UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) FOR THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _________ to _________
Commission File Number 0-24100
HMN FINANCIAL, INC.
(Exact name of Registrant as specified in its Charter)
Delaware | 41-1777397 |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification Number) |
1016 Civic Center Drive NW, Rochester, Minnesota | 55901 |
(Address of principal executive offices) | (ZIP Code) |
Registrant's telephone number, including area code: | (507) 535-1200 |
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes (X) No ( )
Indicate the number of shares outstanding of each of the issuer's common stock as of the latest practicable date.
Class | Outstanding at August 1, 2002 |
Common stock, $0.01 par value | 4,426,906 |
1
HMN FINANCIAL, INC.
CONTENTS
PART I - FINANCIAL INFORMATION Page
Item 1: Financial Statements (unaudited)
Consolidated Balance Sheets at June 30, 2002 and December 31, 2001 3
Consolidated Statements of Income for the
Three Months Ended and Six Months Ended June 30, 2002 and 2001 4
Consolidated Statements of Comprehensive Income for the
Three Months Ended and Six Months Ended June 30, 2002 and 2001 5
Consolidated Statement of Stockholders' Equity for the Six Month Period Ended June 30, 2002 5
Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2002 and 2001 6
Notes to Consolidated Financial Statements 7-16
Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations 17-26
Item 3: Quantitative and Qualitative Disclosures about Market Risk
Discussion included in Item 2 under Market Risk 21
PART II - OTHER INFORMATION
Item 1: Legal Proceedings 27
Item 2: Changes in Securities 27
Item 3: Defaults Upon Senior Securities 27
Item 4: Submission of Matters to a Vote of Security Holders 27
Item 5: Other Information 28
Item 6: Exhibits and Reports on Form 8-K 28
Signatures 29
2
HMN FINANCIAL, INC. AND SUBSIDIARIES |
|||||
Consolidated Balance Sheets |
|||||
(unaudited) |
|||||
June 30, |
December 31, |
||||
2002 |
2001 |
||||
Assets |
|||||
Cash and cash equivalents |
$ |
37,845,222 |
23,019,553 |
||
Securities available for sale: |
|||||
Mortgage-backed and related securities |
|||||
(amortized cost $65,838,697 and $65,878,534) |
65,565,268 |
66,229,732 |
|||
Other marketable securities |
|||||
(amortized cost $67,061,818 and $53,439,401) |
67,052,837 |
53,665,502 |
|||
|
|
||||
132,618,105 |
119,895,234 |
||||
Loans held for sale |
12,305,092 |
68,017,570 |
|||
Loans receivable, net |
470,292,428 |
471,667,772 |
|||
Accrued interest receivable |
3,284,326 |
3,508,828 |
|||
Federal Home Loan Bank stock, at cost |
12,245,000 |
12,245,000 |
|||
Mortgage servicing rights, net |
2,382,612 |
1,903,636 |
|||
Premises and equipment, net |
13,105,139 |
10,860,756 |
|||
Investment in limited partnerships |
1,850,514 |
1,523,650 |
|||
Goodwill |
3,800,938 |
3,800,938 |
|||
Core deposit intangible |
623,420 |
685,509 |
|||
Prepaid expenses and other assets |
3,370,635 |
3,985,625 |
|||
|
|
||||
Total assets |
$ |
693,723,431 |
721,114,071 |
||
Liabilities and Stockholders' Equity |
|||||
Deposits |
$ |
399,529,841 |
421,843,369 |
||
Federal Home Loan Bank advances |
214,300,000 |
217,800,000 |
|||
Accrued interest payable |
725,382 |
1,017,456 |
|||
Advance payments by borrowers for taxes and insurance |
631,834 |
1,015,570 |
|||
Accrued expenses and other liabilities |
4,563,467 |
6,535,734 |
|||
Deferred tax liabilities |
548,900 |
976,900 |
|||
|
|
||||
Total liabilities |
620,299,424 |
649,189,029 |
|||
|
|||||
Commitments and contingencies | |||||
Minority interest |
(332,553) |
(236,309) |
|||
Stockholders' equity: |
|||||
Serial preferred stock ($.01 par value): |
|||||
Authorized 500,000 shares; issued and outstanding none |
0 |
0 |
|||
Common stock ($.01 par value): |
|||||
Authorized 11,000,000; issued shares 9,128,662 |
91,287 |
91,287 |
|||
Additional paid-in capital |
58,920,012 |
59,168,782 |
|||
Retained earnings, subject to certain restrictions |
78,987,595 |
76,956,978 |
|||
Accumulated other comprehensive income (loss) |
(191,209) |
367,744 |
|||
Unearned employee stock ownership plan shares |
(5,028,032) |
(5,124,746) |
|||
Unearned compensation restricted stock awards |
0 |
(7,350) |
|||
Treasury stock, at cost 4,714,756 and 4,732,521 shares |
(59,023,093) |
(59,291,344) |
|||
|
|
||||
Total stockholders' equity |
73,756,560 |
72,161,351 |
|||
|
|
||||
Total liabilities and stockholders' equity |
$ |
693,723,431 |
721,114,071 |
||
See accompanying notes to consolidated financial statements.
3
HMN FINANCIAL, INC. AND SUBSIDIARIES
Consolidated Statements of Income
(unaudited)
Three Months Ended |
Six Months Ended |
|||||||
June 30, |
June 30, |
|||||||
|
|
|||||||
2002 |
2001 |
2002 |
2001 |
|||||
Interest income: |
||||||||
Loans receivable |
$ |
9,019,269 |
11,321,443 |
18,768,775 |
22,547,937 |
|||
Securities available for sale: |
||||||||
Mortgage-backed and related |
554,104 |
1,029,327 |
1,012,165 |
2,277,956 |
||||
Other marketable |
704,003 |
632,461 |
1,436,796 |
1,490,404 |
||||
Cash equivalents |
168,773 |
28,308 |
259,352 |
71,536 |
||||
Other |
65,040 |
130,842 |
174,702 |
296,728 |
||||
|
|
|
|
|||||
Total interest income |
10,511,189 |
13,142,381 |
21,651,790 |
26,684,561 |
||||
Interest expense: |
||||||||
Deposits |
2,633,678 |
4,909,776 |
5,747,225 |
9,971,378 |
||||
Federal Home Loan Bank advances |
2,594,935 |
3,018,502 |
5,171,798 |
6,348,866 |
||||
|
|
|
|
|||||
Total interest expense |
5,228,613 |
7,928,278 |
10,919,023 |
16,320,244 |
||||
|
|
|
|
|||||
Net interest income |
5,282,576 |
5,214,103 |
10,732,767 |
10,364,317 |
||||
Provision for loan losses |
310,000 |
300,000 |
1,030,000 |
450,000 |
||||
|
|
|
|
|||||
Net interest income after provision for loan losses |
4,972,576 |
4,914,103 |
9,702,767 |
9,914,317 |
||||
Non-interest income: |
||||||||
Fees and service charges |
390,352 |
362,760 |
794,161 |
714,551 |
||||
Mortgage servicing fees |
177,229 |
107,457 |
337,162 |
214,231 |
||||
Securities gains (losses), net |
26,583 |
(610,000) |
45,508 |
(332,296) |
||||
Gain on sales of loans |
498,469 |
1,453,930 |
1,543,029 |
2,207,926 |
||||
Earnings (losses) in limited partnerships |
(51,946) |
(325,258) |
326,975 |
(628,539) |
||||
Other |
150,914 |
199,827 |
408,980 |
329,951 |
||||
Total non-interest income |
1,191,601 |
1,188,716 |
3,455,815 |
2,505,824 |
||||
Non-interest expense : |
||||||||
Compensation and benefits |
2,068,560 |
2,042,047 |
4,020,044 |
3,955,058 |
||||
Occupancy |
726,261 |
514,572 |
1,409,688 |
1,079,791 |
||||
Federal deposit insurance premiums |
18,671 |
19,969 |
38,107 |
40,772 |
||||
Advertising |
146,537 |
113,988 |
289,082 |
200,143 |
||||
Data processing |
286,925 |
240,928 |
551,384 |
471,754 |
||||
Amortization of mortgage servicing rights, net of valuation adjustments and servicing costs |
171,104 |
195,395 |
382,306 |
336,038 |
||||
Other |
1,107,948 |
811,500 |
1,981,054 |
1,555,778 |
||||
Total noninterest expense |
4,526,006 |
3,938,399 |
8,671,665 |
7,639,334 |
||||
Income before income tax expense |
1,638,171 |
2,164,420 |
4,486,917 |
4,780,807 |
||||
Income tax expense |
485,100 |
787,300 |
1,325,200 |
1,784,900 |
||||
Income before minority interest |
1,153,071 |
1,377,120 |
3,161,717 |
2,995,907 |
||||
Minority interest |
(114,968) |
105,001 |
(74,294) |
132,880 |
||||
Net income |
$ |
1,268,039 |
1,272,119 |
3,236,011 |
2,863,027 |
|||
Basic earnings per share |
$ |
0.34 |
0.34 |
0.87 |
0.77 |
|||
Diluted earnings per share |
$ |
0.32 |
0.32 |
0.82 |
0.72 |
|||
See accompanying notes to consolidated financial statements.
4
HMN FINANCIAL, INC. AND SUBSIDIARIES
Three Months Ended June 30, |
||||||||||||
2002 |
2001 |
|||||||||||
Net income |
$ |
1,268,039 |
1,272,119 |
|||||||||
Other comprehensive income (loss), net of tax: |
||||||||||||
Unrealized losses on hedging valuation |
(13,563) |
(81,621) |
||||||||||
Less: minority interest in hedging valuation |
(8,116) |
(30,688) |
||||||||||
Net unrealized losses on hedging valuation |
(5,447) |
(50,933) |
||||||||||
Unrealized gains (losses) on securities: |
||||||||||||
Unrealized holding gains (losses) arising during period |
(598,418) |
585,459 |
||||||||||
Less: reclassification adjustment for gains |
||||||||||||
(losses) included in net income |
17,184 |
(368,300) |
||||||||||
Net unrealized gains (losses) on securities |
(615,602) |
953,759 |
||||||||||
Other comprehensive income (loss) |
(621,049) |
902,826 |
||||||||||
|
|
|||||||||||
Comprehensive income |
$ |
646,990 |
2,174,945 |
|||||||||
Six Months Ended June 30, |
||||||||||||
2002 |
2001 |
|||||||||||
Net income |
$ |
3,236,011 |
2,863,027 |
|||||||||
Other comprehensive income (loss), net of tax: |
||||||||||||
Unrealized losses on hedging valuation |
(35,795) |
(81,621) |
||||||||||
Less: minority interest in hedging valuation |
(21,950) |
(30,688) |
||||||||||
Net unrealized losses on hedging valuation |
(13,845) |
(50,933) |
||||||||||
Unrealized gains (losses) on securities: |
||||||||||||
Unrealized holding gains (losses) arising during period |
(515,700) |
1,943,193 |
||||||||||
Less: reclassification adjustment for gains |
||||||||||||
(losses) included in net income |
29,408 |
(197,589) |
||||||||||
Net unrealized gains (losses) on securities |
(545,108) |
2,140,782 |
||||||||||
Other comprehensive income (loss) |
(558,953) |
2,089,849 |
||||||||||
|
|
|||||||||||
Comprehensive income |
$ |
2,677,058 |
4,952,876 |
|||||||||
See accompanying notes to consolidated financial statements.
HMN FINANCIAL, INC. AND SUBSIDIARIES
Consolidated Statement of Stockholders' Equity
For the Six Month Period Ended June 30, 2002
(unaudited)
|
Unearned |
|||||||
Employee |
Unearned |
|||||||
Accumulated |
Stock |
Compensation |
Total |
|||||
Additional |
Other |
Ownership |
Restricted |
Stock- |
||||
Common |
Paid-in |
Retained |
Comprehensive |
Plan |
Stock |
Treasury |
Holders' |
|
Stock |
Capital |
Earnings |
Income (Loss) |
Shares |
Awards |
Stock |
Equity |
|
|
||||||||
Balance, December 31, 2001 |
$ 91,287 |
59,168,782 |
76,956,978 |
367,744 |
(5,124,746) |
(7,350) |
(59,291,344) |
72,161,351 |
Net income |
3,236,011 |
3,236,011 |
||||||
Other comprehensive loss |
(558,953) |
(558,953) |
||||||
Treasury stock purchases |
(658,611) |
(658,611) |
||||||
Employee stock options |
||||||||
exercised |
(415,938) |
926,862 |
510,924 |
|||||
Tax benefits of exercised |
||||||||
stock options |
100,011 |
100,011 |
||||||
Amortization of restricted |
||||||||
stock awards |
7,350 |
7,350 |
||||||
Dividends paid |
(1,205,394) |
(1,205,394) |
||||||
Earned employee stock |
||||||||
ownership plan shares |
67,157 |
96,714 |
163,871 |
|||||
|
||||||||
Balance, June 30, 2002 |
$ 91,287 |
58,920,012 |
78,987,595 |
(191,209) |
(5,028,032) |
0 |
(59,023,093) |
73,756,560 |
See accompanying notes to consolidated financial statements.
5
HMN FINANCIAL, INC. AND SUBSIDIARIES |
||||
Consolidated Statements of Cash Flows |
||||
(unaudited) |
||||
Six Months Ended |
||||
|
||||
2002 |
2001 |
|||
|
|
|||
Cash flows from operating activities: |
||||
Net income |
$ |
3,236,011 |
2,863,027 |
|
Adjustments to reconcile net income to cash provided (used) by operating activities: |
||||
Provision for loan losses |
1,030,000 |
450,000 |
||
Depreciation |
620,765 |
496,208 |
||
Amortization of premiums, net |
100,001 |
46,564 |
||
Amortization of deferred loan fees |
(415,631) |
(260,738) |
||
Amortization of goodwill |
0 |
90,018 |
||
Amortization of core deposit intangible |
62,089 |
62,749 |
||
Amortization of other purchase accounting adjustments |
5,088 |
6,220 |
||
Amortization of mortgage servicing rights and net valuation adjustments |
371,667 |
329,604 |
||
Capitalized mortgage servicing rights |
(850,643) |
(620,244) |
||
Deferred income taxes |
(104,400) |
132,375 |
||
Securities(gains) losses, net |
(45,508) |
332,296 |
||
Gains on sales of real estate |
0 |
(16,921) |
||
Gain on sales of loans |
(1,543,029) |
(2,207,926) |
||
Proceeds from sale of loans held for sale |
167,703,663 |
383,937,788 |
||
Disbursements on loans held for sale |
(105,746,755) |
(420,124,178) |
||
Principal collected on loans held for sale |
87,982 |
40,905 |
||
Amortization of restricted stock awards |
7,350 |
2,450 |
||
Amortization of unearned ESOP shares |
96,714 |
96,714 |
||
Earned employee stock ownership shares priced above original cost |
67,157 |
47,550 |
||
Decrease in accrued interest receivable |
224,502 |
846,018 |
||
Decrease in accrued interest payable |
(292,074) |
(466,264) |
||
Equity (earnings) losses of limited partnerships |
(326,975) |
628,539 |
||
Equity earnings (losses) of minority interest |
(74,294) |
132,880 |
||
Increase in other assets |
(489,476) |
(1,260,404) |
||
Increase (decrease) in other liabilities |
(1,461,835) |
1,028,834 |
||
Other, net |
7,602 |
11,152 |
||
|
|
|||
Net cash (used) provided by operating activities |
|
62,269,971 |
|
(33,374,784) |
|
|
|||
Cash flows from investing activities: |
||||
Proceeds from sales of securities available for sale |
3,566,891 |
15,000,567 |
||
Principal collected on securities available for sale |
10,427,472 |
5,351,723 |
||
Proceeds collected on maturity of securities available for sale |
12,400,000 |
8,695,000 |
||
Purchases of securities available for sale |
(40,055,856) |
0 |
||
Proceeds from sales of loans receivable |
0 |
12,156 |
||
Net decrease (increase) in loans receivable |
(3,169,588) |
14,227,463 |
||
Proceeds from sale of real estate |
0 |
311,544 |
||
Purchases of premises and equipment |
(2,876,412) |
(875,372) |
||
|
|
|||
Net cash (used) provided by investing activities |
|
(19,707,493) |
|
42,723,081 |
|
|
|||
Cash flows from financing activities: |
||||
Decrease in deposits |
(22,499,992) |
(9,279,172) |
||
Purchase of treasury stock |
(658,611) |
(74,152) |
||
Stock options exercised |
510,924 |
190,506 |
||
Dividends to stockholders |
(1,205,394) |
(815,771) |
||
Proceeds from Federal Home Loan Bank advances |
0 |
194,200,000 |
||
Repayment of Federal Home Loan Bank advances |
(3,500,000) |
(176,300,000) |
||
Minority interest in mortgage services |
0 |
125,000 |
||
Increase (decrease) in advance payments by borrowers for taxes and insurance |
(383,736) |
237,465 |
||
|
|
|||
Net cash (used) provided by financing activities |
|
(27,736,809) |
|
8,283,876 |
|
|
|||
Increase in cash and cash equivalents |
|
14,825,669 |
|
17,632,173 |
Cash and cash equivalents, beginning of period |
23,019,553 |
14,416,861 |
||
|
|
|||
Cash and cash equivalents, end of period |
$ |
37,845,222 |
|
32,049,034 |
|
|
|||
Supplemental cash flow disclosures: |
||||
Cash paid for interest |
$ |
11,211,097 |
16,786,508 |
|
Cash paid for income taxes |
1,492,500 |
2,163,000 |
||
Supplemental noncash flow disclosures: |
||||
Loans transferred to loans held for sale |
3,621,521 |
801,947 |
||
Transfer of loans to real estate |
224,288 |
81,242 |
||
|
See accompanying notes to consolidated financial statements.
6
HMN FINANCIAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(unaudited)
June 30, 2002 and 2001
(1) HMN Financial, Inc.
HMN Financial, Inc. (HMN) is a stock savings bank holding company that owns 100 percent of Home Federal Savings Bank (the Bank or Home Federal). Home Federal has a community banking philosophy and operates retail banking facilities in Minnesota and Iowa. The Bank has two wholly owned subsidiaries, Osterud Insurance Agency, Inc. (OAI) which offers financial planning products and services and Home Federal REIT, Inc. (HFREIT) which invests in real estate loans acquired from the Bank. HMN has another wholly owned subsidiary, Security
Finance Corporation (SFC) which holds a limited number of commercial and commercial real-estate loans originated by third parties. The Bank has a 51% owned subsidiary, Home Federal Mortgage Services, LLC (HFMS), which is a mortgage banking and mortgage brokerage business located in Brooklyn Park, Minnesota.The consolidated financial statements included herein are for HMN, SFC, the Bank and the Bank's subsidiaries, OAI, HFREIT and HFMS. All significant intercompany accounts and transactions have been eliminated in consolidation.
(2) Basis of Preparation
The accompanying unaudited consolidated financial statements were prepared in accordance with instructions for Form 10-Q and therefore, do not include all disclosures necessary for a complete presentation of the consolidated balance sheets, consolidated statements of income, consolidated statements of comprehensive income, consolidated statements of stockholders' equity and consolidated statements of cash flows in conformity with generally accepted accounting principles. However, all adjustments consisting of only normal recurring adjustments that are, in the opinion of management, necessary for the fair presentation of the interim financial statements have been included. The statement of income for the three month and six month periods ended June 30, 2002 are not necessarily indicative of the results which may be expected for the entire year.
Certain amounts in the consolidated financial statements for prior periods have been reclassified to conform with the current period presentation.
(3) New Accounting Standards
In July 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001 as well as all purchase method business combinations completed after June 30, 2001. SFAS No. 141 also specifies criteria that intangible assets acquired in a purchase method business combination must meet to be recognized and reported apart from goodwill, noting that any purchase price allocable to an assembled workforce may not be accounted for separately. SFAS No. 142 requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead tested for impairment at least annually in accordance with the provisions of SFAS No. 142.
HMN adopted the provisions of SFAS No. 141 effective July 1, 2001 and adopted SFAS No. 142 effective January 1, 2002. Intangible assets acquired in business combinations completed before July 1, 2001 were
7
evaluated during the first quarter of 2002 to determine if the useful lives and residual values of all intangible assets acquired in purchase business combinations met the new criteria established in SFAS No. 141 for recognition apart from goodwill and to make any necessary amortization period adjustments. Core deposit intangibles acquired in December of 1997 were assigned a remaining life of six years and are being amortized on an accelerated basis.
At December 31, 2001 the Bank (a reporting unit) had goodwill of $3,800,938 and during the first quarter of 2002 it was determined that the fair value of the Bank was in excess of the book value of the Bank therefore no impairment loss was necessary for goodwill. In determining the fair value of the Bank, management compiled recent financial institutional sale prices for similar sized financial institutions located in the Midwest and throughout the United States to determine average price to earnings multiples and average multiples of book. Fair value for the Bank was then determined by applying those multiples to the Bank's financial information. On January 1, 2002, in accordance with SFAS No. 142, goodwill amortization ceased. Goodwill amortization for the year ended 2001 was $180,036 or $45,009 per quarter.
In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB statement No. 13, and Technical Corrections. The provisions of this Statement related to the rescission of Statement 4 shall be applied in fiscal years beginning after May 15, 2002. Any gain or loss on extinguishment of debt that was classified as an extraordinary item in prior periods presented that does not meet the criteria in Opinion 30 for classification as an extraordinary item shall be reclassified. The impact of adopting SFAS No. 145 on HMN's financial condition and its results of operations will not be material.
(4) Derivative Instruments and Hedging Activities
HMN adopted SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, in the first quarter of 2001. In July of 2001, HMN entered into an interest rate swap for $15 million. Under the interest rate swap, HMN pays interest based upon the three month London Inter-Bank Offer Rate (LIBOR) and receives interest payments based upon a fixed rate of 6.0% on a notional value of $15 million in a fair value hedge with no ineffectiveness. The hedge is offsetting a callable certificate of deposit for $15 million that was issued by HMN. At June 30, 2002 the interest rate swap had a market value adjustment of $4,347 which is included in other liabilities. The corresponding certificate of deposit was adjusted by the same amount and is reflected in deposits in the consolidated balance sheet of HMN. The interest rate swap was deemed to be totally effective and therefore no gain or loss was recorded in the income statement. The swap was called in July 2002, and HMN simultaneously called the c ertificate of deposit relating to the swap.
HMN originates and purchases single family residential loans for sale into the secondary market and enters into commitments to sell or securitize those loans in order to mitigate the interest rate risk associated with holding the loans until they are sold. At the beginning of the second quarter of 2001, certain commitments to sell Loans Held for Sale were designated as a cash flow hedge of a forecasted transaction and were accounted for in accordance with SFAS No. 133 with no ineffectiveness recognized in the income statement. The derivative recorded in the balance sheet is a consolidated number that is partially owned by a minority interest. At June 30, 2002, there were no commitments to sell or securitize these loans and therefore, cash flow hedge accounting has been discontinued.
HMN has commitments outstanding to extend credit to future borrowers or to purchase loans that had not closed prior to the end of the quarter which it intends to sell. These commitments are referred to as its mortgage pipeline. As commitments to originate or purchase loans enter the mortgage pipeline, HMN simultaneously enters into commitments to sell the mortgage pipeline into the secondary market. As a result of marking the mortgage pipeline and the related commitments to sell to market for the second quarter ended June 30, 2002, HMN recorded a debit to Other Assets of $18,458, and a credit in Other Liabilities of $18,458.
The current commitments to sell Loans Held for Sale are derivatives that do not qualify for hedge accounting. As a result, these derivatives are marked to market. The Loans Held for Sale that are not hedged are recorded at the lower of cost or market. The lower of cost or market and the market value adjustments as of and for the quarter
8
ended June 30, 2002 were not material.
(5) Comprehensive Income
Comprehensive income is defined as the change in equity during a period from transactions and other events from nonowner sources. Comprehensive income is the total of net income and other comprehensive income, which for HMN is comprised of unrealized gains and losses on securities available for sale and unrealized gains and losses on hedging activity for loans held for sale and certificates of deposit with matching interest rate swaps.
The gross unrealized losses in hedging valuation for the second quarter of 2002 was $17,000, the income tax benefit would have been $3,000 and therefore, the net loss was $14,000. The gross minority interest in hedging valuation for the second quarter of 2002 was $8,000. The gross unrealized holding losses on securities for the second quarter of 2002 was $916,000, the income tax benefit would have been $318,000 and therefore, the net loss was $598,000. The gross reclassification adjustment for the second quarter of 2002 was $26,000, the income tax expense would have been $9,000 and therefore the net gain was $17,000. The gross unrealized hedging valuation loss for the second quarter of 2001 was $132,000, the income tax benefit would have been $50,000 and therefore, the net loss was $82,000. The gross minority interest in hedging valuation for the second quarter of 2001 was $31,000. The gross unrealized holding gains on securities for the second quarter of 2001 was $975,000, the income tax expense would have been $390,000 and therefore, the net gain was $585,000. The gross reclassification adjustment in the second quarter of 2001 was $610,000, the income tax benefit would have been $242,000 and therefore, the net reclassification adjustment was $368,000.
The gross unrealized losses in hedging valuation for the six month period ended June 30, 2002 was $45,000, the income tax benefit would have been $9,000 and therefore, the net loss was $36,000. The gross minority interest in hedging valuation for the six month period ended June 30, 2002 was $22,000. The gross unrealized holding losses on securities for the six month period ended June 30, 2002 was $814,000, the income tax benefit would have been $298,000 and therefore, the net loss was $516,000. The gross reclassification adjustment in the six month period ended June 30, 2002 was $45,000, the income tax expense would have been $16,000 and therefore, the net reclassification adjustment was $29,000. The gross unrealized losses in hedging valuation for the six month period ended June 30, 2001 was $132,000, the income tax benefit would have been $50,000 and therefore, the net loss was $82,000. The gross minority interest in hedging valuation for the six month period ended June 30, 2001 was $31,000. The gross u nrealized holding gains on securities for the six month period ended June 30, 2001 was $3,225,000, the income tax expense would have been $1,282,000 and therefore, the net gain was $1,943,000. The gross reclassification adjustment in the six month period ended June 30, 2001 was $332,000, the income tax benefit would have been $134,000 and therefore, the net reclassification adjustment was $198,000.
(6) Cash Dividend
On July 23, 2002 HMN's Board of Directors announced a cash dividend of $0.18 per share, payable on September 10, 2002 to stockholders of record on August 27, 2002.
9
(7) Investment in Mortgage Servicing Rights
A summary of mortgage servicing activity is as follows:
|
|||||||
|
|
Six Months ended |
|
Twelve Months ended |
|
Six Months ended |
|
|
|
|
|||||
Mortgage servicing rights |
|
|
|
|
|
|
|
Balance, beginning of period |
$ |
1,922,736 |
|
1,188,928 |
|
1,188,928 |
|
Originations |
|
850,643 |
|
1,458,321 |
|
620,244 |
|
Amortization |
|
(385,267) |
|
(724,513) |
|
(329,604) |
|
|
|
|
|||||
Balance, end of period |
|
2,388,112 |
|
1,922,736 |
|
1,479,568 |
|
|
|
|
|
|
|
|
|
Valuation reserve |
|
|
|
|
|
||
Balance, beginning of period |
|
(19,100) |
|
0 |
|
0 |
|
Additions |
|
0 |
|
(19,100) |
|
0 |
|
Reductions |
|
13,600 |
|
0 |
|
0 |
|
|
|
|
|||||
Balance, end of period |
|
(5,500) |
|
(19,100) |
|
0 |
|
|
|
|
|
|
|
|
|
Mortgage servicing rights, net |
$ |
2,382,612 |
|
1,903,636 |
|
1,479,568 |
|
|
|
|
|||||
Fair value of mortgage servicing rights |
$ |
2,536,000 |
|
1,939,000 |
|
1,632,000 |
|
|
|
|
|
|
|
|
|
|
Mortgage servicing costs, which include professional services for valuing mortgage servicing rights, were $1,310 at June 30, 2002, and $6,434 and $16,750 for the six and twelve months ended in June and December 2001, respectively.
All of the loans being serviced were single family loans serviced for FNMA under the mortgage-backed security program or the individual loan sale program. The following is a summary of the risk characteristics of the loans being serviced at June 30, 2002.
|
|||||||||
|
|
Loan Principal Balance |
|
Weighted Average Interest Rate |
|
Weighted Average Remaining Term |
|
Number of Loans |
|
|
|
|
|
||||||
Original term 30 year fixed rate |
$ |
132,844,000 |
|
7.05 |
% |
341 |
|
1,426 |
|
Original term 15 year fixed rate |
|
143,878,000 |
|
6.46 |
% |
161 |
|
2,068 |
|
Seven year balloon |
|
36,000 |
|
7.25 |
% |
308 |
|
1 |
|
Adjustable rate |
|
5,067,000 |
|
6.26 |
% |
326 |
|
36 |
|
|
10
(8) Investment in Limited Partnerships
Investments in limited partnerships were as follows:
|
|||||
Primary partnership activity |
|
June 30, 2002 |
|
December 31, 2001 |
|
|
|
||||
Mortgage servicing rights |
$ |
1,322,799 |
|
991,941 |
|
Common stock of financial institutions |
|
289,528 |
|
265,955 |
|
Low to moderate income housing |
|
238,187 |
|
265,754 |
|
|
|
||||
|
$ |
1,850,514 |
|
1,523,650 |
|
|
|
||||
|
During the second quarter of 2002 HMN's proportionate loss from a mortgage servicing partnership was $50,785, its proportionate share of gains from the common stock investments in financial institutions was $5,339 and it recognized $6,500 of losses on the low income housing partnerships. During 2002 HMN anticipates receiving low income housing credits totaling $84,000, of which $21,000 were credited to current income tax benefits in the second quarter of 2002. During the second quarter of 2001 HMN's proportionate loss from a mortgage servicing partnership (which included additional impairment reserves of $67,000) was $333,400, its proportionate share of losses from common stock investments in financial institutions was $14,600 and it recognized $6,500 of losses on low income housing partnerships. During 2001 HMN received low income housing credits totaling $84,000, of which $21,000 were credited to current income tax benefits in the second quarter.
During the six month period ended June 30, 2002 HMN's proportionate gain from a mortgage servicing partnership was $330,858, its proportionate share of gains from the common stock investments in financial institutions was $23,573 and it recognized $27,456 of losses on the low income housing partnerships. During 2002 HMN anticipates receiving low income housing credits totaling $84,000, of which $42,000 were credited to current income tax benefits in the six month period ended June 30, 2002. During the six month period ended June 30, 2001 HMN's proportionate loss from a mortgage servicing partnership (which included the reduction of previously established impairment reserves of $164,300) was $608,900, its proportionate share of losses from the common stock investments in financial institutions was $6,600 and it recognized $13,000 of losses on the low income housing partnerships. During 2001 HMN received low-income housing credits totaling $84,000, of which $42,000 were credited to current income tax bene fits in the six month period ended June 30, 2001.
(9) Intangible Assets
The gross carrying amount of intangible assets and the associated accumulated amortization at June 30, 2002 is presented in the table below. Amortization expense for intangible assets was $202,148 for the second quarter of 2002 and $443,085 for the six months ended June 30, 2002.
|
||||||||
Gross |
Unamortized |
|||||||
Carrying |
Accumulated |
Valuation |
Intangible |
|||||
Amount |
Amortization |
Adjustment |
Assets |
|||||
Amortized intangible assets: |
||||||||
Mortgage servicing rights* |
$ |
3,685,403 |
(1,316,391) |
13,600 |
2,382,612 |
|||
Core deposit intangible |
1,567,000 |
(943,580) |
0 |
623,420 |
||||
|
|
|
|
|||||
Total |
$ |
5,252,403 |
(2,259,971) |
13,600 |
3,006,032 |
|||
|
|
|
|
|||||
|
* The gross carrying amount and related accumulated amortization have been estimated because the mortgage servicing software utilized by HMN does not retain the original gross carrying amount of each mortgage servicing asset.
11
|
||||||
Mortgage |
Core |
|||||
Servicing |
Deposit |
|||||
Rights |
Intangible |
Total |
||||
|
||||||
Six months ended December 31, 2002 |
170,674 |
31,044 |
201,718 |
|||
Year ended December 31, |
||||||
2003 |
373,295 |
113,857 |
487,152 |
|||
2004 |
327,080 |
113,857 |
440,937 |
|||
2005 |
286,473 |
113,857 |
400,330 |
|||
2006 |
250,770 |
113,857 |
364,627 |
|||
2007 |
225,462 |
105,902 |
331,364 |
|||
|
Projections of amortization are based on existing asset balances and the existing interest rate environment as of June 30, 2002. HMN's actual experiences may be significantly different depending upon changes in mortgage interest rates and other market conditions.
(10) "Adjusted" Earnings SFAS No. 142 Transitional Disclosure
Effective January 1, 2002, the amortization of goodwill was discontinued. The table below reconciles reported earnings for the second quarter of 2001 to "adjusted" earnings, which exclude goodwill amortization.
|
||||||||
Quarter Ended June 30, 2001 |
||||||||
|
||||||||
Quarter |
||||||||
Ended |
Reported |
Goodwill |
Adjusted |
|||||
June 30, 2002 |
Earnings |
Amortization |
Earnings |
|||||
|
||||||||
Income before income tax expense |
$ |
1,638,171 |
2,164,420 |
45,009 |
2,209,429 |
|||
Income tax expense |
485,100 |
787,300 |
0 |
787,300 |
||||
|
|
|
|
|||||
Income before minority interest |
1,153,071 |
1,377,120 |
45,009 |
1,422,129 |
||||
Minority interest |
(114,968) |
105,001 |
0 |
105,001 |
||||
|
|
|
|
|||||
Net income |
$ |
1,268,039 |
1,272,119 |
45,009 |
1,317,128 |
|||
|
|
|
|
|||||
Earnings per common share |
$ |
0.34 |
0.34 |
0.01 |
0.35 |
|||
|
|
|
|
|||||
Diluted earnings per common share |
$ |
0.32 |
0.32 |
0.01 |
0.33 |
|||
|
|
|
|
|||||
|
|
||||||||
Six Months Ended June 30, 2001 |
||||||||
|
||||||||
Six Months |
||||||||
Ended |
Reported |
Goodwill |
Adjusted |
|||||
June 30, 2002 |
Earnings |
Amortization |
Earnings |
|||||
|
||||||||
Income before income tax expense |
$ |
4,486,917 |
4,780,807 |
90,018 |
4,870,825 |
|||
Income tax expense |
1,325,200 |
1,784,900 |
0 |
1,784,900 |
||||
|
|
|
|
|||||
Income before minority interest |
3,161,717 |
2,995,907 |
90,018 |
3,085,925 |
||||
Minority interest |
(74,294) |
132,880 |
0 |
132,880 |
||||
|
|
|
|
|||||
Net income |
$ |
3,236,011 |
2,863,027 |
90,018 |
2,953,045 |
|||
|
|
|
|
|||||
Earnings per common share |
$ |
0.87 |
0.77 |
0.02 |
0.79 |
|||
|
|
|
|
|||||
Diluted earnings per common share |
$ |
0.82 |
0.72 |
0.03 |
0.75 |
|||
|
|
|
|
|||||
|
12
At June 30, 2002 substantially all full-time employees of the Bank were included in a trusteed noncontributory retirement plan sponsored by the Financial Institutions Retirement Fund (FIRF). The actuarial present value of accumulated plan benefits and net assets available for benefits relating to the Bank's employees is not available at June 30, 2002 because such information is not accumulated for each participating institution. As of June 30, 2002, the FIRF valuation report reflected that the Bank was obligated to make contributions for the plan year ended June 30, 2002 totaling $20,575. On July 23, 2002 the Board of Directors of the Bank resolved to freeze the accrual of benefits for existing participants and the addition of new enrollments to the plan as of September 1, 2002. The costs associated with operating the plan from June 30, 2002 to the freeze date of September 1, 2002 are not known at this time but are estimated to be between $25,000 to $30,000.
(12) Earnings per Share
The following table reconciles the weighted average shares outstanding and the income available to common shareholders used for basic and diluted EPS:
|
Three months ended June 30, |
Six Months ended June 30, |
||||||||||||
|
|
|||||||||||||
|
2002 |
2001 |
2002 |
2001 |
||||||||||
|
|
|
|
|||||||||||
Weighted average number of common shares outstanding Used in basic earnings per common share calculation |
3,748,052 |
3,745,151 |
3,740,500 |
3,733,951 |
||||||||||
|
||||||||||||||
Net dilutive effect of: |
||||||||||||||
Options |
223,398 |
219,121 |
209,038 |
217,913 |
||||||||||
Restricted stock awards |
12 |
585 |
73 |
660 |
||||||||||
|
|
|
|
|||||||||||
Weighted average number of shares outstanding |
||||||||||||||
Adjusted for effect of dilutive securities |
3,971,462 |
3,964,857 |
3,949,611 |
3,952,524 |
||||||||||
|
|
|
|
|||||||||||
Income available to common shareholders |
$ |
1,268,039 |
1,272,119 |
3,236,011 |
2,863,027 |
|||||||||
Basic earnings per common share |
$0.34 |
0.34 |
0.87 |
0.77 |
||||||||||
Diluted earnings per common share |
$0.32 |
0.32 |
0.82 |
0.72 |
||||||||||
(13) Regulatory Capital
The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on HMN's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulations to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the following table) of Tier I or Core capital and Risk-based capital (as defined in the regulations) to total assets (as defined). Management believes, as of June 30, 2002, that the Bank meets all capital adequacy requirements to which it is subject.
Management believes that based upon the Bank's capital calculations at June 30, 2002 and other conditions consistent with the Prompt Corrective Actions Provisions of the OTS regulations, the Bank would be categorized as well capitalized.
13
On June 30, 2002 the Bank's tangible assets and adjusted total assets were $678.3 million and its risk-weighted assets were $465.3 million. The following table presents the Bank's capital amounts and ratios at June 30, 2002 for actual capital, required capital and excess capital including ratios in order to qualify as being well capitalized under the Prompt Corrective Actions regulations.
|
|||||||||||||||||
|
|
Actual |
|
Required to be |
|
Excess Capital |
|
To Be Well Capitalized Under Prompt Corrective Actions Provisions |
|
||||||||
|
|
|
|
||||||||||||||
(in thousands) |
|
Amount |
|
Percent of Assets(1) |
|
Amount |
|
Percent of Assets (1) |
|
Amount |
|
Percent of Assets(1) |
|
Amount |
|
Percent of Assets(1) |
|
|
|
|
|
|
|
|
|
||||||||||
Bank stockholder's equity |
$ |
62,629 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Plus: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Goodwill and other intangibles |
|
4,424 |
|
|
|||||||||||||
Excess mortgage servicing rights |
|
226 |
|||||||||||||||
|
|||||||||||||||||
Tier I or core capital |
|
58,165 |
|||||||||||||||
|
|||||||||||||||||
Tier I capital to adjusted total assets |
|
|
|
8.58% |
|
$ 27,132 |
|
4.00% |
|
$ 31,033 |
|
4.58% |
|
$ 33,915 |
5.00% |
|
|
Tier I capital to risk-weighted assets |
|
|
|
12.50% |
|
$ 18,610 |
|
4.00% |
|
$ 39,555 |
|
8.50% |
|
$ 27,915 |
|
6.00% |
|
Plus: |
|
|
|
||||||||||||||
|
|||||||||||||||||
Risk-based capital |
$ |
61,611 |
|
|
|
$ 37,221 |
|
|
|
$ 24,390 |
|
|
|
$ 46,526 |
|||
|
|||||||||||||||||
Risk-based capital to risk- weighted assets |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) Based upon the Bank's adjusted total assets for the purpose of the tangible and core capital ratios and risk-weighted assets for the purpose of the risk-based capital ratio. |
|
||||||||||||||||
|
The tangible capital of the Bank was in excess of the minimum 2% required at June 30, 2002 but is not reflected in the table above.
(14) Business Segments
HMN's subsidiary Home Federal Savings Bank and the Bank's subsidiary, Home Federal Mortgage Services, LLC (HFMS), have been identified as reportable operating segments in accordance with the provisions of SFAS 131. HFMS was deemed to be a segment because its operations were conducted independently from the Bank. HFMS has been segmented further into Mortgage Servicing Rights and Mortgage Banking activities. The mortgage servicing segment owns servicing rights on loans which have either been sold to FNMA or securitized into mortgage-backed instruments which were issued by FNMA. HFMS receives a servicing fee that is based upon the outstanding balance of the loan being serviced and pays a subservicer a monthly fee to service the loan. HFMS' mortgage banking activity purchases loans from other loan originators. All loans acquired are intended to be resold in the secondary loan market.
Security Finance Corporation and HMN, the holding company, did not meet the quantitative thresholds for determining reportable segments and therefore are included in the "Other" category.
HMN evaluates performance and allocates resources based on the segment's net income or loss, return on average assets and return on average equity. Each corporation is managed separately with its own president, who reports directly to HMN's chief operating decision maker, and board of directors.
The following table sets forth certain information about the reconciliations of reported profit or loss and assets for each of HMN's reportable segments.
14
Home Federal |
|||||||||||||||
Mortgage Services, LLC |
|||||||||||||||
|
|||||||||||||||
Home |
|||||||||||||||
Federal |
Mortgage |
Total |
|||||||||||||
Savings |
Servicing |
Mortgage |
Reportable |
Consolidated |
|||||||||||
(Dollars in thousands) |
Bank |
Rights |
Banking |
Segments |
Other |
Eliminations |
Total |
||||||||
|
|||||||||||||||
At or for the quarter ended |
|||||||||||||||
Interest income - external customers |
$ |
10,240 |
0 |
178 |
10,418 |
93 |
0 |
10,511 |
|||||||
Non-interest income - external customers |
1,147 |
10 |
66 |
1,223 |
21 |
0 |
1,244 |
||||||||
Earnings (loss) on limited partnerships |
(58) |
0 |
0 |
(58) |
6 |
0 |
(52) |
||||||||
Intersegment interest income |
99 |
0 |
0 |
99 |
0 |
(99) |
0 |
||||||||
Intersegment non-interest income (expense) |
(19) |
0 |
0 |
(19) |
1,216 |
(1,197) |
0 |
||||||||
Interest expense |
5,229 |
0 |
99 |
5,328 |
0 |
(99) |
5,229 |
||||||||
Amortization of mortgage servicing rights, |
|
|
|
|
|
|
|
||||||||
Other non-interest expense |
3,986 |
0 |
383 |
4,369 |
147 |
(162) |
4,354 |
||||||||
Income tax expense (benefit) |
593 |
0 |
0 |
593 |
(107) |
0 |
486 |
||||||||
Minority interest |
(115) |
0 |
0 |
(115) |
0 |
0 |
(115) |
||||||||
Net income (loss) |
1,263 |
3 |
(238) |
1,028 |
1,216 |
(976) |
1,268 |
||||||||
Goodwill |
3,801 |
0 |
0 |
3,801 |
0 |
0 |
3,801 |
||||||||
Total assets |
709,593 |
63 |
6,622 |
716,278 |
74,174 |
(96,729) |
693,723 |
||||||||
Net interest margin |
3.04 |
% |
NM |
NM |
NM |
NM |
NM |
3.17 |
% |
||||||
Return on average assets |
0.71 |
% |
18.18 |
% |
(8.44) |
% |
NM |
NM |
NM |
0.72 |
% |
||||
Return on average realized common equity |
8.00 |
% |
756.72 |
% |
(336.02) |
% |
NM |
NM |
NM |
6.75 |
% | ||||
At or for the quarter ended June 30, 2001: |
|||||||||||||||
Interest income- external customers |
$ |
12,126 |
0 |
911 |
13,037 |
105 |
0 |
13,142 |
|||||||
Non-interest income - external customers |
610 |
12 |
800 |
1,422 |
92 |
0 |
1,514 |
||||||||
Earnings (loss) on limited partnerships |
(339) |
0 |
0 |
(339) |
14 |
0 |
(325) |
||||||||
Intersegment interest income |
834 |
0 |
0 |
834 |
85 |
(919) |
0 |
||||||||
Intersegment non-interest income |
230 |
0 |
0 |
230 |
1,364 |
(1,594) |
0 |
||||||||
Interest expense |
7,975 |
0 |
869 |
8,844 |
3 |
(919) |
7,928 |
||||||||
Amortization of mortgage servicing rights,net valuation adjustments, and servicing costs |
|
|
|
|
|
|
|
||||||||
Other non-interest expense |
2,910 |
(1) |
611 |
3,520 |
369 |
(146) |
3,743 |
||||||||
Income tax expense |
771 |
0 |
0 |
771 |
16 |
0 |
787 |
||||||||
Minority interest |
105 |
0 |
0 |
105 |
0 |
0 |
105 |
||||||||
Net income (loss) |
1,234 |
(16) |
231 |
1,449 |
1,272 |
(1,449) |
1,272 |
||||||||
Goodwill |
3,891 |
0 |
0 |
3,891 |
0 |
0 |
3,891 |
||||||||
Total assets |
723,447 |
134 |
46,115 |
769,696 |
71,156 |
(109,507) |
731,345 |
||||||||
Net interest margin |
2.92 |
% |
NM |
NM |
NM |
NM |
NM |
2.98 |
% |
||||||
Return on average assets |
0.68 |
% |
(44.97) |
% |
1.72 |
% |
NM |
NM |
NM |
0.70 |
% |
||||
Return on average realized common equity |
8.62 |
% |
(1,991.20) |
% |
77.20 |
% |
NM |
NM |
NM |
7.11 |
% |
||||
N/M -Not meaningful
15
Home Federal |
|||||||||||||||
Mortgage Services, LLC |
|||||||||||||||
|
|||||||||||||||
Home |
|||||||||||||||
Federal |
Mortgage |
Total |
|||||||||||||
Savings |
Servicing |
Mortgage |
Reportable |
Consolidated |
|||||||||||
(Dollars in thousands) |
Bank |
Rights |
Banking |
Segments |
Other |
Eliminations |
Total |
||||||||
|
|||||||||||||||
At or for the six months ended June 30, 2002: |
|||||||||||||||
Interest income - external customers |
$ |
20,599 |
0 |
852 |
21,451 |
201 |
0 |
21,652 |
|||||||
Non-interest income - external customers |
2,791 |
21 |
271 |
3,083 |
46 |
0 |
3,129 |
||||||||
Earnings (loss) on limited partnerships |
303 |
0 |
0 |
303 |
24 |
0 |
327 |
||||||||
Intersegment interest income |
415 |
0 |
0 |
415 |
0 |
(415) |
0 |
||||||||
Intersegment non-interest income |
261 |
0 |
0 |
261 |
3,129 |
(3,390) |
0 |
||||||||
Interest expense |
10,919 |
0 |
415 |
11,334 |
0 |
(415) |
10,919 |
||||||||
Amortization of mortgage servicing rights, net valuation adjustments, and servicing costs |
|
|
|
|
|
|
|
||||||||
Other non-interest expense |
7,474 |
0 |
857 |
8,331 |
286 |
(328) |
8,289 |
||||||||
Income tax expense (benefit) |
1,476 |
0 |
0 |
1,476 |
(150) |
0 |
1,326 |
||||||||
Minority interest |
(74) |
0 |
0 |
(74) |
0 |
0 |
(74) |
||||||||
Net income (loss) |
3,175 |
(3) |
(149) |
3,023 |
3,184 |
(2,971) |
3,236 |
||||||||
Goodwill |
3,801 |
0 |
0 |
3,801 |
0 |
0 |
3,801 |
||||||||
Total assets |
709,593 |
63 |
6,622 |
716,278 |
74,174 |
(96,729) |
693,723 |
||||||||
Net interest margin |
3.13 |
% |
NM |
NM |
NM |
NM |
NM |
3.20 |
% |
||||||
Return on average assets |
0.90 |
% |
(8.98) |
% |
(1.16) |
% |
NM |
NM |
NM |
0.92 |
% |
||||
Return on average realized common equity |
10.22 |
% |
(435.03) |
% |
(59.93) |
% |
NM |
NM |
NM |
8.79 |
% |
||||
At or for the six months ended |
|||||||||||||||
Interest income - external customers |
$ |
25,095 |
0 |
1,373 |
26,468 |
216 |
0 |
26,684 |
|||||||
Non-interest income - external customers |
1,519 |
28 |
1,246 |
2,793 |
342 |
0 |
3,135 |
||||||||
Earnings (loss) on limited partnerships |
(622) |
0 |
0 |
(622) |
(7) |
0 |
(629) |
||||||||
Intersegment interest income |
1,252 |
0 |
0 |
1,252 |
173 |
(1,425) |
0 |
||||||||
Intersegment non-interest income |
381 |
0 |
0 |
381 |
2,765 |
(3,146) |
0 |
||||||||
Interest expense |
16,385 |
0 |
1,345 |
17,730 |
15 |
(1,425) |
16,320 |
||||||||
Amortization of mortgage servicing rights,net valuation adjustments, and servicing costs |
|
|
|
|
|
|
|
||||||||
Other non-interest expense |
6,028 |
0 |
1,048 |
7,076 |
497 |
(270) |
7,303 |
||||||||
Income tax expense (benefit) |
1,699 |
0 |
(28) |
1,671 |
114 |
0 |
1,785 |
||||||||
Minority interest |
133 |
0 |
0 |
133 |
0 |
0 |
133 |
||||||||
Net income (loss) |
2,646 |
(24) |
254 |
2,876 |
2,863 |
(2,876) |
2,863 |
||||||||
Goodwill |
3,891 |
0 |
0 |
3,891 |
0 |
0 |
3,891 |
||||||||
Total assets |
723,447 |
134 |
46,115 |
769,696 |
71,156 |
(109,507) |
731,345 |
||||||||
Net interest margin |
2.93 |
% |
NM |
NM |
NM |
NM |
NM |
2.97 |
% |
||||||
Return on average assets |
0.74 |
% |
(29.69) |
% |
1.24 |
% |
NM |
NM |
NM |
0.79 |
% |
||||
Return on average realized common equity |
9.55 |
% |
(567.43) |
% |
44.14 |
% |
NM |
NM |
NM |
8.13 |
% |
||||
N/M -Not meaningful
16
HMN FINANCIAL, INC.
Item 2: MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General
HMN's net income is dependent primarily on its net interest income, which is the difference between interest earned on its loans and investments and the interest paid on interest-bearing liabilities. Net interest income is determined by (i) the difference between the yield earned on interest-earning assets and rates paid on interest-bearing liabilities (interest rate spread) and (ii) the relative amounts of interest-earning assets and interest-bearing liabilities. HMN's interest rate spread is affected by regulatory, economic and competitive factors that influence interest rates, loan demand and deposit flows. Net interest margin is calculated by dividing net interest income by the average interest-earning assets and is normally expressed as a percentage. Net interest income and net interest margin are affected by changes in interest rates, the volume and the mix of interest-earning assets and interest-bearing liabilities, and the level of non-performing assets. HMN's net income is also affected by the generation of non-interest income, which primarily consists of gains from the sale of securities, gains from sale of loans, service charges, fees and other income. In addition, net income is affected by the level of operating expenses, provisions made for loan losses and impairment reserve adjustments required on mortgage servicing assets.
The operations of financial institutions, including the Bank, are significantly affected by prevailing economic conditions, competition and the monetary and fiscal policies of governmental agencies. Lending activities are influenced by the demand for and supply of housing, competition among lenders, the level of interest rates and the availability of funds. Deposit flows and costs of funds are influenced by prevailing market rates of interest primarily on competing investments, account maturities and the levels of personal income and savings in the market area of the Bank.
Net Income
HMN's net income for the second quarter of 2002 was $1.3 million, a decrease of $4,000, or 0.3%, compared to net income of $1.3 million for the second quarter of 2001. Basic earnings per share were $0.34 for the quarter ended June 30, 2002, the same as for the second quarter of 2001. Diluted earnings per share for the second quarter of 2002 were $0.32, the same as for the second quarter of 2001.
HMN's net income for the six months ended June 30, 2002 was $3.2 million, an increase of $373,000, or 13.0%, compared to net income of $2.9 million for the six month period ended June 30, 2001. Basic earnings per share were $0.87 for the six months ended June 30, 2002, an increase of $0.10 or 13.0%, from $0.77 for the same six month period in 2001. Diluted earnings per share for the six-month period in 2002 were $0.82, an increase of $0.10 or 13.9%, from $0.72 for the same six-month period in 2001.
Net Interest Income
Net interest income for the second quarter of 2002 was $5.3 million, an increase of $68,000 or 1.3%, compared to $5.2 million for the second quarter of 2001. Interest income for the second quarter of 2002 was $10.5 million, a decrease of $2.6 million or 20.0%, compared to $13.1 for the second quarter of 2001. Interest income decreased by $533,000 due to a $29.3 million net decrease in average interest-earning assets from the second quarter of 2001 to the second quarter of 2002. The decrease in average interest-earning assets is the result of HMN using cash to fund the outflow of deposits and the repayment of Federal Home Loan Bank advances. Deposits declined between the periods as HMN lowered the interest rates it paid on deposits to take advantage of the lower interest rate environment. Interest earning assets also decreased because of increased investments in premises and equipment
17
for additional banking facilities and the repurchase of HMN common stock. Interest income decreased by $2.1million due to a decrease in interest rates from the second quarter of 2001 to the second quarter of 2002. The yield on interest-earning assets decreased from 7.50% at June 30, 2001 to 6.26% at June 30, 2002. During the 12-month period ending on June 30, 2002, the Federal Reserve Board reduced the Federal Funds interest rate five times and the Wall Street Journal prime rate decreased from 6.75% to 4.75%. As a result, the yield on loans with rates that were indexed to prime such as commercial loans and consumer lines of credit and the yield on new loans originated during the period were less than the yields that were earned in the loan portfolio during a comparable period in 2001.
Interest expense was $5.2 million for the second quarter of 2002, a decrease of $2.7 million or 34.1%, compared to $7.9 million for the same quarter in 2001. Interest expense on deposit accounts was $2.6 million, a decrease of $2.3 million or 46.4%, from $4.9 million for the second quarter of 2001. Interest expense on deposits decreased by $2.1 million because HMN lowered the interest rates it paid on deposits to take advantage of the lower interest rate environment and $133,000 because of a decrease in the average outstanding balance of deposits. Interest expense on Federal Home Loan Bank (FHLB) advances was $2.6 million for the second quarter of 2002, a decrease of $424,000 or 14.0%, from $3.0 million for the second quarter of 2001. Interest expense on FHLB advances decreased by $114,000 due to a decline in the average outstanding advances between the two quarters. Interest expense also declined by $310,000 due to a decline in the interest rates paid on FHLB advances between the two quarters. HMN has many advances which are tied to a London Inter-Bank Offer Rates (LIBOR) index and the interest rate on those advances adjusts monthly to changes in the index. As the Federal Reserve Board reduced short-term interest rates between the quarters, the LIBOR index also decreased.
Net interest margin (net interest income divided by average interest earning assets) for the second quarter of 2002 was 3.17%, a 19 basis point increase, compared to 2.98% for the second quarter of 2001.
Net interest income for the six-month period ended June 30, 2002 was $10.7 million, an increase of $368,000 or 3.6%, compared to $10.4 million for the same period of 2001. Interest income for the six-month period of 2002 was $21.7 million, a decrease of $5.0 million, or 18.9%, compared to $26.7 million for the same period of 2001. Interest income decreased by $894,000 due to a $24.1 million net decrease in average interest-earning assets from the six-month period of 2001 to the same period of 2002. The decrease in average interest-earning assets is the result of HMN using cash to fund the outflow of deposits and the repayment of Federal Home Loan Bank advances. Deposits declined between the periods as HMN lowered the interest rates it paid on deposits to take advantage of the lower interest rate environment. Interest income decreased by $4.1 million due to lower interest rates being earned on the loan and investment portfolios. The decrease in rates paid decreased the yield on interest earning assets from 7.65% at June 30, 2001 to 6.26% at June 30, 2002.
Interest expense was $10.9 million for the six months ended June 30, 2002, a decrease of $5.4 million, or 33.1%, compared to $16.3 million for the same six-month period of 2001. Interest expense on deposits was $5.8 million for the six-month period ended June 30, 2002, a decrease of $4.2 million or 42.4%, compared to $10.0 million for the same period of 2001. Interest expense on deposits decreased $4.1 million because HMN lowered the interest rates it paid on deposits to take advantage of the lower interest rate environment and $112,000 because of the decrease in the average outstanding deposit balances. Interest expense on FHLB advances was $5.2 million for the six-month period of 2002, a decrease of $1.2 million, or 18.5%, from $6.4 million for the same period of 2001. Interest expense decreased by $289,000 due to a $10.7 million decrease in the average outstanding advances from the FHLB. Interest expense decreased by $888,000 due to a decrease in the cost of borrowing from the FHLB. HMN has many advances which are tied to a London Inter-Bank Offer Rates (LIBOR) index and the interest rate on those advances adjusts monthly to changes in the index. As the Federal Reserve Board reduced short-term interest rates between the quarters the LIBOR index also decreased. The average interest rate paid on average interest-bearing liabilities was 3.51% during the six months ended June 30, 2002, compared to 5.11% for the same period of 2001.
Net interest margin (net interest income divided by average interest earning assets) for the six months ended June 30, 2002, was 3.20%, an increase of 23 basis points, compared to 2.97% for the same period of 2001.
18
Provision for Loan Losses
*The provision for loan losses for the second quarter ended June 30, 2002 was $310,000, an increase of $10,000, or 3.3%, compared to $300,000 for the second quarter of 2001. The provision for loan losses for the six months ended June 30, 2002 was $1,030,000, an increase of $580,000, or 128.9% compared to $450,000 for the same six month period ended in 2001. The provision for loan losses increased primarily due to the specific loan reserves of $451,000 established in the first quarter of 2002 on two non-accruing commercial loan relationships. The provision also increased due to the growth that was experienced in the commercial and consumer loan portfolios which generally require a larger provision due to the greater inherent credit risk of these loans. The provision is the result of management's evaluation of the composition of the loan portfolio, the historical level of non-performing loans, increases in loan charge-off experience, and its assessment of the general economic conditions in the geograp hic area where properties securing the loan portfolio are located such as national and regional unemployment data, local single family construction permits and local economic growth rates. Management's evaluation of probable losses inherent in the loan portfolio revealed conditions that resulted in increasing the 2002 loan loss provision compared to the provision for 2001. This increase was due primarily to the growth that was experienced in the commercial and consumer loan portfolios and an increase in loans charged off. HMN will continue to monitor its allowance for losses as these conditions dictate. Future economic conditions and other unknown factors will impact the need for future provisions for loan losses. As a result, no assurances can be given that increases in the allowance for loan losses will not be required during future periods.
A reconciliation of HMN's allowance for loan losses is summarized as follows:
2002 | 2001 | |||
|
|
|||
Balance at January 1, | $ | 3,783,112 | $ | 3,143,746 |
Provision | 1,030,000 | 450,000 | ||
Charge-offs | (709,737) | (68,830) | ||
Recoveries | 5,445 | 326 | ||
|
|
|||
Balance at June 30, | $ | 4,108,820 | $ | 3,525,242 |
|
|
Non-Interest Income
Non-interest income was $1.2 million for the second quarter of 2002, an increase of $3,000 or 0.2%, from $1.2 million for the second quarter of 2001.
Non-interest income was $3.5 million for the six months ended June 30, 2002, an increase of $950,000, or 37.9%, from $2.5 million for the same six month period of 2001. Non-interest income increased by $956,000 due to increased earnings from limited partnerships. Interest rates on fixed rate single family residential loans increased slightly during the first quarter of 2002 which caused the value of HMN's investment in a limited partnership that owns mortgage loan servicing assets to increase in value. Security losses decreased by $378,000 primarily due to a $610,000 impairment loss that was recognized in the second quarter of 2001. Mortgage servicing fees increased
* This paragraph contains a forward-looking statement(s). Refer to information regarding Forward-looking Information on page 25 of this discussion.
19
$123,000, or 57.4%, due primarily to an increase in the amount of loans being serviced. These increases were partially offset by a $665,000 decline in loan sale gains primarily due to HMN's decision to phase down the mortgage banking operation in Brooklyn Park.
Non-Interest Expense
Non-interest expense was $4.5 million for the second quarter of 2002, an increase of $588,000, or 14.9%, from $3.9 million for the second quarter of 2001. Occupancy expense increased by $212,000, or 41.1%, due to the costs associated with maintaining additional facilities including the new corporate office. Other operating expenses increased by $296,000, or 36.5%, due primarily to $231,000 of reserves established for losses on merchant and other accounts receivables.
Non-interest expense was $8.7 million for the six months ended June 30, 2002, an increase of $1.0 million or 13.5%, from $7.7 million for the same period of 2001. Occupancy costs increased by $330,000 or 30.6%, primarily due to the costs associated with maintaining additional facilities including the new corporate office. Advertising expenses increased $89,000 and other expenses increased by $425,000 or 27.3%, primarily due to $231,000 of reserves established for losses on merchant and other accounts receivables and additional increases in general and administrative expenses relating to operating additional facilities.
Income Tax Expense
Income tax expense was $485,000 for the second quarter of 2002, a decrease of $302,000 compared to $787,000 for the second quarter of 2001. Income tax expense was $1.3 million for the six months ended June 30, 2002, a decrease of $460,000 compared to $1.8 million for the same six month period of 2001. The decreases in income taxes are primarily due to the Bank reducing its effective income tax rate through the use of certain state tax planning initiatives, increased tax exempt earnings, and a reduction in taxable income.
Non-Performing Assets
The following table sets forth the amounts and categories of non-performing assets in the Bank's portfolio at
June 30, 2002 and December 31, 2001.
|
||||||
|
June 30, |
December 31, |
||||
(Dollars in Thousands) |
2002 |
2001 |
||||
|
||||||
Non-Accruing Loans |
||||||
One-to-four family real estate |
$ |
1,307 |
771 |
|||
Commercial real estate |
167 |
187 |
||||
Consumer |
102 |
311 |
||||
Commercial business |
994 |
890 |
||||
|
|
|||||
Total |
2,570 |
2,159 |
||||
|
|
|||||
Accruing loans delinquent 90 |
||||||
days or more |
0 |
24 |
||||
Other assets |
1,796 |
1,390 |
||||
Foreclosed and Repossessed Assets |
||||||
One-to-four family real estate |
226 |
0 |
||||
Consumer |
204 |
155 |
||||
Commercial business |
0 |
33 |
||||
|
|
|||||
Total non-performing assets |
$ |
4,796 |
$ |
3,761 |
||
|
|
|||||
Total as a percentage of total assets |
0.69 |
% |
0.52 |
% |
||
|
|
|||||
Total non-performing loans |
$ |
2,570 |
$ |
2,183 |
||
|
|
|||||
Total as a percentage of total |
||||||
loans receivable, net |
0.55 |
% |
0.46 |
% |
||
|
|
|||||
|
20
Total non-performing assets at June 30, 2002 were $4.8 million, an increase of $1 million, from $3.8 million at December 31, 2001.
Dividends
On July 23, 2002 HMN declared a cash dividend of $.18 per share, payable on September 10, 2002 to shareholders of record on August 27, 2002.
During 2002, HMN has declared and paid dividends as follows:
Record date | Payable date | Dividend per share | Dividend Payout Ratio |
|
|
|
|
February 21, 2002 | March 7, 2002 | $0.14 | 100.0% |
April 23, 2002 | June 10, 2002 | $0.18 | 36.0 % |
The annualized dividend payout ratio for the past four quarters, ending with the September 10, 2002 payment will be 43.84%.
The declaration of dividends are subject to, among other things, HMN's financial condition and results of operations, the Bank's compliance with its regulatory capital requirements, including the fully phased-in capital requirements, tax considerations, industry standards, economic conditions, regulatory restrictions, general business practices and other factors.
Liquidity
For the six months ended June 30, 2002 the net cash provided by operating activities was $62.3 million. HMN collected $3.6 million from the sale of securities and $22.8 million from principal repayments and the maturity of securities. It purchased securities available for sale of $40.1 million and premises and equipment of $2.9 million. Net loans receivable increased by $3.2 million due to loan production. HMN had a net decrease in deposit balances of $22.5 million for the six-month period. It paid out $3.5 million on FHLB advances and $384,000 on advance payments from borrowers for taxes and insurance. HMN received $511,000 related to the exercise of HMN stock options. HMN purchased $659,000 of its own stock and paid $1.2 million in dividends to its shareholders.
*HMN has certificates of deposits with outstanding balances of $153.2 million that come due over the next 12 months. Based upon past experience management anticipates that the majority of the deposits will renew for another term. HMN believes that deposits that do not renew will be replaced with deposits from other customers, or funded with advances from the FHLB, or will be funded through the sale of securities. Management does not anticipate that it will have a liquidity problem due to maturing deposits.
*HMN has $85.0 million of FHLB advances which mature after 2003 but have call features that can be exercised by the FHLB during the next 12 months. If the call features are exercised HMN has the option of requesting any advance otherwise available to it pursuant to the Credit Policy of the FHLB. HMN also has $35 million of FHLB advances that will mature during the next 12 months. Since HMN has the ability to request another advance to replace the advance that is being called or is maturing, management does not anticipate that it will have a liquidity problem due to advances being called by the FHLB during the next 12 month period.
* This paragraph contains a forward-looking statement(s). Refer to information regarding Forward-looking Information on page 25 of this discussion.
21
Market Risk
Market risk is the risk of loss from adverse changes in market prices and rates. HMN's market risk arises primarily from interest rate risk inherent in its investing, lending and deposit taking activities. Management actively monitors and manages its interest rate risk exposure.
HMN's profitability is affected by fluctuations in interest rates. A sudden and substantial increase in interest rates may adversely impact HMN's earnings to the extent that the interest rates borne by assets and liabilities do not
change at the same speed, to the same extent, or on the same basis. HMN monitors the projected changes in net interest income that occur if interest rates were to suddenly change up or down. The Rate Shock Table located below in the Asset/Liability Management section of this report discloses HMN's projected changes in net interest income based upon immediate interest rate changes called rate shocks.
*HMN utilizes a model which uses the discounted cash flows from its interest-earning assets and its interest-bearing liabilities to calculate the current market value of those assets and liabilities. The model also calculates the changes in market value of the interest-earning assets and interest-bearing liabilities due to different interest rate changes. HMN believes that over the next twelve months interest rates could conceivably fluctuate in a range of 200 basis points up or 100 basis points down from where the rates were at June 30, 2002. HMN does not have a trading portfolio. The following table discloses the projected changes in market value to HMN's interest-earning assets and interest-bearing liabilities based upon incremental 100 basis point changes in interest rates from interest rates in effect on June 30, 2002.
* This paragraph contains a forward-looking statement(s). Refer to information regarding Forward-looking Information on page 25 of this discussion.
22
|
||||||||||
Other than trading portfolio |
Market Value |
|||||||||
|
||||||||||
(Dollars in thousands) |
|
100 |
|
0 |
|
+100 |
|
+200 |
|
|
|
||||||||||
Cash and cash equivalents |
$ |
38,067 |
|
38,067 |
|
38,067 |
|
38,067 |
|
|
Securities available for sale: |
|
|
|
|
|
|
|
|
|
|
Fixed-rate CMOs |
|
11,822 |
|
11,741 |
|
11,485 |
|
11,141 |
|
|
Variable-rate CMOs |
|
50,830 |
|
51,064 |
|
49,977 |
|
48,437 |
|
|
Fixed-rate available for sale mortgage- |
|
2,250 |
|
2,185 |
|
2,118 |
|
2,046 |
|
|
Variable-rate available for sale mortgage- |
|
583 |
|
583 |
|
579 |
|
575 |
|
|
Fixed-rate available for sale other marketable securities |
|
67,933 |
|
66,942 |
|
65,046 |
|
63,659 |
|
|
Variable-rate available for sale other marketable securities |
|
112 |
|
111 |
|
106 |
|
106 |
|
|
Federal Home Loan Bank stock 9; 9; 9; |
|
12,224 |
|
12,209 |
|
12,195 |
|
12,182 |
||
Loans held for sale 9; 9; 9; |
|
12,669 |
|
12,242 |
|
11,814 |
|
11,632 |
|
|
Loans receivable, net: |
||||||||||
Fixed-rate real estate loans 9; 9; 9; |
|
207,948 |
|
202,989 |
|
197,235 |
|
191,548 |
|
|
Variable-rate real estate loans |
122,374 |
|
120,216 |
|
117,997 |
|
115,921 |
|
||
Fixed-rate other loans |
|
74,507 |
|
73,653 |
|
72,257 |
|
71,014 |
|
|
Variable-rate other loans |
|
96,421 |
|
95,109 |
|
92,034 |
|
89,911 |
|
|
Mortgage servicing rights, net 9; 9; 9; |
|
1,188 |
|
2,383 |
|
3,040 |
|
3,302 |
|
|
Investment in limited partnerships 9; 9; 9; |
|
1,349 |
|
1,851 |
|
1,997 |
|
2,188 |
|
|
|
|
|
|
|||||||
Total market risk sensitive assets |
|
700,277 |
|
691,345 |
|
675,947 |
|
661,729 |
|
|
|
|
|
|
|||||||
NOW deposits |
|
58,126 |
|
58,126 |
|
58,126 |
|
58,126 |
|
|
Passbook deposits |
|
34,143 |
|
34,143 |
|
34,143 |
|
34,143 |
|
|
Money market deposits |
|
42,802 |
|
42,802 |
|
42,802 |
|
42,802 |
|
|
Certificate deposits |
|
270,166 |
|
266,957 |
|
263,823 |
|
260,762 |
|
|
Federal Home Loan Bank: |
||||||||||
Fixed-rate advances |
191,783 |
185,155 | 182,069 | 177,350 | ||||||
Variable-rate advances |
|
33,941 |
|
33,845 |
|
33,808 |
|
33,770 |
|
|
|
|
|
|
|||||||
Total market risk sensitive liabilities |
|
630,961 |
|
621,028 |
|
614,771 |
|
606,953 |
|
|
|
|
|
|
|||||||
Off-balance sheet financial instruments: |
||||||||||
Commitments to extend credit 9; 9; 9; |
155 |
|
0 |
|
(156) |
|
(222) |
|||
Commitments to sell or deliver loans |
|
363 |
|
0 |
|
(365) |
|
(520) |
|
|
Interest rate swap |
|
(4) |
|
(4) |
|
(4) |
|
(4) |
||
|
|
|
|
|||||||
Net market risk |
$ |
68,794 |
|
70,313 |
|
61,693 |
|
55,514 |
|
|
|
|
|
|
|||||||
Percentage change from current market value |
$ |
(2.16) |
% |
0.00 |
% |
(12.26) |
% |
(21.05) |
% |
|
|
|
|
|
The preceding table was prepared utilizing the following assumptions (the "Model Assumptions") regarding prepayment and decay ratios that were determined by management based upon their review of historical prepayment speeds and future prepayment projections. Fixed rate loans were assumed to prepay at annual rates of between 6% to 45%, depending on the note rate and the period to maturity. Adjustable rate mortgages ("ARMs") were assumed to prepay at annual rates of between 11% and 26%, depending on the note rate and the period to maturity. Growing Equity Mortgage (GEM) loans
23
be withdrawn until maturity. Passbook and money market accounts were assumed to decay at an annual rate of 9%. FHLB advances were projected to be called at the first call date where the projected interest rate on similar remaining term advances exceeded the interest rate on HMN's callable advance.
*Certain shortcomings are inherent in the method of analysis presented in the foregoing table. The interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types of assets and liabilities may lag behind changes in market interest rates. The model assumes that the difference between the current interest rate being earned or paid compared to a treasury instrument or other interest index with a similar term to maturity (the "Interest Spread") will remain constant over the interest changes disclosed in the table. Changes in Interest Spread could impact projected market value changes. Certain assets, such as ARMs, have features which restrict changes in interest rates on a short-term basis and over the life of the assets. The market value of the interest-bearing assets which are approaching their lifetime interest rate caps could be different from the values disclosed in the table. In the event of a change in inter est rates, prepayment and early withdrawal levels may deviate significantly from those assumed in calculating the foregoing table. The ability of many borrowers to service their debt may decrease in the event of an interest rate increase.
Asset/Liability Management
*HMN's management reviews the impact that changing interest rates will have on its net interest income projected for the twelve months following June 30, 2002 to determine if its current level of interest rate risk is acceptable. The following table projects the estimated annual impact on net interest income of immediate interest rate changes called rate shocks.
Rate Shock | Net Interest | Percentage |
in Basis Points | Income | Change |
|
|
|
+200 | 23,261 | 8.49 % |
+100 | 22,766 | 6.18 % |
0 | 21,440 | 0.00 % |
-100 | 18,856 | -12.05 % |
The preceding table was prepared utilizing the Model Assumptions regarding prepayment and decay ratios which were determined by management based upon their review of historical prepayment speeds and future prepayment projections.
*Certain shortcomings are inherent in the method of analysis presented in the foregoing table. In the event of a change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed in calculating the foregoing table. The ability of many borrowers to service their debt may decrease in the event of a substantial increase in interest rates and could impact net interest income.
In an attempt to manage its exposure to changes in interest rates, management closely monitors interest rate risk. The Bank has an Asset/Liability Committee consisting of executive officers which meets at least quarterly to review the interest rate risk position and projected profitability. The committee makes recommendations for adjustments to the asset/liability position of the Bank to the Board of Directors of the Bank. This committee also reviews the Bank's portfolio, formulates investment strategies and oversees the timing and implementation of transactions to assure attainment of the Board's objectives in the most effective manner. In addition, the Board reviews on a quarterly basis the Bank's asset/liability position, including simulations of the effect on the Bank's capital of various interest rate scenarios.
In managing its asset/liability mix, the Bank, at times, depending on the relationship between long- and short-term interest rates, market conditions and consumer preference, may place more emphasis on managing net interest
* This paragraph contains a forward-looking statement(s). Refer to information regarding Forward-looking Information on page 25 of this discussion.
24
margin than on better matching the interest rate sensitivity of its assets and liabilities in an effort to enhance net interest income. Management believes that the increased net interest income resulting from a mismatch in the maturity of its asset and liability portfolios can, during periods of declining or stable interest rates, provide high enough returns to justify the increased exposure to sudden and unexpected increases in interest rates.
To the extent consistent with its interest rate spread objectives, the Bank attempts to reduce its interest rate risk and has taken a number of steps to restructure its assets and liabilities. The Bank has primarily focused its fixed rate one-to-four family residential lending program on loans with contractual terms of 20 years or less. The Bank generally follows the practice of selling all of its fixed rate single family loans which conform to the secondary market guidelines. HMN has focused its portfolio lending on the origination of commercial loan products and consumer loans which generally have shorter weighted average terms to maturity and/or interest rates which adjust at least every three years. At times, depending on its interest rate sensitivity, the Bank may sell fixed rate single family loans with shorter contractual maturities than thirty years in order to reduce interest rate risk and record a gain on the sale of loans.
Forward-looking Information
The following paragraphs within Management's Discussion and Analysis of Financial Condition and Results of Operations contain forward-looking statements and actual results may differ materially from the expectations disclosed within this Discussion and Analysis. These forward-looking statements are subject to risks and uncertainties, including those discussed below. HMN assumes no obligations to publicly release results of any revision or updates to these forward-looking statements to reflect future events or unanticipated occurrences.
Provision for Loan Losses
The provision for loan losses for the second quarter ended June 30, 2002 was $310,000, an increase of $10,000, or 3.3%, compared to $300,000 for the second quarter of 2001. The provision for loan losses for the six months ended June 30, 2002 was $1,030,000, an increase of $580,000, or 128.9% compared to $450,000 for the same six month period ended in 2001. The provision is the result of management's evaluation of the composition of the loan portfolio, the historical level of non-performing loans, increases in loan charge-off experience, and its assessment of the general economic conditions in the geographic area where properties securing the loan portfolio are located such as national and regional unemployment data, local single family construction permits and local economic growth rates. Management's evaluation of probable losses inherent in the loan portfolio revealed conditions that resulted in increasing the 2002 loan loss provision compared to the provision for 2001. This increase was due primarily to the growth that was experienced in the commercial and consumer loan portfolios and an increase in loans charged off. HMN will continue to monitor its allowance for losses as these conditions dictate. Future economic conditions and other unknown factors will impact the need for future provisions for loan losses. As a result, no assurances can be given that increases in the allowance for loan losses will not be required during future periods.
Liquidity
HMN has certificates of deposits with outstanding balances of $153.2 million that come due over the next 12 months. Based upon past experience management anticipates that the majority of the deposits will renew for another term. HMN believes that deposits that do not renew will be replaced with deposits from other customers, or funded with advances from the FHLB, or will be funded through the sale of securities. Management does not anticipate that it will have a liquidity problem due to maturing deposits.
HMN has $85.0 million of FHLB advances which mature after 2003 but have call features that can be exercised by the FHLB during the next 12 months. If the call features are exercised HMN has the option of requesting any advance otherwise available to it pursuant to the Credit Policy of the FHLB. HMN also has $35 million of FHLB advances which will mature during the next 12 months. Since HMN has the
25
ability to request another advance to replace the advance that is being called or is maturing, management does not anticipate that it will have a liquidity problem due to advances being called by the FHLB during the next 12 month period.
Competitive pricing by other institutions, the desire of a competitor to pay interest rates on deposits that are above the current rates paid by HMN, or the desire by customers to put more of their funds into nontraditional bank products such as stocks and bonds could be circumstances that would cause the maturing certificates to become a liquidity problem.
Market Risk
HMN utilizes a model which uses the discounted cash flows from its interest-earning assets and its interest-bearing liabilities to calculate the current market value of those assets and liabilities. The model also calculates the changes in market value of the interest-earning assets and interest-bearing liabilities due to different interest rate changes. HMN believes that over the next twelve months interest rates could conceivably fluctuate in a range of 200 basis points up or 100 basis points down from where the rates were at June 30, 2002. HMN does not have a trading portfolio. The following table discloses the projected changes in market value to HMN's interest-earning assets and interest-bearing liabilities based upon incremental 100 basis point changes in interest rates from interest rates in effect on June 30, 2002.
Certain shortcomings are inherent in the method of analysis presented in the foregoing table. The interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types of assets and liabilities may lag behind changes in market interest rates. The model assumes that the difference between the current interest rate being earned or paid compared to a treasury instrument or other interest index with a similar term to maturity (the "Interest Spread") will remain constant over the interest changes disclosed in the table. Changes in Interest Spread could impact projected market value changes. Certain assets, such as ARMs, have features which restrict changes in interest rates on a short-term basis and over the life of the assets. The market value of the interest-bearing assets which are approaching their lifetime interest rate caps could be different from the values disclosed in the table. In the event of a change in intere st rates, prepayment and early withdrawal levels may deviate significantly from those assumed in calculating the foregoing table. The ability of many borrowers to service their debt may decrease in the event of an interest rate increase.
Asset/Liability Management
HMN's management reviews the impact that changing interest rates will have on its net interest income projected for the twelve months following June 30, 2002 to determine if its current level of interest rate risk is acceptable. The table in the asset/liability section projects the estimated annual impact on net interest income of immediate interest rate changes called rate shocks.
Certain shortcomings are inherent in the method of analysis presented in the foregoing table. In the event of a change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed in calculating the foregoing table. The ability of many borrowers to service their debt may decrease in the event of a substantial increase in interest rates and could impact net interest income.
26
HMN FINANCIAL, INC.
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings.
None.
ITEM 2. Changes in Securities and Use of Proceeds.
Not applicable.
ITEM 3. Defaults Upon Senior Securities.
Not applicable.
ITEM 4. Submission of Matters to a Vote of Security Holders.
The Annual Meeting of Stockholders of the Company was held on April 23, 2002 at 10:00 a.m.
The following is a record of the votes cast in the election of directors of the Company:
Term expiring in 2005: | For | Withhold |
|
|
|
Timothy P. Johnson | 3,938,299 | 63,753 |
Timothy R. Geisler | 3,957,930 | 44,121 |
Allan R. DeBoer | 3,953,152 | 48,900 |
Term expiring in 2004: | ||
Michael J. Fogarty | 3,952,978 | 49,074 |
Terms for Directors continuing in office are as follows:
Term | |
|
|
Michael McNeil | 2003 |
Duane D. Benson | 2003 |
Mahlon C. Schneider | 2003 |
Susan K. Kolling | 2004 |
Roger P. Weise | 2004 |
There were no broker non-votes and 31,093 abstentions for each of the directors. Accordingly the individuals named above were declared to be duly elected directors of the Company for terms to expire as stated above.
27
The following is a record of the votes cast in respect of the proposal to ratify the appointment of KPMG LLP as the Company's auditors for the fiscal year ending December 31, 2002.
NUMBER | PERCENTAGE OF | |
OF VOTES | VOTES ACTUALLY CAST | |
FOR | 3,976,178 | 99.35% |
AGAINST | 19,167 | 0.48% |
ABSTAIN | 6,707 | 0.17% |
BROKER NON-VOTE | 0 | 0.00% |
Accordingly, the proposal described above was declared to be duly adopted by the stockholders of the Company.
ITEM 5. Other Information.
None.
ITEM 6. Exhibits and Reports on Form 8-K.
(a) Exhibits. See Index to Exhibits on page 30 of this report
28
SIGNATURES
Pursuant to the requirement of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
HMN FINANCIAL, INC.
Registrant
Date: August 13, 2002
/s/ Michael McNeil
Michael McNeil, President
(Principal Executive Officer)
Date: August 13, 2002
/s/ Timothy P. Johnson
Timothy P. Johnson,
Chief Financial Officer
(Principal Financial Officer)
29
HMN FINANCIAL, INC.
INDEX TO EXHIBITS
FOR FORM 10-Q
Sequential | |||
Reference | Page Numbering | ||
to Prior | Where Attached | ||
Regulation | Filing or | Exhibits Are | |
S-K | Exhibit | Located in This | |
Exhibit Number | Document Attached Hereto | Number | Form 10-Q Report |
3.1 | Amended and Restated Articles of Incorporation | *1 | N/A |
3.2 | Amended and Restated By-laws | *2 | N/A |
4 | Form of Common Stock Including indentures | *3 | N/A |
10.1 | Employment Agreement for Michael McNeil Dated January 1, 2002 | 10.1 | Filed Electronically |
10.2 | Employment Agreement for Timothy Johnson Dated January 1, 2002 | 10.2 | Filed Electronically |
99.1 | Certification Pursuant to 18 U.S.C. Section 1350 by Michael McNeil | 99.1 | Filed Electronically |
99.2 | Certification Pursuant to 18 U.S.C. Section 1350 by Timothy Johnson | 99.2 | Filed Electronically |
*1 Incorporated by reference to the same numbered exhibit to the Company's Quarterly Report on Form 10-Q for the period ended March 31, 1998 (File No. 0-24100).
*2 Incorporated by reference to the same numbered exhibit to the Company's Quarterly Report on Form 10-Q for the period ended September 30, 1997 (File 0-24100).
*3 Incorporated by reference to the same numbered exhibit to the Company's Registration Statement on Form S-1 dated April 1, 1994 (File No. 33-77212).
30