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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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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, 1998
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. [ ]
As of March 5, 1999, the Registrant had issued and outstanding 5,247,104
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 5, 1999 was
$52.7 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, 1998,
are incorporated by reference in Parts II and IV of this Form 10-K. Parts of
the Registrant's Proxy Statement dated March 23, 1999, are incorporated by
reference in Part III of this Form 10-K.
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TABLE OF CONTENTS
PART I
PAGE
Item 1. Business..................................................................3
General.............................................................3
Lending Activities..................................................4
Investment Activities..............................................20
Sources of Funds...................................................24
Other Information
Service Corporations.........................................28
Competition..................................................28
Other Corporations Owned by HMN..............................28
Employees....................................................29
Executive Officers...........................................29
Regulation.........................................................29
Taxation...........................................................38
Item 2. Properties...............................................................40
Item 3. Legal Proceedings........................................................41
Item 4. Submission of Matters to a Vote of Security Holders......................41
PART II
Item 5. Market for the Registrant's Common Stock and Related Stockholder
Matters............................................................41
Item 6. Selected Financial Data..................................................41
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations..............................................41
Item 7A. Quantitative and Qualitative Disclosure About Market Risk................41
Item 8. Financial Statements and Supplementary Data..............................41
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure...............................................42
PART III
Item 10. Directors and Executive Officers of the Registrant.......................42
Item 11. Executive Compensation...................................................42
Item 12. Security Ownership of Certain Beneficial Owners and Management...........42
Item 13. Certain Relationships and Related Transactions...........................42
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K..........43
Signatures.........................................................................46
Index to Exhibits..................................................................47
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 a mortgage banking and mortgage brokerage facility located in 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 and Technical College, University of Minnesota - Rochester Center,
Winona State University - Rochester Center and Austin's Riverland Community
College.
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 information obtained from the Minnesota State Demographic
Center for 1996, the population of the six primary counties in the Bank's
Minnesota market area was as follows: Fillmore - 20,900; Freeborn - 33,000;
Houston - 19,200; Mower - 37,700; Olmsted - 115,200; and Winona - 49,200.
Total income per capita for 1996 in these six counties ranged from
approximately $19,100 to $26,500.
Based upon information obtained from the State Library of Iowa for 1996,
the population of Marshall County was 38,700 and the population of Tama County
was 17,600. Total income per capita of the above mentioned Iowa counties ranged
from approximately $20,000 to $21,900.
During the fourth quarter of 1996, HMN opened a mortgage banking and
mortgage brokerage office which is currently located in Brooklyn Park,
Minnesota. The office primarily originates single family residential loans
for sale in the secondary market or purchases loans from third party
originators located primarily in the seven county metropolitan area of
Minneapolis and St. Paul and sells the loans in the secondary market. The
office also has purchased mortgage servicing rights from third parties for
the purpose of generating loan servicing income.
LENDING ACTIVITIES
GENERAL. Historically, HMN 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, HMN has emphasized the origination
or purchase of loans for the loan portfolio which have shorter terms to maturity
such as 15 year, fixed rate residential loans and Graduated Equity Mortgages
("GEMs") which fully amortize in 15 to 20 years. HMN has also emphasized the
origination and purchase of Adjustable Rate Mortgage loans ("ARMs") for
portfolio which have interest rates which are fixed for an initial period of
one, three or five years and then generally adjust annually, thereafter, based
upon a treasury interest rate index plus a certain margin, subject to annual and
lifetime rate adjustment limits. HMN offers a competitive home equity line of
credit as well as other consumer loans. The home equity line of credit has an
adjustable interest rate based upon the Wall Street Journal prime rate plus a
margin. During 1998 HMN hired experienced commercial loan officers who actively
pursued commercial real estate, commercial business and development loans in
HMN's market area.
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,
--------------------------------------------------------------
1998 1997 1996
------------------- -------------------- ------------------
(DOLLARS IN THOUSANDS) Amount Percent Amount Percent Amount Percent
--------- ------- ---------- ------- --------- -------
REAL ESTATE LOANS:
One-to-four family................. $ 365,496 79.31% $ 395,668 87.58% $ 321,340 90.19%
Multi-family....................... 4,719 1.02 2,717 0.60 280 0.08
Commercial......................... 28,990 6.29 10,572 2.34 7,918 2.22
Construction or development........ 15,155 3.29 5,725 1.27 3,474 0.98
--------- ------ --------- ------ --------- ------
Total real estate loans......... 414,360 89.91 414,682 91.79 333,012 93.47
--------- ------ --------- ------ --------- ------
OTHER LOANS:
Consumer loans:
Savings account................... 994 0.22 1,362 0.30 938 0.26
Education......................... 118 0.03 123 0.03 467 0.13
Automobile........................ 2,897 0.63 2,438 0.54 566 0.16
Home equity line.................. 19,476 4.22 19,490 4.31 11,881 3.33
Home equity....................... 9,566 2.08 7,176 1.59 5,927 1.67
Home improvement.................. 436 0.09 652 0.14 585 0.16
Other............................. 1,313 0.28 624 0.14 568
--------- ------ --------- ------ --------- ------
Total consumer loans............ 34,800 7.55 31,865 7.05 20,932 5.87
Commercial business loans.......... 11,695 2.54 5,226 1.16 2,344 0.66
--------- ------ --------- ------ --------- ------
Total other loans............... 46,495 10.09 37,091 8.21 23,276 6.53
--------- ------ --------- ------ --------- ------
Total loans.................. 460,855 100.00% 451,773 100.00% 356,288 100.00%
------ ------ ------
------ ------ ------
LESS:
Loans in process................... 7,997 4,562 2,814
Unamortized discounts.............. 414 547 417
Net deferred loan fees............. 1,948 1,847 1,695
Allowance for losses on loans...... 3,041 2,748 2,340
--------- --------- ---------
Total loans receivable, net.. $ 447,455 $ 442,069 $ 349,022
--------- --------- ---------
--------- --------- ---------
December 31,
------------------------------------------
1995 1994
------------------- --------------------
(DOLLARS IN THOUSANDS) Amount Percent Amount Percent
--------- ------- --------- --------
REAL ESTATE LOANS:
One-to-four family................. $ 292,497 90.62% $ 252,943 91.14%
Multi-family....................... 361 0.11 311 0.11
Commercial......................... 8,744 2.71 8,316 3.00
Construction or development........ 5,082 1.58 2,799 1.01
--------- ------ --------- ------
Total real estate loans......... 306,684 95.02 264,369 95.26
--------- ------ --------- ------
OTHER LOANS:
Consumer loans:
Savings account................... 1,210 0.37 648 0.23
Education......................... 342 0.11 2,007 0.72
Automobile........................ 671 0.21 520 0.19
Home equity line.................. 3,509 1.09 0 0.00
Home equity....................... 7,997 2.47 7,716 2.78
Home improvement.................. 785 0.24 870 0.31
--------- ------ --------- ------
Total consumer loans............ 15,059 4.66 12,263 4.42
Commercial business loans.......... 1,018 0.32 897 0.32
--------- ------ --------- ------
Total other loans............... 16,077 4.98 13,160 4.74
--------- ------ --------- ------
Total loans.................. 322,761 100.00% 277,529 100.00%
------ ------
------ ------
LESS:
Loans in process................... 3,531 2,327
Unamortized discounts.............. 289 162
Net deferred loan fees............. 1,899 2,147
Allowance for losses on loans...... 2,191 1,893
--------- ---------
Total loans receivable, net.. $ 314,851 $ 271,000
--------- ---------
--------- ---------
5
The following table shows the composition of HMN's loan portfolio by fixed
and adjustable rate loans at the dates indicated.
December 31,
------------------------------------------------------------------------------------
1998 1997 1996
----------------------- ------------------------ -----------------------
(DOLLARS IN THOUSANDS) Amount Percent Amount Percent Amount Percent
----------- --------- ----------- --------- ----------- ---------
FIXED-RATE LOANS
Real estate:
One-to-four family
GEM...................................... $ 56,211 12.20% $ 53,258 11.79% $ 48,831 13.71%
Other.................................... 227,790 49.43 256,263 56.72 187,519 52.63
----------- --------- ----------- -------- ----------- --------
Total one-to-four family................ 284,001 61.63 309,521 68.51 236,350 66.34
Multi-family.............................. 3,509 0.76 2,490 0.55 223 0.06
Commercial................................ 17,768 3.86 1,914 0.42 1,276 0.36
Construction or development............... 9,366 2.03 3,180 0.71 2,970 0.83
----------- --------- ----------- -------- ----------- --------
Total fixed-rate real estate loans...... 314,644 68.27 317,105 70.19 240,819 67.59
----------- --------- ----------- -------- ----------- --------
Consumer loans:
Savings................................... 994 0.22 1,362 0.30 938 0.26
Education................................. 0 0.00 0 0.00 434 0.12
Automobile................................ 2,897 0.63 2,437 0.54 566 0.16
Home equity............................... 9,384 2.04 6,701 1.48 5,338 1.50
Home improvement.......................... 436 0.09 652 0.14 585 0.16
Other..................................... 1,175 0.25 612 0.14 568 0.16
----------- --------- ----------- -------- ----------- --------
Total consumer loans.................... 14,886 3.23 11,764 2.60 8,429 2.36
----------- --------- ----------- -------- ----------- --------
Commercial business loans.................. 10,157 2.20 5,226 1.16 1,344 0.38
----------- --------- ----------- -------- ----------- --------
Total other loans....................... 25,043 5.43 16,990 3.76 9,773 2.74
----------- --------- ----------- -------- ----------- --------
Total fixed-rate loans.................. 339,687 73.71 334,095 73.95 250,592 70.33
----------- --------- ----------- -------- ----------- --------
ADJUSTABLE-RATE LOANS
Real estate:
One-to-four family........................ 81,495 17.68 86,147 19.07 84,990 23.85
Multi-family.............................. 1,210 0.26 227 0.05 57 0.02
Commercial................................ 11,222 2.44 8,658 1.92 6,642 1.87
Construction or development............... 5,789 1.26 2,545 0.56 504 0.14
----------- --------- ----------- -------- ----------- --------
Total adjustable-rate real estate loans. 99,716 21.64 97,577 21.60 92,193 25.88
Consumer................................... 19,914 4.32 20,101 4.45 12,503 3.51
Commercial business loans.................. 1,538 0.33 0 0.00 1,000 0.28
----------- --------- ----------- -------- ----------- --------
Total adjustable-rate loans............. 121,168 26.29 117,678 26.05 105,696 29.67
----------- --------- ----------- -------- ----------- --------
Total loans............................. 460,855 100.00% 451,773 100.00% 356,288 100.00%
----------- --------- ----------- -------- ----------- --------
--------- -------- --------
LESS
Loans in process........................... 7,997 4,562 2,814
Unamortized discounts...................... 414 547 417
Net deferred loan fees..................... 1,948 1,847 1,695
Allowance for losses on loans.............. 3,041 2,748 2,340
----------- ----------- -----------
Total loans receivable, net............. $ 447,455 $ 442,069 $ 349,022
----------- ----------- -----------
----------- ----------- -----------
December 31,
---------------------------------------------------
1995 1994
----------------------- ----------------------
(DOLLARS IN THOUSANDS) Amount Percent Amount Percent
----------- --------- ----------- --------
FIXED-RATE LOANS
Real estate:
One-to-four family
GEM...................................... $ 30,175 9.35% $ 24,769 8.93%
Other.................................... 181,401 56.20 168,272 60.63
----------- -------- ----------- -------
Total one-to-four family................ 211,576 65.55 193,041 69.56
Multi-family.............................. 302 0.10 311 0.11
Commercial................................ 1,518 0.47 1,612 0.58
Construction or development............... 4,848 1.50 1,008 0.37
----------- -------- ----------- -------
Total fixed-rate real estate loans...... 218,244 67.62 195,972 70.62
----------- -------- ----------- -------
Consumer loans:
Savings................................... 1,210 0.37 648 0.23
Education................................. 299 0.09 1,278 0.46
Automobile................................ 671 0.21 520 0.19
Home equity............................... 7,254 2.25 7,258 2.62
Home improvement.......................... 785 0.24 870 0.31
Other..................................... 545 0.17 502 0.18
----------- -------- ----------- -------
Total consumer loans.................... 10,764 3.33 11,076 3.99
----------- -------- ----------- -------
Commercial business loans.................. 1,018 0.32 897 0.32
----------- -------- ----------- -------
Total other loans....................... 11,782 3.65 11,973 4.31
----------- -------- ----------- -------
Total fixed-rate loans.................. 230,026 71.27 207,945 74.93
----------- -------- ----------- -------
ADJUSTABLE-RATE LOANS
Real estate:
One-to-four family........................ 80,921 25.07 59,901 21.58
Multi-family.............................. 59 0.02 0 0.00
Commercial................................ 7,226 2.24 6,704 2.42
Construction or development............... 234 0.07 1,792 0.64
----------- -------- ----------- -------
Total adjustable-rate real estate loans. 88,440 27.40 68,397 24.64
Consumer................................... 4,295 1.33 1,187 0.43
Commercial business loans.................. 0 0.00 0 0.00
----------- -------- ----------- -------
Total adjustable-rate loans............. 92,735 28.73 69,584 25.07
----------- -------- ----------- -------
Total loans............................. 322,761 100.00% 277,529 100.00%
----------- -------- ----------- -------
-------- -------
LESS
Loans in process........................... 3,531 2,327
Unamortized discounts...................... 289 162
Net deferred loan fees..................... 1,899 2,147
Allowance for losses on loans.............. 2,191 1,893
----------- -----------
Total loans receivable, net............. $ 314,851 $ 271,000
----------- -----------
----------- -----------
6
The following schedule illustrates the interest rate sensitivity of
HMN's loan portfolio at December 31, 1998. 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
One-to-four family Commercial Construction Consumer
------------------------ ------------------------ ------------------------ ------------------------
Weighted Weighted Weighted Weighted
Average Average Average Average
(DOLLARS IN THOUSANDS) Amount Rate Amount Rate Amount Rate Amount Rate
------------ -------- ----------- -------- ----------- -------- ----------- --------
Due During
Years Ending
December 31,
- -----------------------
1999(1)...................$ 23,681 7.03% $ 2,461 7.61% $ 2,873 8.49% $ 4,420 8.71%
2000...................... 21,871 7.34 1,289 8.53 304 8.32 2,518 8.57
2001...................... 21,345 7.29 1,403 8.71 221 8.23 2,239 8.48
2002 through 2003......... 41,134 7.24 4,860 8.82 260 7.99 2,846 8.30
2004 through 2008......... 97,120 7.22 10,683 8.36 1,411 8.37 21,950 8.35
2009 through 2023......... 145,862 7.18 13,013 8.14 7,676 7.98 827 8.84
2024 and following........ 14,483 7.06 0 0.00 2,410 7.23 0 0.00
------------ ----------- ----------- -----------
$ 365,496 $ 33,709 $ 15,155 $ 34,800
------------ ----------- ----------- -----------
------------ ----------- ----------- -----------
Commercial
Business Total
------------------------ ------------------------
Weighted Weighted
Average Average
(DOLLARS IN THOUSANDS) Amount Rate Amount Rate
------------ -------- ----------- --------
Due During
Years Ending
December 31,
- -----------------------
1999(1)...................$ 2,533 8.62% $ 35,968 7.50%
2000...................... 1,792 8.95 27,774 7.62
2001...................... 1,488 9.01 26,696 7.57
2002 through 2003......... 4,243 8.61 53,343 7.55
2004 through 2008......... 394 8.95 131,558 7.52
2009 through 2023......... 1,245 8.51 168,623 7.31
2024 and following........ 0 0.00 16,893 7.08
------------ -----------
$ 11,695 $ 460,855
------------ -----------
------------ -----------
- ------------
(1) Includes demand loans, loans having no stated maturity, overdraft loans and
education loans.
The total amount of loans due after December 31, 2000 which have
predetermined interest rates is $311.5 million, while the total amount of
loans due after such dates which have floating or adjustable interest rates
is $113.3 million.
At December 31, 1998 construction or development loans for one-to-four
family dwellings totaled $5.7 million, multi-family totaled $6.6 million, and
non-residential totaled $2.9 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,
1998, based upon the 15% limitation, the Bank's regulatory loans-to-one
borrower limit was approximately $6.9 million. On the same date, the Bank had
no borrowers with net outstanding balances in excess of this amount. At
December 31, 1998, the largest dollar amount outstanding to one borrower or
group of related borrowers was $6.35 million. This loan, which is secured by
a shopping mall located in Winona, Minnesota, was performing in accordance
with its terms at December 31, 1998.
The Bank's Mortgage and Consumer 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. For the majority of 1998 the Limit
was $227,150, compared to $214,600 for the majority of 1997. 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.
During 1998, the Bank centralized its one-to-four family real estate
loan processing, underwriting, and servicing functions in Spring Valley. Each
of the branch's loan officers are responsible for taking the initial loan
application. The application and other pertinent information is then
forwarded to a central loan processor who is responsible for obtaining
information relating to processing the loan application. A loan underwriter
reviews the information obtained by the processor and determines whether the
loan applicant is eligible to receive the loan in conformity with the Bank's
written underwriting guidelines and other loan policies.
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. At December 31, 1998
HMN's one-to-four family real estate loans totaled $365.5 million, or 79.3%
of its total loan portfolio, and represented a decline of $30.2 million,
compared to $395.7 million at December 31, 1997. In order to reduce its
interest rate risk during 1998, HMN securitized and sold $27.9 million of
one-to-four family residential loans out of its loan portfolio. It also sold
approximately 44% of the Bank's one-to-four family residential loans that
were originated or refinanced during 1998. The loan securitizations and the
loan sales, when coupled with the accelerated prepayments experienced in the
loan portfolio during 1998, caused the one-to-four family real estate loan
portfolio to decline from December 31,1997 to December 31, 1998. See
"Originations, Purchases and Sales of Loans and Mortgage-Backed and Related
Securities".
8
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.
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").
The GEM loans require 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 has primarily offered 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. At December 31, 1998, HMN had $56.2 million of GEM
loans which comprised 12.2% of the total loan portfolio and represented an
increase of $2.9 million from GEM loans of $53.3 million at December 31, 1997.
HMN currently offers conventional fixed-rate one-to-four family loans
with maximum terms of up to 30 years. During 1998, HMN generally sold the
majority of new loan originations or refinances with fixed rates and terms to
maturity ranging from 15 years to 30 years that were eligible for sale in the
secondary market. Loans which were originated under the First Time Home
Buyers program were not sold because many of the loans did not conform to
secondary market underwriting requirements. The interest rates charged on the
fixed rate loan products are generally set based on the FNMA or FHLMC
delivery rates, as well as other competitive factors. At December 31, 1998,
HMN had $227.8 million of fixed rate one-to-four family other loans which
comprised 49.4% of the total loan portfolio and represented a decrease of
$28.5 million, from $256.3 million at December 31, 1997.
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 600
basis points over or under the initial rate. Initial interest rates offered
on the ARM loans during 1998 ranged from 4 to 186 basis points below the
fully indexed loan rate. All borrowers are now qualified for the loan at the
fully indexed rate. 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. 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, 1998 the one-to-four family ARMs totaled $81.5
million, or 17.7% of the total loan portfolio and represented a decrease of
$4.6 million from $86.1 million at December 31, 1997.
9
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 credit history, 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
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.
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. During 1998 HMN
hired experienced commercial loan officers to originate commercial real
estate and commercial business loans in HMN's market area. HMN also purchased
commercial real estate and multi-family loans from third party originators
during 1998. At December 31, 1998, commercial real estate loans were $29.0
million or 6.3% of the total loan portfolio and represented an increase of
$18.4 million compared to $10.6 million at December 31, 1997. At December 31,
1998 multi-family residential loans were $4.7 million, or 1.0% of the total
loan portfolio and represented an increase of $2.0 million compared to $2.7
million at December 31, 1997.
The commercial real estate and multi-family loan portfolio includes
loans secured by motels, hotels, apartment buildings, churches, small office
buildings, small business facilities, shopping malls, nursing homes and other
non-residential building properties primarily located in the upper Midwestern
United States.
Permanent commercial real estate and multi-family loans are generally
originated for a maximum term of 15 years and may have longer amortization
periods with balloon maturity features. The interest rates may be fixed for
the term of the loan or have adjustable features which are tied to prime or a
treasury index. Commercial real estate and multi-family loans are written in
amounts of up to 75% of the lesser of the appraised value of the property or
the purchase price and generally have a debt service coverage ratio of at
least 120%. The debt service coverage is the ratio of net cash from
operations before payment of debt to debt service. HMN may originate
construction loans secured by commercial or multi-family real estate, or may
purchase participation interests in third party originated construction loans
secured by commercial or multi-family real estate.
Appraisals on commercial real estate and multi-family real estate
properties are performed by independent appraisers prior to the time the loan
is made. All appraisals on commercial and multi-family real estate are
reviewed and approved by the commercial loan officer. 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. All commercial real estate and multi-family
loans must be approved by a majority of the commercial loan committee prior
to closing. The commercial loan policy generally requires personal guarantees
from the proposed borrowers. Once the loan is closed, HMN performs an annual
on-site inspection on collateral properties for loans with balances in excess
of $250,000 and also includes an annual review of the financial performance
of the property to determine that it is performing as anticipated.
10
At December 31, 1998, HMN's two largest commercial real estate loans
totaled $6.35 million and $4.9 million. The first loan is secured by a
shopping mall in Winona, Minnesota and the second loan is secured by a hotel
and other commercial real estate in St. Cloud, Minnesota. Both of these loans
were performing at December 31, 1998.
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, 1998, HMN had one commercial real estate loan
totaling $73,000 and no multi-family loans which were 90 days or more
delinquent.
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.
At December 31, 1998, HMN had $15.2 million of construction loans
outstanding, representing 3.3% of its total loan portfolio which represents
an increase of $9.5 million, compared to $5.7 million at December 31, 1997.
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. Generally, 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 1 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.
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. HMN
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. Generally
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.
At December 31, 1998 construction loans on one-to-four family
residential real estate totaled $5.7 million, construction on multi-family
residential real estate totaled $6.6 million and construction on commercial
real estate totaled $2.9 million.
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
11
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.
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, 1998, consumer loans totaled
$34.8 million, and represented 7.6% of total loans outstanding, compared to
$31.9 million at December 31, 1997.
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 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, 1998, HMN's home equity loans
totaled $9.6 million, or 2.1% of the total loan portfolio and the home equity
lines totaled $19.5 million, or 4.2% of the total loan portfolio, compared to
home equity loans of $7.2 million and home equity lines of $19.5 million at
December 31, 1997.
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, 1998, $86,000 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, 1998, HMN had $11.7 million
of commercial business loans outstanding, or 2.5% of the total loan portfolio
compared to $5.2 million at December 31, 1997.
12
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,
1998, there were no delinquent commercial business loans.
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 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.
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 under-writing standards. The seller generally continues to
service these purchased loans. During 1998, HMN originated $148.7 million of
loans compared to $68.1 million and $56.8 million during the years ended
December 31, 1997 and 1996, respectively. HMN purchased $71.0 million of
loans during 1998 compared to $71.8 million and $57.3 million during the
years ended December 31, 1997 and 1996, respectively. 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 1998, HMN purchased $1.8 million of mortgage-backed
securities compared to $3.4 million and $7.2 million for the years ended
December 31, 1997 and 1996. It also purchased $112.0 million of CMOs during
1998 compared to $24.0 million and $50.4 million for the years ended December
31, 1997 and 1996, respectively. See -"Investment Activities." During 1998,
HMN sold $96.5 million of mortgage-backed and related securities compared to
$67.9 million and $81.1 million for the years ended December 31, 1997 and
1996, respectively.
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.
(DOLLARS IN THOUSANDS)
LOANS Year Ended December 31,
ORIGINATIONS BY TYPE: 1998 1997 1996
-------- ------- -------
Adjustable-rate:
Real estate - one-to-four family.................... $ 2,328 1,987 5,441
- commercial............................ 5,388 1,000 0
- construction or development........... 787 375 916
Non-real estate - consumer.......................... 15,689 16,871 12,012
- commercial business............... 176 0 0
-------- ------- -------
Total adjustable-rate......................... 24,368 20,233 18,369
-------- ------- -------
Fixed-rate:
Real estate - one-to-four family.................... 44,413 32,024 27,036
- multi-family.......................... 1,694 263 145
- commercial............................ 16,882 50 30
- construction or development........... 10,626 6,539 6,181
Non-real estate - consumer.......................... 13,100 7,579 4,583
- commercial business............... 37,672 1,409 430
-------- ------- -------
Total fixed-rate.............................. 124,387 47,864 38,405
-------- ------- -------
Total loans originated........................ 148,755 68,097 56,774
-------- ------- -------
PURCHASES:
Real estate - one-to-four family.................... 58,512 67,213 55,839
- multi-family.......................... 8,571 0 0
- commercial............................ 1,172 0 0
- construction or development........... 0 2,425 1,500
Non-real estate - commercial business............... 2,731 2,174 0
-------- ------- -------
Total purchased............................... 70,986 71,812 57,339
-------- ------- -------
ACQUISITION:
Real estate - one-to-four family.................... 0 63,328 0
- multi-family.......................... 0 2,308 0
- commercial............................ 0 2,099 0
Non-real estate - consumer.......................... 0 2,599 0
-------- ------- -------
Total loans acquired........................... 0 70,334 0
-------- ------- -------
Transfers from loans held for sale..................... 0 96 0
SALES AND REPAYMENTS:
Real estate - one-to-four family.................... 5,878 8,969 2,310
- commercial............................ 650 0 0
Non-real estate - consumer.......................... 238 339 176
-------- ------- -------
Total sales................................... 6,766 9,308 2,486
-------- ------- -------
Loans securitized and transferred to securities..... 27,953 16,526 15,412
Transfers to loans held for sale.................... 52,295 4,347 2,492
Principal repayments................................ 106,824 84,244 56,533
-------- ------- -------
Total reductions.............................. 193,838 114,425 76,923
-------- ------- -------
Decrease in other items, net........................ (20,517) (2,867) (3,019)
-------- ------- -------
Net increase.................................. $ 5,386 93,047 34,171
-------- ------- -------
-------- ------- -------
14
MORTGAGE-BACKED AND RELATED SECURITIES
Loans securitized and transferred to securities... $ 27,953 16,526 15,441
PURCHASES:
Mortgage-backed securities:(1)
Adjustable-rate.................................... 0 0 0
Fixed-rate......................................... 1,766 3,426 7,266
CMOs and REMICs:
Adjustable-rate.................................... 76,174 3,417 6,527
Fixed-rate......................................... 35,839 20,617 43,831
-------- ------- -------
Total purchases................................ 113,779 27,460 57,624
-------- ------- -------
ACQUISITION:
Adjustable rate..................................... 0 12,522 0
Fixed rate.......................................... 0 25,738 0
-------- ------- -------
Total acquisitions............................. 0 38,260 0
-------- ------- -------
SALES:
Mortgage-backed securities:(1)
Adjustable-rate.................................... 24,955 9,535 0
Fixed-rate......................................... 46,432 344 24,786
CMOs and REMICs:
Adjustable-rate.................................... 13,765 26,486 23,876
Fixed-rate......................................... 11,366 31,529 32,487
-------- ------- -------
Total sales..................................... 96,518 67,894 81,149
-------- ------- -------
PRINCIPAL REPAYMENTS:
Decrease in other items, net......................... 38,003 13,578 28,915
-------- ------- -------
Net increase (decrease)........................... $ 7,211 774 (36,999)
-------- ------- -------
-------- ------- -------
- ---------------
(1) Consists of pass-through securities.
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.
15
The following table sets forth HMN's loan delinquencies by type, by
amount and by percentage of type at December 31, 1998.
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........... 9 $297 0.08% 13 $630 0.17% 22 $ 927 0.25%
Multi-family............ 0 0 0.00 0 0 0.00 0 0 0.00
Commercial.............. 0 0 0.00 1 73 0.25 1 73 0.25
Construction or
development........... 0 0 0.00 0 0 0.00 0 0 0.00
Consumer................ 12 68 0.20 8 86 0.25 20 154 0.44
Commercial
business.............. 0 0 0.00 0 0 0.00 0 0 0.00
-- ---- -- ---- -- ------
Total............... 21 $365 0.08% 22 $789 0.17% 43 $1,154 0.25%
-- ---- -- ---- -- ------
-- ---- -- ---- -- ------
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, 1998, the Bank had classified a total of $879,000 of
its loans and other assets as follows:
Commercial Real
One-to-Four Construction or Estate and Commercial
(DOLLARS IN THOUSANDS) Family Development Multi-Family Consumer Business
----------- --------------- --------------- -------- ----------
Substandard............. $716 0 73 90 0
Doubtful................ 0 0 0 0 0
Loss.................... 0 0 0 0 0
---- - -- -- -
Total............... $716 0 73 90 0
---- - -- -- -
---- - -- -- -
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.
16
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) 1998 1997 1996 1995 1994
----- ----- ----- ----- -----
Non-accruing loans:
Real estate:
One-to-four family............................ $ 317 177 235 196 178
Commercial real estate........................ 73 79 83 85 0
Consumer...................................... 86 7 7 32 57
Commercial business........................... 0 0 13 128
----- ---- ----- ----- -----
Total....................................... 476 263 338 441 235
----- ---- ----- ----- -----
Accruing loans delinquent 90 days or more:
One-to-four family............................. 312 365 0 0 0
Consumer....................................... 0 37 0 0 0
----- ---- ----- ----- -----
Total....................................... 312 402 0 0 0
----- ---- ----- ----- -----
Restructured loans:
Multi-family................................... 0 0 0 94 199
Foreclosed assets:
Real estate:
One-to-four family............................ 18 142 23 315 64
----- ---- ----- ----- -----
Total....................................... 18 142 23 315 64
----- ---- ----- ----- -----
Total non-performing assets...................... $ 806 807 361 850 498
----- ---- ----- ----- -----
----- ---- ----- ----- -----
Total as a percentage of total assets............ 0.12% 0.12% 0.07% 0.16% 0.10%
----- ---- ----- ----- -----
----- ---- ----- ----- -----
Total non-performing loans....................... $ 788 665 $ 338 $ 535 $ 434
----- ---- ----- ----- -----
----- ---- ----- ----- -----
Total as a percentage of total
loans receivable, net........................... 0.18% 0.15% 0.10% 0.17% 0.16%
----- ---- ----- ----- -----
----- ---- ----- ----- -----
For the year ended December 31, 1998, gross interest income which would
have been recorded had the non-accruing loans been current in accordance with
their original terms amounted to $49,382. The amounts that were included in
interest income on such loans during 1998 were $28,618.
Total non-performing assets were $806,000 at December 31, 1998, a
decrease of $1,000, compared to $807,000 at December 31, 1997 and $361,000 at
December 31, 1996. Non-performing assets had the following activity during
1998: sales of $142,000, transfers in of $389,000 and transfers out due to
performance of $248,000. Non-performing assets had the following activity
during 1997: sales of $42,000, charge-offs of $35,000, payments of $80,000
and net transfers to non-performing assets of $603,000. The increase in
non-performing assets from 1996 to 1997 is primarily the result of three
one-to-four family purchased loans totaling $365,000 that were 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.
17
OTHER LOANS OF CONCERN. In addition to the non-performing assets set
forth in the table above, as of December 31, 1998 there were $72,000 of loans
with 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.
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) 1998 1997 1996 1995 1994
------ ------ ------ ------ ------
Balance at beginning of year................... $2,748 2,341 2,191 1,893 1,489
MFC allowance for losses acquired.............. 0 122 0 0 0
Provision for losses........................... 310 300 300 300 410
CHARGE-OFFS
Real estate:
One-to-four family........................... (2) (4) 0 0 0
Multi-family................................. 0 0 (88) 0 0
Consumer..................................... (17) (7) (1) (2) (6)
Commercial business.......................... 0 (12) (61) 0 0
------ ------ ------ ------ ------
(19) (23) (150) (2) (6)
------ ------ ------ ------ ------
RECOVERIES
Real estate:
Commercial business.......................... 2 8 0 0 0
------ ------ ------ ------ ------
2 8 0 0 0
------ ------ ------ ------ ------
Net charge-offs................................ (17) (15) (150) (2) (6)
------ ------ ------ ------ ------
Balance at end of year......................... $3,041 2,748 2,341 2,191 1,893
------ ------ ------ ------ ------
------ ------ ------ ------ ------
Ratio of net charge-offs during the year to
average loans outstanding during the year..... 0.00% 0.01% 0.05% 0.00% 0.00%
------ ------ ------ ------ ------
------ ------ ------ ------ ------
Ratio of allowance for losses on loans to
total non-performing loans, at end of year.... 385.79% 413.17% 691.84% 409.13% 436.52%
------ ------ ------ ------ ------
------ ------ ------ ------ ------
18
The distribution of the Bank's allowance for losses on loans at the dates
indicated is summarized as follows:
December 31,
------------------------------------------------------------------------------
1998 1997 1996
-------------------- --------------------- -------------------------
Percent Percent Percent
of Loans of Loans of Loans
in Each in Each in Each
Category Category Category
to Total to Total to Total
(DOLLARS IN THOUSANDS) Amount Loans Amount Loans Amount Loans
--------- ---------- ---------- ---------- ---------- ---------
Real Estate:
One-to-four family.............. $ 544 79.31% $ 560 87.58% $ 496 90.19%
Multi-family.................... 142 1.02 80 0.60 8 0.08
Commercial ..................... 797 6.29 198 2.34 113 2.22
Construction or development..... 455 3.29 172 1.27 104 0.98
Consumer.......................... 546 7.55 527 7.05 473 5.87
Commercial business............... 328 2.54 46 1.16 29 0.66
Unallocated....................... 229 0.00 1,165 0.00 1,118 0.00
--------- -------- ---------- -------- ---------- ------
Total....................... $ 3,041 100.00% $ 2,748 100.00% $ 2,341 100.00%
--------- -------- ---------- -------- ---------- ------
--------- -------- ---------- -------- ---------- ------
1995 1994
------------------------- ---------------------------
Percent Percent
of Loans of Loans
in Each in Each
Category Category
to Total to Total
(DOLLARS IN THOUSANDS) Amount Loans Amount Loans
-------- ----------- ----------- -----------
Real Estate:
One-to-four family............. $ 452 90.62% $ 475 92.18%
Multi-family................... 21 0.11 21 0.14
Commercial .................... 125 2.71 128 1.80
Construction or development.... 153 1.58 84 1.31
Consumer......................... 286 4.66 280 4.14
Commercial business.............. 37 0.32 27 0.43
Unallocated...................... 1,117 0.00 878 0.00
-------- -------- --------- --------
Total....................... $ 2,191 100.00% $ 1,893 100.00%
-------- -------- --------- --------
-------- -------- --------- --------
19
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.
Refer to Management's Discussion and Analysis on Allowances for Loan and Real
Estate Losses and Non-performing Assets in the Annual Report.
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, 1998, the Bank's liquidity ratio (liquid assets
as a percentage of net withdrawable savings deposits and current borrowings)
was 10.27%. 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, 1998, 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.
20
The following table sets forth the composition of HMN's securities portfolio,
excluding mortgage-backed and related securities, at the dates indicated.
December 31,
-------------------------------------------------------------------------------------
1998 1997
--------------------------------------------- -------------------------------------
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....................... $ 17,379 12 17,391 25.11% $ 43,403 (60) 43,343 49.98%
Municipal obligations............... 2,901 (5) 2,896 4.18 0 0 0 0.00
Corporate debt ..................... 4,232 (3) 4,229 6.10 2,903 0 2,903 3.35
Corporate equity(1)................. 8,271 (296) 7,975 11.51 8,017 1,021 9,038 10.42
Stock of federal agencies(1)........ 5,874 114 5,988 8.64 14,034 605 14,639 16.88
Securities held to maturity:
Corporate debt...................... 0 0 0.00 0 0 0.00
--------- ------ ------ --------- ------ ------
Subtotal.......................... 38,657 38,479 55.54 68,357 69,923 80.63
FHLB stock............................ 9,838 9,838 14.20 7,432 7,432 8.57
--------- ------ ------ --------- ------ ------
Total investment securities
and FHLB stock................... 48,495 48,317 69.74 75,789 77,355 89.20
--------- ------ ------ --------- ------ ------
Average remaining life of investment
securities excluding FHLB stock.... 4.5 years 2.5 years
Other Interest-earning Assets:
Cash equivalents.................... 20,961 20,961 30.26 9,365 9,365 10.80
--------- ------ ------ --------- ------ ------
Total............................. $ 69,456 69,278 100.00% $ 85,154 86,720 100.00%
--------- ------ ------ --------- ------ ------
--------- ------ ------ --------- ------ ------
Average remaining life or term
to repricing of investment securities
and other interest-earning assets,
excluding FHLB stock................. 3.2 years 2.3 years
1996
-----------------------------------------
Amortized Adjusted Market % of
(DOLLARS IN THOUSANDS) Cost To Value Total
--------- -------- ------ ------
Securities available for sale:
U.S. government and agency
obligations....................... $ 29,600 (322) 29,278 49.93%
Municipal obligations............... 0 0 0 0.00
Corporate debt ..................... 1,091 1 1,092 1.86
Corporate equity(1)................. 7,796 386 8,182 13.96
Stock of federal agencies(1)........ 3,874 49 3,923 6.69
Securities held to maturity:
Corporate debt...................... 1,000 1,001 1.71
--------- ------ ------
Subtotal.......................... 43,361 43,476 74.15
FHLB stock............................ 5,434 5,434 9.27
--------- ------ ------
Total investment securities
and FHLB stock................... 48,795 48,910 83.42
--------- ------ ------
Average remaining life of investment
securities excluding FHLB stock.... 3.4 years
Other Interest-earning Assets:
Cash equivalents.................... 9,718 9,718 16.58
--------- ------ ------
Total............................. $ 58,513 58,628 100.00%
--------- ------ ------
--------- ------ ------
Average remaining life or term
to repricing of investment securities
and other interest-earning assets,
excluding FHLB stock................. 2.8 years
(1) Average life assigned to corporate equity holdings and stock of federal
agencies is five years.
21
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, 1998
----------------------------------------------------------
After 1 After 5
1 Year through 5 through 10 Over No Stated
or Less Years Years 10 Years Maturity
--------- --------- --------- --------- ---------
Amortized Amortized Amortized Amortized Amortized
(DOLLARS IN THOUSANDS) Cost Cost Cost Cost Cost
--------- --------- --------- --------- ---------
Securities available for sale:
U.S. government securities........ $ 0 9,887 0 7,492 0
Municipal obligations............. 0 0 0 2,901 0
Corporate debt.................... 1,152 2,520 560 0 0
Corporate equity.................. 0 0 0 0 8,271
Stock of federal agencies......... 0 0 0 0 5,874
-------- -------- -------- ------- --------
Total stock......................... $ 1,152 12,407 560 10,393 14,145
-------- -------- -------- ------- --------
-------- -------- -------- ------- --------
Weighted average yield.............. 6.50% 6.39% 8.00% 6.83% 5.34%
December 31, 1998
--------------------------------
Total
Securities
--------------------------------
Amortized Adjusted Market
(DOLLARS IN THOUSANDS) Cost to Value
--------- -------- -------
Securities available for sale:
U.S. government securities........ 17,379 12 17,391
Municipal obligations............. 2,901 (5) 2,896
Corporate debt.................... 4,232 (3) 4,229
Corporate equity.................. 8,271 (296) 7,975
Stock of federal agencies......... 5,874 114 5,988
-------- -------
Total stock......................... 38,657 38,479
-------- -------
-------- -------
Weighted average yield.............. 6.15%
22
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, 1998, HMN had
$143.1 million of mortgage-backed and related securities all classified as
available for sale, compared to $135.9 at December 31, 1997 and $135.2
million at December 31, 1996, of which $133.4 million were classified as
available for sale.
The contractual maturities of the mortgage-backed and related securities
portfolio without any prepayment assumptions at December 31, 1998 is as
follows:
December 31,
1998
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........ $ 133 561 1,183 0 1,877
Federal National Mortgage Association......... 0 0 0 574 574
Government National Mortgage Association...... 0 13 108 1,366 1,487
Other mortgage-backed securities.............. 0 0 0 101 101
Collateralized Mortgage Obligations........... 1,028 2,208 18,928 116,943 139,107
------------ ---------- ------------ ----------- ------------
Total...................................... $ 1,161 2,782 20,219 118,984 143,146
------------ ---------- ------------ ----------- ------------
------------ ---------- ------------ ----------- ------------
Weighted average yield........................ 7.50% 7.21% 7.03% 6.66% 6.73%
At December 31, 1998, HMN did not have any non-agency mortgage-backed or
related securities in excess of 10% of its stockholders' equity, except for a
$11.9 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.
At December 31, 1998, HMN had $94.5 million invested in CMOs which have
floating interest rates that change either monthly or quarterly, compared to
$23.3 million at December 31, 1997 and $43.5 million at December 31, 1996.
During 1998 HMN increased its investment in floating rate CMOs in order to
reduce its overall interest rate risk exposure.
At December 31, 1998 the projected duration (period of time until half
the interest and half the principal is collected) of the $44.6 million fixed
rate CMO portfolio is approximately 1.0 year using median prepayment speeds
projected by the Bloomberg security system, compared to approximately 3.3
years for the $61.8 million fixed rate CMO security portfolio at December 31,
1997.
Refer to Management's Discussion and Analysis-Market Risk in the Annual
Report for information on changes in market value of the mortgage-backed or
related securities under different rate shock environments.
To assess price volatility, the Federal Financial Institutions
Examination Council ("FFIEC") adopted a policy in 1992 which required an
annual "stress" test of mortgage derivative securities. The policy, which was
adopted by the OTS, required the Bank to annually test its CMOs and other
mortgage-related securities to
23
determine whether they were "high-risk" or "nonhigh-risk securities". During
1998 the OTS adopted Thrift Bulletin 13A which no longer required that
"high-risk" testing be performed on an institution's CMOs and other
mortgage-related securities.
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 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) 1998 1997 1996
--------- -------- --------
Opening balance............................. $ 467,348 362,477 373,539
MFC deposits acquired....................... 0 103,612 0
Deposits.................................... 536,135 370,761 351,330
Withdrawals................................. (588,662) (385,002) (378,009)
Interest credited........................... 19,048 15,500 15,617
---------- -------- --------
Ending balance............................ 433,869 467,348 362,477
---------- -------- --------
Net increase (decrease)..................... $ (33,479) 104,871 (11,062)
---------- -------- --------
---------- -------- --------
Percent increase (decrease)................. (7.16)% 28.93% (2.96)%
---------- -------- --------
---------- -------- --------
24
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:
1998 1997 1996
---------------------------- -------------------------- ----------------------
Percent Percent Percent
(DOLLARS IN THOUSANDS) Amount of Total Amount of Total AMOUNT of Total
-------- -------- -------- -------- --------- --------
TRANSACTIONS AND SAVINGS DEPOSITS(1):
Non-interest checking.................... $ 13,187 3.04% $ 3,833 0.82% $ 2,389 0.66%
NOW Accounts - 1.00%(2).................. 25,459 5.87 23,144 4.95 17,589 4.85
Passbook Accounts - 2.00%(3)............. 35,766 8.24 36,199 7.75 30,070 8.29
Money Market Accounts - 3.19%(4)......... 29,419 6.78 24,807 5.31 16,533 4.56
---------- -------- ---------- -------- --------- -------
Total Non-Certificates................. $ 103,831 23.93% $ 87,983 18.83% $ 66,581 18.36%
---------- -------- ---------- -------- --------- -------
CERTIFICATES:
3.00 - 3.99%........................... $ 1,943 0.45% $ 727 0.15% $ 425 0.12%
4.00 - 4.99%........................... 87,582 20.19 24,155 5.17 22,553 6.22
5.00 - 5.99%........................... 160,630 37.02 162,916 34.86 168,040 46.36
6.00 - 6.99%........................... 78,273 18.04 178,847 38.27 76,704 21.16
7.00 - 7.99%........................... 1,342 0.31 11,627 2.49 28,077 7.75
8.00 - 8.99%........................... 264 0.06 1,091 0.23 96 0.03
9.00% and over.......................... 4 0.00 2 0.00 1 0.00
---------- -------- --------- ------- --------- -------
Total Certificates..................... 330,038 76.07 379,365 81.17 295,896 81.64
---------- -------- ---------- -------- --------- -------
Total Deposits...................... $ 433,869 100.00% $ 467,348 100.00% $ 362,477 100.00%
---------- -------- ---------- ------- --------- ------
---------- -------- ---------- ------- --------- ------
- ------------
(1) Reflects rates paid on transaction and savings deposits at
December 31, 1998.
(2) The rate on NOW Accounts for 1997 was 1.50% and 1996 was 2.01%.
(3) The rate on Passbook Accounts for 1997 was 2.62% and 1996 was 2.50%.
(4) The rate on Money Market Accounts for 1997 was 3.34% and 1996 was 2.83%.
25
The following table shows rate and maturity information for the Bank's
certificates of deposit as of December 31, 1998.
(DOLLARS IN THOUSANDS)
Certificate accounts maturing in 2.00- 3.00- 4.00- 5.00- 6.00-
quarter ending: 2.99% 3.99% 4.99% 5.99% 6.99%
------ ----- ------ ------- ------
March 31, 1999.......................... $ 0 1,322 12,578 30,572 21,601
June 30, 1999........................... 0 3 12,859 26,839 8,536
September 30, 1999...................... 100 43 22,019 19,162 5,520
December 31, 1999....................... 400 39 12,675 17,599 1,654
March 31, 2000.......................... 0 0 10,874 8,520 3,427
June 30, 2000........................... 0 2 2,964 4,397 1,736
September 30, 2000...................... 0 0 3,891 4,031 13,958
December 31, 2000....................... 0 33 4,040 7,124 6,575
March 31, 2001.......................... 0 0 278 9,072 2,832
June 30, 2001........................... 0 0 739 8,998 1,975
September 30, 2001...................... 0 0 2,638 5,243 2,230
December 31, 2001....................... 0 1 1,753 1,112 2,867
Thereafter.............................. 0 0 274 17,961 5,362
------ ----- ------ ------- ------
Total................................ $ 500 1,443 87,582 160,630 78,273
------ ----- ------ ------- ------
------ ----- ------ ------- ------
Percent of total..................... 0.15% 0.44% 26.54% 48.66% 23.72%
------ ----- ------ ------- ------
------ ----- ------ ------- ------
(DOLLARS IN THOUSANDS)
Certificate accounts maturing in 7.00- 8.00- 9.00- Percent
quarter ending: 7.99% 8.99% 9.99% Total of Total
----- ----- ----- ------- --------
March 31, 1999.......................... 477 253 0 66,803 20.25
June 30, 1999........................... 248 11 2 48,498 14.70
September 30, 1999...................... 358 0 0 47,202 14.30
December 31, 1999....................... 257 0 0 32,624 9.88
March 31, 2000.......................... 0 0 1 22,822 6.92
June 30, 2000........................... 0 0 0 9,099 2.76
September 30, 2000...................... 0 0 0 21,880 6.63
December 31, 2000....................... 0 0 0 17,772 5.38
March 31, 2001.......................... 0 0 0 12,182 3.69
June 30, 2001........................... 0 0 0 11,712 3.55
September 30, 2001...................... 0 0 1 10,112 3.06
December 31, 2001....................... 2 0 0 5,735 1.74
Thereafter.............................. 0 0 0 23,597 7.15
----- ----- ----- ------- ------
Total................................ 1,342 264 4 330,038 100.00%
----- ----- ----- ------- ------
----- ----- ----- ------- ------
Percent of total..................... 0.41% 0.08% 0.00% 100.00%
----- ----- ----- -------
----- ----- ----- -------
26
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,
1998.
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........................................... $ 55,559 44,651 69,631 123,848 293,689
Certificates of deposit of
$100,000 or more........................................ 5,520 2,100 5,568 10,717 23,905
Public funds(1).......................................... 5,725 1,747 4,627 345 12,444
-------- ------- ------- -------- -------
Total certificates of
deposit.............................................. $ 66,804 48,498 79,826 134,910 330,038
-------- ------- ------- -------- -------
-------- ------- ------- -------- -------
- ------------
(1) Deposits from governmental and other public entities.
For additional information regarding the composition of the Bank's deposits, see
Note 12 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 starting on page 21 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, 1998, the Bank had $185.4
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 $60.0 million for liquidity purposes. See "Financial
Review - Federal Home Loan Bank Advances" and Note 13 of the Notes to
Consolidated Financial Statements in the Annual Report.
During 1998, HMN has established a $2.5 million revolving line of credit
with Norwest Bank Minnesota, N.A. The credit line matures September 15, 1999
and floats at the Federal Funds rate plus 250 basis points.
The following table sets forth the maximum month-end balance and average
balance of FHLB advances and the revolving line of credit ("Other Borrowings")
for the periods indicated.
Year Ended December 31,
-----------------------------------------
1998 1997 1996
---------- ------- -------
(DOLLARS IN THOUSANDS)
MAXIMUM BALANCE:
FHLB advances and Other Borrowings........................ $ 195,829 128,007 106,436
FHLB short-term borrowings and Other Borrowings........... 46,893 60,429 64,429
AVERAGE BALANCE:
FHLB advances and Other Borrowings........................ 172,232 112,500 89,656
FHLB short-term borrowings and Other Borrowings........... 32,320 45,598 47,949
27
The following table sets forth certain information as to the Bank's FHLB
advances and Other Borrowings at the dates indicated.
December 31,
---------------------------
1998 1997 1996
------- ------ ------
(DOLLARS IN THOUSANDS)
FHLB short-term borrowings and Other Borrowings....... $17,500 43,250 46,429
Weighted average interest rate of
FHLB short-term borrowings and Other Borrowings..... 5.38% 5.85% 5.52%
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. OIAI recorded net income of $29,000 for the year
ended December 31, 1998.
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 and through internet banking operations which are
throughout the continental United States. 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 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 facility located in Brooklyn Park, Minnesota.
Brooklyn Park is 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
28
market to FNMA, FHLMC or other third parties. It also from 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, 1998, HMN had a total of 136 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.
MICHAEL MCNEIL. Mr. McNeil, age 51, has been the President and Chief
Executive Officer of the Bank since January 1, 1999. From April 1, 1998
through December 1998, Mr. McNeil was the Senior Vice President Business
Development of the Bank. Prior to joining the Bank, Mr. McNeil was the
President and a director of Stearns Bank, N.A. in St. Cloud, Minnesota from
August 1, 1991 until March 1, 1998.
DWAIN C. JORGENSEN. Mr. Jorgensen, age 50, is Senior Vice President
Operations of HMN and the Bank. Mr. Jorgensen has held such positions with
the Bank since 1998. Prior to such time, he served as Vice President,
Controller and Chief Accounting Officer of HMN and the Bank from 1989 to
1998. From 1983 to 1989, Mr. Jorgensen was an Assistant Vice President and
Operations Officer with the Bank.
TIMOTHY P. JOHNSON. Mr. Johnson, age 46, is Vice President and
Treasurer of HMN and the Bank, a position he has held since 1997. He has also
been Principal Accounting Officer since 1998. 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.
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 by the
OTS and the FDIC. The last regular OTS examination of the Bank was dated
July of 1998. The Bank has not been scheduled for an examination in 1999,
except for an on-site year 2000 examination which started
29
on March 1, 1999. 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. From time to time, 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, the savings association's condition as reflected by
its composite rating, and the complexity of the savings association's
business determined by the amount of trust assets administered, assets
subject to recourse or similar obligations and the principal amount of loans
serviced by the savings association. Savings associations (unlike the Bank)
with a composite rating of 3 receive a condition component equal to 25% of
their size component and savings associations with a composite rating of 4 or
5 receive a condition component equal to 50% of their size component. The
Bank's OTS assessment for the year ended December 31, 1998 was approximately
$147,000.
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, 1998, the Bank's lending limit under
this restriction was $6.9 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 credit
underwriting and loan documentation, internal controls and audit systems,
interest rate risk exposure, asset growth and quality, compensation and
other employee benefits and year 2000 issues. The proposal also establishes
the maximum ratio of classified assets to total capital (which for this
purpose
30
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 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 Bank is subject to a wide array of other laws and regulations, both
federal and state, including, but not limited to, usury laws, the Community
Reinvestment Act 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 liability 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 required the FDIC to implement a risk-based deposit insurance
assessment system. Under the system, all insured depository institutions were
placed into one of nine categories and assessed insurance premiums, ranging
from .04% to .31% of deposits, based upon their level of capital and
supervisory evaluation. 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.
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
31
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, 1998, the Bank had goodwill
and other intangibles of $5.6 million and $264,000 of mortgage servicing
rights which were required to be deducted from stockholders' equity to arrive
at tangible capital and Tier I 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, or meeting other criteria, 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, 1998, the Bank had tangible capital of $42.8 million, or
6.4% of adjusted total assets, which is $16.0 million above the minimum
requirement of 1.5% of adjusted total assets in effect on that date.
The capital standards also require core capital or Tier I capital to
equal 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.
The OTS regulations only allow those savings associations rated a
composite one (the highest rating) under the safety and soundness rating
system for savings associations to be permitted to operate at or near the
regulatory minimum leverage ratio of 3%. All other savings associations are
required to maintain a Tier I capital to adjusted total assets of 4% to 5%.
The OTS assesses each individual savings association through the supervisory
process on a case-by-case basis to determine the applicable requirement.
The Bank is also required to have a Tier I capital ratio to risk-weighted
assets of 4%. 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
32
unless insured to such ratio by an insurer approved by the FNMA or the FHLMC.
At December 31, 1998, the Bank had Tier I capital equal to $42.8
million, or 6.4%, of adjusted total assets, which is $16.0 million above the
minimum Tier I ratio requirement of 4% based upon the Bank's composite
rating. At December 31, 1998, the Bank had a Tier I capital to risk-weighted
assets ratio of 12.9%, which is $29.5 million above the minimum requirement
of $13.3 million.
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, 1998, the Bank had $3.0 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, 1998
the Bank had $22,000 of exclusions from capital.
On December 31, 1998, the Bank had total "risk-based" capital of $45.8
million and risk-weighted assets of $332.7 million, or total capital of 13.8%
of risk-weighted assets. This amount was $19.2 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.
On December 1, 1998 the OTS issued Thrift Bulletin 13a ("TB 13a"), Management
of Interest Rate Risk, Investment Securities, and Derivatives Activities,
which among other things established guidelines for measuring an
institution's sensitivity to market risk. TB 13a had a table which examiners
should use as a starting point in their analysis of an institution's level of
interest rate risk, assuming there were no deficiencies in the institution's
risk management practices. Based upon an IRR exposure report prepared by OTS
from data submitted by the Bank at December 31, 1998, the Bank was deemed to
have "minimal interest rate risk" per the table. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations -
Asset/Liability Management" in the Annual Report.
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.
33
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% Tier 1 to adjusted
total assets ratio, a 4% 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 Tier I to
adjusted total assets 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, 1998 the Bank would be considered to be "well
capitalized" under the prompt corrective actions provisions mentioned above.
See Note 20 "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.
34
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 generally 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 include associations that before and after the proposed
distribution meet their current minimum capital requirements, may generally
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 promulgated regulations that revise the current capital
distribution restrictions. These regulations become effective on April 1,
1999. The regulations eliminate the current tiered structure and the
safe-harbor percentage limitations. Under the regulations, a savings
association that is a subsidiary of a holding company, like the Bank, must
file either a notice or an application 30 days before declaring a dividend or
seeking board approval of a capital distribution. A notice is required unless
a savings association (that is a holding company subsidiary) is not eligible
for expedited treatment under OTS regulation or would not be adequately
capitalized after the distribution, or the distribution would cause the
association's distributions for the calendar year to exceed its net income
for the year to date plus retained net income for the prior two years, or the
distribution is otherwise contrary to statute, regulation or regulatory
agreement or condition. If any of these conditions exist, then an
application must be filed with the OTS. As under the current rule, the OTS
may object to a capital distribution if it would constitute an unsafe or
unsound practice.
In March of 1999, the Bank received notification from the OTS that
subject to certain restrictions (which could only be calculated at the time
of distribution) a dividend from the Bank to HMN of $4.0 million could be
paid during 1999 and not violate the dividend limitations mentioned above.
35
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" 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% or an amount that would be required to operate the Bank in a safe and
sound manner.
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, 1998, 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 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 bank. In addition, it may have to repay promptly
any outstanding FHLB borrowings, which could result in prepayment penalties
or purchase additional FHLB stock to meet the stockholder requirements of
non-QTL members. 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."
36
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, acquire the securities of most affiliates, or purchase low quality
assets from 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.
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.
37
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, 1998, 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, 1998, the Bank had $9.8 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 7.07% and were 6.62% for calendar year 1998. For
the year ended December 31, 1998, dividends paid by the FHLB of Des Moines to
the Bank totaled $589,000.
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.
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 additions 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.
38
Beginning in 1996, the favorable bad debt method described above was
repealed putting savings institutions on the same tax bad debt method as
commercial banks. This legislation required 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, 1998, 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 1998 has been extended and will be filed
by September 1999. 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%.
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.
39
ITEM 2. PROPERTIES
The following table sets forth information concerning the main office
and each branch office of HMN at December 31, 1998. At December 31, 1998,
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, 1998(1)
- -------------------------- -------- -------- --------------------
(In Thousands)
CORPORATE OFFICE:
101 North Broadway 1975 Owned 336
Spring Valley, Minnesota
FULL SERVICE BRANCHES:
715 North Broadway 1998 Owned 1,107
Spring Valley, Minnesota
201 Oakland Avenue 1960 Owned 157
Austin, Minnesota
Crossroads Shopping Center 1962 Owned 481
Rochester, Minnesota
4th & Center (2) 1973 Owned 111
Winona, Minnesota
175 Center Street 1998 Owned 1,751
Winona, Minnesota
208 South Walnut 1975 Owned 86
LaCrescent, Minnesota
1110 6th St., NW 1982 Owned 849
Rochester, Minnesota
143 West Clark Street 1993 Owned 568
Albert Lea, Minnesota
303 W. Main St. 1997 Owned 694
Marshalltown, Iowa
110 W. High St. 1997 Leased 2
Toledo, Iowa
29 S. Center 1997 Owned 245
Marshalltown, Iowa
MORTGAGE BANKING/BROKERAGE OFFICES:
7101 Northland Circle, Suite 105 1997 Leased --
Brooklyn Park, Minnesota
- ---------------
(1) Does not include $2,174,857 of net furniture and equipment distributed
between all of the above offices or its subsidiaries.
(2) The property is the old bank building in Winona and is currently being
held for sale. The portions of the property are being rented on a month
to month basis to tenants.
40
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, 1998
was approximately $462,882.
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 21, 52 and the back cover page of the Annual
Report to Security Holders for the year ended December 31, 1998 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, 1998 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 28 of the Annual Report to Security
Holders for the year ended December 31, 1998 is incorporated herein by
reference.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The information on pages 23 through 24 of the Annual Report to Security
Holders for the year ended December 31, 1998 is incorporated herein by
reference.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information on pages 29 through 52 of the Annual Report to Security
Holders for the year ended December 31, 1998 is incorporated herein by
reference.
41
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 4 through 5 of the Registrant's definitive
Proxy Statement dated March 23, 1999 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 12 of the Registrant's definitive
Proxy Statement dated March 23, 1999 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, 3 and 15 of the Registrant's definitive
Proxy Statement dated March 23, 1999 is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None.
42
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, 1998, is
incorporated by reference in this Form 10-K Annual Report as Exhibit
13.
Pages in
1998 Annual
Annual Report Section Report
--------------------- -----------
Five Year Consolidated Financial Highlights 11
Consolidated Balance Sheets --
December 31, 1998 and 1997 29
Consolidated Statements of Income --
Each of the Years in the Three-Year
Period Ended December 31, 1998 30
Consolidated Statements of Comprehensive Income --
Each of the Years in the Three-Year
Period Ended December 31, 1998 30
Consolidated Statement of Stockholders'
Equity -- Each of the Years in the
Three-Year Period Ended December 31, 1998 31
Consolidated Statements of Cash Flows --
Each of the Years in the Three-Year
Period Ended December 31, 1998 32
Notes to Consolidated Financial Statements 33 - 48
Independent Auditors' Report 49
Selected Quarterly Financial Data 50 - 51
Other Financial Data 52
Common Stock Price Information 52
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.
43
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 5* Not applicable
dated July 1, 1997
3 (i) Articles of Incorporation 1* Not applicable
Certificate of Incorporation as amended 7*
on April 28, 1998
(ii) By-laws 6* Not applicable
4 Instruments defining the rights of security 1* Not applicable
holders, including indentures
9 Voting trust agreement Not applicable Not applicable
10.1+ Employment Agreement for Mr. Weise 2* Not applicable
dated June 29, 1994
Extension of Employment Contract 8* Not applicable
10.2+ Employment Agreement for Mr. Gardner 2* Not applicable
dated June 29, 1994
Extension of Employment Contract 8* Not applicable
10.3+ Change in Control Severance Agreement 10.3 Filed electronically
for Mr. McNeil dated April 1, 1998
10.4+ Directors Deferred Compensation Plan 2* Not applicable
10.5+ 1995 Recognition and Retention Plan 3* Not applicable
Amended and Restated HMN Financial, Inc. 9* Not applicable
Recognition and Retention Plan dated
July 29, 1998
10.6+ 1995 Stock Option and Incentive Plan 3* Not applicable
Amended and Restated HMN Financial, Inc. 9* Not applicable
Stock Option and Incentive Plan dated
July 29, 1998
11 Statement re: Computation of per share 11 Filed electronically
earnings
12 Statement re: Computation of ratios Not applicable Not applicable
+Management contract of compensatory arrangement.
44
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
- -------------- ------------------------------------------- --------------- -------------------
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
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 30, 1999
24 Power of Attorney Not applicable Not applicable
27 Financial Data Schedule 27 Filed electronically
Year ended 1998
99 Additional exhibits None Not applicable
- ------------------
1* 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.
2* 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.
3* 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.
4* 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.
5* 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.
6* 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.
7* Filed as an exhibit to the Registrant's Form 10-Q for the first quarter of
1998 (file no. 0-24100). All previously filed documents are hereby
incorporated by reference.
8* Filed as an exhibit to the Registrant's Form 10-Q for the second quarter of
1998 (file no. 0-24100). All previously filed documents are hereby
incorporated by reference.
9* Filed as an exhibit to the Registrant's Form 10-Q for the third quarter of
1998 (file no. 0-24100). All previously filed documents are hereby
incorporated by reference.
45
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 30, 1999 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
Executive Officer (Principal and Director
Executive and Operating Officer) (Principal Financial Officer)
Date: March 30, 1999 Date: March 30, 1999
----------------------------- -----------------------------
By: /s/ Irma R. Rathbun By: /s/ Timothy R. Geisler
----------------------------- -----------------------------
Irma R. Rathbun, Director Timothy R. Geisler, Director
Date: March 30, 1999 Date: March 30, 1999
----------------------------- -----------------------------
By: /s/ M. F. Schumann By: /s/ Duane D. Benson
----------------------------- -----------------------------
M.F. Schumann, Director Duane D. Benson, Director
Date: March 30, 1999 Date: March 30, 1999
----------------------------- -----------------------------
By: /s/ Timothy P. Johnson
-----------------------------
Timothy P. Johnson,
Vice President and Treasurer
(Principal Accounting Officer)
Date: March 30, 1999
-----------------------------
46
INDEX TO EXHIBITS
Sequential
Page Numbering
Where Attached
Exhibits Are
Regulation S-K Located in This
Exhibit Number Document Form 10-K Report
- -------------- --------- -------------------
10.3 Change in Control Severence Agreement for Filed electronically
Michael McNeil dated April 1, 1998
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 30, 1999
27 Financial Data Schedule Filed electronically
Year ended 1998