million of mortgage-backed and related securities.
13
The following table shows the loan and mortgage-backed and related
securities origination, purchase, sale and repayment activities of HMN for the
periods indicated.
Year Ended December 31,
(DOLLARS IN THOUSANDS)
LOANS 1997 1996 1995
-------------------------
ORIGINATIONS BY TYPE:
Adjustable-rate:
Real estate - one-to-four family . . . . . . . . $ 1,987 5,441 2,117
- multi-family . . . . . . . . . . . 0 0 58
- commercial . . . . . . . . . . . . 1,000 0 0
- construction or development . . . 375 916 691
Non-real estate - consumer . . . . . . . . . . . 16,871 12,012 4,575
--------- ------ ------
Total adjustable-rate . . . . . . . . . . 20,233 18,369 7,441
--------- ------ ------
Fixed-rate:
Real estate - one-to-four family . . . . . . . . 32,024 27,036 23,565
- multi-family . . . . . . . . . . . 263 145 0
- commercial . . . . . . . . . . . . 50 30 150
- construction or development . . . 6,539 6,181 4,847
Non-real estate - consumer . . . . . . . . . . . 7,579 4,583 7,267
- commercial business . . . . . 1,409 430 610
--------- ------ ------
Total fixed-rate . . . . . . . . . . . . . 47,864 38,405 36,439
--------- ------ ------
Total loans originated . . . . . . . . . . 68,097 56,774 43,880
--------- ------ ------
Purchases:
Real estate - one-to-four family . . . . . . . . 67,213 55,839 47,136
Commercial real estate guaranteed by SBA . . . . 0 0 946
Construction or development . . . . . . . . . . 2,425 0 0
Non-real estate - commercial business . . . . . 2,174 1,500 0
--------- ------ ------
Total purchased . . . . . . . . . . . . . 71,812 57,339 48,082
ACQUISITION:
Real estate - one-to-four family . . . . . . . . 63,328 0 0
- multi-family . . . . . . . . . . . 2,308 0 0
- commercial . . . . . . . . . . . . 2,099 0 0
Non-real estate - consumer . . . . . . . . . . . 2,599 0 0
--------- ------ ------
Total loans acquired . . . . . . . . . . . 70,334 0 0
TRANSFERS FROM LOANS HELD FOR SALE . . . . . . . . 96 0 0
SALES AND REPAYMENTS:
Real estate - one-to-four family . . . . . . . . 8,969 2,310 2,414
Non-real estate - consumer . . . . . . . . . . . 339 176 1,791
--------- ------ ------
Total sales . . . . . . . . . . . . . . . 9,308 2,486 4,205
Loans securitized and transferred to securities 16,526 15,441 0
Transfers to loans held for sale . . . . . . . . 21,211 1,407 0
Principal repayments . . . . . . . . . . . . . . 64,846 58,262 39,215
--------- ------ ------
Total reductions . . . . . . . . . . . . . 111,891 77,596 43,420
--------- ------ ------
Increase (decrease) in other items, net . . . . (2,963) (2,990) (3,310)
--------- ------ ------
Net increase . . . . . . . . . . . . . . . $ 95,485 33,527 45,232
--------- ------ ------
--------- ------ ------
MORTGAGE-BACKED AND RELATED SECURITIES
Loans securitized and transferred to $ 16,526 15,441 0
securities . . . . . . . . . . . . . . . .
PURCHASES:
Mortgage-backed securities:(1)
Adjustable-rate . . . . . . . . . . . . . . . . 0 0 0
Fixed-rate . . . . . . . . . . . . . . . . . . 3,426 7,266 10,139
CMOs and REMICs:
Adjustable-rate . . . . . . . . . . . . . . . . 3,417 6,527 55,321
Fixed-rate . . . . . . . . . . . . . . . . . . 20,617 43,831 11,881
--------- ------ ------
Total purchases . . . . . . . . . . . . . . 27,460 57,624 77,341
--------- ------ ------
ACQUISITION:
Adjustable rate . . . . . . . . . . . . . . . . 12,522 0 0
Fixed rate . . . . . . . . . . . . . . . . . . . 25,738 0 0
--------- ----- ------
Total acquisitions . . . . . . . . . . . . 38,260 0 0
--------- ------ ------
14
SALES:
Mortgage-backed securities:(1)
Adjustable-rate . . . . . . . . . . . . . . . . 9,535 0 23,073
Fixed-rate . . . . . . . . . . . . . . . . . . 344 24,786 11,953
CMOs and REMICs:
Adjustable-rate . . . . . . . . . . . . . . . . 26,486 23,876 9,008
Fixed-rate . . . . . . . . . . . . . . . . . . 31,529 32,487 13,681
--------- ------ ------
Total sales . . . . . . . . . . . . . . . . 67,894 81,149 57,715
--------- ------ ------
PRINCIPAL REPAYMENTS:
Decrease in other items, net . . . . . . . . . . 13,578 28,915 4,440
--------- ------ ------
Net increase (decrease) . . . . . . . . . . . $ 774 (36,999) 15,186
--------- ------ ------
--------- ------ ------
- - -------------------
(1) Consists of pass-through securities.
15
DELINQUENCIES AND NON-PERFORMING ASSETS
DELINQUENCY PROCEDURES. When a borrower fails to make a required
payment on a loan, HMN attempts to cure the delinquency by contacting the
borrower. A late notice is sent on all loans over 16 days delinquent.
Additional written and verbal contacts may be made with the borrower between
30 and 60 days after the due date. If the loan is contractually delinquent
90 days, HMN usually sends a 30-day demand letter to the borrower and, after
the loan is contractually delinquent 120 days, institutes appropriate action
to foreclose on the property. If foreclosed, the property is sold at a
sheriff's sale and may be purchased by HMN. Delinquent consumer loans are
generally handled in a similar manner. HMN's procedures for repossession and
sale of consumer collateral are subject to various requirements under state
consumer protection laws.
Real estate acquired by HMN as a result of foreclosure or by deed in
lieu of foreclosure is classified as real estate in judgement for six months
to one year and thereafter as real estate owned until it is sold. When
property is acquired or expected to be acquired by foreclosure or deed in
lieu of foreclosure, it is recorded at the lower of cost or estimated fair
value, less the estimated cost of disposition. After acquisition, all costs
incurred in maintaining the property are expensed. Costs relating to the
development and improvement of the property, however, are capitalized to the
extent of fair value less disposition cost.
The following table sets forth HMN's loan delinquencies by type, by
amount and by percentage of type at December 31, 1997.
Loans Delinquent For:
------------------------------------------------------------------- Total Delinquent
60-89 Days 90 Days and Over Loans
------------------------------ ------------------------------- ----------------------------
Percent Percent Percent
of Loan of Loan of Loan
(DOLLARS IN THOUSANDS) Number Amount Category Number Amount Category Number Amount Category
------ ------ -------- ------ ------ -------- ------ ------ --------
One-to-four family
real estate . . . . 5 $ 412 0.10 % 8 $ 541 0.14% 13 $ 953 0.24%
Multi-family . . . . 0 0 0.00 0 0 0.00 0 0 0.00
Commercial . . . . . 0 0 0.00 1 79 0.75 1 79 0.75
Construction or
development . . . . 0 0 0.00 0 0 0.00 0 0 0.00
Consumer . . . . . . 3 26 0.08 6 45 0.14 9 71 0.22
Commercial
business . . . . . . 0 0 0.00 0 0 0.00 0 0 0.00
--- ----- --- ----- --- ------
Total . . . . . . 8 $ 438 0.10 % 15 $ 665 0.15% 23 $1,103 0.24%
--- ----- --- ----- --- ------
--- ----- --- ----- --- ------
CLASSIFICATION OF ASSETS. Federal regulations require that each savings
institution classify its own assets on a regular basis. In addition, in
connection with examinations of savings institutions, OTS and FDIC examiners
have authority to identify problem assets and, if appropriate, require them
to be classified. There are three classifications for problem assets:
Substandard, Doubtful and Loss. Substandard assets have one or more defined
weaknesses and are characterized by the distinct possibility that the Bank
will sustain some loss if the deficiencies are not corrected. Doubtful
assets have the weaknesses of Substandard assets, with the additional
characteristics that the weaknesses make collection or liquidation in full on
the basis of currently existing facts, conditions and values questionable,
and there is a high possibility of loss. An asset classified as Loss is
considered uncollectible and of such little value that continuance as an
asset on the balance sheet of the institution is not warranted. Assets
classified as Substandard or Doubtful require the institution to establish
prudent general allowances for loan losses. If an asset or portion thereof is
classified as Loss, the institution must either establish specific allowances
for loan losses in the amount of 100% of the portion of the asset classified
as Loss, or charge off such amount. If an institution does not agree with an
examiner's classification of an asset, it may appeal this determination to
the District Director of the OTS. On the basis of management's review of its
assets, at December 31, 1997, the Bank had classified a total of $901,000 of
its loans and other assets as follows:
16
One-to- Commercial Real
(DOLLARS IN Four Construction or Estate and Commercial
THOUSANDS) Family Development Multi-Family Consumer Business
------- --------------- ---------------- -------- ----------
Substandard . . . . . $ 722 0 79 53 45
Doubtful . . . . . . 0 0 0 0 0
Loss . . . . . . . . 0 0 0 2 0
--- --- --- --- ---
Total . . . . . . $ 722 0 79 55 45
--- --- --- --- ---
--- --- --- --- ---
The Bank's classified assets consist of the non-performing loans and
loans and other assets of concern discussed herein. As of the date hereof,
these asset classifications are materially consistent with those of the OTS
and FDIC.
NON-PERFORMING ASSETS. Loans are reviewed quarterly and any loan
whose collectibility is doubtful is placed on non-accrual status. Loans are
placed on nonaccrual status when either principal or interest is 90 days or
more past due, unless, in the judgment of management, the loan is well
collateralized and in the process of collection. Interest accrued and unpaid
at the time a loan is placed on non-accrual status is charged against
interest income. Subsequent payments are either applied to the outstanding
principal balance or recorded as interest income, depending on the assessment
of the ultimate collectibility of the loan. Restructured loans include the
Bank's troubled debt restructurings (which involved forgiving a portion of
interest or principal on any loans or making loans at a rate materially less
than the market rate). Foreclosed assets include assets acquired in
settlement of loans. The following table sets forth the amounts and
categories of non-performing assets in the Bank's portfolio.
December 31,
-------------------------------------------
(DOLLARS IN THOUSANDS) 1997 1996 1995 1994 1993
------ ------ ------ ------ ------
Non-accruing loans:
Real estate:
One-to-four family . . . . . $ 177 235 196 178 80
Multi-family . . . . . . . . 0 0 0 0 0
Commercial real estate . . . 79 83 85 0 0
Consumer . . . . . . . . . . 7 7 32 57 58
Commercial business . . . . 0 13 128 0
--- --- --- --- ---
Total . . . . . . . . . . 263 338 441 235 138
--- --- --- --- ---
Accruing loans delinquent 90
One-to-four family . . . . . 365 0 0 0 23
Consumer . . . . . . . . . . 37 0 0 0 0
--- --- --- --- ---
Total . . . . . . . . . . 402 0 0 0 23
--- --- --- --- ---
Restructured loans:
Multi-family . . . . . . . . 0 0 94 199 0
Foreclosed assets:
Real estate:
One-to-four family . . . . . 142 23 315 64 316
Commercial real estate . . . 0 0 0 0 95
Construction or development 0 0 0 0 0
Consumer . . . . . . . . . . 0 0 0 0 10
--- --- --- --- ---
Total . . . . . . . . . . 142 23 315 64 421
--- --- --- --- ---
Total non-performing assets . . $ 807 361 850 498 582
--- --- --- --- ---
--- --- --- --- ---
Total as a percentage of total
assets . . . . . . . . . . . . 0.12 % 0.07 % 0.16 % 0.10 % 0.14%
---- ---- ---- ---- ----
---- ---- ---- ---- ----
Total non-performing loans . . $ 665 $ 338 $ 535 $ 434 $ 161
---- ---- ---- ---- ----
---- ---- ---- ---- ----
Total as a percentage of total
loans receivable, net . . . . 0.15 % 0.10 % 0.17 % 0.16 % 0.07%
---- ---- ---- ---- ----
---- ---- ---- ---- ----
17
For the year ended December 31, 1997, gross interest income which would
have been recorded had the non-accruing loans been current in accordance with
their original terms amounted to $27,690. The amounts that were included in
interest income on such loans during 1997 were $14,444.
Total non-performing assets were $807,000 at December 31, 1997, an
increase of $446,000, compared to $361,000 at December 31, 1996. The
increase in non-performing assets is primarily the result of three
one-to-four family purchased loans totaling $365,000 that are behind on their
payments by more than 90 days and the foreclosure of two one-to-four family
mortgages totaling $142,000. The decrease in the non-accruing loans is the
result of the normal inflow and outflow of delinquent loans caused by
borrowers getting behind on their payments and then bringing the loans
current again.
Total non-performing assets were $361,000 at December 31, 1996, a
decrease of $489,000, compared to $850,000 at December 31, 1995. The
decrease in non-performing assets is the result of the sale of foreclosed
assets of $315,000, the charge-off of $72,000 of commercial loans, and the
normal inflow and outflow of delinquent loans caused by borrowers getting
behind on their payments and then bringing the loans current again.
OTHER LOANS OF CONCERN. In addition to the non-performing assets set
forth in the table above, as of December 31, 1997 there were $94,000 of loans
with respect to which known information about the possible credit problems of
the borrowers or the cash flows of the secured properties have caused
management to have concerns as to the ability of the borrowers to comply with
present loan repayment terms and which may result in the future inclusion of
such items in the non-performing asset categories.
Management has considered the Bank's non-performing and "of concern"
assets in establishing its allowance for loan losses.
18
ALLOWANCE FOR LOSSES ON LOANS. The following table sets forth an
analysis of the Bank's allowance for loan losses for the year ended:
(DOLLARS IN THOUSANDS) 1997 1996 1995 1994 1993
------ ------ ------ ------ ------
Balance at beginning of year . . . $2,341 2,191 1,893 1,489 831
MFC allowance for losses acquired . 122 0 0 0 0
CHARGE-OFFS
Real estate:
One-to-four family . . . . . . . (4) 0 (1) (6) (1)
Multi-family . . . . . . . . . . 0 (88) 0 0 0
Consumer . . . . . . . . . . . . (7) (1) 0 0 (1)
Commercial business . . . . . . . (12) (61) (1) 0 0
------ ------ ------ ------ ------
(23) (150) (2) (6) (2)
------ ------ ------ ------ ------
RECOVERIES
Real estate:
Commercial business . . . . . . . 8 0 0 0 0
------ ------ ------ ------ ------
8 0 0 0 0
Net charge-offs . . . . . . . . . . (15) (150) (2) (6) (2)
Additions charged to operations . . 300 300 300 410 660
------ ------ ------ ------ ------
Balance at end of year . . . . . . $2,748 2,341 2,191 1,893 1,489
------ ------ ------ ------ ------
------ ------ ------ ------ ------
Ratio of net charge-offs during the
year to average loans outstanding
during the year . . . . . . . . . . 0.01% 0.05% 0.00% 0.00% 0.00%
------ ------ ------ ------ ------
------ ------ ------ ------ ------
Ratio of allowance for losses on
loans to total non-performing loans,
at end of year . . . . . . . . . . 413.17 691.84 409.13 436.52 924.84
------ ------ ------ ------ ------
------ ------ ------ ------ ------
19
The distribution of the Bank's allowance for losses on loans at the dates
indicated is summarized as follows:
December 31,
---------------------------------------------------------------------------------------------------------
1997 1996 1995 1994 1993
------------------- ------------------- ------------------ ------------------- ------------------
Percent Percent Percent Percent Percent
of Loans of Loans of Loans of Loans of Loans
in Each in Each in Each in Each in Each
Category Category Category Category Category
to Total to Total to Total to Total to Total
(DOLLARS IN THOUSANDS) Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Real Estate:
One-to-four family . . $ 560 87.58% $ 496 90.19% $ 452 90.62% $ 475 92.18% $ 374 92.18%
Multi-family . . . . . . 80 0.60 8 0.08 21 0.11 21 0.14 10 0.14
Commercial real estate . 198 2.34 113 2.22 125 2.71 128 1.80 140 1.80
Construction or
development. . . . . . . 172 1.27 104 0.98 153 1.58 84 1.31 1 1.31
Consumer . . . . . . . . 527 7.05 473 5.87 286 4.66 280 4.14 234 4.14
Commercial business . . . 46 1.16 29 0.66 37 0.32 27 0.43 30 0.43
Unallocated . . . . . . . 1,165 0.00 1,118 0.00 1,117 0.00 878 0.00 700 0.00
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Total . . . . . . . .$ 2,748 100.00% $ 2,341 100.00% $ 2,191 100.00% $ 1,893 100.00% $ 1,489 100.00%
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
20
The allowance for losses on loans is established through a provision for
losses on loans charged to earnings based on management's evaluation of the
risk inherent in its entire loan portfolio and changes in the nature and
volume of its loan activity. Such evaluation, which includes a review of all
loans of which full collectibility may not be reasonably assured, considers
specific occurrences, general and local economic conditions, loan portfolio
composition, historical and local experience and other factors that warrant
recognition in providing for an adequate allowance for loan losses. In
determining the general reserves under these policies, historical charge-offs
and recoveries, changes in the mix and levels of the various types of loans,
the general level of non-performing assets and the anticipated net realizable
values, the current loan portfolio and current economic conditions are
considered. The Bank also requires additional reserves for all classified
loans.
While management believes that it uses the best information available to
determine the allowance for losses on loans, unforeseen market conditions
could result in adjustments to the allowance for losses on loans, and net
earnings could be significantly affected, if circumstances differ
substantially from the assumptions used in making the final determination.
INVESTMENT ACTIVITIES
HMN and the Bank utilize the available for sale securities portfolio in
virtually all aspects of asset/liability management strategy. In making
investment decisions, the Investment/Asset - Liability Committee considers,
among other things, the yield and interest rate objectives, the credit risk
position and the projected cash flow requirements.
The Bank must maintain minimum levels of investments that qualify as
liquid assets under OTS regulations. Liquidity may increase or decrease
depending upon the availability of funds and comparative yields on
investments in relation to the return on loans. Cash flow projections are
regularly reviewed and updated to assure that adequate liquidity is
maintained. At December 31, 1997, the Bank's liquidity ratio (liquid assets
as a percentage of net withdrawable savings deposits and current borrowings)
was 19.39%. The Bank's level of liquidity is a result of management's
asset/liability strategy. See "Regulation - Liquidity."
SECURITIES. Federally chartered savings institutions have the authority
to invest in various types of liquid assets, including United States Treasury
obligations, securities of various federal agencies, certain certificates of
deposit of insured banks and savings institutions, certain bankers'
acceptances, repurchase agreements and federal funds. Subject to various
restrictions, federally chartered savings institutions may also invest their
assets in commercial paper, investment grade corporate debt securities and
mutual funds whose assets conform to the investments that a federally
chartered savings institution is otherwise authorized to make directly.
The investment strategy of HMN and the Bank has been directed toward a
mix of high-quality assets (primarily government and agency obligations) with
short and intermediate terms to maturity. At December 31, 1997, HMN did not
own any investment securities of a single issuer which exceeded 10% of HMN's
stockholder's equity other than U.S. government or federal agency obligations.
The Bank invests a portion of its liquid assets in interest-earning
overnight deposits of the Federal Home Loan Bank ("FHLB") of Des Moines and
various money market mutual funds. Other investments include high grade
medium-term (up to three years) corporate debt securities, medium-term
federal agency notes, and a variety of other types of mutual funds which
invest in adjustable-rate, mortgage-backed securities, asset-backed
securities, repurchase agreements and U.S. Treasury and agency obligations.
HMN invests in the same type of investment securities as the Bank and also
invests in taxable and tax exempt municipal obligations and corporate
equities such as preferred and common stock. See Notes 3 and 4 of the Notes
to Consolidated Financial Statements in the Annual Report for additional
information regarding HMN's securities portfolio.
21
The following table sets forth the composition of HMN's securities
portfolio, excluding mortgage-backed and related securities, at the dates
indicated.
December 31,
-------------------------------------------------------------------------------------------
1997 1996
------------------------------------------ --------------------------------------------
Amortized Adjusted Market % of Amortized Adjusted Market % of
(DOLLARS IN THOUSANDS) Cost To Value Total Cost To Value Total
--------- -------- ------ ----- --------- -------- ------ -----
Securities available for sale:
U.S. government and agency
obligations . . . . . . . . . . $ 43,403 (60) 43,343 49.98% $29,600 (322) 29,278 49.93%
Municipal obligations . . . . . . 0 0 0 0.00 0 0 0 0.00
Corporate debt . . . . . . . . . 2,903 0 2,903 3.35 1,091 1 1,092 1.86
Corporate equity(1) . . . . . . . 8,017 1,021 9,038 10.42 7,796 386 8,182 13.96
Stock of federal agencies(1). . . 14,034 605 14,639 16.88 3,874 49 3,923 6.69
Securities held to maturity:
U.S. agency obligations . . . . . 0 0 0.00 0 0 0.00
Municipal obligations . . . . . . 0 0 0.00 0 0 0.00
Corporate debt . . . . . . . . . 0 0 0.00 1,000 1,001 1.71
--------- ------ ----- --------- ------ -----
Subtotal . . . . . . . . . . . 68,357 69,923 80.63 43,361 43,476 74.15
FHLB stock . . . . . . . . . . 7,432 7,432 8.57 5,434 5,434 9.27
--------- ------ ----- --------- ------ -----
Total investment securities
and FHLB stock. . . . . . . . . 75,789 77,355 89.20 48,795 48,910 83.42
--------- ------ ----- --------- ------ -----
Average remaining life of
investment securities excluding
FHLB stock. . . . . . . . . . . . 2.5 years 3.4 years
Other Interest-earning Assets:
Cash equivalents . . . . . . . . 9,365 9,365 10.80 9,718 9,718 16.58
--------- ------ ----- --------- ------ -----
Total . . . . . . . . . . . . . $ 85,154 86,720 100.00% $58,513 58,628 100.00%
--------- ------ ----- --------- ------ -----
--------- ------ ----- --------- ------ -----
Average remaining life or term
to repricing of investment
securities and other
interest-earning assets,
excluding FHLB stock . . . . . 2.3 years 2.8 years
December 31,
------------------------------------------
1995
------------------------------------------
Amortized Adjusted Market % of
(DOLLARS IN THOUSANDS) Cost To Value Total
--------- -------- ------ -----
Securities available for sale:
U.S. government and agency
obligations . . . . . . . . . . $ 21,896 (566) 21,330 50.58%
Municipal obligations . . . . . . 1,600 1 1,601 3.80
Corporate debt . . . . . . . . . 851 9 860 2.04
Corporate equity(1) . . . . . . . 6,898 174 7,072 16.77
Stock of federal agencies(1). . . 1,004 37 1,041 2.47
Securities held to maturity:
U.S. agency obligations . . . . . 0 0 0.00
Municipal obligations . . . . . . 228 229 0.54
Corporate debt . . . . . . . . . 2,999 2,995 7.10
--------- ------ -----
Subtotal . . . . . . . . . . . 35,476 35,128 83.30
FHLB stock . . . . . . . . . . . . 3,802 3,802 9.02
--------- ------ -----
Total investment securities
and FHLB stock . . . . . . . . 39,278 38,930 92.32
Average remaining life of
investment securities excluding
FHLB stock . . . . . . . . . . . 3.0 years
Other Interest-earning Assets:
Cash equivalents . . . . . . . . $ 3,238 3,238 7.68
--------- ------ -----
Total . . . . . . . . . . . . . 42,516 42,168 100.00%
--------- ------ -----
--------- ------ -----
Average remaining life or term
to repricing of investment
securities and other
interest-earning assets,
excluding FHLB stock . . . . . . . 2.7 years
(1)Average life assigned to corporate equity holdings and stock of federal
agencies is five years.
22
The composition and maturities of the securities portfolio, excluding
FHLB stock, mortgage-backed and other related securities, are indicated in
the following table.
December 31, 1997
------------------------------------------------------------------------------------------
After 1 After 5
1 Year through 5 through 10 No Stated Total
or Less Years Years Maturity Securities
--------- --------- --------- --------- ------------------------------------
Amortized Amortized Amortized Amortized Amortized Adjusted Market
(DOLLARS IN THOUSANDS) Cost Cost Cost Cost Cost To Value
--------- --------- --------- --------- --------- -------- ---------
Securities available for sale:
U.S. government securities . . . . $ 11,482 31,921 0 0 43,403 (60) 43,343
Corporate debt . . . . . . . . . . 993 910 1,000 0 2,903 0 2,903
Corporate equity . . . . . . . . . 0 0 0 8,017 8,017 1,021 9,038
Stock of federal agencies . . . . . 0 0 0 14,034 14,034 605 14,639
--------- --------- --------- --------- --------- ---------
Total stock . . . . . . . . . . . . . $ 12,475 32,831 1,000 22,051 68,357 69,923
--------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- ---------
Weighted average yield . . . . . . . 4.22% 6.46% 8.80% 6.12% 5.98%
23
MORTGAGE-BACKED AND RELATED SECURITIES. In order to supplement loan
production (particularly those of interest rate sensitive loans) and achieve
its asset/liability management goals, HMN invests in mortgage-backed and
related securities. All of the mortgage-backed and related securities owned
by HMN are issued, insured or guaranteed either directly or indirectly by a
federal agency or are rated "AA" or higher. At December 31, 1997, HMN had
$135.9 million of mortgage-backed and related securities all classified as
available for sale, compared to $135.2 at December 31, 1996, of which $133.4
million were classified as available for sale.
At December 31, 1997, HMN had $23.3 million invested in CMOs which have
floating interest rates that change either monthly or quarterly compared to
$43.5 million at December 31, 1996 and $69.8 million at December 31, 1995.
HMN decreased its investment in floating rate CMOs in order to invest in
mortgage loans and meet other cash needs.
The projected weighted average life of the $61.8 million fixed rate CMO
security portfolio is approximately 2.5 years using median prepayment speeds
projected by the Bloomberg security system. The contractual maturities of
the mortgage-backed and related securities portfolio without any prepayment
assumptions at December 31, 1997 is as follows:
December 31,
1997
5 Years 5 to 10 10 to 20 Over 20 Balance
(Dollars in Thousands) or Less Years Years Years Outstanding
-------- -------- -------- -------- -----------
Securities available for sale:
Federal Home Loan Mortgage Corporation. . . . $ 17,256 1,409 4,166 7,249 30,080
Federal National Mortgage Association . . . . 3,444 1,922 2,629 6,345 14,340
Government National Mortgage Association. . . 0 17 2,621 3,581 6,219
Other mortgage-backed securities. . . . . . . 0 0 0 185 185
Collateralized Mortgage Obligations . . . . . 2,793 3,736 25,583 52,999 85,111
-------- -------- -------- -------- --------
Total . . . . . . . . . . . . . . . . . . $ 23,493 7,084 34,999 70,359 135,935
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
Weighted average yield . . . . . . . . . . . 6.33% 7.23% 7.02% 6.78% 6.79%
At December 31, 1997, HMN did not have any non-agency mortgage-backed or
related securities in excess of 10% of its stockholders' equity, except for a
$12.0 million collateralized mortgage obligation issued by Bear Stearns with
an AAA rating by Moody's.
CMOs are securities derived by reallocating the cash flows from
mortgage-backed securities or pools of mortgage loans in order to create
multiple classes, or tranches, of securities with coupon rates and average
lives that differ from the underlying collateral as a whole. The terms to
maturity of any particular tranche is dependent upon the prepayment speed of
the underlying collateral as well as the structure of the particular CMO.
Although a significant proportion of HMN's CMOs are in tranches which have
been structured (through the use of cash flow priority and "support"
tranches) to give somewhat more predictable cash flows, the cash flow and
hence the value of CMOs is subject to change.
To assess price volatility, the Federal Financial Institutions
Examination Council ("FFIEC") adopted a policy in 1992 which requires an
annual "stress" test of mortgage derivative securities. This policy, which
has been adopted by the OTS, requires the Bank to annually test its CMOs and
other mortgage-related securities to determine whether they are "high-risk"
or "nonhigh-risk securities". At December 31, 1997, the Bank had $6.7
million of CMO's which were classified as high-risk securities under the OTS
guidelines.
Mortgage-backed and related securities can serve as collateral for
borrowings and, through sales and repayments, as a source of liquidity. In
addition, mortgage-backed and related securities available for sale can be
sold to respond to changes in economic conditions. For information regarding
the carrying and
24
market values of HMN's mortgage-backed and related securities portfolio, see
Notes 3 and 4 of the Notes to Consolidated Financial Statements in the Annual
Report.
MERGERS AND ACQUISITIONS. On December 5, 1997 HMN, through its wholly
owned subsidiary, the Bank, completed its merger with Marshalltown Financial
Corporation (MFC) pursuant to a merger agreement dated July 1, 1997. Refer to
Note 2 of the Notes to Consolidated Financial Statements in the Annual Report
for information on assets acquired in the merger.
SOURCES OF FUNDS
GENERAL. The Bank's primary sources of funds are deposits, payments
(including prepayments) of loan principal, interest earned on loans and
securities, repayments of securities, borrowings and other funds provided
from operations.
DEPOSITS. The Bank offers a variety of deposit accounts having a wide
range of interest rates and terms. The Bank's deposits consist of passbook,
NOW, money market, non-interest bearing checking and certificate accounts
(including individual retirement accounts). The Bank relies primarily on
competitive pricing policies and customer service to attract and retain these
deposits.
The variety of deposit accounts offered by the Bank has allowed it to be
competitive in obtaining funds and to respond with flexibility to changes in
consumer demand. As customers have become more interest rate conscious, the
Bank has become more susceptible to short-term fluctuations in deposit flows.
The Bank manages the pricing of its deposits in keeping with its
asset/liability management, profitability and growth objectives. Based on
its experience, the Bank believes that its passbook and NOW accounts are
relatively stable sources of deposits. However, the ability of the Bank to
attract and maintain certificate deposits, and the rates paid on these
deposits, has been and will continue to be significantly affected by market
conditions.
The following table sets forth the savings flows at the Bank during the
periods indicated.
Year Ended December 31,
-----------------------------------
(DOLLARS IN THOUSANDS) 1997 1996 1995
---------- ---------- ----------
Opening balance . . . . . . . . . . . $ 362,477 373,539 350,575
MFC deposits acquired . . . . . . . . . 103,612 0 0
Deposits . . . . . . . . . . . . . . . 370,761 351,330 339,781
Withdrawals . . . . . . . . . . . . . . 385,002 378,009 331,481
Interest credited . . . . . . . . . . . 15,500 15,617 14,664
---------- ---------- ----------
Ending balance . . . . . . . . . . . 467,348 362,477 373,539
---------- ---------- ----------
Net increase (decrease) . . . . . . . $ 104,871 (11,062) 22,964
---------- ---------- ----------
---------- ---------- ----------
Percent increase (decrease) . . . . . . 28.93% (2.96)% 6.55%
---------- ---------- ----------
---------- ---------- ----------
25
The following table sets forth the dollar amount of savings deposits in
the various types of deposit programs offered by the Bank as of December 31:
1997 1996 1995
---------------------- ----------------------- ----------------------
Percent Percent Percent
(DOLLARS IN THOUSANDS) Amount of Total Amount of Total Amount of Total
--------- -------- --------- -------- --------- --------
TRANSACTIONS AND SAVINGS DEPOSITS(1):
Non-interest checking . . . . . . . . . . . . $ 3,833 0.82% $ 2,389 0.66% $ 2,505 0.67%
NOW Accounts - 1.5% (2) . . . . . . . . . . . 23,144 4.95 17,589 4.85 15,997 4.28
Passbook Accounts - 2.62%(3). . . . . . . . . 36,199 7.75 30,070 8.29 29,384 7.86
Money Market Accounts - 3.34% (4) . . . . . . 24,807 5.31 16,533 4.56 18,472 4.95
--------- -------- --------- -------- --------- --------
Total Non-Certificates . . . . . . . . . . $ 87,983 18.83% $ 66,581 18.36% $ 66,358 17.76%
--------- -------- --------- -------- --------- --------
CERTIFICATES:
3.00 - 3.99% . . . . . . . . . . . . . . . $ 727 0.15% $ 425 0.12% $ 0 0.00%
4.00 - 4.99% . . . . . . . . . . . . . . . 24,155 5.17 22,553 6.22 22,440 6.01
5.00 - 5.99% . . . . . . . . . . . . . . . 162,916 34.86 168,040 46.36 152,971 40.95
6.00 - 6.99% . . . . . . . . . . . . . . . 178,847 38.27 76,704 21.16 89,754 24.03
7.00 - 7.99% . . . . . . . . . . . . . . . 11,627 2.49 28,077 7.75 40,721 10.90
8.00 - 8.99% . . . . . . . . . . . . . . . 1,091 0.23 96 0.03 1,294 0.35
9.00 - 9.99% . . . . . . . . . . . . . . . 2 0.00 1 0.00 1 0.00
10.00% and over . . . . . . . . . . . . . . . 0 0.00 0 0.00 0 0.00
--------- -------- --------- -------- --------- --------
Total Certificates . . . . . . . . . . . . 379,365 81.17 295,896 81.64 307,181 82.24
--------- -------- --------- -------- --------- --------
Total Deposits . . . . . . . . . . . . . $ 467,348 100.00% $ 362,477 100.00% $ 373,539 100.00%
--------- -------- --------- -------- --------- --------
--------- -------- --------- -------- --------- --------
- - -----------------------------
(1) Reflects rates paid on transaction and savings deposits at December 31,
1997.
(2) The rate on NOW Accounts for 1996 was 2.01% and 1995 was 2.22%.
(3) The rate on Passbook Accounts for 1996 and 1995 was 2.50%.
(4) The rate on Money Market Accounts for 1996 and 1995 was 2.83%.
26
The following table shows rate and maturity information for the Bank's
certificates of deposit as of December 31, 1997.
3.00- 4.00- 5.00- 6.00- 7.00- 8.00- 9.00- Percent
(DOLLARS IN THOUSANDS) 3.99% 4.99% 5.99% 6.99% 7.99% 8.99% 9.99% Total of Total
----- ----- ----- ----- ----- ----- ----- ------- --------
Certificate accounts maturing in
quarter ending:
March 31, 1998 . . . . . . . . . $ 709 8,756 38,831 10,304 5,525 594 0 64,719 17.05
June 30, 1998 . . . . . . . . . . 18 6,845 30,059 17,525 1,906 95 0 56,448 14.88
September 30, 1998 . . . . . . . 0 2,769 29,934 31,065 1,407 93 0 65,268 17.20
December 31, 1998 . . . . . . . . 0 3,690 16,620 51,060 1,476 50 0 72,896 19.22
March 31, 1999 . . . . . . . . . 0 494 14,321 21,027 473 247 0 36,562 9.64
June 30, 1999 . . . . . . . . . . 0 587 7,057 8,933 241 12 2 16,832 4.44
September 30, 1999 . . . . . . . 0 403 5,324 5,745 335 0 0 11,807 3.11
December 31, 1999 . . . . . . . . 0 420 3,031 1,662 264 0 0 5,377 1.42
March 31, 2000 . . . . . . . . . 0 136 1,287 1,383 0 0 0 2,806 0.74
June 30, 2000 . . . . . . . . . . 0 55 1,402 1,562 0 0 0 3,019 0.80
September 30, 2000 . . . . . . . 0 0 2,256 13,675 0 0 0 15,931 4.20
December 31, 2000 . . . . . . . . 0 0 2,789 3,536 0 0 0 6,325 1.67
Thereafter . . . . . . . . . . . 0 0 10,005 11,370 0 0 0 21,375 5.63
------- ------ ------- ------- ------ ----- ---- ------- -------
Total . . . . . . . . . . . $ 727 24,155 162,916 178,847 11,627 1,091 2 379,365 100.00%
------- ------ ------- ------- ------ ----- ---- ------- -------
------- ------ ------- ------- ------ ----- ---- ------- -------
Percent of total . . . . . . . 0.19% 6.37% 42.95% 47.14% 3.06% 0.29% 0.00% 100.00%
------- ------ ------- ------- ------ ----- ---- -------
------- ------ ------- ------- ------ ----- ---- -------
27
The following table indicates the amount of the Bank's certificates of
deposit and other deposits by time remaining until maturity as of December
31, 1997.
Maturity
----------------------------------------
Over Over
3 Months 3 to 6 6 to 12 Over
or Less Months Months 12 months Total
-------- ------ ------- --------- -------
(DOLLARS IN THOUSANDS)
Certificates of deposit less
than $100,000 . . . . . . . . $ 51,964 48,648 126,772 111,159 338,543
Certificates of deposit of
$100,000 or more . . . . . . . . 5,120 4,277 8,025 8,874 26,296
Public funds (1) . . . . . . . . . 7,635 3,523 3,368 0 14,526
--------- ------ ------- ------- -------
Total certificates of
deposit . . . . . . . . . . $ 64,719 56,448 138,165 120,033 379,365
--------- ------ ------- ------- -------
--------- ------ ------- ------- -------
- - ---------------
(1)Deposits from governmental and other public entities.
For additional information regarding the composition of the Bank's deposits,
see Note 11 of the Notes to Consolidated Financial Statements in the Annual
Report. For additional information on certificate maturities and the impact
on HMN's liquidity see Liquidity Management starting on page 20 of the Annual
Report.
BORROWINGS. The Bank's other available sources of funds include
advances from the Federal Home Loan Bank ("FHLB") of Des Moines and other
borrowings. As a member of the FHLB of Des Moines, the Bank is required to
own capital stock in the FHLB of Des Moines and is authorized to apply for
advances from the FHLB of Des Moines. Each FHLB credit program has its own
interest rate, which may be fixed or variable, and range of maturities. The
FHLB of Des Moines may prescribe the acceptable uses for these advances, as
well as limitations on the size of the advances and repayment provisions.
Consistent with its asset/liability management strategy, the Bank has
utilized FHLB advances from time to time to extend the term to maturity of
its liabilities. Also, the Bank has used FHLB borrowings to fund loan demand
and other investment opportunities and to offset deposit outflows. At
December 31, 1997, the Bank had $127.7 million of FHLB advances outstanding.
On such date, the Bank had a collateral pledge arrangement with the FHLB of
Des Moines pursuant to which the Bank may borrow up to an additional $150.0
million for liquidity purposes. See "Financial Review - Federal Home Loan
Bank Advances" and Note 10 of the Notes to Consolidated Financial Statements
in the Annual Report.
The following table sets forth the maximum month-end balance and average
balance of FHLB advances and other borrowings for the periods indicated.
Year Ended
December 31,
--------------------------
1997 1996 1995
(DOLLARS IN THOUSANDS) ------ ------ ------
MAXIMUM BALANCE:
FHLB advances . . . . . . . . . . . . . . . . $128,007 106,436 74,534
FHLB short-term borrowings and open line of
credit . . . . . . . . . . . . . . . . . . . . 60,429 64,429 42,429
AVERAGE BALANCE:
FHLB advances . . . . . . . . . . . . . . . . . 112,500 89,656 65,069
FHLB short-term borrowings . . . . . . . . . . 45,598 47,949 20,812
28
The following table sets forth certain information as to the Bank's FHLB
advances at the dates indicated.
December 31,
------------------------
1997 1996 1995
------ ------ ------
(DOLLARS IN THOUSANDS)
FHLB short-term borrowings . . . . . . . . . . $43,250 46,429 33,429
Weighted average interest rate of
FHLB short-term borrowings . . . . . . . . . . . 5.85% 5.52% 6.05%
SERVICE CORPORATIONS OF THE BANK
As a federally chartered savings bank, the Bank is permitted by OTS
regulations to invest up to 2% of its assets in the stock of, or loans to,
service corporation subsidiaries, and may invest an additional 1% of its
assets in service corporations where such additional funds are used for
inner-city or community development purposes. In addition to investments in
service corporations, federal institutions are permitted to invest an
unlimited amount in operating subsidiaries engaged solely in activities which
a federal savings bank may engage in directly.
Osterud Insurance Agency, Inc. ("OIAI"), a Minnesota corporation, was
organized in 1983. OIAI operated as an insurance agency until 1986 when its
assets were sold. OIAI remained inactive until 1993 when it began offering
credit life insurance, annuity products and mutual fund products to the
Bank's customers and others. At December 31, 1997, the Bank's liability
related to OIAI was $21,000. OIAI recorded net income of $12,000 for the
year ended December 31, 1997.
MSL Financial Corporation ("MSL") was acquired in the MFC merger. MSL
offered annuity products to MFC customers and also has an investment in FHLMC
preferred stock.
COMPETITION
The Bank faces strong competition both in originating real estate loans
and in attracting deposits. Competition in originating loans comes primarily
from mortgage bankers, commercial banks, credit unions and other savings
institutions, which also make loans secured by real estate located in the
Bank's market area. The Bank competes for loans principally on the basis of
the interest rates and loan fees it charges, the types of loans it originates
and the quality of services it provides to borrowers.
Competition for those deposits is principally from money market and
mutual funds, securities firms, commercial banks and other savings
institutions located in the same communities. The ability of the Bank to
attract and retain deposits depends on its ability to provide an investment
opportunity that satisfies the requirements of investors as to rate of
return, liquidity, risk, convenient locations and other factors. The Bank
competes for these deposits by offering a variety of deposit accounts at
competitive rates, convenient business hours and a customer oriented staff.
OTHER CORPORATIONS OWNED BY HMN
HMN has two other wholly owned subsidiaries, HMN Mortgage Services, Inc.
("MSI") and Security Finance Corporation ("SFC"). MSI operates a mortgage
banking and mortgage brokerage facilities located in Eden Prairie and
Brooklyn Park, Minnesota. Eden Prairie and Brooklyn Park are located in the
Minneapolis/St. Paul Metropolitan area. MSI's primary function is to
originate and/or purchase single family residential loans for resale on the
secondary market to FNMA, FHLMC or other third parties. It also from
29
time to time purchases mortgage servicing rights from other lenders. SFC
invests in commercial loans and commercial real estate loans located
throughout the United States which were originated by third parties.
EMPLOYEES
At December 31, 1997, HMN had a total of 150 full-time equivalent
employees. None of the employees of HMN or its subsidiaries are represented
by any collective bargaining unit. Management considers its employee
relations to be good.
EXECUTIVE OFFICERS OF THE REGISTRANT WHO ARE NOT DIRECTORS
Officers are elected annually by the Board of Directors of HMN and the
Bank. The business experience of each executive officer of HMN and the Bank
who is not also a director of HMN is set forth below. Unless otherwise
indicated, such individuals have held their current positions for at least
five years.
DWAIN C. JORGENSEN. Mr. Jorgensen, age 49, is Vice President,
Controller and Chief Accounting Officer of HMN and the Bank. Mr. Jorgensen
has held such positions with the Bank since 1989. From 1983 to 1989, Mr.
Jorgensen was an Assistant Vice President and Operations Officer with the
Bank.
SUSAN K. KOLLING. Mrs. Kolling, age 46, is Senior Vice President of HMN
and is Senior Vice President of Marketing of the Bank, a position she has
held since 1995. Prior to such time, she served as Vice President from 1992
through 1994 and as a Loan Officer from 1981 through 1991. Mrs. Kolling
began her career with the Bank in 1969.
TIMOTHY P. JOHNSON. Mr. Johnson, age 45, is Vice President and
Treasurer of HMN and the Bank, a position he has held since 1997. Prior to
such time, he served as Treasurer from 1992 to 1997. From 1983 to 1992, Mr.
Johnson was Chief Financial Officer of St. Louis Bank for Savings, Duluth,
Minnesota.
ROXANNE M. HELLICKSON. Mrs. Hellickson, age 37, is Vice President/Loan
Administrator and Corporate Secretary of HMN and the Bank. She served as
Assistant Secretary of the Bank from 1992 to 1994 and was secretary to the
Bank's President and a loan officer from 1989 to 1992. Mrs. Hellickson began
her career with the Bank in 1979.
REGULATION
GENERAL
The Bank is a federally chartered savings bank, the deposits of which
are federally insured and backed by the full faith and credit of the United
States Government. Accordingly, the Bank is subject to broad federal
regulation and oversight extending to all its operations. The Bank is a
member of the FHLB of Des Moines and is subject to certain limited regulation
by the Federal Reserve Board. The Bank is a member of the Savings
Association Insurance Fund ("SAIF") and the deposits of the Bank are insured
by the FDIC. As a result, the FDIC has certain regulatory and examination
authority over the Bank. As the savings and loan holding company of the
Bank, HMN also is subject to federal regulation and oversight. The purpose
of the regulation of HMN and other holding companies is to protect subsidiary
savings associations.
Certain of these regulatory requirements and restrictions are discussed
below.
FEDERAL REGULATION OF SAVINGS ASSOCIATIONS
The OTS has extensive authority over the operations of savings
associations. As part of this authority, the Bank is required to file
periodic reports with the OTS and is subject to periodic examinations
30
by the OTS and the FDIC. The last regular OTS examination of the Bank was
dated May 1997. The Bank has not been scheduled for an examination in 1998,
except for an on-site year 2000 examination which started on March 23, 1998.
When these examinations are conducted by the OTS and the FDIC, the examiners
may require the Bank to provide for higher general or specific loan loss
reserves. Financial institutions in various regions of the United States
have been called upon by examiners to write down assets and to establish
increased levels of reserves, primarily as a result of perceived weaknesses
in real estate values and a more restrictive regulatory climate.
The OTS has established a schedule for the assessment of fees upon all
savings associations to fund the operations of the OTS. The general
assessment, to be paid on a semi-annual basis, is computed upon the savings
association's total assets as reported in the association's latest quarterly
thrift financial report. Savings associations (unlike the Bank) that are
classified as "troubled" (I.E., having a supervisory rating of "4" or "5" or
subject to a conservatorship) are required to pay a 50% premium over the
standard assessment. The Bank's OTS assessment for the year ended December
31, 1997 was approximately $122,000.
The OTS also has extensive enforcement authority over all savings
institutions and their holding companies, including the Bank and HMN. This
enforcement authority includes, among other things, the ability to assess
civil money penalties, to issue cease-and-desist or removal orders and to
initiate injunctive actions. In general, these enforcement actions may be
initiated for violations of laws and regulations and unsafe or unsound
practices. Other actions or inactions may provide the basis for enforcement
action, including misleading or untimely reports filed with the OTS. Except
under certain circumstances, public disclosure of final enforcement actions
by the OTS is required.
In addition, the investment, lending and branching authority of the Bank
is prescribed by federal laws and regulations, and it is prohibited from
engaging in any activities not permitted by such laws and regulations. For
instance, no savings institution may invest in non-investment grade corporate
debt securities. In addition, unless approved by the OTS, the permissible
level of investment by federal associations in loans secured by
non-residential real property may not exceed 400% of regulatory capital.
Federal savings associations are also generally authorized to branch
nationwide. The Bank is in compliance with the noted restrictions.
The Bank's general permissible lending limit for loans-to-one-borrower
is equal to the greater of $500,000, or 15%, of unimpaired capital and
surplus (except for loans fully secured by certain readily marketable
collateral, in which case this limit is increased to 25% of unimpaired
capital and surplus). At December 31, 1997, the Bank's lending limit under
this restriction was $9.2 million. The Bank is in compliance with the
loans-to-one borrower limitation.
In December 1991, the Federal Deposit Insurance Corporation Improvement
Act of 1991 ("FDICIA") was enacted into law. FDICIA provides for, among
other things, the recapitalization of the Bank Insurance Fund; adoption of
safety and soundness standards; enhanced federal supervision of depository
institutions, including greater authority for the appointment of a
conservator or receiver for undercapitalized institutions; the establishment
of risk-based deposit insurance premiums; liberalization of the qualified
thrift lender test; greater restrictions on transactions with affiliates; and
mandated consumer protection disclosures with respect to deposit accounts.
See "- Insurance of Accounts and Regulation by the FDIC," "- Regulatory
Capital Requirements" and "- Qualified Thrift Lender Test."
The OTS, as well as the other federal banking agencies, have issued
proposed safety and soundness standards on matters such as loan underwriting
and documentation, internal controls and audit systems, interest rate risk
exposure, compensation and other employee benefits. The proposal also
establishes the maximum ratio of classified assets to total capital (which
for this purpose includes loss allowances exceeding the amount includable for
regulatory capital purposes) at 100% and the minimum level of earnings
sufficient to absorb losses without impairing capital. Earnings will be
sufficient if the net income over the last four
31
quarters is assumed to continue over the next four quarters and the
institution would otherwise remain in capital compliance. Any institution
which fails to comply with these standards must submit a compliance plan. A
failure to submit a plan or to comply with an approved plan will subject the
institution to further enforcement action. The proposal also requires savings
and loan holding companies to ensure that transactions and relationships with
their subsidiary savings associations do not have a detrimental effect on the
safe and sound operation of the association. No assurance can be given as to
the final form of the proposed regulations.
The Bank is subject to a wide array of other laws and regulations, both
federal and state, including, but not limited to, usury laws, the CRA and
regulations thereunder, the Equal Credit Opportunity Act and Regulation B,
Regulation E Electronic Funds Transfer requirements, the Truth-in-Lending Act
and Regulation Z, the Real Estate Settlement Procedures Act and Regulation X.
The Bank is also subject to laws and regulations that may impose liablitiy on
lenders and owners for clean-up costs and other costs stemming from hazardous
waste located on property securing real estate loans made by lenders or on
real estate that is owned by lenders following a foreclosure or otherwise.
INSURANCE OF ACCOUNTS AND REGULATION BY THE FDIC
The Bank is a member of the SAIF, which is administered by the FDIC.
Savings deposits are insured up to applicable limits by the FDIC and such
insurance is backed by the full faith and credit of the United States
Government. As insurer, the FDIC imposes deposit insurance premiums and is
authorized to conduct examinations of and to require reporting by
FDIC-insured institutions. It also may prohibit any FDIC-insured institution
from engaging in any activity the FDIC determines by regulation or order to
pose a serious risk to the SAIF. The FDIC also has the authority to initiate
enforcement actions against savings associations, after giving the OTS an
opportunity to take such action, and may terminate the deposit insurance if
it determines that the institution has engaged or is engaging in unsafe or
unsound practices, or is in an unsafe or unsound condition.
FDICIA also requires the FDIC to implement a risk-based deposit
insurance assessment system. Pursuant to this requirement, the FDIC adopted
a transitional risk-based assessment system, effective January 1, 1993, under
which all insured depository institutions are placed into one of nine
categories and assessed insurance premiums, ranging from .23% to .31% of
deposits, based upon their level of capital and supervisory evaluation. The
permanent system, adopted in June 1993 and effective January 1, 1994,
continued the risk classification system established under the transitional
rule. Under the system, institutions classified as well capitalized (I.E., a
core capital ratio of at least 5%, a ratio of Tier 1 or core capital to
risk-weighted assets ("Tier 1 risk-based capital") of at least 6% and a
risk-based capital ratio of at least 10%) and considered healthy would pay
the lowest premium while institutions that are less than adequately
capitalized (I.E., core and Tier 1 risk-based capital ratios of less than 4%
or a risk-based capital ratio of less than 8%) and considered of substantial
supervisory concern would pay the highest premium. Risk classification of all
insured institutions will be made by the FDIC for each semi-annual assessment
period.
The FDIC is authorized to increase assessment rates, on a semi-annual
basis, if it determines that the reserve ratio of the SAIF will be less than
the designated reserve ratio of 1.25% of SAIF insured deposits. In setting
these increased assessments, the FDIC must seek to restore the reserve ratio
to that designated reserve level, or such higher reserve ratio as established
by the FDIC. In addition, under FDICIA, the FDIC may impose special
assessments on SAIF members to repay amounts borrowed from the United States
Treasury or for any other reason deemed necessary by the FDIC.
The Deposit Insurance Fund Act of 1996 (DIFA) was enacted on September
30, 1996. DIFA addressed the inadequate funding of the (SAIF). In order to
recapitalize the SAIF, DIFA imposed a one-time assessment on all thrift
institutions. The Bank's assessment was a pretax charge of $2,351,563 and
was recognized in the third quarter of 1996.
32
DIFA also addressed the funding for the Financing Corp. (FICO) bonds.
Thrifts will pay 6.4 basis points per $100 of deposits from January 1, 1997
to December 31, 1999. From January 1, 2000 until the FICO bonds are retired
in 2019, the estimated assessment to retire the FICO bonds is expected to be
2.5 basis points per $100 of deposits.
DIFA proposed that the Bank Insurance Fund (BIF) and SAIF be merged on
January 1, 1999, provided no insurance depository institution is a savings
association on that date. At this time, HMN does not know what effect, if
any, the proposed legislation or charter revisions will have on future
operations.
REGULATORY CAPITAL REQUIREMENTS
Federally insured savings associations, such as the Bank, are required
to maintain a minimum level of regulatory capital. The OTS has established
capital standards, including a tangible capital requirement, a leverage ratio
(or core capital) requirement and a risk-based capital requirement applicable
to such savings associations. These capital requirements must be generally
as stringent as the comparable capital requirements for national banks. The
OTS is also authorized to impose capital requirements in excess of these
standards on individual associations on a case-by-case basis.
The capital regulations require tangible capital of at least 1.5% of
adjusted total assets (as defined by regulation). Tangible capital generally
includes common stockholders' equity and retained earnings, and certain
noncumulative perpetual preferred stock. In addition, all intangible assets,
other than a limited amount of purchased mortgage servicing rights, must be
deducted from tangible capital. At December 31, 1997, the Bank had goodwill
of $6.0 million and $510,000 of mortgage servicing rights which were required
to be deducted from stockholders' equity to arrive at tangible capital.
The OTS regulations establish special capitalization requirements for
savings associations that own subsidiaries. Under these regulations certain
subsidiaries are consolidated for capital purposes and others are excluded
from assets and capital. In determining compliance with the capital
requirements, all subsidiaries engaged solely in activities permissible for
national banks or engaged in certain other activities solely as agent for its
customers are "includable" subsidiaries that are consolidated for capital
purposes in proportion to the association's level of ownership, including the
assets of includable subsidiaries in which the association has a minority
interest that is not consolidated for GAAP purposes. For excludable
subsidiaries the debt and equity investments in such subsidiaries are
deducted from assets and capital. The subsidiary of the Bank is an includable
subsidiary.
At December 31, 1997, the Bank had tangible capital of $54.1 million, or
8.2% of adjusted total assets, which is $44.2 million above the minimum
requirement of 1.5% of adjusted total assets in effect on that date.
The capital standards also require core capital equal to at least 3% of
adjusted total assets (as defined by regulation). Core capital generally
consists of tangible capital plus certain intangible assets. As a result of
the prompt corrective action provisions of FDICIA discussed below, however, a
savings association must maintain a core capital ratio of at least 4% to be
considered adequately capitalized unless its supervisory condition is such to
allow it to maintain a 3% ratio.
As required by federal law, the OTS has proposed a rule revising its
minimum core capital requirement to be no less stringent than that imposed on
national banks. The OTS has proposed that only those savings associations
rated a composite one (the highest rating) under the safety and soundness
rating system for savings associations will be permitted to operate at or
near the regulatory minimum leverage ratio of 3%. All other savings
associations will be required to maintain a minimum leverage ratio of 4% to
5%. The OTS will assess each individual savings association through the
supervisory process on a case-by-case basis to determine the applicable
requirement. No assurance can be given as to the final form of any such
33
regulation, the date of its effectiveness or the requirement applicable to
the Bank.
At December 31, 1997, the Bank had core capital equal to $54.1 million,
or 8.2%, of adjusted total assets, which is $34.3 million above the minimum
leverage ratio requirement of 3% as in effect on that date.
The OTS risk-based requirement requires savings associations to have
total capital of at least 8% of risk-weighted assets. Total capital consists
of core capital, as defined above, and supplementary capital. Supplementary
capital consists of certain permanent and maturing capital instruments that
do not qualify as core capital and general valuation loan and lease loss
allowances up to a maximum of 1.25% of risk-weighted assets. Supplementary
capital may be used to satisfy the risk-based requirement only to the extent
of core capital. At December 31, 1997, the Bank had $2.7 million of general
loss reserves, which were included in capital.
Certain exclusions from capital and assets are required to be made for
the purpose of calculating total capital, in addition to the adjustments
required for calculating core capital. Such exclusions consist of equity
investments (as defined by regulation) and that portion of land loans and
nonresidential construction loans in excess of an 80% loan-to-value ratio and
reciprocal holdings of qualifying capital instruments. At December 31, 1997
the Bank had $266,000 of exclusions from capital.
In determining the amount of risk-weighted assets, all assets, including
certain off-balance sheet items, will be multiplied by a risk weight, ranging
from 0% to 100%, based on the risk inherent in the type of asset. For
example, the OTS has assigned a risk weight of 50% for prudently underwritten
permanent one-to-four family first lien mortgage loans not more than 90 days
delinquent and having a loan to value ratio of not more than 80% at
origination unless insured to such ratio by an insurer approved by the FNMA
or the FHLMC.
On December 31, 1997, the Bank had total "risk-based" capital of $56.6
million and risk-weighted assets of $303.4 million, or total capital of 18.7%
of risk-weighted assets. This amount was $32.4 million above the 8%
requirement in effect on that date.
Under FDICIA, all the federal banking agencies, including the OTS, were
required to revise their risk-based capital requirements to ensure that such
requirements account for interest rate risk, concentration of credit risk and
the risks of non-traditional activities, and that they reflect the actual
performance of and expected loss on multi-family loans. Such standards were
adopted with the enactment of FDICIA.
The OTS had adopted a rule that required every savings association with
more than normal interest rate risk to deduct from its total capital, for
purposes of determining compliance with such requirement, an interest rate
risk component ("IRR component") equal to 50% of its interest-rate risk
exposure multiplied by the present value of its assets. The IRR component is
a measure of the potential decline in the net portfolio value ("NPV") of a
savings association, greater than 2% of the present value of its assets,
based upon a hypothetical 200 basis point increase or decrease in interest
rates (whichever results in a greater decline). NPV is the present value of
expected cash flows from assets, liabilities and off-balance sheet contracts.
The rule provided for a two quarter lag between calculating interest rate
risk and recognizing any deduction from capital. The OTS has decided not to
require the IRR component to be deducted from the capital calculations of all
institutions. It has reserved the right to take the IRR component into
account in assessing the capital requirements for an individual institution.
Based upon an IRR component analysis at December 31, 1997, the Bank was
deemed to have more than "normal" interest rate risk and may, at some time in
the future, be required to deduct an amount from capital. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Asset/Liability Management" in the Annual Report.
34
Pursuant to FDICIA, the federal banking agencies, including the OTS,
have adopted regulations authorizing the agencies to require a depository
institution to maintain an additional amount of total capital to account for
concentration of credit risk and the risk of non-traditional activities.
The OTS and the FDIC are authorized and, under certain circumstances,
required to take certain actions against associations that fail to meet
capital requirements. Effective December 19, 1992, the federal banking
agencies, including the OTS, were given additional enforcement authority over
undercapitalized
depository institutions. The OTS is generally required to take action to
restrict the activities of an "undercapitalized association" (generally
defined to be one with less than either a 4% core ratio, a Tier 1
risked-based capital ratio or an 8% risk-based capital ratio). Any such
association must submit a capital restoration plan and until such plan is
approved by the OTS may not increase its assets, acquire another institution,
establish a branch or engage in any new activities, and generally may not
make capital distributions. The OTS is authorized to impose the additional
restrictions, discussed below, that are applicable to significantly
undercapitalized associations.
As a condition to the approval of the capital restoration plan, any
company controlling an undercapitalized association must agree that it will
enter into a limited capital maintenance guarantee with respect to the
institution's achievement of its capital requirements.
Any savings association that fails to comply with its capital plan or is
"significantly undercapitalized" (I.E., Tier 1 risk-based or core capital
ratios of less than 3% or a risk-based capital ratio of less than 6%) must be
made subject to one or more additional specified actions and operating
restrictions mandated by FDICIA. These actions and restrictions include
requiring the issuance of additional voting securities; limitations on asset
growth; mandated asset reduction; changes in senior management; divestiture,
merger or acquisition of the association; restrictions on executive
compensation; and any other action the OTS deems appropriate. An association
that becomes "critically undercapitalized" (I.E., a tangible equity to total
asset ratio of 2% or less) is subject to further mandatory restrictions on
its activities in addition to those applicable to significantly
undercapitalized associations. In addition, the OTS must appoint a receiver
(or conservator with the concurrence of the FDIC) for a savings association,
with certain limited exceptions, within 90 days after it becomes critically
undercapitalized.
Any undercapitalized association is also subject to other possible
enforcement actions by the OTS or the FDIC. Such actions could include a
capital directive, a cease-and-desist order, civil money penalties, the
establishment of restrictions on all aspects of the association's operations,
the appointment of a receiver or conservator or a forced merger into another
institution.
If the OTS determines that an association is in an unsafe or unsound
condition, or is engaged in an unsafe or unsound practice, it is authorized
to reclassify a well-capitalized association as an adequately capitalized
association, and if the association is adequately capitalized, to impose the
restrictions applicable to an undercapitalized association. If the
association is undercapitalized, the OTS is authorized to impose the
restrictions applicable to a significantly undercapitalized association.
The imposition by the OTS or the FDIC of any of these measures on the
Bank may have a substantial adverse effect on the Bank's operations and
profitability and the value of HMN's stock. HMN shareholders do not have
preemptive rights, and therefore, if HMN is directed by the OTS or the FDIC
to issue additional shares of common stock, such issuance may result in the
dilution in the percentage of ownership of existing stockholders of HMN.
At December 31, 1997 the Bank would be considered to be "well
capitalized" under the prompt corrective actions provisions mentioned above.
See Note 16 "Federal Home Loan Bank Investment, Regulatory Liquidity and
Regulatory Capital Requirements" in the Notes to Consolidated Financial
Statements in the Annual Report for more information on the Bank's capital.
35
LIMITATIONS ON DIVIDENDS AND OTHER CAPITAL DISTRIBUTIONS
OTS regulations impose various restrictions or requirements on
associations with respect to their ability to pay dividends or make other
distributions of capital. OTS regulations prohibit an association from
declaring or paying any dividends or from repurchasing any of its stock if,
as a result, the regulatory capital of the association would be reduced below
the amount required to be maintained for the liquidation account established
in connection with its mutual to stock conversion.
The OTS utilizes a three-tiered approach to permit associations, based
on their capital level and supervisory condition, to make capital
distributions which include dividends, stock redemptions or repurchases,
cash-out mergers and other transactions charged to the capital account. See
"- Regulatory Capital Requirements."
Generally, Tier 1 associations, which are associations that before and
after the proposed distribution meet their fully phased-in capital
requirements, may make capital distributions during any calendar year equal
to the greater of 100% of net income for the year-to-date plus 50% of the
amount by which the lesser of the association's tangible, core or risk-based
capital exceeds its fully phased-in capital requirement for such capital
component, as measured at the beginning of the calendar year, or the amount
authorized for a Tier 2 association. However, a Tier 1 association deemed to
be in need of more than normal supervision by the OTS may be downgraded to a
Tier 2 or Tier 3 association as a result of such a determination. The Bank
meets the requirements for a Tier 1 association and has not been notified of
a need for more than normal supervision. Tier 2 associations, which are
associations that before and after the proposed distribution meet their
current minimum capital requirements, may make capital distributions of up to
75% of net income over the most recent four quarter period.
Tier 3 associations (which are associations that do not meet current
minimum capital requirements) that propose to make any capital distribution
and Tier 2 associations that propose to make a capital distribution in excess
of the noted safe harbor level must obtain OTS approval prior to making such
distribution. Tier 2 associations proposing to make a capital distribution
within the safe harbor provisions and Tier 1 associations proposing to make
any capital distribution need only submit written notice to the OTS 30 days
prior to such distribution. As a subsidiary of HMN, the Bank will also be
required to give the OTS 30 days' notice prior to declaring any dividend on
its stock. The OTS may object to the distribution during that 30-day period
based on safety and soundness concerns. See "- Regulatory Capital
Requirements."
The OTS has proposed regulations that would revise the current capital
distribution restrictions. The proposal eliminates the current tiered
structure and the safe-harbor percentage limitations. Under the proposal a
savings association may make a capital distribution without notice to the OTS
(unless it is a subsidiary of a holding company) provided that it has a
CAMELS 1 or 2 rating, is not in troubled condition and would remain
adequately capitalized (as defined in the OTS prompt corrective action
regulations) following the proposed distribution. Savings associations that
would remain adequately capitalized following the proposed distribution but
do not meet the other noted requirements must notify the OTS 30 days prior to
declaring a capital distribution. The OTS stated it will generally regard as
permissible that amount of capital distributions that do not exceed 50% of
the institution's excess regulatory capital plus net income to date during
the calendar year. A savings association may not make a capital distribution
without prior approval of the OTS and the FDIC if it is undercapitalized
before, or as a result of, such a distribution. A savings association will be
considered in troubled condition if it has a CAMELS rating of 4 or 5, is
subject to an enforcement action relating to its safety and soundness or
financial viability or has been informed in writing by the OTS that it is in
troubled condition. As under the current rule, the OTS may object to a
capital distribution if it would constitute an unsafe or unsound practice.
No assurance may be given as to whether or in what form the regulations may
be adopted.
36
In March of 1998, the Bank received confirmation from OTS that a
dividend from the Bank to HMN of $15.0 million could be paid during 1998 and
not violate the dividend limitations mentioned above.
LIQUIDITY
All savings associations, including the Bank, are required to maintain
an average daily balance of liquid assets equal to a certain percentage of
the sum of its average daily balance of net withdrawable deposit accounts and
borrowings payable in one year or less. For a discussion of what the Bank
includes in liquid assets, see "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Liquidity Management" in the
Annual Report. This liquid asset ratio requirement may vary from time to
time (between 4% and 10%) depending upon economic conditions and savings
flows of all savings associations. At the present time, the minimum liquid
asset ratio is 4%.
In addition, short-term liquid assets (E.G., cash, certain time
deposits, certain bankers acceptances and short-term United States Treasury
obligations) currently must constitute at least 1% of the association's
average daily balance of net withdrawable deposit accounts and current
borrowings. Penalties may be imposed upon associations for violations of
either liquid asset ratio requirement. At December 31, 1997, the Bank had an
overall liquid asset ratio of 19.4% and a short-term liquid asset ratio of
6.4%.
ACCOUNTING
An OTS policy statement applicable to all savings associations clarifies
and re-emphasizes that the investment activities of a savings association
must be in compliance with approved and documented investment policies and
strategies, and must be accounted for in accordance with GAAP. Under the
policy statement, management must support its classification of and
accounting for loans and securities (I.E., whether held to maturity, sale or
trading) with appropriate documentation. The Bank is in compliance with
these amended rules.
The OTS has adopted an amendment to its accounting regulations, which
may be made more stringent than GAAP, to require that transactions be
reported in a manner that best reflects their underlying economic substance
and inherent risk and that financial reports must incorporate any other
accounting regulations or orders prescribed by the OTS.
QUALIFIED THRIFT LENDER TEST
All savings associations, including the Bank, are required to meet a
qualified thrift lender ("QTL") test to avoid certain restrictions on their
operations. This test requires a savings association to have at least 65% of
its portfolio assets (which consists of total assets less intangibles,
properties used to conduct the savings association's business and liquid
assets not exceeding 20% of total assets) in qualified thrift investments on
a monthly average for nine out of every 12 months on a rolling basis. For
HMN such assets primarily consist of residential housing related loans and
investments. At December 31, 1997, the Bank met the test and has always met
the test since its effectiveness.
Any savings association that fails to meet the QTL test must convert to
a national bank charter, unless it requalifies as a QTL and thereafter
remains a QTL. If an association does not requalify and converts to a
national bank charter, it must remain SAIF-insured until the FDIC permits it
to transfer to the Bank Insurance Fund. If an association that fails the
test has not yet requalified and has not converted to a national bank, its
new investments and activities are limited to those permissible for both a
savings association and a national bank, and it is limited to national bank
branching rights in its home state. In addition, the association is
immediately ineligible to receive any new FHLB borrowings and is subject to
national bank limits for payment of dividends. If such association has not
requalified or converted to a national bank within three years after the
failure, it must divest of all investments and cease all activities not
permissible for a national
37
bank. In addition, it must repay promptly any outstanding FHLB borrowings,
which may result in prepayment penalties. If any association that fails the
QTL test is controlled by a holding company, then within one year after the
failure, the holding company must register as a bank holding company and
become subject to all restrictions on bank holding companies. See "- Holding
Company Regulation."
TRANSACTIONS WITH AFFILIATES
Generally, transactions between a savings association or its
subsidiaries and its affiliates are required to be on terms as favorable to
the association as transactions with non-affiliates. In addition, certain of
these transactions are restricted to a percentage of the association's
capital. Affiliates of the Bank include HMN and any company which is under
common control with the Bank. In addition, a savings association may not lend
to any affiliate engaged in activities not permissible for a bank holding
company or acquire the securities of most affiliates. The Bank's
subsidiaries are not deemed affiliates, however, the OTS has the discretion
to treat subsidiaries of savings associations as affiliates on a case by case
basis.
Certain transactions with directors, officers or controlling persons are
also subject to conflict of interest regulations enforced by the OTS. These
conflict of interest regulations and other statutes also impose restrictions
on loans to such persons and their related interests. Among other things,
such loans must be made on terms substantially the same as for loans to
unaffiliated individuals.
HOLDING COMPANY REGULATION
HMN is a unitary savings and loan holding company subject to regulatory
oversight by the OTS. As such, HMN is registered and required to file
reports with and subject to regulation and examination by the OTS. In
addition, the OTS has enforcement authority over HMN and its non-savings
association subsidiaries which also permits the OTS to restrict or prohibit
activities that are determined to be a serious risk to the subsidiary savings
association.
As a unitary savings and loan holding company, HMN generally is not
subject to activity restrictions. If HMN acquires control of another savings
association as a separate subsidiary, it would become a multiple savings and
loan holding company, and the activities of HMN and any of its subsidiaries
(other than the Bank or any other SAIF-insured savings association) would
become subject to such restrictions unless such other associations qualify as
QTLs and were acquired in a supervisory acquisition.
If the Bank fails the QTL test, HMN must obtain the approval of the OTS
prior to continuing after such failure, directly or through its other
subsidiaries, any business activity other than those approved for multiple
savings and loan holding companies or their subsidiaries. In addition,
within one year of such failure HMN must register as, and will become subject
to, the restrictions applicable to bank holding companies. The activities
authorized for a bank holding company are more limited than are the
activities authorized for a unitary or multiple savings and loan holding
company. See "- Qualified Thrift Lender Test."
HMN must obtain approval from the OTS before acquiring control of any
other SAIF-insured association. Such acquisitions are generally prohibited
if they result in a multiple savings and loan holding company controlling
savings associations in more than one state. However, such interstate
acquisitions are permitted based on specific state authorization or in a
supervisory acquisition of a failing savings association.
FEDERAL SECURITIES LAW
The stock of HMN is registered with the SEC under the Securities
Exchange Act of 1934, as amended (the "Exchange Act"). HMN is subject to the
information, proxy solicitation, insider trading restrictions and other
requirements of the SEC under the Exchange Act.
38
HMN stock held by persons who are affiliates (generally officers,
directors and principal stockholders) of HMN may not be resold without
registration or unless sold in accordance with certain resale restrictions.
If HMN meets specified current public information requirements, each
affiliate of HMN is able to sell in the public market, without registration,
a limited number of shares in any three-month period.
FEDERAL RESERVE SYSTEM
The Federal Reserve Board requires all depository institutions to
maintain non-interest bearing reserves at specified levels against their
transaction accounts (primarily checking, NOW and Super NOW checking
accounts). At December 31, 1997, the Bank was in compliance with these
reserve requirements. The balances maintained to meet the reserve
requirements imposed by the Federal Reserve Board may be used to satisfy
liquidity requirements that may be imposed by the OTS. See "- Liquidity."
Savings associations are authorized to borrow from the Federal Reserve
Bank "discount window," but Federal Reserve Board regulations require
associations to exhaust other reasonable alternative sources of funds,
including FHLB borrowings, before borrowing from the Federal Reserve Bank.
FEDERAL HOME LOAN BANK SYSTEM
The Bank is a member of the FHLB of Des Moines, which is one of 12
regional FHLBs, that administers the home financing credit function of
savings associations. Each FHLB serves as a reserve or central bank for its
members within its assigned region. It is funded primarily from proceeds
derived from the sale of consolidated obligations of the FHLB System. It
makes loans to members (I.E., advances) in accordance with policies and
procedures established by the board of directors of the FHLB. These policies
and procedures are subject to the regulation and oversight of the Federal
Housing Finance Board. All advances from the FHLB are required to be fully
secured by sufficient collateral as determined by the FHLB. In addition, all
long-term advances are required to provide funds for residential home
financing.
As a member, the Bank is required to purchase and maintain stock in the
FHLB of Des Moines. At December 31, 1997, the Bank had $7.4 million in FHLB
stock, which was in compliance with this requirement. In past years, the
Bank has received dividends on its FHLB stock. Over the past five calendar
years such dividends have averaged 7.41% and were 7.00% for calendar year
1997. For the year ended December 31, 1997, dividends paid by the FHLB of
Des Moines to the Bank totaled $421,000.
Under federal law the FHLBs are required to provide funds for the
resolution of troubled savings associations and to contribute to low and
moderately priced housing programs through direct loans or interest subsidies
on advances targeted for community investment and low- and moderate-income
housing projects. These contributions have affected adversely the level of
FHLB dividends paid and could continue to do so in the future. These
contributions could also have an adverse effect on the value of FHLB stock in
the future. A reduction in value of the Bank's FHLB stock may result in a
corresponding reduction in the Bank's capital.
39
FEDERAL AND STATE TAXATION
FEDERAL TAXATION.
HMN and its subsidiaries file consolidated federal income tax returns on
a calendar year basis using the accrual method of accounting. Prior to 1996,
savings institutions were subject to special bad debt reserve rules and
certain other rules. During this period of time, a savings institution that
held 60% or more of its assets in "qualifying assets" (as defined in the
Internal Revenue Code) was permitted to maintain reserves for bad debts and
to make annual additions to such reserves that qualified as deductions from
taxable income, HMN was in compliance with this requirement.
A qualifying thrift institution could elect annually to compute its
allowable additons to bad debt reserves under either the percentage of
taxable income method or the experience method. The percentage of taxable
income method of calculating bad debt reserves limited the applicable
percentage deduction to 8% of taxable income and could not cause the reserves
to exceed 6% of qualifying loans at the end of the taxable year. HMN used the
experience method to calculate additions to tax bad debt reserves through tax
year 1995.
Beginning in 1996, the favorable bad debt method described above was
repealed putting savings insitutions on the same tax bad debt method as
commercial banks. This legislation requires recapture of the amount of the
tax bad debt reserves to the extent that they exceed the adjusted base year
reserve ("the applicable excess reserves"). The applicable excess reserves
are recaptured over a six-year period. This recapture period can be deferred
for a period of up to two years to the extent that a certain residential
lending test is met. HMN has previously provided taxes for the applicable
excess reserves.
In addition to the regular income tax, corporations, including savings
associations such as the Bank, generally are subject to a minimum tax. An
alternative minimum tax is imposed at a minimum tax rate of 20% on
alternative minimum taxable income, which is the sum of a corporation's
regular taxable income (with certain adjustments) and tax preference items,
less any available exemption. The alternative minimum tax is imposed to the
extent it exceeds the corporation's regular income tax and net operating
losses can offset no more than 90% of alternative minimum taxable income.
To the extent earnings appropriated to a savings association's bad debt
reserves for "qualifying real property loans" and deducted for federal income
tax purposes before 1988 exceed the allowable amount of such reserves
computed under the experience method and to the extent of the association's
supplemental reserves for losses on loans ("Excess"), such Excess may not,
without adverse tax consequences, be utilized for the payment of cash
dividends or other distributions to a shareholder (including distributions on
redemption, dissolution or liquidation) or for any other purpose (except to
absorb bad debt losses). As of December 31, 1997, the Bank's Excess for tax
purposes totaled approximately $8.8 million.
HMN was incorporated in 1994 and filed its first consolidated Federal
income tax return with its subsidiaries for the year ended December 31, 1994.
The return required to be filed for 1997 has been extended and will be filed
by September 1998. The Bank and its consolidated subsidiaries have been
audited by the IRS with respect to consolidated federal income tax returns
through December 31, 1983. With respect to years examined by the IRS, either
all deficiencies have been satisfied or sufficient reserves have been
established to satisfy asserted deficiencies. In the opinion of management,
any examination of still open returns (including returns of subsidiaries and
predecessors of, or entities merged into, the Bank) would not result in a
deficiency which could have a material adverse effect on the consolidated
financial condition of HMN.
MINNESOTA TAXATION. HMN and its subsidiaries that operate in Minnesota
are subject to Minnesota state taxation. A Minnesota corporation's income or
loss is allocated based on a three-factor apportionment of the corporation's
Minnesota gross receipts, payroll and property over the total gross receipts,
payroll and property of all corporations in the unitary group. The corporate
tax rate in Minnesota is 9.8%. The Minnesota Alternative Minimum Tax rate is
5.8%.
40
The Bank and it subsidiaries have not been audited by the Minnesota
taxation authorities.
IOWA TAXATION. On December 5, 1997 the Bank acquired MFC and its
subsidiaries which were located in the state of Iowa. The Bank is now subject
to Iowa Franchise tax on an apportionment basis weighted based upon deposits
located within Iowa to total deposits of the Bank. Income apportioned to Iowa
is subject to a 5% tax rate.
DELAWARE TAXATION. As a Delaware holding company, HMN is exempted from
Delaware corporate income tax but is required to file an annual report with
and pay an annual fee to the State of Delaware. HMN is also subject to an
annual franchise tax imposed by the State of Delaware.
41
ITEM 2. PROPERTIES
The following table sets forth information concerning the main office
and each branch office of HMN at December 31, 1997. At December 31, 1997,
HMN's premises had an aggregate net book value of approximately $4.6 million.
YEAR OWNED OR NET BOOK VALUE AT
LOCATION ACQUIRED LEASED DECEMBER 31, 1997(1)
- - ------------------------------ -------- -------- --------------------
(In Thousands)
MAIN OFFICE:
101 North Broadway 1975 Owned 341
Spring Valley, Minnesota
FULL SERVICE BRANCHES:
201 Oakland Avenue 1960 Owned 176
Austin, Minnesota
Crossroads Shopping Center 1962 Owned 500
Rochester, Minnesota
4th & Center 1973 Owned 123
Winona, Minnesota
208 South Walnut 1975 Owned 90
LaCrescent, Minnesota
1110 6th St., NW 1982 Owned 878
Rochester, Minnesota
143 West Clark Street 1993 Owned 582
Albert Lea, Minnesota
303 W. Main St. 1997 Owned 636
Marshalltown, Iowa
119 W. High St. 1997 Leased 3
Toledo, Iowa
29 S. Center 1997 Owned 159
Marshalltown, Iowa
MORTGAGE BANKING/BROKERAGE OFFICES:
9973 Valley View Road 1996 Leased ---
Eden Prairie, Minnesota
7101 Northland Circle, Suite 105 1997 Leased ---
Brooklyn Park, Minnesota
- - ---------------------
(1) Does not include $955,163 of net furniture and equipment distributed
between all of the above offices or its subsidiaries.
42
During 1997 HMN purchased land totaling $392,700 in order to build new
retail banking facilities in Spring Valley and Winona. During 1997 HMN spent
$700,000 for construction in process on the two banking facilities. During
1998 HMN will spend approximately $2,200,000 to complete its building
projects and provide the buildings with furniture and equipment. The
facilities will replace the existing retail facilities in both locations.
HMN believes that its remaining facilities are adequate to meet their present
needs.
The Bank's depositor and borrower customer files are maintained by an
independent data processing company. The net book value of the data
processing and computer equipment utilized by the Bank at December 31, 1997
was approximately $575,000.
ITEM 3. LEGAL PROCEEDINGS
From time to time, the Bank and HMN are involved as plaintiff or
defendant in various legal proceedings arising in the normal course of its
business. While the ultimate outcome of these various legal proceedings
cannot be predicted with certainty, it is the opinion of management that the
resolution of these legal actions should not have a material effect on HMN's
consolidated financial condition or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SECURITY HOLDER
MATTERS
The information on pages 26, 48 and the back cover page of the Annual
Report to Security Holders for the year ended December 31, 1997 is
incorporated herein by reference.
ITEM 6. SELECTED FINANCIAL DATA
The information on page 11 of the Annual Report to Security Holders for
the year ended December 31, 1997 is incorporated herein by reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The information on pages 12 through 26 of the Annual Report to Security
Holders for the year ended December 31, 1997 is incorporated herein by
reference.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The information on pages 21 through 23 of the Annual Report to Security
Holders for the year ended December 31, 1997 is incorporated herein by
reference.
43
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information on pages 27 through 48 of the Annual Report to Security
Holders for the year ended December 31, 1997 is incorporated herein by
reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information on pages 5 through 8 of the Registrant's definitive
Proxy Statement dated March 30, 1998 is incorporated herein by reference.
See "Business - Executive Officers" in Part I of the Form 10-K for
information regarding executive officers.
ITEM 11. EXECUTIVE COMPENSATION
The information on pages 8 through 14 of the Registrant's definitive
Proxy Statement dated March 30, 1998 is incorporated herein be reference,
except for information contained under the heading "Compensation Committee
Report on Executive Compensation".
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information on pages 2 through 4 of the Registrant's definitive
Proxy Statement dated March 30, 1998 is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None.
44
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) FINANCIAL STATEMENTS, FINANCIAL STATEMENT SCHEDULES AND EXHIBITS
1. Financial Statements
The following information appearing in the Registrant's Annual
Report to Security Holders for the year ended December 31, 1997,
is incorporated by reference in this Form 10-K Annual Report as
Exhibit 13.
Pages in
1997 Annual
Annual Report Section Report
--------------------- -----------
Five Year Consolidated Financial Highlights 11
Consolidated Balance Sheets --
December 31, 1997 and 1996 27
Consolidated Statements of Income --
Each of the Years in the Three-Year
Period Ended December 31, 1997 28
Consolidated Statement of Stockholders'
Equity -- Each of the Years in the
Three-Year Period Ended December 31, 1997 29
Consolidated Statements of Cash Flows --
Each of the Years in the Three-Year
Period Ended December 31, 1997 30
Notes to Consolidated Financial Statements 31 - 44
Independent Auditors' Report 45
Selected Quarterly Financial Data 46 - 47
Other Financial Data 48
Common Stock Price Information 48
2. Financial Statement Schedules
All financial statement schedules have been omitted as information is
not required under the related instructions, is not applicable or has
been included in the Notes to Consolidated Financial Statements.
45
3. Exhibits
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-K Report
-------------- ---------------------------- --------------- ----------------
2 Agreement and Plan of Merger ***** Not applicable
dated July 1, 1997
3 (i) Articles of Incorporation * Not applicable
(ii) By-laws ****** Not applicable
4 Instruments defining the rights of security * Not applicable
holders, including indentures
9 Voting trust agreement Not applicable Not applicable
10.1 + Employment agreement for Mr. Weise ** Not applicable
dated June 29, 1994
Extension of Employment Contract ******* Not applicable
10.2 + Employment agreement for Mr. Gardner ** Not applicable
dated June 29, 1994
Extension of Employment Contract ******* Not applicable
10.3 + Directors Deferred Compensation Plan ** Not applicable
10.4 + 1995 Recognition and Retention Plan *** Not applicable
10.5 + 1995 Stock Option and Incentive Plan *** Not applicable
11 Statement re: Computation of per share 11 Filed electronically
earnings
12 Statement re: Computation of ratios Not applicable Not applicable
13 Annual Report to Security Holders 13 Filed electronically
16 Letter re: Change in certifying accountant Not applicable Not applicable
18 Letter re: Change in accounting principles Not applicable Not applicable
21 Subsidiaries of Registrant 21 Filed electronically
+ Management contract of compensatory arrangement.
46
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-K Report
-------------- ---------------------------- --------------- ----------------
22 Published report regarding matters Not applicable Not applicable
submitted to vote of security holders
23 Consent of KPMG Peat Marwick LLP 23 Filed electronically
dated March 26, 1998
24 Power of Attorney Not applicable Not applicable
27.1 Finacial Data Schedule 27.1 Filed electronically
Year ended 1997
27.2 Financial Data Schedule 27.2 Filed electronically
Restated for quarters ended March 31, 1997
June 30, 1997 and September 30, 1997
27.3 Financial Data Schedule 27.3 Filed electronically
Restated for March 31, 1996, June 30, 1996
September 30, 1996 and December 31, 1996
27.4 Financial Data Schedule 27.4 Filed electronically
Restated for the year ended December 31, 1995
28 Information from reports furnished to None Not applicable
state insurance regulatory authorities
99 Additional exhibits None Not applicable
- - -------------
* Filed April 1, 1994, as exhibits to the Registrant's Form S-1 registration
statement (Registration No. 33-77212) pursuant to the Securities Act of 1933.
All of such previously filed documents are hereby incorporated herein by
reference in accordance with Item 601 of Regulation S-K.
** Filed as an exhibit to the Registrant's Form 10-K for 1994 (file no.
0-24100). All previously filed documents are hereby incorporated by
reference in accordance with Item 601 of Regulation S-K.
*** Filed as an exhibit to the Registrant's Form 10-K for 1995 (file no.
0-24100). All previously filed documents are hereby incorporated by
reference in accordance with Item 601 of Regulation S-K.
****Filed as an exhibit to the Registrant's Form 10-K for 1996 (file no.
0-24100). All previously filed documents are hereby incorporated by
reference in accordance with Item 601 of Regulation S-K.
*****Filed as an exhibit to Current Report of Form 8-K dated July 1, 1997,
filed on July 10, 1997. All previously filed documents are hereby
incorporated by reference.
******Filed as an exhibit to the Registrant's Form 10-Q for the third quarter
of 1997 (file no. 0-24100). All previously filed documents are hereby
incorporated by reference.
*******Filed as an exhibit to the Registrant's Form 10-Q for the second
quarter of 1997 (file no. 0-24100). All previously filed documents are hereby
incorporated by reference.
47
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
Date: March 31, 1998 By: /s/ Roger P. Weise
----------------------------- -------------------------------------
Roger P. Weise
(Duly Authorized Representative)
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
By: /s/ Roger P. Weise By: /s/ James B. Gardner
----------------------------- -------------------------------------
Roger P. Weise, Chairman of James B. Gardner,
the Board, President and Chief Executive Vice President and Director
Executive Officer (Principal (Principal Financial Officer)
Executive and Operating
Officer)
Date: March 31, 1998 Date: March 31, 1998
----------------------------- -----------------------------------
By: /s/ Irma R. Rathbun By: /s/ Timothy R. Geisler
------------------------------- -------------------------------------
Irma R. Rathbun, Director Timothy R. Geisler, Director
Date: March 31, 1998 Date: March 31, 1998
----------------------------- -----------------------------------
By: /s/ M. F. Schumann By: /s/ Duane D. Benson
------------------------------- -------------------------------------
M.F. Schumann, Director Duane D. Benson, Director
Date: March 31, 1998 Date: March 31, 1998
----------------------------- -----------------------------------
By: /s/ Dwain C. Jorgensen
-------------------------------
Dwain C. Jorgensen,
Vice President and Controller
(Principal Accounting Officer)
Date: March 31, 1998
-----------------------------
48
INDEX TO EXHIBITS
Sequential
Page Numbering
Where Attached
Exhibits Are
Regulation S-K Located in This
Exhibit Number Document Form 10-K Report
-------------- ------------------------------------- ----------------
11 Statement re: Computation of per share earnings Filed electronically
13 Annual Report to Security Holders Filed electronically
21 Subsidiaries of Registrant Filed electronically
23 Consent of KPMG Peat Marwick LLP Filed electronically
dated March 26, 1998
27.1 Finacial Data Schedule Filed electronically
Year ended 1997
27.2 Financial Data Schedule Filed electronically
Restated for quarters ended March 31, 1997,
June 30, 1997 and September 30, 1997
27.3 Financial Data Schedule Filed electronically
Restated for March 31, 1996, June 30, 1996,
September 30, 1996 and December 31, 1996
27.4 Financial Data Schedule Filed electronically
Restated for the year ended December 31, 1995
49