**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C.  20549**

 

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**FORM 10-Q**

 

**ý****        QUARTERLY REPORTPURSUANT TO SECTION 13 OR 15 (d) OF THE**

**SECURITIES EXCHANGE ACT OF 1934**

 

**For the Quarterly Period ended March 31, 2003**

 

**Commission File Number: 0-19972**

 

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**HF FINANCIAL CORP.**

(Exact name of registrant as specified in its charter.)

 

| **Delaware**                                                    |   | **46-0418532**                          |
|-----------------------------------------------------------------|--------|-----------------------------------------|
| (State or other jurisdiction of  incorporation or organization) |   | (I.R.S. Employer Identification Number) |
|                                                            |   |                                    |
| **225 South Main Avenue,  Sioux Falls, SD**                     |   | **57104**                               |
| (Address of principal executive office)                         |   | (ZIP Code)                              |

 

**(605) 333-7556**

(Registrant’s telephone number, including area code)

 

Indicate bycheck mark whether the registrant (1)  has filed all reportsrequired to be filed  by Section 13 or15  (d) of the Securities Exchange Act of 1934 during the preceding 12 months(or for such shorter period that the registrant was required to file suchreports), and (2) has been subject to such filing requirements for the past 90days.  Yes  ý  No  o

 

Indicate bycheck mark whether the registrant is an accelerated filer (as defined in Rule12b-2 of the Exchange Act).  Yes  o  No  ý

 

Indicate thenumber of shares outstanding of each of the issuer’s classes of common stock,as of the latest practicable date.

 

As of May 14,2003 there were 3,263,082 issued and outstanding shares of the Registrant’sCommon Stock, with $.01 par value.

 

 

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**HF FINANCIAL CORP.**

 

**Form 10-Q**

 

**Table of Contents**

 
| **PART I**  |
|-------------|
|        |   |
| Item 1.     | Financial  Statements (Unaudited): |
|        |   |
|        | Consolidated Statements of Financial  Condition As of March 31, 2003 and June 30, 2002 |
|        |   |
|        | Consolidated Statements of Income for the  Three and Nine Months Ended March 31, 2003 and 2002 |
|        |   |
|        | Consolidated Statements of Cash Flows for  the Nine Months Ended March 31, 2003 and 2002 |
|        |   |
|        | Notes to Consolidated Financial Statements |
|        |   |
| Item 2.     | Management’s Discussion and Analysis of  Financial Condition and Results of Operations |
|        |   |
| Item 3.     | Quantitative and Qualitative Disclosures  about Market Risk |
|        |   |
| Item 4.     | Controls and Procedures |
|        |   |
| **PART II** |
|        |   |
| Item 1.     | Legal Proceedings |
|        |   |
| Item 2.     | Changes in Securities and Use of Proceeds |
|        |   |
| Item 3.     | Defaults upon Senior Securities |
|        |   |
| Item 4.     | Submission of Matters to a Vote of Security  Holders |
|        |   |
| Item 5.     | Other Information |
|        |   |
| Item 6.     | Exhibits and Reports on Form 8-K |
|        |   |
| Form  10-Q  | Signature  Page |
|        |   |
| Form  10-Q  | Certifications |

 

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**HF FINANCIALCORP. AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF FINANCIAL CONDITION**

**(Dollars inThousands)**

 
|                                                                                                                                                  |   | **March 31,  2003** |    | **June 30,  2002** |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------|---------|--------------------|--------|
|                                                                                                                                                  |   | **(Unaudited)**     |    |               |   |
| **ASSETS**                                                                                                                                            |   |                |    |               |   |
| Cash and cash equivalents                                                                                                                             |   | $                   | 35,847  |               | $      | 27,546 |   |
| Securities available for  sale                                                                                                                        |   | 109,653             |    | 89,136             |   |
| Loans and leases receivable                                                                                                                           |   | 573,645             |    | 564,275            |   |
| Loans held for sale                                                                                                                                   |   | 7,788               |    | 6,559              |   |
| Allowance for loan and  lease losses                                                                                                                  |   | (4,376              | )       | (4,461             | )      |
| Net loans and leases  receivable                                                                                                                      |   | 577,057             |    | 566,373            |   |
| Accrued interest receivable                                                                                                                           |   | 4,168               |    | 4,410              |   |
| Office properties and  equipment, net of accumulated depreciation                                                                                     |   | 13,360              |    | 13,714             |   |
| Foreclosed real estate and  other properties                                                                                                          |   | 1,969               |    | 1,672              |   |
| Prepaid expenses and other  assets                                                                                                                    |   | 18,272              |    | 8,505              |   |
| Servicing rights                                                                                                                                      |   | 3,937               |    | 3,467              |   |
| Deferred income taxes                                                                                                                                 |   | 2,378               |    | 2,831              |   |
| Goodwill, net                                                                                                                                         |   | 5,020               |    | 4,604              |   |
| Other intangible assets,  net                                                                                                                         |   | 187                 |    | 659                |   |
| Total assets                                                                                                                                          |   | $                   | 771,848 |               | $      | 722,917 |   |
|                                                                                                                                                  |   |                |    |               |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                        |   |                |    |               |   |
| **LIABILITIES**                                                                                                                                       |   |                |    |               |   |
| Deposits                                                                                                                                              |   | $                   | 594,297 |               | $      | 562,596 |   |
| Advances from Federal Home  Loan Bank and other borrowings                                                                                            |   | 85,659              |    | 84,308             |   |
| Company obligated mandatorily  redeemable preferred securities of subsidiary trusts that solely hold  subordinated debentures                         |   | 20,000              |    | 10,000             |   |
| Advances by borrowers for  taxes and insurance                                                                                                        |   | 10,943              |    | 6,436              |   |
| Accrued interest payable                                                                                                                              |   | 3,880               |    | 3,751              |   |
| Accrued benefit liability                                                                                                                             |   | 1,093               |    | 1,093              |   |
| Other liabilities                                                                                                                                     |   | 5,788               |    | 6,197              |   |
| Total liabilities                                                                                                                                     |   | 721,660             |    | 674,381            |   |
|                                                                                                                                                  |   |                |    |               |   |
| **STOCKHOLDERS’  EQUITY**                                                                                                                        |   |                |    |               |   |
| Preferred stock, $.01 par  value, 500,000 shares authorized, none outstanding                                                                         |   | —              |    | —             |   |
| Series A Junior  Participating Preferred Stock, $1.00 stated value, 50,000 shares authorized,  none outstanding                                       |   | —              |    | —             |   |
| Common stock, $.01 par  value, 10,000,000 shares authorized, 4,924,008 and 4,886,494 shares issued at  March 31, 2003 and June 30, 2002, respectively |   | 49                  |    | 49                 |   |
| Additional paid-in capital                                                                                                                            |   | 16,451              |    | 16,014             |   |
| Retained earnings,  substantially restricted                                                                                                          |   | 57,912              |    | 54,516             |   |
| Deferred compensation                                                                                                                                 |   | (373                | )       | (141               | )      |
| Accumulated other  comprehensive income (loss), net of related deferred tax effect:                                                                   |   |                |    |               |   |
| Unrealized gain (loss) on securities  available for sale                                                                                              |   | (63                 | )       | 498                |   |
| Fair value change in  retained interest                                                                                                               |   | 90                  |    | —             |   |
| Unrecognized pension costs                                                                                                                            |   | (704                | )       | (704               | )      |
| Less cost of treasury  stock, 1,660,346 and 1,559,030 shares at March 31, 2003 and June 30, 2002,  respectively                                       |   | (23,174             | )       | (21,696            | )      |
| Total stockholders’ equity                                                                                                                       |   | 50,188              |    | 48,536             |   |
| Total liabilities and  stockholders’ equity                                                                                                      |   | $                   | 771,848 |               | $      | 722,917 |   |

 

*Seeaccompanying notes to unaudited consolidated financial statements.*

 

1

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**HFFINANCIAL CORP. AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF INCOME**

**(Dollars inThousands, Except Per Share Data)**

**(Unaudited)**

 
|                                                                                                       |   | **Three  Months Ended  March 31,** |   | **Nine  Months Ended  March 31,** |   |
|------------------------------------------------------------------------------------------------------------|--------|------------------------------------|--------|-----------------------------------|--------|
|                                                                                                       |   | **2003**                           |   | **2002**                          |   | **2003** |   | **2002** |   |
|                                                                                                       |   |                               |   |                              |   |   |   |   |   |
| **Continuing  operations:**                                                                                |   |                               |   |                              |   |   |   |   |   |
| Interest and dividend  income:                                                                             |   |                               |   |                              |   |   |   |   |   |
| Loans and leases  receivable                                                                               |   | $                                  | 9,356  |                              | $      | 9,847 |   | $ | 30,154 |   | $ | 32,201 |   |
| Investment securities and  interest-bearing deposits                                                       |   | 1,157                              |   | 1,220                             |   | 3,189 |   | 4,471 |   |
|                                                                                                       |   | 10,513                             |   | 11,067                            |   | 33,343 |   | 36,672 |   |
| Interest expense:                                                                                          |   |                               |   |                              |   |   |   |   |   |
| Deposits                                                                                                   |   | 3,046                              |   | 3,685                             |   | 9,766 |   | 15,049 |   |
| Advances from Federal Home  Loan Bank and other borrowings                                                 |   | 1,334                              |   | 1,185                             |   | 4,122 |   | 3,875 |   |
|                                                                                                       |   | 4,380                              |   | 4,870                             |   | 13,888 |   | 18,924 |   |
| Net interest income                                                                                        |   | 6,133                              |   | 6,197                             |   | 19,455 |   | 17,748 |   |
| Provision for losses on  loans and leases                                                                  |   | 391                                |   | 355                               |   | 1,874 |   | 1,421 |   |
| Net interest income after  provision for losses on loans and leases                                        |   | 5,742                              |   | 5,842                             |   | 17,581 |   | 16,327 |   |
| Noninterest income:                                                                                        |   |                               |   |                              |   |   |   |   |   |
| Fees on deposits                                                                                           |   | 979                                |   | 921                               |   | 3,185 |   | 2,905 |   |
| Loan fees and service  charges                                                                             |   | 472                                |   | 253                               |   | 1,609 |   | 915 |   |
| Gain on sale of loans, net                                                                                 |   | 623                                |   | 422                               |   | 1,300 |   | 1,313 |   |
| Loan servicing income                                                                                      |   | 442                                |   | 377                               |   | 1,210 |   | 1,415 |   |
| Commission and insurance  income                                                                           |   | 233                                |   | 320                               |   | 775 |   | 951 |   |
| Gain on sale of  securities, net                                                                           |   | 1                                  |   | —                            |   | 351 |   | 5 |   |
| Other                                                                                                      |   | 475                                |   | 288                               |   | 1,076 |   | 851 |   |
|                                                                                                       |   | 3,225                              |   | 2,581                             |   | 9,506 |   | 8,355 |   |
| Noninterest expense:                                                                                       |   |                               |   |                              |   |   |   |   |   |
| Compensation and employee  benefits                                                                        |   | 4,123                              |   | 4,333                             |   | 12,616 |   | 12,033 |   |
| Other general and  administrative expenses                                                                 |   | 1,547                              |   | 1,399                             |   | 4,535 |   | 4,044 |   |
| Occupancy and equipment                                                                                    |   | 1,021                              |   | 585                               |   | 2,695 |   | 2,295 |   |
| Federal insurance premiums                                                                                 |   | 23                                 |   | 27                                |   | 70 |   | 82 |   |
| Amortization of intangible  assets                                                                         |   | (7                                 | )      | 125                               |   | 56 |   | 375 |   |
| Other                                                                                                      |   | 53                                 |   | 23                                |   | 243 |   | 172 |   |
|                                                                                                       |   | 6,760                              |   | 6,492                             |   | 20,215 |   | 19,001 |   |
| Income from continuing  operations before income taxes                                                     |   | 2,207                              |   | 1,931                             |   | 6,872 |   | 5,681 |   |
| Income tax expense                                                                                         |   | 691                                |   | 720                               |   | 2,361 |   | 2,170 |   |
| Income from continuing  operations                                                                         |   | 1,516                              |   | 1,211                             |   | 4,511 |   | 3,511 |   |
|                                                                                                       |   |                               |   |                              |   |   |   |   |   |
| **Discontinued  operations:**                                                                              |   |                               |   |                              |   |   |   |   |   |
| Income (loss) from  operations of discontinued segment, net of income taxes of $34, $(53), $133  and $(73) |   | 65                                 |   | (102                              | )      | 258 |   | (142 | ) |
| Income (loss) on  discontinued segment, net of income taxes of $10 and $(116)                              |   | 20                                 |   | —                            |   | (224 | ) | — |   |
| Income (loss) from  discontinued operations                                                                |   | 85                                 |   | (102                              | )      | 34 |   | (142 | ) |
| **Net  Income**                                                                                            |   | $                                  | 1,601  |                              | $      | 1,109 |   | $ | 4,545 |   | $ | 3,369 |   |
| **Comprehensive  income**                                                                                  |   | $                                  | 2,305  |                              | $      | 762 |   | $ | 4,778 |   | $ | 3,302 |   |
| **Cash  dividends paid per share**                                                                         |   | $                                  | 0.115  |                              | $      | 0.110 |   | $ | 0.345 |   | $ | 0.330 |   |
|                                                                                                       |   |                               |   |                              |   |   |   |   |   |
| **Basic  earnings (loss) per share:**                                                                      |   |                               |   |                              |   |   |   |   |   |
| Income from continuing  operations                                                                         |   | $                                  | 0.46   |                              | $      | 0.36 |   | $ | 1.36 |   | $ | 0.98 |   |
| Income (loss) from  discontinued operations                                                                |   | 0.03                               |   | (0.03                             | )      | 0.01 |   | (0.04 | ) |
| Net income                                                                                                 |   | $                                  | 0.49   |                              | $      | 0.33 |   | $ | 1.37 |   | $ | 0.94 |   |
|                                                                                                       |   |                               |   |                              |   |   |   |   |   |
| **Diluted  earnings (loss) per share:**                                                                    |   |                               |   |                              |   |   |   |   |   |
| Income from continuing  operations                                                                         |   | $                                  | 0.45   |                              | $      | 0.36 |   | $ | 1.34 |   | $ | 0.96 |   |
| Income (loss) from  discontinued operations                                                                |   | 0.03                               |   | (0.03                             | )      | 0.01 |   | (0.04 | ) |
| Net income                                                                                                 |   | $                                  | 0.48   |                              | $      | 0.33 |   | $ | 1.35 |   | $ | 0.92 |   |

 

*Seeaccompanying notes to unaudited consolidated financial statements.*

 

2

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**HFFINANCIAL CORP. AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(Dollars inThousands)**

**(Unaudited)**

 
|                                                                                          |   | **Nine  Months Ended March 31,** |   |
|-----------------------------------------------------------------------------------------------|--------|----------------------------------|--------|
|                                                                                          |   | **2003**                         |   | **2002** |   |
| **Cash  flows from operating activities**                                                     |   |                             |   |   |   |
| Net income                                                                                    |   | $                                | 4,545  |   | $ | 3,369 |   |
| Adjustments to reconcile  net income to net cash provided by operating activities:            |   |                             |   |   |   |
| Provision for losses on  loans and leases                                                     |   | 1,874                            |   | 2,493 |   |
| Depreciation                                                                                  |   | 1,238                            |   | 1,237 |   |
| Amortization of premiums  and discounts on securities available for sale, net                 |   | 638                              |   | 59 |   |
| Amortization of intangible  assets                                                            |   | 56                               |   | 375 |   |
| Amortization of servicing  rights                                                             |   | 336                              |   | 254 |   |
| Amortization of debt issue  costs                                                             |   | 14                               |   | — |   |
| Stock based compensation                                                                      |   | 205                              |   | 104 |   |
| Increase (decrease) in  deferred loan fees                                                    |   | 397                              |   | (405 | ) |
| Loans originated for  resale                                                                  |   | (169,140                         | )      | (134,257 | ) |
| Proceeds from the sale of  loans                                                              |   | 170,440                          |   | 133,310 |   |
| (Gain) on sale of loans,  net                                                                 |   | (1,300                           | )      | (1,313 | ) |
| Servicing rights  capitalized                                                                 |   | (416                             | )      | (367 | ) |
| Realized (gain) on sale of  securities, net                                                   |   | (351                             | )      | (5 | ) |
| Losses and provision for  losses on sales of foreclosed real estate and other properties, net |   | 89                               |   | 80 |   |
| Loss on disposal of office  properties and equipment, net                                     |   | 22                               |   | 8 |   |
| Impairment loss on office  properties and equipment, net                                      |   | 200                              |   | — |   |
| Decrease in accrued  interest receivable                                                      |   | 242                              |   | 915 |   |
| (Increase) in prepaid  expenses and other assets                                              |   | (9,481                           | )      | (255 | ) |
| Deferred income taxes  (credits)                                                              |   | 887                              |   | (1 | ) |
| (Decrease) in accrued  interest payable and other liabilities                                 |   | (280                             | )      | (4,797 | ) |
| Net cash provided by  operating activities                                                    |   | 215                              |   | 804 |   |
|                                                                                          |   |                             |   |   |   |
| **Cash  flows from investing activities**                                                     |   |                             |   |   |   |
| Loans and leases purchased                                                                    |   | (635                             | )      | (25,127 | ) |
| Loans and leases  originated and held                                                         |   | (126,421                         | )      | (167,166 | ) |
| Principal collected on  loans and leases                                                      |   | 113,048                          |   | 224,096 |   |
| Securities available for  sale:                                                               |   |                             |   |   |   |
| Sales and maturities and  calls                                                               |   | 20,277                           |   | 47,341 |   |
| Purchases                                                                                     |   | (61,711                          | )      | (70,570 | ) |
| Repayments                                                                                    |   | 19,725                           |   | 14,970 |   |
| Proceeds from sale of  office properties and equipment                                        |   | 10                               |   | 5 |   |
| Purchase of office  properties and equipment                                                  |   | (1,116                           | )      | (1,214 | ) |
| Purchase of servicing  rights                                                                 |   | (390                             | )      | (463 | ) |
| Proceeds from sale of  foreclosed real estate and other properties, net                       |   | 667                              |   | 1,031 |   |
| Net cash provided by (used  in) investing activities                                          |   | (36,546                          | )      | 22,903 |   |
|                                                                                               |        |                                  |        |  |  |  |  |

 

*Seeaccompanying notes to unaudited consolidated financial statements.*

 

3

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**HFFINANCIAL CORP. AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS (CONTINUED)**

**(Dollars inThousands)**

**(Unaudited)**

 
|                                                                    |   | **Nine  Months Ended March 31,** |   |
|-------------------------------------------------------------------------|--------|----------------------------------|--------|
|                                                                    |   | **2003**                         |   | **2002** |   |
|                                                                    |   |                             |   |   |   |
| **Cash  flows from financing activities**                               |   |                             |   |   |   |
| Net increase (decrease) in  deposit accounts                            |   | $                                | 31,701 |   | $ | (63,701 | ) |
| Proceeds of advances from  Federal Home Loan  Bank and other borrowings |   | 473,250                          |   | 11,400 |   |
| Payments on advances from  Federal Home Loan  Bank and other borrowings |   | (471,899                         | )      | (45,089 | ) |
| Proceeds from issuance of  preferred securities of subsidiary trust     |   | 10,000                           |   | 10,000 |   |
| Payment of debt issue  costs                                            |   | (300                             | )      | — |   |
| Increase in advances by  borrowers for taxes and insurance              |   | 4,507                            |   | 2,159 |   |
| Purchase of treasury stock                                              |   | (1,478                           | )      | (5,043 | ) |
| Proceeds from issuance of  common stock                                 |   | —                           |   | 63 |   |
| Cash dividends paid                                                     |   | (1,149                           | )      | (1,182 | ) |
| Net cash provided by (used  in) financing activities                    |   | 44,632                           |   | (91,393 | ) |
|                                                                    |   |                             |   |   |   |
| Increase (decrease) in  cash and cash equivalents                       |   | 8,301                            |   | (67,686 | ) |
|                                                                    |   |                             |   |   |   |
| Cash and cash equivalents                                               |   |                             |   |   |   |
| Beginning                                                               |   | 27,546                           |   | 84,913 |   |
| Ending                                                                  |   | $                                | 35,847 |   | $ | 17,227 |   |
|                                                                    |   |                             |   |   |   |
| Supplemental Disclosures  of Cash Flows Information                     |   |                             |   |   |   |
| Cash payments for interest                                              |   | $                                | 13,793 |   | $ | 22,755 |   |
| Cash payments for income  and franchise taxes, net                      |   | 2,378                            |   | 2,256 |   |
|                                                                    |   |                             |   |   |   |
| Supplemental Schedule of  Noncash Investing and Financing Activities    |   |                             |   |   |   |
| Loans receivable reclassified  as held for sale                         |   | $                                | 51,085 |   | $ | — |   |
| Core deposit intangibles  reclassifed as goodwill                       |   | 416                              |   | — |   |

 

4

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**HF FINANCIAL CORP. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

For The Three and Nine Months Ended March 31, 2003 and 2002

(Unaudited)

 

**NOTE1.          SELECTED ACCOUNTING POLICIES**

 

*Basis of presentation:*

 

The consolidated financial information of HF Financial Corp. (the“Company”) and its wholly-owned subsidiaries included in this Form 10-Q is unaudited.  However, in the opinion of management,adjustments (consisting of normal recurring adjustments) necessary for a fairpresentation for the interim periods have been included.  Results for any interim period are notnecessarily indicative of results to be expected for the year.  The accounting and reporting policies of theCompany and its subsidiaries conform to accounting principles generallyaccepted in the United States of America (“GAAP”) and to general practicewithin the industry.

 

The interim consolidated financial statements include the accounts ofthe Company, its wholly-owned subsidiaries, HomeFirst Mortgage Corp. (the“Mortgage Corp.”), HF Card Services, LLC (“HF Card”), HF Financial Group, Inc.,HF Financial Capital Trust I (“Trust I”), HF Financial Capital Trust II (“TrustII”), HF Financial Capital Trust III (“Trust III”), Home Federal Bank (the“Bank”) and the Bank’s wholly-owned subsidiaries, Hometown Insurors, Inc.(“Hometown”), Mid America Capital Services, Inc. (“Mid America Leasing”), HomeFederal Securitization Corp. (“HFSC”), Mid-America Service Corporation and PMD,Inc.  The Bank formed HFSC on January28, 2003.  See Note 6.  The Company dissolved HF Card on February28, 2003.  See Note 2.

 

While the credit card loan portfolio resided in the Bank’s loanportfolio, the results of operations and discontinuance of the credit cardoperations are reported in the financial statements of HF Card and included inthe consolidated financial statements of the Company.

 

Stock-based compensation:  The Company accounts for stock-basedcompensation in accordance with Accounting Principals Board (“APB”) Opinion No.25, *Accounting for Stock Issued toEmployees,*and related interpretations.  Accordingly, no stock-based employee compensation cost has beenrecognized for grants under the fixed stock option plans, as all optionsgranted under those plans had an exercise price equal to the market value ofthe underlying common stock on the date of grant.  These stock-based compensation plans are described more fully inthe Company’s June 30, 2002 Form 10-K Notes to Consolidated FinancialStatements under Note 17. Stock-Based Compensation Plans.

 

The following table illustrates the effect on net income and earningsper share had compensation cost for all stock-based compensation plans beendetermined based on the grant date fair value of awards (the method describedin Financial Accounting Standards Board (“FASB”) Statement No. 123, *Accounting for Stock-Based Compensation)*:

 
|                                |   | **Three  Months Ended March 31,** |   | **Nine Months  Ended March 31,** |   |
|-------------------------------------|--------|-----------------------------------|--------|----------------------------------|--------|
|                                |   | **2003**                          |   | **2002**                         |   | **2003** |   | **2002** |   |
| Income from continuing  operations: |   |                              |   |                             |   |   |   |   |   |
| As reported                         |   | $                                 | 1,516  |                             | $      | 1,211 |   | $ | 4,511 |   | $ | 3,511 |   |
| Pro forma                           |   | 1,482                             |   | 1,177                            |   | 4,409 |   | 3,408 |   |
|                                |   |                              |   |                             |   |   |   |   |   |
| Basic earnings per share:           |   |                              |   |                             |   |   |   |   |   |
| As reported                         |   | 0.46                              |   | 0.36                             |   | 1.36 |   | 0.98 |   |
| Pro forma                           |   | 0.45                              |   | 0.35                             |   | 1.33 |   | 0.96 |   |
|                                |   |                              |   |                             |   |   |   |   |   |
| Diluted earnings per share:         |   |                              |   |                             |   |   |   |   |   |
| As reported                         |   | 0.45                              |   | 0.36                             |   | 1.34 |   | 0.96 |   |
| Pro forma                           |   | 0.44                              |   | 0.35                             |   | 1.31 |   | 0.93 |   |
|                                     |        |                                   |        |                                  |        |  |  |  |  |  |  |  |  |

 

5

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**NOTE2.          DISCONTINUED OPERATIONS ANDSALE**

 

During the fourth quarter of fiscal 2002, management committed to aplan to sell the subprime credit card operations which were previously reportedin the credit card segment of the Company. At June 30, 2002, the Company estimated the net realizable value basedon estimates from a third party and reclassified the net realizable value of$1.1 million at that time from loans receivable to loans held for sale.  The Bank ceased processing subprime creditcard applications in March 1999 and has been managing the portfolio from abalance of $18.1 million at June 30, 1999, to the sale of the receivables as ofJanuary 31, 2003.  On December 31, 2002,the Company, through the Bank, entered into an agreement to sell thediscontinued credit card operations to an independent third party.  The Company recorded income ondiscontinuance of segment (net of income taxes) of $20,000 for the three monthsended March 31, 2003 and a loss on discontinuance of segment (net of incometaxes) for the nine months ended March 31, 2003 of $224,000.  The sale of the receivables took place onJanuary 31, 2003, and the Company dissolved the operations of HF Card duringthe third quarter of fiscal 2003.

 

**NOTE3.          REGULATORY CAPITAL**

 

The following table sets forththe Bank’s compliance with its capital requirements at March 31, 2003:

 
|                   |   | **Amount**                 |   | **Percent** |   |
|------------------------|--------|----------------------------|--------|-------------|--------|
|                   |   | **(Dollars in Thousands)** |   |
| Tier I (core) capital: |   |                       |   |        |   |
| Required               |   | $                          | 30,538 |        | 4.00   | % |
| Actual                 |   | 61,221                     |   | 8.02        |   |
| Excess                 |   | 30,683                     |   | 4.02        |   |
|                   |   |                       |   |        |   |
| Risk-based capital:    |   |                       |   |        |   |
| Required               |   | $                          | 48,538 |        | 8.00   | % |
| Actual                 |   | 61,085                     |   | 10.07       |   |
| Excess                 |   | 12,547                     |   | 2.07        |   |

 

**NOTE4.          EARNINGS PER SHARE**

 

Basic earnings per share is computed by dividing income available tocommon stockholders (the numerator) by the weighted-average number of commonshares outstanding  (the denominator)during the period.  Shares issued duringthe period and shares reacquired during the period are weighted for the portionof the period that they were outstanding. The weighted average number of commonshares outstanding for the three month period ended March 31, 2003 and 2002 was3,290,634 and 3,325,629, respectively. The weighted average number of common shares outstanding for the ninemonth period ended March 31, 2003 and 2002 was 3,319,292 and 3,568,424,respectively.

 

Dilutive earnings per share is similar to the computation of basicearnings per share except that the denominator is increased to include thenumber of additional common shares that would have been outstanding if the dilutiveoptions outstanding had been exercised. The weighted average number of commonand dilutive potential common shares outstanding for the three month periodended March 31, 2003 and 2002 was 3,366,226 and 3,396,927, respectively.  The weighted average number of common anddilutive potential common shares

 

6

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outstanding for the nine monthperiod ended March 31, 2003 and 2002 was 3,367,678 and 3,646,849, respectively.

 

**NOTE5.          LONG-LIVED ASSET IMPAIRMENT**

 

In April 2003, the Company became aware of a significant change inmarket value of an office building it vacated after ceasing operations of abanking center during the prior fiscal year. The tax assessment, representing a correlation to market value, decreasedsignificantly.  As a result, animpairment loss of $200,000 was recorded during the quarter ended March 31,2003.  The amount is included underoccupancy and equipment expense and is based upon the Company’s best estimateof fair value for which the building can be sold in the present market.  As of April 1, 2003, the Companyreclassified the building as real estate held for sale and will be proceedingto sell the facility.

 

**NOTE 6.          FORMATIONOF HF SECURITIZATION CORP. AND CONSUMER LOAN SECURITIZATION**

 

On January 28, 2003, the Bank formed a newwholly-owned subsidiary, Home Federal Securitization Corp. (“HFSC”),incorporated under the laws of the State of Delaware.

 

On January 31, 2003, the Bank securitized andsold motor vehicle installment loans with principal balances totaling $50.0million for a gain of $308,000 through HFSC and a newly formed trust, HomeFederal Automobile Securitization Trust 2003-A (“Automobile SecuritizationTrust”).  As part of the salestransaction, the Bank retains servicing responsibilities.  In addition, the Bank retains the rights tocash flows remaining after investors in the Automobile Securitization Trusthave received their contractual payments and has pledged a $1.3 million reservefund to the Automobile Securitization Trust. These retained interests are subordinated to investors’ interests.  The investors and Automobile SecuritizationTrust have no recourse to the Bank’s other assets for failure of debtors to paywhen due.

 

The gain recognized on the sale of these loans is determined byallocating the carrying amount of the loans between the loans sold and theinterests retained.  It was initiallydisclosed that no amount had been allocated to the servicing rights.  Subsequently during the quarter, the Bankreviewed the adequate compensation for similar automobile servicing and diddetermine 50 basis points of the 100 basis points servicing contractrepresented was excess servicing and was capitalized as part of the transactionutilizing a market discount rate of 10.0%. This asset is amortized in proportion to, and over the period of,estimated net servicing income.  Thetransaction does not have any recourse provisions back to the Bank.

 

The retained interest asset is initially recorded as an asset at fairvalue.  Fair value for this transactionis based estimating future cash flows paid to the Bank from the AutomobileSecuritization Trust sometimes called the “cash-out” method.  The cash flows are modeled to reflectcertain assumptions for prepayment speeds, discount rates and chargeoff ratesas well as cash reserve balances reflecting the required creditenhancements.  The retained interest wascharacterized as an available for sale asset with changes in fair value beingrecorded as other comprehensive income in the equity section of the balancesheet.  Due to the utilization of thisaccounting method, the Bank recorded other comprehensive income of $143,000 onthe transaction.

 

The value of the retained interest asset will fluctuate over the lifeof the securitization to reflect income recorded on the amortized balance ofthe retained interest, cash received from the trust and changes in initialassumptions.  The amortized balance iscomprised of the initial

 

7

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allocated retained interestplus the interest accrued on the outstanding amortized balance less excess cashpayments received from the Automobile Securitization Trust  and less any recognized impairment on thesecuritization asset.  The incomerecorded on the retained interest asset is classified as noninterest income andnot interest income, which is consistent with the Office of Thrift Supervision(“OTS”) guidelines.

 

Impairment usually occurs whenever the current fair value of theretained interest is lower than its current amortized cost.  If this occurs a test must take place to seeif an impairment charge for the deficiency is required to be taken throughcurrent earnings.  If there has been anadverse change in estimated cash flows considering both the timing and amountof flows, the retained interest must be written down to fair value, whichbecomes the new amortized cost basis for future amortization.  Key economic assumptions used in measuringthe fair value of retained interests at the date of the securitizationresulting from securitizations completed during the current year were asfollows:

 
|                                     |   | **Automobile  Loans** |   |
|------------------------------------------|--------|-----------------------|--------|
|                                     |   |                  |   |
| Prepayment speed (ABS  annual rate)      |   | 18.00                 | %(1)   |
| Weighted-average life (in  years)        |   | 3.58                  |   |
| Expected credit losses  (annual rate)    |   | 1.25                  | %      |
| Discount rate for the  retained interest |   | 15.00                 | %      |
| Discount rate for loan  servicing rights |   | 10.00                 | %      |

 

----

(1) 18.00% ABS is the equivalent to 20.21% CPR and 721.61 PSA.

 

**NOTE 7.****                              NEWACCOUNTING STANDARDS**

 

In July 2001, the FASB issued Statement No. 142,  *Goodwilland Other Intangible Assets,* which requires that goodwill no longerbe amortized to earnings, but instead be reviewed for impairment.  The provisions of FASB Statement No. 142were implemented by the Company in the first quarter of fiscal 2003.  At March 31, 2003 the Company had $5.0million of goodwill that is not being amortized.

 

In October 2002, the FASB issued Statement No. 147, *Acquisitions of Certain Financial Institutions,*which provides guidance on the accounting for the acquisition of a financialinstitution.  The provisions of FASBStatement No. 147 reflect the conclusion that the excess of the fair value ofliabilities assumed over the fair value of tangible and identifiable intangibleassets acquired in a business combination represents goodwill that should beaccounted for under FASB Statement No. 142. Thus, the specialized accounting guidance in paragraph 5 of FASBStatement No. 72 does not apply after September 30, 2002 for those acquisitionsthat meet the definition of a business combination.  The Company adopted FASB Statement No. 147, effective October 1,2002, and accordingly reclassified FASB Statement No. 72 unidentifiableintangible assets to goodwill and no longer amortizes these assets after October1, 2002.  The adoption of FASB StatementNo. 147 did not have a material impact on the financial position or results ofoperations of the Company.

 

8

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The Company has completed the first step of its impairment testing todetermine if goodwill is impaired. Management is not aware of any events that would materially impairgoodwill at March 31, 2003.  The impactof FASB Statement No. 142 on the Company’s net income for the three and ninemonths ended March 31, 2003 and March 31, 2002 is as follows:

 
|                                          |   | **Three Months Ended  March 31,** |   | **Nine Months Ended  March 31,** |   |
|-----------------------------------------------|--------|-----------------------------------|--------|----------------------------------|--------|
|                                          |   | **2003**                          |   | **2002**                         |   | **2003** |   | **2002** |   |
|                                          |   |                              |   |                             |   |   |   |   |   |
| Reported net income                           |   | $                                 | 1,601  |                             | $      | 1,109 |   | $ | 4,545 |   | $ | 3,369 |   |
| Addback: goodwill  amortization, net of taxes |   | —                            |   | 70                               |   | — |   | 210 |   |
| Adjusted net income                           |   | $                                 | 1,601  |                             | $      | 1,179 |   | $ | 4,545 |   | $ | 3,579 |   |
|                                          |   |                              |   |                             |   |   |   |   |   |
| Basic earnings per share:                     |   |                              |   |                             |   |   |   |   |   |
| Reported net income                           |   | $                                 | 0.49   |                             | $      | 0.33 |   | $ | 1.37 |   | $ | 0.94 |   |
| Goodwill amortization, net  of taxes          |   | —                            |   | 0.02                             |   | — |   | 0.06 |   |
| Adjusted net income                           |   | $                                 | 0.49   |                             | $      | 0.35 |   | $ | 1.37 |   | $ | 1.00 |   |
|                                          |   |                              |   |                             |   |   |   |   |   |
| Diluted earnings per share:                   |   |                              |   |                             |   |   |   |   |   |
| Reported net income                           |   | $                                 | 0.48   |                             | $      | 0.33 |   | $ | 1.35 |   | $ | 0.92 |   |
| Goodwill amortization, net  of taxes          |   | —                            |   | 0.02                             |   | — |   | 0.06 |   |
| Adjusted net income                           |   | $                                 | 0.48   |                             | $      | 0.35 |   | $ | 1.35 |   | $ | 0.98 |   |

 

 

**ITEM 2****.  MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL**

**CONDITION AND RESULTSOF OPERATIONS**

 

**General**

 

The Company is a financial services provider and, as such, has inherentrisks that must be managed in order to achieve net income.  Primary risks that affect net income includecredit risk, liquidity risk, operational risk, regulatory compliance risk andreputation risk.  The Company’s netincome is derived by management of the net interest margin, the ability tocollect fees from services provided, by controlling the costs of deliveringservices and the management of loan and lease losses.  The primary source of revenues comes from the net interestmargin, which represents the difference between income on interest-earningassets (i.e. loans and investment securities) and expense on interest-bearingliabilities (i.e. deposits and borrowed funding).  The net interest margin is affected by regulatory, economic andcompetitive factors that influence interest rates, loan demand and depositflows.  Fees earned include charges fordeposit services, trust services and loan services.  Personnel costs are the primary expenses required to deliver theservices to customers.  Other costsinclude occupancy and equipment and general and administrative expenses.

 

During the fourth quarter of fiscal 2002, management committed to aplan to sell the subprime credit card operations which were previously reportedin the credit card segment of the Company. At June 30, 2002, the Company estimated the net realizable value basedon estimates from a third party and reclassified the net realizable value of$1.1 million at that time from loans receivable to loans held for sale.  The Bank ceased processing subprime creditcard applications in March 1999 and has been managing the portfolio from abalance of $18.1 million at June 30, 1999, to the sale of the receivables as ofJanuary 31, 2003.  On December 31, 2002,the Company, through the Bank, entered into an agreement to sell thediscontinued credit card operations to an independent third party.  The Company recorded income ondiscontinuance of segment (net of income taxes) of $20,000 for the three monthsended March 31, 2003 and a

 

9

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loss on discontinuance ofsegment (net of income taxes) for the nine months ended March 31, 2003 of$224,000.  The sale of the receivablestook place on January 31, 2003, and the Company dissolved the operations of HFCard during the third quarter of fiscal 2003.

 

**Forward-LookingStatements**

 

This Form 10-Q and other reports issued by the Company, includingreports filed with the Securities and Exchange Commission, contain“forward-looking statements” that deal with future results, expectations, plansand performance.  In addition, theCompany’s management may make forward-looking statements orally to the media,securities analysts, investors or others. These forward-looking statements might include one or more of thefollowing:

 

•                  Projectionsof income, loss, revenues, earnings or losses per share, dividends, capitalexpenditures, capital structure, tax benefit or other financial items.

•                  Descriptionsof plans or objectives of management for future operations, products orservices and transactions.

•                  Forecastsof future economic performance.

•                  Descriptionsof assumptions underlying or relating to such matters.

 

Forward-looking statements can be identified by the fact that they donot relate strictly to historical or current facts.  They often include words such as “optimism”, “look-forward”,“bright”, “believe”, “expect”, “anticipate”, “intend”, “plan”, “estimate” orwords of similar meaning, or future or conditional verbs such as “will”,“would”, “should”, “could” or “may.”

 

Forward-looking statements about theCompany’s expected financial results and other plans are subject to certainrisks, uncertainties and assumptions. These include, but are not limited to, possible legislative changes andadverse economic, business and competitive developments, such as shrinkinginterest margins; deposit outflows; reduced demand for financial services andloan products; changes in accounting policies or guidelines, or in monetary andfiscal policies of the federal government; changes in credit and other risksposed by the Company’s loan portfolios; the ability or inability to successfullyenter into a definitive agreement for and close anticipated transactions;technological, computer-related or operational difficulties; adverse changes insecurities markets; results of litigation; or other significant uncertainties.

 

Forward-looking statements speak only as ofthe date they are made.  The Companydoes not undertake to update forward-looking statements to reflectcircumstances or events that occur after the date the forward-lookingstatements are made.

 

**FinancialCondition Data**

 

At March 31, 2003, the Company had totalassets of $771.8 million, an increase of $48.9 million from the level at June30, 2002.  The increase in assets wasdue primarily to increases in securities available for sale of $20.5million,  prepaid expenses and otherassets of $9.8 million, net loans and leases receivable of $10.7 million andcash and cash equivalents of $8.3 million. The increase in liabilities of $47.3 million was due to increases indeposits of $31.7 million, the liability for company obligated mandatorilyredeemable preferred securities of $10.0 million and advances by borrowers fortaxes and insurance of $4.5 million from the levels at June 30, 2002.  In addition, stockholders’ equity increasedto $50.2 million at March 31, 2003 from $48.5 million at June 30, 2002primarily due to net income of $4.5 million offset by the cost of treasurystock acquired of $1.5 million and cash dividends paid of $1.1 million.

 

The increase in securities available for saleof $20.5 million was primarily the result of purchases of $61.7 millionexceeding sales, maturities, calls and repayments of $40.0 million.  The

 

10

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purchases consisted of $40.2 million in variable-rate mortgage-backedsecurities.  Variable-rate mortgage-backedsecurities comprise 60.3% of the Company’s securities available for saleportfolio.  Included in the securitiespurchases was $4.0 million of trust preferred securities for a total of $9.0million investment in trust preferred securities at March  31, 2003. This investment is limited by OTS regulation to 15.0% of equity of theBank.  Management is utilizing thepurchase of trust preferred securities to mitigate the Company’s interest raterisk from the total issuance of $20.0 million in company obligated mandatorilyredeemable preferred securities through March 31, 2003.

 

The increase in prepaid expenses and otherassets of $9.8 million was in part due to $3.4 million retained interest as theresult of securitization of automobile loans during the quarter ended March 31,2003.  See Note 6.  In addition, the Bank’s bank owned lifeinsurance (“BOLI”) increased $5.0 million as compared to the prior fiscal year.

 

The increase in net loans and leasesreceivable of $10.7 million was due primarily to an increase in purchases andoriginations over sales, amortization and repayments of principal.  Commercial business, commercial real estateand agricultural loan balances increased $28.8 million over the levels at June30, 2002.  Residential mortgage productionincreased 26.8% for the nine months ended March 31, 2003 as compared to thesame period in the prior fiscal year.

 

The increase in cash and cash equivalents of$8.3 million was primarily due to increased liquidity.  See “Liquidity.”

 

The $31.7 million increase in deposits wasprimarily due to increases in out-of-market certificates of deposit of $30.5million, demand accounts of $15.9 million, in-market certificates of depositsof $1.0 million offset by decreases in savings accounts of $13.8 million andmoney market accounts of $1.9 million.

 

The liability for company obligatedmandatorily redeemable preferred securities increased $10.0 million due to theCompany issuing additional trust preferred securities through Trust II andTrust III.  The proceeds from theissuance are primarily utilized for injection of Tier 1 (core) capital into theBank and to provide liquidity for repurchasing Company stock.

 

The $4.5 million increase in advances byborrowers for taxes and insurance was due primarily to the receipt of escrowpayments in excess of amounts paid out. The major escrow payments are primarily paid semiannually in April andOctober.

 

11

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The following tables show the composition ofthe Company’s loan and lease portfolio and deposits from continuing operationsat the dates indicated.  Balancesrelated to discontinued credit card loan operations have been eliminated forall periods presented.

 
|                               |   | **At March 31, 2003**       |    | **At June 30, 2002**                    |   |
|------------------------------------|--------|-----------------------------|---------|-----------------------------------------|--------|
|                               |   | **Amount**                  |    | **Percent of  Loans in  Each Category** |   | **Amount** |   | **Percent of  Loans in  Each Category** |   |
|                               |   | **(Dollars  in Thousands)** |    |
|                               |   |                        |    |                                    |   |   |   |   |   |
| One- to four-family (1)            |   | $                           | 80,538  |                                    | 14.04  | % | $ | 81,118 |   | 14.38 | % |
| Commercial real estate             |   | 97,111                      |    | 16.93                                   | %      | 88,897 |   | 15.75 | % |
| Multi-family real estate           |   | 58,766                      |    | 10.24                                   | %      | 56,677 |   | 10.05 | % |
| Commercial business                |   | 106,336                     |    | 18.54                                   | %      | 95,447 |   | 16.91 | % |
| Equipment finance leases           |   | 22,713                      |    | 3.96                                    | %      | 22,834 |   | 4.05 | % |
| Consumer                           |   | 157,392                     |    | 27.44                                   | %      | 177,527 |   | 31.46 | % |
| Agricultural                       |   | 49,130                      |    | 8.56                                    | %      | 39,401 |   | 6.98 | % |
| Mobile homes                       |   | 1,659                       |    | 0.29                                    | %      | 2,374 |   | 0.42 | % |
| Total Loans and Leases  Receivable |   | $                           | 573,645 |                                    | 100.00 | % | $ | 564,275 |   | 100.00 | % |

 

----

(1) Excludes $7,788 and $5,444 loans held for sale at March 31, 2003 andJune 30, 2002, respectively.

 

 
|                                   |   | **At March 31, 2003**       |    | **At June 30, 2002**                       |   |
|----------------------------------------|--------|-----------------------------|---------|--------------------------------------------|--------|
|                                   |   | **Amount**                  |    | **Percent of  Deposits in  Each Category** |   | **Amount** |   | **Percent of  Deposits in  Each Category** |   |
|                                   |   | **(Dollars  in Thousands)** |    |
|                                   |   |                        |    |                                       |   |   |   |   |   |
| Noninterest bearing  checking accounts |   | $                           | 75,568  |                                       | 12.71  | % | $ | 61,355 |   | 10.91 | % |
| Interest bearing accounts              |   | 43,369                      |    | 7.30                                       | %      | 41,669 |   | 7.41 | % |
| Money market accounts                  |   | 155,912                     |    | 26.23                                      | %      | 157,770 |   | 28.04 | % |
| Savings accounts                       |   | 36,590                      |    | 6.16                                       | %      | 50,387 |   | 8.95 | % |
| Certificates of deposit                |   | 282,858                     |    | 47.60                                      | %      | 251,415 |   | 44.69 | % |
| Total Deposits                         |   | $                           | 594,297 |                                       | 100.00 | % | $ | 562,596 |   | 100.00 | % |

 

**Analysis of Net Interest Income**

 

Net interest income represents the differencebetween income on interest-earning assets and expense on interest-bearingliabilities.  Net interest incomedepends upon the volume of interest-earning assets and interest-bearingliabilities and the interest rates earned or paid on them.

 

*Average Balances, Interest Rates and Yields.*  The following table presents for the periodsindicated, the total dollar amount of interest income from averageinterest-earning assets and the resulting yields, as well as the interestexpense on average interest-bearing liabilities, expressed both in dollars andrates, and the net interest margin.  Thetable does not reflect any effect of income taxes.  All average balances are monthly average balances and include the

 

12

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balances of nonaccruing loans. The yields and costs for the three and nine months ended March 31, 2003and 2002 include fees which are considered adjustments to yield.  Balances related to discontinued credit cardloan operations have been reclassified to non-interest earning assets for allperiods presented.

 

 
|                                           |   | **THREE MONTHS ENDED MARCH 31,**  |    |
|------------------------------------------------|--------|-----------------------------------|---------|
|                                           |   | **2003**                          |    | **2002** |   |
|                                           |   | **Average  Outstanding  Balance** |    | **Interest  Earned/  Paid** |   | **Yield/  Rate** |   | **Average  Outstanding  Balance** |   | **Interest  Earned/  Paid** |   | **Yield/  Rate** |   |
|                                           |   |                              |    |   |   |   |   |   |   |   |   |   |   |
| Interest-earning assets:                       |   |                              |    |   |   |   |   |   |   |   |   |   |   |
| Loans and leases receivable  (1)               |   | $                                 | 584,888 |   | $ | 9,356 |   | 6.49 | % | $ | 535,492 |   | $ | 9,847 |   | 7.46 | % |
| Investment securities (2)  (3)                 |   | 128,330                           |    | 1,088 |   | 3.44 | % | 107,878 |   | 1,173 |   | 4.41 | % |
| FHLB stock                                     |   | 7,025                             |    | 69 |   | 3.98 | % | 6,332 |   | 47 |   | 3.01 | % |
|                                           |   |                              |    |   |   |   |   |   |   |   |   |   |   |
| Total interest-earning  assets                 |   | $                                 | 720,243 |   | $ | 10,513 |   | 5.92 | % | $ | 649,702 |   | $ | 11,067 |   | 6.91 | % |
| Noninterest-earning assets                     |   | 57,553                            |    |   |   |   |   | 50,987 |   |   |   |   |   |
| Total assets                                   |   | $                                 | 777,796 |   |   |   |   |   | $ | 700,689 |   |   |   |   |   |
|                                           |   |                              |    |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing  liabilities:                 |   |                              |    |   |   |   |   |   |   |   |   |   |   |
| Deposits:                                      |   |                              |    |   |   |   |   |   |   |   |   |   |   |
| Checking and money market                      |   | $                                 | 199,230 |   | $ | 633 |   | 1.29 | % | $ | 207,760 |   | $ | 774 |   | 1.51 | % |
| Savings                                        |   | 45,618                            |    | 79 |   | 0.70 | % | 39,599 |   | 99 |   | 1.01 | % |
| Certificates of deposit                        |   | 293,115                           |    | 2,334 |   | 3.23 | % | 253,205 |   | 2,812 |   | 4.50 | % |
| Total deposits                                 |   | $                                 | 537,963 |   | $ | 3,046 |   | 2.30 | % | $ | 500,564 |   | $ | 3,685 |   | 2.99 | % |
| FHLB advances and other  borrowings            |   | 107,702                           |    | 1,334 |   | 5.02 | % | 80,607 |   | 1,185 |   | 5.96 | % |
|                                           |   |                              |    |   |   |   |   |   |   |   |   |   |   |
| Total interest-bearing  liabilities            |   | $                                 | 645,665 |   | $ | 4,380 |   | 2.76 | % | $ | 581,171 |   | $ | 4,870 |   | 3.40 | % |
| Noninterest-bearing  deposits (4)              |   | 61,944                            |    |   |   |   |   | 48,175 |   |   |   |   |   |
| Other liabilities                              |   | 20,189                            |    |   |   |   |   | 21,313 |   |   |   |   |   |
| Total liabilities                              |   | $                                 | 727,798 |   |   |   |   |   | $ | 650,659 |   |   |   |   |   |
| Equity                                         |   | 49,998                            |    |   |   |   |   | 50,030 |   |   |   |   |   |
| Total liabilities and  equity                  |   | $                                 | 777,796 |   |   |   |   |   | $ | 700,689 |   |   |   |   |   |
|                                           |   |                              |    |   |   |   |   |   |   |   |   |   |   |
| Net interest income;  interest rate spread (5) |   |                              |    | $ | 6,133 |   | 3.16 | % |   |   | $ | 6,197 |   | 3.51 | % |
|                                           |   |                              |    |   |   |   |   |   |   |   |   |   |   |
| Net interest margin (5) (6)                    |   |                              |    |   |   | 3.45 | % |   |   |   |   | 3.87 | % |

 

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(1)          Includes interest on accruing loans and leases past due 90 days or more.

(2)          Includes primarily U.S. Government and agency securities and FHLB dailytime.

(3)          Yields do not reflect the tax exempt nature of municipal securities.

(4)          Previously reported in interest-bearing liabilities under checking andmoney market.  Rates have been restatedfor all periods presented to reflect change in classification.

(5)          Percentages for the three months ended March 31, 2003 and March 31, 2002have been annualized. (6) Net interest margin is net interest income divided by averageinterest-earning assets.

 

13

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|                                           |   | **NINE MONTHS  ENDED MARCH 31,**  |    |
|------------------------------------------------|--------|-----------------------------------|---------|
|                                           |   | **2003**                          |    | **2002** |   |
|                                           |   | **Average  Outstanding  Balance** |    | **Interest  Earned/  Paid** |   | **Yield/  Rate** |   | **Average  Outstanding  Balance** |   | **Interest  Earned/  Paid** |   | **Yield/  Rate** |   |
|                                           |   | **(Dollars in  Thousands)**       |    |
| Interest-earning assets:                       |   |                              |    |   |   |   |   |   |   |   |   |   |   |
| Loans and leases receivable  (1)               |   | $                                 | 592,443 |   | $ | 30,154 |   | 6.78 | % | $ | 541,843 |   | $ | 32,201 |   | 7.92 | % |
| Investment securities (2)  (3)                 |   | 105,100                           |    | 3,021 |   | 3.83 | % | 129,879 |   | 4,296 |   | 4.41 | % |
| FHLB stock                                     |   | 6,797                             |    | 168 |   | 3.29 | % | 6,332 |   | 175 |   | 3.68 | % |
|                                           |   |                              |    |   |   |   |   |   |   |   |   |   |   |
| Total interest-earning  assets                 |   | $                                 | 704,340 |   | $ | 33,343 |   | 6.31 | % | $ | 678,054 |   | $ | 36,672 |   | 7.20 | % |
| Noninterest-earning assets                     |   | 53,619                            |    |   |   |   |   | 51,885 |   |   |   |   |   |
| Total assets                                   |   | $                                 | 757,959 |   |   |   |   |   | $ | 729,939 |   |   |   |   |   |
|                                           |   |                              |    |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing  liabilities:                 |   |                              |    |   |   |   |   |   |   |   |   |   |   |
| Deposits:                                      |   |                              |    |   |   |   |   |   |   |   |   |   |   |
| Checking and money market                      |   | $                                 | 193,484 |   | $ | 2,045 |   | 1.41 | % | $ | 186,833 |   | $ | 3,106 |   | 2.21 | % |
| Savings                                        |   | 40,141                            |    | 241 |   | 0.80 | % | 38,864 |   | 468 |   | 1.60 | % |
| Certificates of deposit                        |   | 280,873                           |    | 7,480 |   | 3.55 | % | 290,342 |   | 11,475 |   | 5.26 | % |
| Total deposits                                 |   | $                                 | 514,498 |   | $ | 9,766 |   | 2.53 | % | $ | 516,039 |   | $ | 15,049 |   | 3.88 | % |
| FHLB advances and other  borrowings            |   | 116,516                           |    | 4,122 |   | 4.71 | % | 90,606 |   | 3,875 |   | 5.70 | % |
|                                           |   |                              |    |   |   |   |   |   |   |   |   |   |   |
| Total interest-bearing  liabilities            |   | $                                 | 631,014 |   | $ | 13,888 |   | 2.93 | % | $ | 606,645 |   | $ | 18,924 |   | 4.16 | % |
| Noninterest-bearing  deposits (4)              |   | 57,804                            |    |   |   |   |   | 48,487 |   |   |   |   |   |
| Other liabilities                              |   | 19,538                            |    |   |   |   |   | 22,287 |   |   |   |   |   |
| Total liabilities                              |   | $                                 | 708,356 |   |   |   |   |   | $ | 677,419 |   |   |   |   |   |
| Equity                                         |   | 49,603                            |    |   |   |   |   | 52,520 |   |   |   |   |   |
|                                           |   |                              |    |   |   |   |   |   |   |   |   |   |   |
| Total liabilities and  equity                  |   | $                                 | 757,959 |   |   |   |   |   | $ | 729,939 |   |   |   |   |   |
|                                           |   |                              |    |   |   |   |   |   |   |   |   |   |   |
| Net interest income;  interest rate spread (5) |   |                              |    | $ | 19,455 |   | 3.38 | % |   |   | $ | 17,748 |   | 3.04 | % |
|                                           |   |                              |    |   |   |   |   |   |   |   |   |   |   |
| Net interest margin (5) (6)                    |   |                              |    |   |   | 3.68 | % |   |   |   |   | 3.49 | % |

 

----

(1)          Includes interest on accruing loans and leases past due 90 days or more.

(2)          Includes primarily U.S. Government and agency securities and FHLB dailytime.

(3)          Yields do not reflect the tax exempt nature of municipal securities.

(4)          Previously reported in interest-bearing liabilities under checking andmoney market.  Rates have been restatedfor all periods         presented to reflect change inclassification.

(5)          Percentages for the nine months ended March 31, 2003 and March 31, 2002have been annualized. (6) Net interest margin is net interest income divided by averageinterest-earning assets.

 

14

----

 

**Rate/Volume Analysis of Net Interest Income**

 

The following schedule presents the dollaramount of changes in interest income and interest expense for major componentsof interest-earning assets and interest-bearing liabilities.  It distinguishes between the increases anddecreases due to fluctuating outstanding balances that are due to the levelsand volatility of interest rates.  Foreach category of interest-earning assets and interest-bearing liabilities,information is provided on changes attributable to (i) changes in volume (i.e.,changes in volume multiplied by old rate) and (ii) changes in rate (i.e.,changes in rate multiplied by old volume). For purposes of this table, changes attributable to both rate andvolume, which cannot be segregated, have been allocated proportionately to thechange due to volume and the change due to rate.

 

 
|                                |   | **Three Months Ended March 31,**         |   | **Nine Months Ended March 31,**        |   |
|-------------------------------------|--------|------------------------------------------|--------|----------------------------------------|--------|
|                                |   | **2003 vs 2002**                         |   | **2003 vs 2002**                       |   |
|                                |   | **Increase  (Decrease)  Due to  Volume** |   | **Increase  (Decrease)  Due to  Rate** |   | **Total  Increase  (Decrease)** |   | **Increase  (Decrease)  Due to  Volume** |   | **(Decrease)  Due to  Rate** |   | **Total  Increase  (Decrease)** |   |
|                                |   | **(Dollars in Thousands)**               |   |
| Interest-earning assets:            |   |                                     |   |                                   |   |   |   |   |   |   |   |   |   |
| Loans and leases receivable  (1)    |   | $                                        | 908    |                                   | $      | (1,399 | ) | $ | (491 | ) | $ | 3,007 |   | $ | (5,054 | ) | $ | (2,047 | ) |
| Other investment securities  (2)    |   | 222                                      |   | (307                                   | )      | (85 | ) | (820 | ) | (455 | ) | (1,275 | ) |
| FHLB stock                          |   | 6                                        |   | 16                                     |   | 22 |   | 13 |   | (20 | ) | (7 | ) |
|                                |   |                                     |   |                                   |   |   |   |   |   |   |   |   |   |
| Total interest-earning  assets      |   | $                                        | 1,136  |                                   | $      | (1,690 | ) | $ | (554 | ) | $ | 2,200 |   | $ | (5,529 | ) | $ | (3,329 | ) |
|                                |   |                                     |   |                                   |   |   |   |   |   |   |   |   |   |
| Interest-bearing  liabilities:      |   |                                     |   |                                   |   |   |   |   |   |   |   |   |   |
| Deposits:                           |   |                                     |   |                                   |   |   |   |   |   |   |   |   |   |
| Checking and money market           |   | $                                        | (32    | )                                      | $      | (109 | ) | $ | (141 | ) | $ | 111 |   | $ | (1,172 | ) | $ | (1,061 | ) |
| Savings                             |   | 15                                       |   | (35                                    | )      | (20 | ) | 15 |   | (242 | ) | (227 | ) |
| Certificates of deposit             |   | 443                                      |   | (921                                   | )      | (478 | ) | (374 | ) | (3,621 | ) | (3,995 | ) |
| Total deposits                      |   | 426                                      |   | (1,065                                 | )      | (639 | ) | (248 | ) | (5,035 | ) | (5,283 | ) |
| FHLB advances and other  borrowings |   | 398                                      |   | (249                                   | )      | 149 |   | 1,108 |   | (861 | ) | 247 |   |
|                                |   |                                     |   |                                   |   |   |   |   |   |   |   |   |   |
| Total interest-bearing  liabilities |   | $                                        | 824    |                                   | $      | (1,314 | ) | $ | (490 | ) | $ | 860 |   | $ | (5,896 | ) | $ | (5,036 | ) |
|                                |   |                                     |   |                                   |   |   |   |   |   |   |   |   |   |
| Net interest income                 |   |                                     |   |                                   |   | $ | (64 | ) |   |   |   |   | $ | 1,707 |   |

 

----

(1)          Includes interest on accruing loans and leases past due 90 days or more.

(2)          Includes primarily U. S. Government and agency securities and FHLB dailytime.

 

15

----

 

**Applicationof Critical Accounting Policies**

** **

GAAP requiresmanagement to utilize estimates when reporting financial results.  The Company has identified the policiesdiscussed below as Critical Accounting Policies because the accountingestimates require management to make certain assumptions about matters that maybe uncertain at the time the estimate was made and a different method ofestimating could have been reasonably made that could have a material impact onthe presentation of the Company’s financial condition, changes in financialcondition or results of operations.

 

Allowance forLoan and Lease Losses – GAAP requires the Company to set aside reserves ormaintain an allowance against inherent loan and lease losses in the loan andlease portfolio.  Management mustdevelop a consistent and systematic approach to estimate the appropriatebalances that will cover the inherent losses. Due to the uncertainty of future events, the approach includes a processthat may differ significantly from other methodologies and still produce anestimate that is in accordance with GAAP.

 

The allowanceis compiled by utilizing the Company’s loan risk rating system which isstructured to identify weaknesses in the loan portfolio.  The risk rating system has evolved to aprocess whereby management believes the system will properly identify thecredit risk associated with the loan portfolio.  Due to the segmenting of loans for the allowance calculation, theestimate of the allowance for loan and lease losses could change materially ifthe loan risk rating system would not properly identify the strength of a largeor a few large loan customers.  Althoughmanagement believes that it uses the best information available to determinethe allowance, unforeseen market or borrower conditions could result inadjustments and net earnings being significantly affected if circumstancesdiffer substantially from the assumptions used in making the finaldeterminations.

 

MortgageServicing Rights (“MSR”) – The Company records a servicing asset forcontractually separated servicing from the underlying mortgage loans.   The asset is initially recorded at fairvalue and represents an intangible asset backed by an income stream from theserviced assets.  The asset is amortizedin proportion to and over the period of estimated net servicing income.

 

At each balance sheet date, the MSRs need to be analyzed for impairmentwhich occurs when the fair value of the MSRs is lower than the amortized bookvalue. The Company’s MSRs are primarily servicing rights acquired on SouthDakota Housing Development Authority first time home buyers program.  Due to the lack of quoted markets for theCompany’s portfolio, the Company estimates the fair value of the MSRs usingpresent value of future cash flow analysis. If the analysis produces a fair value that is greater than or equal tothe amortized book value of the MSRs, no impairment is recognized.  If the fair value is less than the bookvalue, an expense for the difference is charged to earnings by initiating a MSRvaluation account.  If the Companydetermines this impairment is temporary, any future changes  in fair value are recorded as a change inearnings and the valuation.  If theCompany determines the impairment to be permanent, the valuation is written offagainst the MSRs which results in a new amortized balance.

 

Due to the substantial decline in interest rates over the last severalquarters, the Company has included MSRs as a critical accounting policy becausethe use of estimates for determining fair value using present value conceptsmay produce results which may significantly differ from other fair valueanalysis perhaps even to the point of recording impairment.  The risk to earnings is when the underlyingmortgages payoff significantly faster than the previously recorded amortization.  Estimating future cash flows on theunderlying mortgages is a difficult analysis and requires judgment based on thebest information available.  The Companylooks at many

 

18

----

 

reasonableand supportable assumptions and projections in preparing the analysis.  Based on the Company’s analysis of MSRs atquarter-end, there is no impairment to the MSRs.

 

Retained Interest from Securitization – The Company recorded an assetas a result of the automobile securitization. See Note 7.  This asset isrecorded based on present value concepts of future expected cash flows.  The assumptions used to calculate theinitial retained interest value and subsequent assumptions are based the bestinformation available.  The value of theretained interest may change significantly if actual cash flows differ fromexpected cash flows.

** **

**Asset Quality**

** **

When a borrower fails to make a required payment on real estate securedloans within 10 to 15 days after the payment is due, the Bank generallyinstitutes collection procedures by issuing a late notice.  The customer is contacted again when thepayment is 30 days past due.  In thecase of consumer loans, the borrower is sent a notice when a loan is 10 dayspast due and is contacted by telephone when a loan is 30 days past due.  In most cases, delinquencies are curedpromptly; however, if a loan has been delinquent for more than 30 days, theBank attempts additional written as well as verbal contacts and, if necessary,personal contact with the borrower in order to determine the reason for thedelinquency and to effect a cure, and, where appropriate, reviews the conditionof the property and the financial circumstances of the borrower.  Based upon the results of any such investigation,the Bank may: (i) accept a repayment program which under appropriatecircumstances could involve an extension in the case of consumer loans for thearrearage from the borrower, (ii) seek evidence, in the form of a listingcontract, of efforts by the borrower to sell the property if the borrower hasstated that he is attempting to sell, or (iii) initiate foreclosureproceedings. When a loan payment is delinquent for 90 days, the Bank generallywill initiate foreclosure proceedings unless management is satisfied the creditproblem is correctable.

 

Loans aregenerally classified as nonaccrual when there are reasonable doubts as to thecollectibility of principal and/or interest and/or when payment becomes 90 dayspast due, except loans which are well secured and in the process of collection.  Interest collections on nonaccrual loans,for which the ultimate collectibility of principal is uncertain, are applied asprincipal reductions.

 

Nonperformingassets (nonaccrual loans and leases, accruing loans and leases delinquent morethan 90 days and foreclosed assets) decreased to $8.7 million at March 31, 2003from $11.5 million at June 30, 2002, a decrease of $2.8 million, or 24.2%.  In addition, the ratio of nonperformingassets to total assets, which is one indicator of credit risk exposure, decreasedto 1.13% at March 31, 2003 as compared to 1.59% at June 30, 2002.

 

Nonaccruingloans and leases decreased 31.4% or $3.2 million to $7.0 million at March 31,2003 compared to $10.2 million at June 30, 2002.  Included in nonaccruing loans and leases at March 31, 2003 wereseven loans totaling $409,000 secured by one- to four-family real estate, fourloans totaling $317,000 secured by commercial real estate, four mobile homeloans totaling $43,000, fourteen commercial business loans totaling $398,000, tenagricultural loans totaling $4.9 million, fourteen equipment finance leasestotaling $78,000 and forty-six consumer loans totaling $876,000.  One loan, secured by commercial real estate,in the amount of $2.4 million included in nonaccrual loan balances at June 30,2002 was paid in full during the first quarter of fiscal 2003.  Offsetting the commercial real estate loanpayoff was one large agricultural real estate nonaccrual loan in the amount of$2.4 million during the first quarter of fiscal 2003.  This agricultural loan has been modified as a troubled debtrestructuring with specific allowance reserve allocation and will be closelymonitored for performance.

 

19

----

 

The Company’snonperforming loans and leases, which represent nonaccrual and past due 90 daysand still accruing, have decreased $3.1 million or 27.7% from the levels atJune 30, 2002.  The risk rating systemin place is designed to identify and manage the nonperforming loans andleases.  Commercial and agriculturalloans will have specific impairment valuation if the loans are deemedimpaired.  The valuation is based oncollateral values or based on the present value of expected cash flows.  Loans and leases that are not performing donot necessarily result in a loss.

 

As of March31, 2003, the Company had $671,000 of foreclosed assets.  The balance of foreclosed assets at March31, 2003 consisted of $92,000 in consumer collateral (excluding mobile homeloans) and $579,000 in single-family residences.

 

At March 31,2003, the Company had (from continuingoperations, including certain loans discussed in this Form 10-Q) criticized$9.1 million of its assets as special mention and classified $16.1 million ofits assets that management has determined need to be closely monitoredbecause of possible credit problems of the borrowers or the cash flows of thesecured properties.  These loans andleases were considered in determining the adequacy of the allowance for loanand lease losses.  The allowance for  loan and lease losses is established basedon management's evaluation of the risks inherent in the loan portfolio andchanges in the nature and volume of loan activity.  Such evaluation, which includes a review of all loans and leasesfor which full collectability may not be reasonably assured, considers theestimated fair market value of the underlying collateral, present value ofexpected principal and interest payments, economic conditions, historical lossexperience and other factors that warrant recognition in providing for anadequate loan and lease loss allowance.

 

Although theCompany's management believes that the March 31, 2003 recorded allowance forloan and lease losses was adequate to provide for inherent losses on therelated loans and leases, there can be no assurance that the allowance existingat March 31, 2003 will be adequate in the future.

 

20

----

 

In accordancewith the Company’s internal classification of assets policy, managementevaluates the loan and lease portfolio on a monthly basis to identify losspotential and determines the adequacy of the allowance for loan and leaselosses quarterly.  Loans are placed onnonaccrual status when the collection of principal and/or interest become doubtful.  Foreclosed assets include assets acquired onsettlement of loans.  The followingtable sets forth the amounts and categories of the Company’s nonperformingassets from continuing operations for the periods indicated.  Balances related to discontinued credit cardloan operations have been eliminated for all periods presented.

 
|                                                                   |   | **Nonperforming Assets As Of** |   |
|------------------------------------------------------------------------|--------|--------------------------------|--------|
|                                                                   |   | **March 31,  2003**            |   | **June 30,  2002** |   |
|                                                                   |   | **(Dollars in Thousands)**     |   |
| Nonaccruing  loans and leases:                                         |   |                           |   |   |   |
| One-  to four-family                                                   |   | $                              | 409    |   | $ | 886 |   |
| Commercial  real estate                                                |   | 317                            |   | 3,678 |   |
| Multi-family                                                           |   | —                         |   | 290 |   |
| Commercial  business                                                   |   | 398                            |   | 1,872 |   |
| Equipment  finance leases                                              |   | 78                             |   | — |   |
| Consumer                                                               |   | 876                            |   | 690 |   |
| Agriculture                                                            |   | 4,906                          |   | 2,801 |   |
| Mobile  homes                                                          |   | 43                             |   | 25 |   |
| Total                                                                  |   | 7,027                          |   | 10,242 |   |
|                                                                   |   |                           |   |   |   |
| Accruing  loans and leases delinquent more than 90 days:               |   |                           |   |   |   |
| One-  to four-family                                                   |   | 150                            |   | — |   |
| Commercial  real estate                                                |   | 66                             |   | — |   |
| Commercial  business                                                   |   | 494                            |   | 512 |   |
| Equipment  finance leases                                              |   | 315                            |   | 229 |   |
| Consumer                                                               |   | 5                              |   | — |   |
| Agriculture                                                            |   | —                         |   | 165 |   |
| Total                                                                  |   | 1,030                          |   | 906 |   |
|                                                                   |   |                           |   |   |   |
| Foreclosed  assets: (1)                                                |   |                           |   |   |   |
| One-  to four-family                                                   |   | 579                            |   | 239 |   |
| Consumer                                                               |   | 92                             |   | 132 |   |
| Mobile  homes                                                          |   | —                         |   | 3 |   |
| Total                                                                  |   | 671                            |   | 374 |   |
|                                                                   |   |                           |   |   |   |
| Total  nonperforming assets                                            |   | $                              | 8,728  |   | $ | 11,522 |   |
|                                                                   |   |                           |   |   |   |
| Ratio  of nonperforming assets to total assets                         |   | 1.13                           | %      | 1.59 | % |
|                                                                   |   |                           |   |   |   |
| Ratio  of nonperforming loans and leases to total loans and leases (2) |   | 1.39                           | %      | 1.96 | % |

 

----

(1) Total foreclosed assets do not includeland held for sale.

(2) Nonperformingloans and leases include both nonaccruing and accruing loans and leasesdelinquent more than 90 days.

 

21

----

 

The followingtable sets forth information with respect to activity in the Company’sallowance for loan and lease losses from continuing operations during theperiods indicated.  Balances related todiscontinued credit card loan operations have been eliminated for all periodspresented.

 
|                                                                                                     |   | **Nine Months Ended March 31,** |   |
|----------------------------------------------------------------------------------------------------------|--------|---------------------------------|--------|
|                                                                                                     |   | **2003**                        |   | **2002** |   |
|                                                                                                     |   | **(Dollars in Thousands)**      |   |
|                                                                                                     |   |                            |   |   |   |
| Balance  at beginning of period                                                                          |   | $                               | 4,461  |   | $ | 5,509 |   |
| Charge-offs:                                                                                             |   |                            |   |   |   |
| One-  to four-family                                                                                     |   | (9                              | )      | (38 | ) |
| Commercial  real estate                                                                                  |   | —                          |   | (50 | ) |
| Commercial  business                                                                                     |   | (1,078                          | )      | (486 | ) |
| Equipment  finance leases                                                                                |   | (69                             | )      | (41 | ) |
| Consumer                                                                                                 |   | (893                            | )      | (980 | ) |
| Agriculture                                                                                              |   | —                          |   | (58 | ) |
| Mobile  homes                                                                                            |   | (34                             | )      | (50 | ) |
| Total  charge-offs                                                                                       |   | (2,083                          | )      | (1,703 | ) |
|                                                                                                     |   |                            |   |   |   |
| Recoveries:                                                                                              |   |                            |   |   |   |
| One-  to four-family                                                                                     |   | 3                               |   | 2 |   |
| Commercial  real estate                                                                                  |   | —                          |   | 2 |   |
| Commercial  business                                                                                     |   | 4                               |   | 37 |   |
| Equipment  finance leases                                                                                |   | 33                              |   | 44 |   |
| Consumer                                                                                                 |   | 244                             |   | 233 |   |
| Agriculture                                                                                              |   | 100                             |   | 28 |   |
| Mobile  homes                                                                                            |   | 4                               |   | 8 |   |
| Total  recoveries                                                                                        |   | 388                             |   | 354 |   |
|                                                                                                     |   |                            |   |   |   |
| Net  (charge-offs)                                                                                       |   | (1,695                          | )      | (1,349 | ) |
|                                                                                                     |   |                            |   |   |   |
| Additions  charged to operations                                                                         |   | 1,874                           |   | 1,421 |   |
| Allowance  related to assets sold, net                                                                   |   | (264                            | )      | — |   |
|                                                                                                     |   |                            |   |   |   |
| Balance  at end of period                                                                                |   | $                               | 4,376  |   | $ | 5,581 |   |
|                                                                                                     |   |                            |   |   |   |
| Ratio  of net (charge-offs) during the period to average loans and leases  outstanding during the period |   | (0.29                           | )%     | (0.25 | )% |
|                                                                                                     |   |                            |   |   |   |
| Ratio  of allowance for loan and lease losses to total loans and leases at end of  period                |   | 0.76                            | %      | 1.02 | % |
|                                                                                                     |   |                            |   |   |   |
| Ratio  of allowance for loan and lease losses to nonperforming loans and leases at  end of period (1)    |   | 54.31                           | %      | 58.65 | % |

 

----

(1) Nonperformingloans and leases include both nonaccruing and accruing loans and leasesdelinquent more than 90 days.

 

22

----

 

Thedistribution of the Company’s allowance for loan and lease losses and impairedloss summary at the dates indicated are summarized in the followingtables.  The combination of FASB 5 andFASB 114 calculations comprise the Company’s allowance for loan and leaselosses.  Balances related todiscontinued credit card loan operations have been eliminated for all periodspresented.

 
|                      |   | **FASB 5  Allowance  for loan and  lease losses** |   | **FASB 114  Impaired Loan  Valuation  Allowance** |   | **FASB 5  Allowance  for loan and  lease losses** |   | **FASB 114  Impaired Loan  Valuation  Allowance** |   |
|---------------------------|--------|---------------------------------------------------|--------|---------------------------------------------------|--------|---------------------------------------------------|--------|---------------------------------------------------|--------|
| **Loan Type**             |   | **At March 31, 2003**                             |   | **At June 30, 2002**                              |   |
|                      |   | **(Dollars in Thousands)**                        |   |
|                      |   |                                              |   |                                              |   |                                              |   |                                              |   |
| One-  to four-family      |   | $                                                 | 34     |                                              | $      | —                                            |   | $                                                 | 81     |   | $ | — |   |
| Commercial  real estate   |   | 135                                               |   | —                                            |   | 490                                               |   | —                                            |   |
| Multi-family  real estate |   | 120                                               |   | —                                            |   | 116                                               |   | —                                            |   |
| Commercial  business      |   | 537                                               |   | 211                                               |   | 481                                               |   | 683                                               |   |
| Equipment  finance leases |   | 301                                               |   | —                                            |   | 296                                               |   | —                                            |   |
| Consumer                  |   | 1,539                                             |   | —                                            |   | 1,889                                             |   | —                                            |   |
| Agricultural              |   | 131                                               |   | 1,331                                             |   | 78                                                |   | 297                                               |   |
| Mobile  homes             |   | 37                                                |   | —                                            |   | 50                                                |   | —                                            |   |
|                      |   |                                              |   |                                              |   |                                              |   |                                              |   |
| Total                     |   | $                                                 | 2,834  |                                              | $      | 1,542                                             |   | $                                                 | 3,481  |   | $ | 980 |   |

** **

**FASB 114 Impaired Loan Summary**

** **
|                     |   | **Number  of Loan  Customers** |   | **Loan  Balance** |   | **Impaired Loan  Valuation  Allowance** |   |
|--------------------------|--------|--------------------------------|--------|-------------------|--------|-----------------------------------------|--------|
| **Loan Type**            |   | **At March 31, 2003**          |   |
|                     |   | **(Dollars in Thousands)**     |   |
|                     |   |                           |   |              |   |                                    |   |
| Commercial  real estate  |   | 1                              |   | $                 | 30     |                                    | $      | — |   |
| Commercial  business     |   | 5                              |   | 288               |   | 211                                     |   |
| Agriculture  real estate |   | 1                              |   | 2,416             |   | 528                                     |   |
| Other  agriculture loans |   | 1                              |   | 2,204             |   | 803                                     |   |
|                     |   |                           |   |              |   |                                    |   |
| Total                    |   | 8                              |   | $                 | 4,938  |                                    | $      | 1,542 |   |

 

23

----

 

**FASB 114 ImpairedLoan Summary**

 

|                     |   | **Number  of Loan  Customers** |   | **Loan  Balance** |   | **Impaired Loan  Valuation  Allowance** |   |
|--------------------------|--------|--------------------------------|--------|-------------------|--------|-----------------------------------------|--------|
| **Loan Type**            |   | **At June 30, 2002**           |   |
|                     |   | **(Dollars in Thousands)**     |   |
|                     |   |                           |   |              |   |                                    |   |
| Commercial  business     |   | 5                              |   | $                 | 1,597  |                                    | $      | 683 |   |
| Other  agriculture loans |   | 2                              |   | 2,380             |   | 297                                     |   |
|                     |   |                           |   |              |   |                                    |   |
| Total                    |   | 7                              |   | $                 | 3,977  |                                    | $      | 980 |   |

 

The allowancefor loan and lease losses was $4.4 million at March 31, 2003 as compared to$5.6 million at March 31, 2002.  Theratio of the allowance for loan and lease losses to total loans and leases was0.76% at March 31, 2003 compared to 1.02% at March 31, 2002, a decrease of25.5%.  The Company’s management hasconsidered nonperforming assets and other assets of concern in establishing theallowance for loan and lease losses. The Company continues to monitor its allowance for possible loan andlease losses and make future additions or reductions in light of the level ofloans in its portfolio and as economic conditions dictate.  The current level of the allowance for loanand lease losses is a result of management's assessment of the risks within theportfolio based on the information revealed in credit reporting processes. TheCompany utilizes a risk-rating system on all commercial business, agricultural,construction and multi-family and commercial real estate loans, includingpurchased loans.  A periodic creditreview is performed on all types of loans to establish the necessary reservebased on the estimated risk within the portfolio. This assessment of risk takesinto account the composition of the loan portfolio, historical loss experiencefor each loan category, previous loan experience, concentrations of credit,current economic conditions and other factors that in management’s judgmentdeserve recognition. Regulators have reviewed the Bank's methodology fordetermining allowance requirements on the Bank’s loan portfolio and have madeno required recommendations for increases in the allowances during the ninemonths ended March 31, 2003.

 

Real estate properties acquired through foreclosure arerecorded at the lower of cost or fair value (less a deduction for dispositioncosts).  Valuations are periodicallyupdated by management and a specific provision for losses on such properties isestablished by a charge to operations if the carrying values of the propertiesexceed their estimated net realizable values.

 

Although management believes that it uses the best informationavailable to determine the allowances, unforeseen market conditions couldresult in adjustments and net earnings being significantly affected ifcircumstances differ substantially from the assumptions used in making thefinal determinations.  Future additionsto the Bank's allowances result from periodic loan, property and collateralreviews and thus cannot be predicted in advance.

 

24

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**Comparison of the Three Months Ended March31, 2003 and March 31, 2002**

** **

**Continued Operations:**

 

*General*.  The Company's net income from continuingoperations was $1.5 million or $0.46 and $0.45 for basic and diluted earningsper share, respectively, for the three months ended March 31, 2003, a 25.2%increase in earnings compared to $1.2 million or $0.36 for both basic anddiluted earnings per share for the same period in the prior fiscal year.  Basic and diluted earnings per share fromcontinuing operations increased 27.8% and 25.0%, respectively, for the threemonths ended March 31, 2003 as compared to the same period in the prior fiscalyear, due to the increase in earnings and decrease in shares outstanding as aresult of Company stock repurchases. For the three months ended March 31, 2003, the return on average equityfrom continuing operations was 12.13%, a 25.3% increase compared to 9.68% forthe same period in the prior fiscal year. For the three months ended March 31, 2003, the return on average assetsfrom continuing operations was 0.78%, a 13.0% increase compared to 0.69% forthe same period in the prior fiscal year. As discussed in more detail below, the increases were due to a varietyof key factors, including an increase in noninterest income of $644,000 and adecrease in income tax expense of $29,000 offset by a decrease in net interestincome of $64,000 and increases in provision for losses on loans and leases of$36,000 and noninterest expense of $268,000.

 

*Interest and Dividend Income.*  Interest and dividend income was $10.5million for the three months ended March 31, 2003 as compared to $11.1 millionfor the same period in the prior fiscal year, a decrease of $554,000 or 5.0%.  A $1.7 million decrease in interest anddividend income was the result of a 14.3% decrease in the average yield oninterest-earning assets.  The averageyield on interest-earning assets was 5.92% for the three months ended March 31,2003 as compared to 6.91% for the same period in the prior fiscal year.  For the three months ended March 31, 2003,the average yield on loans and leases receivable was 6.49%, a decrease of 13.0%from 7.46% for the same period in the prior fiscal year.  The overall decrease in interest and dividendincome was primarily due to repricing of loans and investments that generallyreflected the decline in national interest rates.  From June 30, 2001 to March 31, 2003, the prime rate dropped from6.75% to 4.25%.  Average volumeincreases of $70.5 million in interest-earning assets contributed to a $1.1million increase in interest and dividend income for the three months endedMarch 31, 2003 as compared to the same period in the prior fiscal year.  The securitization transaction results in aretained interest component which is recorded into income over the life of thesecuritization.  Due to OTS guidelines,the income is recorded as other noninterest income and not interestincome.  The will result in lowerreported net interest margins and higher noninterest income as compared toprior periods when the loans produced interest income.

 

*Interest Expense.*  Interest expense was $4.4 million for thethree months ended March 31, 2003 as compared to $4.9 million for the sameperiod in the prior fiscal year, a decrease of $490,000 or 10.1%.  A $1.3 million decrease in interest expensewas the result of a 18.8% decrease in the average rate paid on interest-bearingliabilities.  The average rate oninterest-bearing liabilities was 2.76% for the three months ended March 31,2003 as compared to 3.40% for the same period in the prior fiscal year.  For the three months ended March 31, 2003,the average rate paid on interest-bearing deposits was 2.30%, a decrease of23.1% from 2.99% for the same period in the prior fiscal year.  Average volume increase of $39.6 million incertificates of deposit contributed to a $443,000 increase in interest expensefor the three months ended March 31, 2003 as compared to the same period in theprior fiscal year.  Average volumeincrease of $27.1 million in advances from Federal Home Loan Bank (“FHLB”) andother borrowings contributed to a $398,000 increase in interest expense for thethree months ended March 31, 2003 as compared to the same period in the priorfiscal year.

 

25

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*Net Interest Income.*The Company's net interest income from continuing operations for the threemonths ended March 31, 2003 decreased $64,000, or 1.0%, to $6.1 millioncompared to $6.2 million for the same period in the prior fiscal year.  The decrease is due primarily to decliningnational interest rates.  The Company’snet interest margin was 3.45% for the three months ended March 31, 2003, anincrease of 10.9% from 3.87% for the same period in the prior fiscal year.

 

*Provision for Losses on Loans.*The allowance for loan and leaselosses is maintained at a level which is considered by management to beadequate to absorb inherent losses on existing loans and leases that may becomeuncollectible, based on an evaluation of the collectability of loans and priorloan loss experience.  The evaluationtakes into consideration such factors as changes in the nature and volume ofthe loan portfolio, overall portfolio quality, review of specific problemloans, and current economic conditions that may affect the borrower's abilityto pay.  The allowance for loan andlease losses is established through a provision for losses on loans and leasescharged to expense.

 

During thethree months ended March 31, 2003, the Company recorded a provision for losseson loans and leases of $391,000 compared to $355,000 for the three months endedMarch 31, 2002, an increase of $36,000. See "Asset Quality" for further discussion.

 

*Noninterest Income.*  Noninterest income was $3.2 million for thethree months ended March 31, 2003 as compared to $2.6 million for the threemonths ended March 31, 2002, an increase of $644,000  or 25.0%.  The increase innoninterest income was due primarily to increases in loan fees and servicecharges of $219,000, net gain on sale of loans of $201,000 and othernoninterest income of $187,000 offset by a decrease in commission and insuranceincome of $87,000.

 

Loan fees andservice charges increased 86.6% to $472,000 for the three months ended March31, 2003 as compared to $253,000 for same period in the prior fiscal year.  The increase was primarily due to anincrease in residential mortgage loan production of 48.4% in dollar volume ascompared to the same period one year ago. In a periodic review of fees received and costs to originate loans,management reduced the loan origination fee deferral amount during the firstquarter of fiscal 2003, thus increasing immediate loan origination feeincome.  This change in estimate, whichis accounted for prospectively, resulted in an increase of approximately$181,000 over the same period in the prior year.

 

Net gain onsale of loans increased 47.6% to $623,000 for the three months ended March 31,2003 as  compared to $422,000 for thesame period in the prior fiscal year primarily due to a gain on thesecuritization of automobile loans in the amount of $308,000.   See Note 6.

 

Othernoninterest income increased 64.9% to $475,000 for the three months ended March31, 2003 as compared to $288,000 for the same period in the prior fiscal yearprimarily due to income in the amount of $94,000 recorded on the retainedinterest obtained through the securitization of automobile loans during thethird quarter of fiscal 2003.  See Note6.  In addition, the Bank recorded anincrease of $55,000 in other noninterest income for bank owned life insurance(“BOLI”) as compared to the same period in the prior fiscal year.

 

Commission andinsurance income was $233,000 for the three months ended March 31, 2003, a  decrease of 27.2% from $320,000 for the sameperiod in the prior fiscal year. Hometown’s personal and commercial insurance lines are down compared tothe prior year primarily due to less emphasis on the property and casualty lineof business.

 

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*Noninterest Expense.*  Noninterest expense was $6.8 million for thethree months ended March 31, 2003 as compared to $6.5 million for the threemonths ended March 31, 2002, an increase of $268,000 or 4.1%.  The increase in noninterest expense was dueprimarily to increases in occupancy and equipment of $436,000 and other generaland administrative expenses of $148,000 offset by decreases in compensation andemployee benefits of $210,000 and amortization of intangible assets of$132,000.

 

Occupancy andequipment increased 74.5% to $1.0 million for the three months ended March 21,2003 as compared to $585,000 for the same period in the prior fiscal year.  The increase was primarily due to anincrease in furniture and fixture expense of $365,000 , including a valuationimpairment of $200,000 recorded in the third quarter of fiscal 2003 as a resultof a significant change in the market value of property that the Company nolonger uses in its banking operations. See Note 5.

 

Other generaland administrative expenses increased 10.6% to $1.5 million for the threemonths ended March 31, 2003 as compared to $1.4 million for the same period inthe prior fiscal year primarily due to a $134,000 increase in consultingexpenses.

 

Compensationand employee benefits decreased 4.8% to $4.1 million for the three months endedMarch 31, 2003 as compared to $4.3 million for the same period in the priorfiscal year in part due to decreased health insurance claim accruals of $84,000and a reduction of $59,000 in compensation for deferred loan originationcosts.  The Company self insures itshealth costs for employees and the Company records expenses based on claimsreceived for payment offset by withholding from employees for their portion ofthe costs.  This structure will causeexpenses for health care to be variable from quarter to quarter depending onvolume of claims received.

 

Amortizationof intangible assets decreased 105.6% or $132,000 for the three months endedMarch 31, 2003 compared to the same period in the prior fiscal year due tocessation of amortization on goodwill. See Note 7.

 

*Income tax expense.*  The Company's income tax expense for thethree months ended March 31, 2003 decreased $29,000 or 4.0% to $691,000compared to $720,000 for the three months ended March 31, 2002.  The decrease was primarily due to areduction in the Company’s effective tax rate due to changes in permanent taxdifferences.   The effective tax ratewas 31.3% and 37.3% for the three months ended March 31, 2003 and March 31,2002, respectively.

 

**DiscontinuedOperations:**

** **

*Income (loss)  from discontinued operations. *Income from discontinued operations increased183.3%,  or $187,000, for the threemonths ended March 31, 2003 compared to the same period in the prior fiscalyear primarily due to the sale of the credit card loan portfolio on January 31,2003 and the reversal of $62,000, net of taxes, for a possible legalsettlement.  The contingent legalliability arising from the normal course of business was recorded during thefourth quarter of fiscal 2002 and reversed during the third quarter of fiscal2003.  See Note 2 for further discussionon discontinued operations.

 

**C****omparison ofthe Nine Months Ended March 31, 2003 and March 31, 2002**

** **

**Continued Operations:**

 

*General*.  The Company's net income from continuingoperations was $4.5 million or $1.36 and $1.34 for basic and diluted earningsper share, respectively, for the nine months ended

 

27

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March 31, 2003, a 28.5%increase in earnings compared to $3.5 million or $0.98 and $0.96 for basic anddiluted earnings per share, respectively, for the same period in the priorfiscal year.  Basic and diluted earningsper share increased 38.8% and 39.6%, respectively, for the nine months endedMarch 31, 2003 as compared to the same period in the prior fiscal year, due tothe increase in earnings and decrease in shares outstanding as a result ofCompany stock repurchases.  For the ninemonths ended March 31, 2003, the return on average equity from continuingoperations was 12.13%, a 36.1% increase compared to 8.91% for the same periodin the prior fiscal year.  For the ninemonths ended March 31, 2003, the return on average assets from continuingoperations was 0.79%, a 23.4% increase compared to 0.64% for the same period inthe prior fiscal year.  As discussed inmore detail below, the increases were due to a variety of key factors,including increases in net interest income of $1.7 million and noninterestincome of $1.2 million offset by increases in provision for losses on loans andleases of $453,000, noninterest expense of $1.2 million and income tax expenseof $191,000.

 

*Interest and Dividend Income.*  Interest and dividend income was $33.3million for the nine months ended March 31, 2003 as compared to $36.7 millionfor the same period in the prior fiscal year, a decrease of $3.3 million or9.1%.  A $5.5 million decrease ininterest and dividend income was the result of a 12.4% decrease in the averageyield on interest-earning assets.  Theaverage yield on interest-earning assets was 6.31% for the nine months endedMarch 31, 2003 as compared to 7.20% for the same period in the prior fiscalyear.  For the nine months ended March31, 2003, the average yield on loans and leases receivable was 6.78%, adecrease of 14.4% from 7.92% for the same period in the prior fiscal year.  The overall decrease in interest anddividend income was primarily due to repricing of loans and investments thatgenerally reflected the decline in national interest rates.  From June 30, 2001 to March 31, 2003, theprime rate dropped from 6.75% to 4.25%. Average volume increases in loans and leases receivable of $50.6 millionresulted in a $3.0  million increase ininterest and dividend income offset by a decrease of $24.8 million ininvestment securities, or $820,000 decrease in interest and dividend income ascompared to the same period in the prior fiscal year.   The Company also recorded an additional net increase to interestincome of $190,000 for nonaccrual loan interest adjustments during the firstquarter of fiscal 2003 for two commercial and agricultural loans.  See “Asset Quality”.

 

*Interest Expense.*  Interest expense was $13.9 million for thenine months ended March 31, 2003 as compared to $18.9 million for the sameperiod in the prior fiscal year, a decrease of $5.0 million or 26.6%.  A $5.9 million decrease in interest expensewas the result of a 29.6% decrease in the average rate paid on interest-bearingliabilities.  The average rate oninterest-bearing liabilities was 2.93% for the nine months ended March 31, 2003as compared to 4.16% for the same period in the prior fiscal year.  For the nine months ended March 31, 2003,the average rate paid on interest-bearing deposits was 2.53%, a decrease of34.8% from 3.88% for the same period in the prior fiscal year.  Average volume increase of $25.9 million inFHLB advances and other borrowings contributed to a $1.1 million increase ininterest expense offset by a reduction in interest expense of $374,000 due toaverage volume decrease of certificates of deposit of $9.5 million for the ninemonths ended March 31, 2003 as compared to the same period in the prior fiscalyear.

 

*Net Interest Income.*The Company's net interest income from continuing operations for the ninemonths ended March 31, 2003 increased $1.7 million, or 9.6%, to $19.5 millioncompared to $17.7 million for the same period in the prior fiscal year.  The increase in net interest income was dueprimarily to an increasing net interest margin as national interest rates weredeclining.  The Company’s net interestmargin was 3.68% for the nine months ended March 31, 2003, a decrease of 5.4%from 3.49% for the same period in the prior fiscal year.

 

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*Provision for Losses on Loans.*The allowance for loan and leaselosses is maintained at a level which is considered by management to beadequate to absorb inherent losses on existing loans and leases that may becomeuncollectible, based on an evaluation of the collectability of loans and priorloan loss experience.  The evaluationtakes into consideration such factors as changes in the nature and volume ofthe loan portfolio, overall portfolio quality, review of specific problemloans, and current economic conditions that may affect the borrower's abilityto pay.  The allowance for loan andlease losses is established through a provision for losses on loans and leasescharged to expense.

 

During thenine months ended March 31, 2003, the Company recorded a provision for losseson loans and leases of $1.9 million compared to $1.4 million for the ninemonths ended March 31, 2002, an increase of $453,000.  See "Asset Quality" for further discussion.

 

*Noninterest Income.*  Noninterest income was $9.5 million for thenine months ended March 31, 2003 as compared to $8.4 million for the ninemonths ended March 31, 2002, an increase of $1.2 million or 13.8%.  The increase in noninterest income was dueprimarily to increases in loan fees and service charges of $694,000, net gainon sale of securities of $346,000, fees on deposits of $280,000 and othernoninterest income of $225,000 offset by decreases in loan servicing income of$205,000 and commission and insurance income of $176,000.

 

Loan fees andservice charges increased 75.8% to $1.6 million during the nine months endedMarch 31, 2003 compared to $915,000 for same period in the prior fiscalyear.  The increase was primarily due toan increase in residential mortgage loan production of 26.8% in dollar volumeas compared to the same period one year ago. In a periodic review of fees received and costs to originate loans,management reduced the loan origination fee deferral amount during the firstquarter of fiscal 2003, thus increasing immediate loan origination fee income.  This change in estimate, which is accountedfor prospectively, resulted in an increase of approximately $614,000 over thesame period in the prior year.

 

Net gain onsale of securities increased $346,000 as there were no sales occurring in thefirst half of fiscal 2002.  Long-termfixed-rate mortgage-backed securities were sold to reduce the potential marketvalue loss of rising interest rates.

 

Fees ondeposits increased 9.6% to $3.2 million during the nine months ended March 31,2003 compared to $2.9 million for the same period in the prior fiscal yearprimarily due to a $23.0 million increase in demand deposit account balances atMarch 31, 2003 compared to balances at March 31, 2002 and an increase inmonthly fees charged on savings accounts.

 

Othernoninterest income increased 26.4% to $1.1 million during the nine months endedMarch 31, 2003 compared to $851,000 for the same period in the prior fiscalyear primarily due to income in the amount of $94,000 recorded on the retainedinterest obtained through the securitization of automobile loans during thethird quarter of fiscal 2003.  See Note6.  In addition, the Bank recorded anincrease of $250,000 in other noninterest income for bank owned life insurance(“BOLI”) as compared to the same period in the prior fiscal year.

 

Loan servicingincome was $1.2 million for the nine months ended March 31, 2003 compared to$1.4 million for the same period in the prior fiscal year, a decrease of14.5%.   The decrease was primarily dueto a $23.1 million package loan sale occurring in the first quarter offiscal  2002.

 

Commission and insurance incomewas $775,000 for the nine months ended March 31, 2003 compared to $951,000 forthe same period in the prior fiscal year, a decrease of 18.5%.

 

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Hometown’s personal andcommercial insurance lines are down compared to the prior year primarily due toless emphasis on the property and casualty line of business.

 

*Noninterest Expense.*  Noninterest expense was $20.2 million forthe nine months ended March 31, 2003 as compared to $19.0 million for the ninemonths ended March 31, 2002, an increase of $1.2 million or 6.4%.  The increase in noninterest expense was dueprimarily to increases in compensation and employee benefits of $583,000, othergeneral and administrative expenses of $491,000 and occupancy and equipment of$400,000 offset by a decrease in amortization of intangible assets of $319,000.

 

Compensationand employee benefits increased 4.8% to $12.6 million for the nine months endedMarch 31, 2003 as compared to $12.0 million for the same period in the priorfiscal year in part due to increased employee base compensation and variablecompensation (performance incentives) of $347,000, health insurance claimaccruals of $300,000 and pension costs of $191,000 offset by a reduction of$186,000 in compensation for deferred loan origination costs.  The increase in pension costs is primarilydue to a combination of higher payroll covered and the investment performanceof the pension trust account.  Five  new in-store locations opened sinceSeptember 30, 2001 attributed to an increase in employee compensation, relatedbenefits and payroll taxes of approximately $431,000 for the nine months endedMarch 31, 2003 as compared to the same period in the prior fiscal year.

 

Other  general and administrative expensesincreased 12.1% to $4.5 million for the nine months ended March 31, 2003 ascompared to $4.0 million for the same period in the prior fiscal year in partdue to increases in computer and data processing expenses of $280,000,charitable contributions expense of $190,000 and consulting expense of $164,000offset by a reduction in advertising expense of $150,000 and audit expense of$110,000.

 

Occupancy andequipment increased 17.4% to $2.7 million for the nine months ended March 31,2003 as compared to $2.3 million for the same period in the prior fiscalyear.  The increase was primarily due toan increase in furniture and fixture expense of $364,000, including a valuationimpairment of $200,000 recorded in the third quarter of fiscal 2003 as a resultof a significant change in the market value of property that the Company nolonger uses in its banking operations. See Note 5.

 

Amortizationof intangible assets decreased 85.1% or $319,000 for the nine months ended March31, 2003 compared to the same period in the prior fiscal year due to cessationof amortization on goodwill.  See Note7.

 

The Company’sproperty and casualty insurance cost increased 18.2% over the previous yearwhich appears to be in line with industry averages.  The Company’s insurance carrier has indicated the terroristattacks of September 11, 2001 was the primary contributor to the increase andsuggested the premium increase of a similar amount is predicted for nextyear.  The Company’s property andcasualty premium for the current year is $52,000 compared to $44,000 for theprevious year.

 

*Income tax expense.*  The Company's income tax expense for thenine months ended March 31, 2003 increased $191,000 or 8.8% to $2.4 millioncompared to $2.2 million for the nine months ended March 31, 2002.  The increase was primarily due to anincrease in the Company’s pre-tax income from continuing operations of $1.2million offset by a reduction in the Company’s effective tax rate due tochanges in permanent tax differences. The effective tax rate was 34.4% and 38.2% for the nine months endedMarch 31, 2003 and March 31, 2002, respectively.

 

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**DiscontinuedOperations:**

** **

*Income (loss) from discontinued operations.  *Income fromdiscontinued operations increased 123.9%, or $176,000, for the nine monthsended March 31, 2003 compared to the same period in the prior fiscal yearprimarily due to the sale of the credit card loan portfolio on January 31,2003.  The contingent legal liabilityarising from the normal course of business was recorded during the fourthquarter of fiscal 2002 and reversed during the third quarter of fiscal2003.  See Note 2 for further discussionon discontinued operations.

 

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**Liquidity and Capital Resources**

 

The Bank’sprimary sources of funds are in-market deposits, FHLB advances and otherborrowings,  repayments of loanprincipal, mortgage-backed securities and callable agency securities and, to alesser extent, sales of mortgage loans, sales and maturities of securities,mortgage-backed securities, and short-term investments.  While scheduled loan payments and maturingsecurities are relatively predictable, deposit flows and loan prepayments aremore influenced by interest rates, general economic conditions and competition.The Bank attempts to price its deposits to meet its asset/liability objectivesconsistent with local market conditions. Excess balances are invested in overnight funds.

 

Liquiditymanagement is both a daily and long-term responsibility of management.  The Bank adjusts its investments in liquidassets based upon management's assessment of (i) expected loan demand, (ii)projected loan sales, (iii) expected deposit flows, (iv) yields available oninterest-bearing deposits, and (v) the objectives of its asset/liabilitymanagement program. Excess liquidity is invested generally in interest-bearingovernight deposits and other short-term government and agency obligations.  At March 31, 2003, the Bank had $15.0million invested in federal funds sold. During the nine months ended March 31, 2003, the Bank increased itsborrowings with the FHLB by $1.4 million. See “Financial Condition Data” for further discussion.

** **

The Bankanticipates that it will have sufficient funds available to meet current loancommitments.  At March 31, 2003, theBank had outstanding commitments to originate and purchase mortgage andcommercial loans of $68.5 million and to sell mortgage loans of $28.3million.  Commitments by the Company tooriginate loans are not necessarily executed by the customer.  The Company monitors the ratio ofcommitments to fundings for use in liquidity management.  At March 31, 2003, the Company hadoutstanding commitments to purchase securities available for sale of $430,000and no commitments to sell securities available for sale.

 

The growth inindirect lending is providing securitization opportunities in the capitalmarkets.  On January 31, 2003, theCompany sold approximately $40.1 million principal of indirect and $9.9 millionprincipal of direct automobile receivables in a securitizationtransaction.  The proceeds will be usedin part to continue to service the demand of the Company’s dealer network.  The securitization is a source of funds at arate lower than other sources of funds, reduces capital requirements andreduces the credit risk to the Company from the loans sold.

** **

Althoughin-market deposits are the Bank’s primary source of funds, the Bank’s policyhas been to utilize borrowings where the funds can be invested in either loansor securities at a positive rate of return or to use the funds for short-termliquidity purposes.  During fiscal 2002,the Bank increased the amount of pledgeable loans at the FHLB in order to increaseits contingent liquidity sources.  TheBank currently has two $10.0 million unsecured lines of federal funds withcorrespondent banks.  There were nofunds drawn on either line of credit at March 31, 2003.  Also, the Bank has implemented arrangements toacquire out-of- market certificate of deposits as an additional source offunding.  As of March 31, 2003, the Bankhad $34.8 million in out-of-market deposits. The Bank may also seek other sources of contingent liquidity includingadditional federal funds purchased lines with correspondent banks and lines ofcredit with the Federal Reserve Bank. See “Financial Condition Data” for further analysis.

 

The Companyhad in effect a stock buy back program in which up to 10.00% of the commonstock of the Company outstanding on May 1, 2002 could be acquired through April30, 2003.  A total of 141,316 shares ofcommon stock were purchased pursuant to this program, with 101,316 sharespurchased during the nine months ended March 31, 2003.  The Company approved a new stock buy backprogram in which up to 10% of the common stock of the Company outstanding onMay 1, 2003 may be acquired through April 30, 2004.

 

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Savingsinstitutions insured by the Federal Deposit Insurance Corporation are requiredby the Financial Institutions Reform, Recovery and Enforcement Act of 1989("FIRREA") to meet three regulatory capital requirements.  If a requirement is not met, regulatoryauthorities may take legal or administrative actions, including restrictions ongrowth or operations or, in extreme cases, seizure.  Institutions not in compliance may apply for an exemption fromthe requirements and submit a recapitalization plan.  Under these capital requirements, at March 31, 2003, the Bank metall current capital requirements.

 

The OTS has acore capital requirement for savings institutions comparable to the requirementfor national banks.  The OTS corecapital requirement is 4.00% of total adjusted assets for thrifts.  The Bank had core capital of 8.02% at March31, 2003.

 

**Impact of Inflationand Changing Prices**

 

TheConsolidated Financial Statements and Notes thereto presented in this Form 10-Qhave been prepared in accordance with GAAP, which require the measurement offinancial position and operating results in terms of historical dollars withoutconsidering the change in the relative purchasing power of money over time dueto inflation.  The impact of inflationis reflected in the increased cost of the Bank's operations. Unlike mostindustrial companies, nearly all the assets and liabilities of the Bank aremonetary in nature.  As a result,interest rates have a greater impact on the Bank's performance than do theeffects of general levels of inflation. Interest rates do not necessarily move in the same direction or to thesame extent as the prices of goods and services.

** **

**Recent Accounting Pronouncements**

** **

The FASB has issued certain Statements of Financial AccountingStandards which have required effective dates occurring after the Company’sJune 30, 2002 fiscal year end.  TheCompany’s financial statements, including the disclosures in this Form 10-Q,are not expected to be materially affected by those accounting pronouncements.

 

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**ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURESABOUT MARKET RISK**

** **

Interest raterisk is the most significant market risk affecting the Company.  Other types of market risk, such as foreigncurrency exchange rate risk and commodity price risk, do not arise in thenormal course of the Company’s business activities.

 

Thecomposition of the Bank’s balance sheet results in maturity mismatches betweeninterest-earning assets and interest-bearing liabilities.  The scheduled maturities of the Bank’s fixedrate interest-earning assets are longer than the scheduled maturities of itsfixed rate interest-bearing liabilities. This mismatch exposes the Bank to interest rate risk.  In a rising rate scenario, as measured bythe OTS interest rate risk exposure simulation model, the estimated market orportfolio value (“PV”) of the Bank’s assets would decline in value to a greaterdegree than the change in the PV of the Bank’s liabilities, thereby reducingnet portfolio value (“NPV”), the estimated market value of its shareholders’equity.

** **

As set forth below, depending upon the volatility of the rate change,the change in asset or liability mix of the Company or other factors mayproduce a decrease in net interest margin in an upward moving rate environmenteven as the NPV estimate indicates an increase in net value.  The converse situation can also be  expected. One approach used to quantify interest rate risk is theNPV analysis.  In essence, this analysiscalculates the difference between the present value of the liabilities and thepresent value of expected cash flows from assets and off-balance sheetcontracts.  The following tables setforth, at June 30, 2002 and December 31, 2002 (most recent report available),an analysis of the Company’s interest rate risk as measured by the estimatedchanges in NPV resulting from instantaneous and sustained parallel shifts inthe yield curve (+ 300 or –100 basis points, measured in 100 basis pointincrements).  Due to the abnormally lowprevailing interest rate environment, -200 and –300 NPV were not estimated bythe OTS.

 

The data inthe following tables is based on assumptions utilized by the OTS in assessinginterest rate risk of thrift institutions and published in “Selected Asset andLiability Price Tables as of June 30, 2002” and “Selected Asset and LiabilityPrice Tables as of December 31, 2002”. Even if interest rates change in the designated amounts, there can be noassurance that the Company’s assets and liabilities would perform as set forthbelow.  Depending upon the volatility ofthe rate change, the change in asset or liability mix of the Company or otherfactors may produce a decrease in net interest margin in an increasing rateenvironment even as the NPV estimate indicates an increase in net value.  The converse situation can also be  expected. In addition, a change in U.S. Treasury rates in the designated amountsaccompanied by a change in the shape of the Treasury yield curve would causesignificantly different changes to the NPV than indicated below.

 

June 30, 2002

 

|                          |   |                        |   | **Estimated  Increase  (Decrease) in NPV** |   |
|-------------------------------|--------|-----------------------------|--------|--------------------------------------------|--------|
| **Change in  Interest Rates** |   | **Estimated  NPV  Amount**  |   | **Amount**                                 |   | **Percent** |   |
|                          |   | **(Dollars  in thousands)** |   |                                       |   |
| Basis Points                  |   |                        |   |                                       |   |   |   |
| +300                          |   | $                           | 88,292 |                                       | $      | 9 |   | 0 | % |
| +200                          |   | 89,899                      |   | 1,615                                      |   | 2 |   |
| +100                          |   | 90,194                      |   | 1,910                                      |   | 2 |   |
| —                        |   | 88,284                      |   | —                                     |   | — |   |
| -100                          |   | 83,720                      |   | (4,564                                     | )      | (5 | ) |
|                               |        |                             |        |                                            |        |  |  |  |  |

 

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December 31, 2002

 

|                          |   |                        |   | **Estimated  Increase  (Decrease) in NPV** |   |
|-------------------------------|--------|-----------------------------|--------|--------------------------------------------|--------|
| **Change in  Interest Rates** |   | **Estimated  NPV  Amount**  |   | **Amount**                                 |   | **Percent** |   |
|                          |   | **(Dollars  in thousands)** |   |                                       |   |
| Basis Points                  |   |                        |   |                                       |   |   |   |
| +300                          |   | $                           | 78,856 |                                       | (5,354 | ) | (6% | ) |
| +200                          |   | 82,464                      |   | (1,747                                     | )      | (2 | ) |
| +100                          |   | 84,359                      |   | 148                                        |   | 0 |   |
| —                        |   | 84,210                      |   | —                                     |   | — |   |
| -100                          |   | 84,617                      |   | 407                                        |   | 0 |   |
|                               |        |                             |        |                                            |        |  |  |  |

 

In managingmarket risk and the asset/liability mix, the Bank has placed its emphasis ondeveloping a portfolio in which, to the extent practicable, assets andliabilities reprice within similar periods. The effect of this policy willgenerally be to reduce the Bank’s sensitivity to interest rate changes.  The goal of this policy is to provide arelatively consistent level of net interest income in varying interest ratecycles and to minimize the potential for significant fluctuations from periodto period.

 

**ITEM 4. CONTROLS AND PROCEDURES**

** **

During the 90-day period prior to the filing date of this report,management, including the Company’s Chairman, President and Chief ExecutiveOfficer and the Chief Financial Officer, evaluated the effectiveness of thedesign and operation of the Company’s disclosure controls and procedures.  Based upon, and as of the date of thatevaluation, the Chairman, President and Chief Executive Officer and the ChiefFinancial Officer****concludedthat the disclosure controls and procedures were effective, in all materialrespects, to ensure that information required to be disclosed in the reportsthe Company files and submits under the Exchange Act is recorded, processed,summarized and reported as and when required.

 

There have been no significant changes in the Company’s internalcontrols or in other factors which could significantly affect internal controlssubsequent to the date the Company carried out its evaluation.  There were no significant deficiencies ormaterial weaknesses identified in the evaluation and therefore, no corrective actionswere taken.

 

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**PART II**

 

**Item 1****.    LegalProceedings**

 

The Company, Home Federal and itssubsidiaries are involved as plaintiff or defendant in various legal actionsarising in the normal course of their businesses.  While the ultimate outcome of these proceedings cannot bepredicted with certainty, it is the opinion of management, after consultationwith counsel representing Home Federal and the Company in the proceedings, thatthe resolution of these proceedings should not have a material effect on theCompany's consolidated financial position or results of operations.  The Company and its direct and indirectsubsidiaries are not aware of any legal actions or proceedings outside of thenormal course of business.

 

**Item 2.    Changesin Securities and Use of Proceeds**

 

None

 

**Item 3****.    Defaultsupon Senior Securities**

 

None

 

**Item 4****.    Submissionof Matters to a Vote of Security Holders**

 

None

 

**Item 5****.    OtherInformation**

 

None

 

**Item 6****.    Exhibitsand Reports on Form 8-K**

 

(a)                        Exhibits

 

Exhibit 99.1 Certification of President and Chief Executive Officer

Exhibit 99.2 Certification of Executive Vice President and ChiefFinancial Officer

 

(b)                       Reports on Form 8-K

 

The Companyfiled Form 8-K , Item 5, “Other Events” with the Securities and ExchangeCommission on February 5, 2003 announcing the sale of $50.0 million principalof motor vehicle installment loans to a newly formed trust, Home FederalAutomobile Securitization Trust 2003-A.

 

The Companyfiled Form 8-K, Item 5, “Other Events” with the Securities and ExchangeCommission on February 7, 2003 announcing the closing date for the sale ofcredit card receivables.  The originalagreement was entered into on December 31, 2002 and the transaction closingdate was February 4, 2003 based on balances at the close of business January31, 2003.

 

36

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**HF FINANCIAL CORP.**

**FORM 10-Q**

**SIGNATURES**

 

Pursuant to the requirements ofthe Securities Exchange Act of 1934, the registrant has duly caused this reportto be signed on its behalf by the undersigned thereunto duly authorized.

 

 
|   | HF Financial Corp. |
|--------|--------------------|
|   | (Registrant)       |

 
| Date:  | May 14, 2003 |   | By:    | /s/ Curtis L. Hage                                                        |
|--------|--------------|--------|--------|---------------------------------------------------------------------------|
|   |         |   |   | Curtis L.  Hage, Chairman, President And Chief Executive Officer          |
|   |         |   |   | (Duly  Authorized Officer)                                                |
|   |         |   |   |                                                                      |
| Date:  | May 14, 2003 |   |   | By:                                                                       | /s/ Darrel L. Posegate |
|   |         |   |   | Darrel L.  Posegate, Executive Vice President And Chief Financial Officer |
|   |         |   |   | (Principal  Financial and Accounting Officer)                             |

 

37

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**CERTIFICATION**

 

I, Curtis L.Hage, certify that:

 

1.               Ihave reviewed this quarterly report on Form 10-Q of HF Financial Corp;

 

2.               Basedon my knowledge, this quarterly report does not contain any untrue statement ofa material fact or omit to state a material fact necessary to make thestatements made, in light of the circumstances under which such statements weremade, not misleading with respect to the period covered by this quarterlyreport;

 

3.               Basedon my knowledge, the financial statements, and other financial informationincluded in this quarterly report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant asof, and for, the periods presented in this quarterly report;

 

4.               Theregistrant’s other certifying officers and I are responsible for establishingand maintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

a)              designedsuch disclosure controls and procedures to ensure that material informationrelating to the registrant, including its consolidated subsidiaries, is madeknown to us by others within those entities, particularly during the period inwhich this quarterly report is being prepared;

 

b)             evaluatedthe effectiveness of the registrant’s disclosure controls and procedures as ofa date within 90 days prior to the filing date of this quarterly report (the“Evaluation Date”); and

 

c)              presentedin this quarterly report our conclusions about the effectiveness of thedisclosure controls and procedures based on our evaluation as of the EvaluationDate;

 

5.               Theregistrant’s other certifying officers and I have disclosed, based on our mostrecent evaluation, to the registrant’s auditors and the audit committee of theregistrant’s board of directors (or persons performing the equivalentfunction):

 

a)              allsignificant deficiencies in the design or operation of internal controls whichcould adversely affect the registrant’s ability to record, process, summarizeand report financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b)             anyfraud, whether or not material, that involves management or other employees whohave a significant role in the registrant’s internal controls; and

 

6.               Theregistrant’s other certifying officers and I have indicated in this quarterlyreport whether or not there were significant changes in internal controls or inother factors that could significantly affect internal controls subsequent tothe date of our most recent evaluation, including any corrective actions withregard to significant deficiencies and material weaknesses.

 

 
| Date:  |    May  14, 2003                  |   |    /s/  Curtis L. Hage |   |
|--------|--------------------------------------------------|--------|---------------------------------------|--------|
|   | Curtis L.  Hage                                  |
|   | Chairman,  President and Chief Executive Officer |

 

38

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**CERTIFICATION**

 

I, Darrel L.Posegate, certify that:

 

1.     I have reviewed thisquarterly report on Form 10-Q of HF Financial Corp;

 

2.               Basedon my knowledge, this quarterly report does not contain any untrue statement ofa material fact or omit to state a material fact necessary to make thestatements made, in light of the circumstances under which such statements weremade, not misleading with respect to the period covered by this quarterlyreport;

 

3.               Basedon my knowledge, the financial statements, and other financial informationincluded in this quarterly report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant asof, and for, the periods presented in this quarterly report;

 

4.               Theregistrant’s other certifying officers and I are responsible for establishingand maintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

a)              designedsuch disclosure controls and procedures to ensure that material informationrelating to the registrant, including its consolidated subsidiaries, is madeknown to us by others within those entities, particularly during the period inwhich this quarterly report is being prepared;

 

b)             evaluatedthe effectiveness of the registrant’s disclosure controls and procedures as ofa date within 90 days prior to the filing date of this quarterly report (the“Evaluation Date”); and

 

c)              presentedin this quarterly report our conclusions about the effectiveness of thedisclosure controls and procedures based on our evaluation as of the EvaluationDate;

 

5.               Theregistrant’s other certifying officers and I have disclosed, based on our mostrecent evaluation, to the registrant’s auditors and the audit committee of theregistrant’s board of directors (or persons performing the equivalentfunction):

 

a)              allsignificant deficiencies in the design or operation of internal controls whichcould adversely affect the registrant’s ability to record, process, summarizeand report financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b)             anyfraud, whether or not material, that involves management or other employees whohave a significant role in the registrant’s internal controls; and

 

6.               Theregistrant’s other certifying officers and I have indicated in this quarterlyreport whether or not there were significant changes in internal controls or inother factors that could significantly affect internal controls subsequent tothe date of our most recent evaluation, including any corrective actions withregard to significant deficiencies and material weaknesses.

 

 
| Date:  |    May  14, 2003 |                                                  |    \s\  Darrel L. Posegate |   |
|--------|---------------------------------|-------------------------------------------------------|-------------------------------------------|--------|
|   |                            | Darrel L.  Posegate                                   |
|   |                            | Executive Vice  President and Chief Financial Officer |

 

39

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**INDEX TO EXHIBITS**

** **

99.1                                              Certificationof President and Chief Executive Officer

 

99.2                                              Certificationof Executive Vice President and Chief Financial Officer

 

40

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