**UNITED STATES****SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C.  20549**

 

----

 

**FORM 10-Q**

 

**ý****      QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15 (d) OF THESECURITIES EXCHANGE ACT OF 1934**

 

**Forthe Quarterly Period ended September 30, 2002**

 

**CommissionFile Number: 0-19972**

 

----

 

| **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 by check markwhether the registrant  (1)  has filed all reports required to befiled  by Section 13 or 15  (d) of the Securities Exchange Act of 1934 during the preceding 12 months(or for such shorter period that the registrant was required to file suchreports), and (2) has been subject to such filing requirements for the past 90days.  Yes  ý  No  o

 

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 12b-2 of theExchange Act).  Yes  o     No  ý

 

Indicate the number ofshares outstanding of each of the issuer’s classes of common stock, as of thelatest practicable date.

 

As of November 8, 2002there were 3,351,949 issued and outstanding shares of the Registrant’s CommonStock, with $.01 par value.

 

 

----

 

**HFFINANCIAL CORP.**

 

**Form10-Q**

 

**Tableof Contents**

 
| **PART  I** |
|-------------|
|        |   |
| Item 1.     | Financial Statements (Unaudited): |
|        |   |
|        | Consolidated  Statements of Financial Condition  As of September 30, 2002 and June 30, 2002 |
|        |   |
|        | Consolidated  Statements of Income for the  Three Months Ended September 30, 2002 and 2001 |
|        |   |
|        | Consolidated  Statement of Stockholders’ Equity for the  Three Months Ended September 30, 2002 and 2001 |
|        |   |
|        | Consolidated  Statements of Cash Flows for the  Three Months Ended September 30, 2002 and 2001 |
|        |   |
|        | 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 |

 

----

 

**HF FINANCIAL CORP. ANDSUBSIDIARIES**

**CONSOLIDATED STATEMENTS OFFINANCIAL CONDITION**

**(Dollars in Thousands)**

 
|                                                                                                                                                      |   | **September 30, 2002** |    | **June 30, 2002** |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------|---------|-------------------|--------|
|                                                                                                                                                      |   | **(Unaudited)**        |    |              |   |
| **ASSETS**                                                                                                                                                |   |                   |    |              |   |
| Cash  and cash equivalents                                                                                                                                |   | $                      | 21,814  |              | $      | 27,546 |   |
| Securities  available for sale                                                                                                                            |   | 100,245                |    | 89,136            |   |
|                                                                                                                                                      |   |                   |    |              |   |
| Loans  and leases receivable                                                                                                                              |   | 591,621                |    | 564,275           |   |
| Loans  held for sale                                                                                                                                      |   | 13,304                 |    | 6,559             |   |
| Allowance  for loan and lease losses                                                                                                                      |   | (5,202                 | )       | (4,461            | )      |
| Net  loans and leases receivable                                                                                                                          |   | 599,723                |    | 566,373           |   |
|                                                                                                                                                      |   |                   |    |              |   |
| Accrued  interest receivable                                                                                                                              |   | 4,921                  |    | 4,410             |   |
| Office  properties and equipment, net of accumulated depreciation                                                                                         |   | 13,374                 |    | 13,714            |   |
| Foreclosed  real estate and other properties                                                                                                              |   | 1,665                  |    | 1,672             |   |
| Prepaid  expenses and other assets                                                                                                                        |   | 8,959                  |    | 8,505             |   |
| Mortgage  servicing rights                                                                                                                                |   | 3,538                  |    | 3,467             |   |
| Deferred  income taxes                                                                                                                                    |   | 3,014                  |    | 2,831             |   |
| Goodwill,  net                                                                                                                                            |   | 4,604                  |    | 4,604             |   |
| Other  intangible assets, net                                                                                                                             |   | 618                    |    | 659               |   |
| Total  assets                                                                                                                                             |   | $                      | 762,475 |              | $      | 722,917 |   |
|                                                                                                                                                      |   |                   |    |              |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                             |   |                   |    |              |   |
| **LIABILITIES**                                                                                                                                           |   |                   |    |              |   |
| Deposits                                                                                                                                                  |   | $                      | 540,035 |              | $      | 562,596 |   |
| Advances  from Federal Home Loan Bank and other borrowings                                                                                                |   | 135,364                |    | 84,308            |   |
| Company  obligated mandatorily redeemable preferred securities of subsidiary trusts  that solely hold subordinated debentures                             |   | 15,000                 |    | 10,000            |   |
| Advances  by borrowers for taxes and insurance                                                                                                            |   | 10,545                 |    | 6,436             |   |
| Accrued  interest payable                                                                                                                                 |   | 3,574                  |    | 3,751             |   |
| Accrued  benefit liability                                                                                                                                |   | 1,093                  |    | 1,093             |   |
| Other  liabilities                                                                                                                                        |   | 7,440                  |    | 6,197             |   |
| Total  liabilities                                                                                                                                        |   | 713,051                |    | 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, 4,912,760 and 4,886,494  shares issued at September 30, 2002 and June 30, 2002, respectively |   | 49                     |    | 49                |   |
| Additional  paid-in capital                                                                                                                               |   | 16,332                 |    | 16,014            |   |
| Retained  earnings, substantially restricted                                                                                                              |   | 55,642                 |    | 54,516            |   |
| Deferred  compensation                                                                                                                                    |   | (358                   | )       | (141              | )      |
| Accumulated  other comprehensive income (loss):                                                                                                           |   |                   |    |              |   |
| Unrealized  gain on securities available for sale, net of related deferred tax effect                                                                     |   | 223                    |    | 498               |   |
| Unrecognized  pension costs, net of related deferred tax effect                                                                                           |   | (704                   | )       | (704              | )      |
| Less  cost of treasury stock, 1,564,246 and 1,559,030 shares at September 30, 2002  and June 30, 2002, respectively                                       |   | (21,760                | )       | (21,696           | )      |
| Total  stockholders’ equity                                                                                                                          |   | 49,424                 |    | 48,536            |   |
| Total  liabilities and stockholders’ equity                                                                                                          |   | $                      | 762,475 |              | $      | 722,917 |   |

 

*See accompanying notes tounaudited consolidated financial statements.*

 

1

----

 

**HF FINANCIAL CORP. ANDSUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF INCOME**

**(Dollars in Thousands,Except Per Share Data)**

**(Unaudited)**

 
|                                                                                |   | **Three Months Ended September 30,** |   |
|-------------------------------------------------------------------------------------|--------|--------------------------------------|--------|
|                                                                                |   | **2002**                             |   | **2001** |   |
| Continuing  operations:                                                             |   |                                 |   |   |   |
| Interest  and dividend income:                                                      |   |                                 |   |   |   |
| Loans  and leases receivable                                                        |   | $                                    | 10,501 |   | $ | 11,692 |   |
| Investment  securities and interest-bearing deposits                                |   | 1,005                                |   | 1,802 |   |
|                                                                                |   | 11,506                               |   | 13,494 |   |
| Interest  expense:                                                                  |   |                                 |   |   |   |
| Deposits                                                                            |   | 3,388                                |   | 6,274 |   |
| Advances  from Federal Home Loan Bank and other borrowings                          |   | 1,383                                |   | 1,447 |   |
|                                                                                |   | 4,771                                |   | 7,721 |   |
| Net  interest income                                                                |   | 6,735                                |   | 5,773 |   |
| Provision  for losses on loans and leases                                           |   | 1,034                                |   | 523 |   |
| Net  interest income after provision for losses on loans and leases                 |   | 5,701                                |   | 5,250 |   |
| Noninterest  income:                                                                |   |                                 |   |   |   |
| Fees  on deposits                                                                   |   | 1,083                                |   | 961 |   |
| Gain  on sale of loans, net                                                         |   | 222                                  |   | 484 |   |
| Loan  servicing income                                                              |   | 404                                  |   | 626 |   |
| Commission  and insurance income                                                    |   | 272                                  |   | 303 |   |
| Loan  fees and service charges                                                      |   | 478                                  |   | 272 |   |
| Gain  on sale of securities, net                                                    |   | 350                                  |   | — |   |
| Other                                                                               |   | 260                                  |   | 257 |   |
|                                                                                |   | 3,069                                |   | 2,903 |   |
| Noninterest  expense:                                                               |   |                                 |   |   |   |
| Compensation  and employee benefits                                                 |   | 4,104                                |   | 3,856 |   |
| Other  general and administrative expenses                                          |   | 1,372                                |   | 1,347 |   |
| Occupancy  and equipment                                                            |   | 821                                  |   | 893 |   |
| Amortization  of intangible assets                                                  |   | 41                                   |   | 125 |   |
| Federal  insurance premiums                                                         |   | 23                                   |   | 25 |   |
| Other                                                                               |   | 78                                   |   | 72 |   |
|                                                                                |   | 6,439                                |   | 6,318 |   |
| Income  from continuing operations before income taxes                              |   | 2,331                                |   | 1,835 |   |
| Income  tax expense                                                                 |   | 880                                  |   | 711 |   |
| Income  from continuing operations                                                  |   | 1,451                                |   | 1,124 |   |
|                                                                                |   |                                 |   |   |   |
| Discontinued  operations:                                                           |   |                                 |   |   |   |
| Income  from operations of discontinued segment, net of income taxes of $45 and $74 |   | 88                                   |   | 143 |   |
| (Loss)  on discontinued segment, net of income taxes of ($15)                       |   | (29                                  | )      | — |   |
| Income  from discontinued operations                                                |   | 59                                   |   | 143 |   |
| Net  Income                                                                         |   | $                                    | 1,510  |   | $ | 1,267 |   |
|                                                                                |   |                                 |   |   |   |
| Basic  earnings per share:                                                          |   |                                 |   |   |   |
| Income  from continuing operations                                                  |   | $                                    | 0.43   |   | $ | 0.30 |   |
| Income  from discontinued operations                                                |   | 0.02                                 |   | 0.04 |   |
| Net  income                                                                         |   | $                                    | 0.45   |   | $ | 0.34 |   |
|                                                                                |   |                                 |   |   |   |
| Diluted  earnings per share:                                                        |   |                                 |   |   |   |
| Income  from continuing operations                                                  |   | $                                    | 0.43   |   | $ | 0.30 |   |
| Income  from discontinued operations                                                |   | 0.02                                 |   | 0.04 |   |
| Net  income                                                                         |   | $                                    | 0.45   |   | $ | 0.34 |   |

 

*See accompanying notes tounaudited consolidated financial statements.*

 

2

----

 

**HF FINANCIAL CORP. ANDSUBSIDIARIES**

**CONSOLIDATED STATEMENT OF STOCKHOLDERS’EQUITY**

**Three Months Ended September30, 2002 and 2001**

**(Dollars In Thousands,Except Per Share Data)**

**(Unaudited)**

 
|                                                                                    |   | **Common  Stock** |   | **Additional  Paid-In  Capital** |   | **Retained  Earnings** |   | **Deferred  Compensation** |   | **Accumulated  Other  Comprehensive  Income (Loss)** |   | **Treasury  Stock** |   | **Total** |   |
|-----------------------------------------------------------------------------------------|--------|-------------------|--------|----------------------------------|--------|------------------------|--------|----------------------------|--------|------------------------------------------------------|--------|---------------------|--------|-----------|--------|
|                                                                                    |   |              |   |                             |   |                   |   |                       |   |                                                 |   |                |   |      |   |
| Balance,  June 30, 2001                                                                 |   | $                 | 48     |                             | $      | 15,378                 |   | $                          | 52,886 |                                                 | $      | —              |   | $         | 338    |   | $ | (16,125 | ) | $ | 52,525 |   |
|                                                                                    |   |              |   |                             |   |                   |   |                       |   |                                                 |   |                |   |      |   |
| Comprehensive  income:                                                                  |   |              |   |                             |   |                   |   |                       |   |                                                 |   |                |   |      |   |
| Net  income                                                                             |   | —            |   | —                           |   | 1,267                  |   | —                     |   | —                                               |   | —              |   | 1,267     |   |
| Net  change in unrealized gain on securities available for sale, net of deferred  taxes |   | —            |   | —                           |   | —                 |   | —                     |   | 618                                                  |   | —              |   | 618       |   |
| Comprehensive  income                                                                   |   | —            |   | —                           |   | 1,267                  |   | —                     |   | 618                                                  |   | —              |   | 1,885     |   |
|                                                                                    |   |              |   |                             |   |                   |   |                       |   |                                                 |   |                |   |      |   |
| 7,560  shares issued under Restricted Stock Plans                                       |   | —            |   | 104                              |   | —                 |   | —                     |   | —                                               |   | —              |   | 104       |   |
|                                                                                    |   |              |   |                             |   |                   |   |                       |   |                                                 |   |                |   |      |   |
| Exercise  of stock options for 5,429 shares                                             |   | —            |   | 26                               |   | —                 |   | —                     |   | —                                               |   | —              |   | 26        |   |
|                                                                                    |   |              |   |                             |   |                   |   |                       |   |                                                 |   |                |   |      |   |
| Cash  dividends paid ($0.11 per share) on common stock                                  |   | —            |   | —                           |   | (406                   | )      | —                     |   | —                                               |   | —              |   | (406      | )      |
|                                                                                    |   |              |   |                             |   |                   |   |                       |   |                                                 |   |                |   |      |   |
| Balance,  September 30, 2001                                                            |   | $                 | 48     |                             | $      | 15,508                 |   | $                          | 53,747 |                                                 | $      | —              |   | $         | 956    |   | $ | (16,125 | ) | $ | 54,134 |   |
|                                                                                    |   |              |   |                             |   |                   |   |                       |   |                                                 |   |                |   |      |   |
| Balance,  June 30, 2002                                                                 |   | $                 | 49     |                             | $      | 16,014                 |   | $                          | 54,516 |                                                 | $      | (141                | )      | $         | (206   | ) | $ | (21,696 | ) | $ | 48,536 |   |
|                                                                                    |   |              |   |                             |   |                   |   |                       |   |                                                 |   |                |   |      |   |
| Comprehensive  income:                                                                  |   |              |   |                             |   |                   |   |                       |   |                                                 |   |                |   |      |   |
| Net  income                                                                             |   | —            |   | —                           |   | 1,510                  |   | —                     |   | —                                               |   | —              |   | 1,510     |   |
| Net  change in unrealized gain on securities available for sale, net of deferred  taxes |   | —            |   | —                           |   | —                 |   | —                     |   | (275                                                 | )      | —              |   | (275      | )      |
| Comprehensive  income                                                                   |   | —            |   | —                           |   | 1,510                  |   | —                     |   | (275                                                 | )      | —              |   | 1,235     |   |
|                                                                                    |   |              |   |                             |   |                   |   |                       |   |                                                 |   |                |   |      |   |
| 26,266  shares issued under Restricted Stock Plans                                      |   | —            |   | 318                              |   | —                 |   | (224                       | )      | —                                               |   | —              |   | 94        |   |
|                                                                                    |   |              |   |                             |   |                   |   |                       |   |                                                 |   |                |   |      |   |
| Cash  dividends paid ($0.115 per share) on common stock                                 |   | —            |   | —                           |   | (384                   | )      | —                     |   | —                                               |   | —              |   | (384      | )      |
|                                                                                    |   |              |   |                             |   |                   |   |                       |   |                                                 |   |                |   |      |   |
| Purchase  of treasury stock                                                             |   | —            |   | —                           |   | —                 |   | —                     |   | —                                               |   | (64                 | )      | (64       | )      |
|                                                                                    |   |              |   |                             |   |                   |   |                       |   |                                                 |   |                |   |      |   |
| Amortization  of deferred compensation                                                  |   | —            |   | —                           |   | —                 |   | 7                          |   | —                                               |   | —              |   | 7         |   |
|                                                                                    |   |              |   |                             |   |                   |   |                       |   |                                                 |   |                |   |      |   |
| Balance,  September 30, 2002                                                            |   | $                 | 49     |                             | $      | 16,332                 |   | $                          | 55,642 |                                                 | $      | (358                | )      | $         | (481   | ) | $ | (21,760 | ) | $ | 49,424 |   |

 

*See accompanying notes tounaudited consolidated financial statements.*

 

3

----

 

**HF FINANCIAL CORP. ANDSUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASHFLOWS**

**(Dollars in Thousands)**

**(Unaudited)**

 
|                                                                                           |   | **Three Months Ended September 30,** |    |
|------------------------------------------------------------------------------------------------|--------|--------------------------------------|---------|
|                                                                                           |   | **2002**                             |    | **2001** |   |
| **Cash flows from operating activities**                                                       |   |                                 |    |   |   |
| Net  income                                                                                    |   | $                                    | 1,510   |   | $ | 1,267 |   |
| Adjustments  to reconcile net income to net cash provided by (used in) operating  activities:  |   |                                 |    |   |   |
| Provision  for losses on loans and leases                                                      |   | 1,034                                |    | 1,062 |   |
| Depreciation                                                                                   |   | 400                                  |    | 408 |   |
| Amortization  (accretion) of premiums and discounts on securities available for sale, net      |   | 175                                  |    | (1 | ) |
| Amortization  of intangible assets                                                             |   | 41                                   |    | 125 |   |
| Amortization  of mortgage servicing rights                                                     |   | 92                                   |    | 72 |   |
| Amortization  of debt issue costs                                                              |   | 4                                    |    | — |   |
| Stock  based compensation                                                                      |   | 101                                  |    | 104 |   |
| (Decrease)  in deferred loan fees                                                              |   | (241                                 | )       | (360 | ) |
| Loans  originated for resale                                                                   |   | (24,219                              | )       | (54,421 | ) |
| Proceeds  from the sale of loans                                                               |   | 17,696                               |    | 53,964 |   |
| (Gain)  on sale of loans, net                                                                  |   | (222                                 | )       | (484 | ) |
| Mortgage  servicing rights capitalized                                                         |   | (43                                  | )       | (275 | ) |
| Realized  (gain) on sale of securities, net                                                    |   | (350                                 | )       | — |   |
| Losses  and provision for losses on sales of foreclosed real estate and other  properties, net |   | 33                                   |    | 21 |   |
| Loss  on disposal of office properties and equipment, net                                      |   | 21                                   |    | 9 |   |
| (Increase)  decrease in accrued interest receivable                                            |   | (511                                 | )       | 298 |   |
| (Increase)  in prepaid expenses and other assets                                               |   | (308                                 | )       | (640 | ) |
| Deferred  income taxes (credits)                                                               |   | (15                                  | )       | — |   |
| Increase  (decrease) in accrued interest payable and other liabilities                         |   | 1,066                                |    | (832 | ) |
| Net  cash provided by (used in) operating activities                                           |   | (3,736                               | )       | 317 |   |
|                                                                                           |   |                                 |    |   |   |
| **Cash flows from investing activities**                                                       |   |                                 |    |   |   |
| Loans  and leases purchased                                                                    |   | (172                                 | )       | (5,710 | ) |
| Loans  and leases originated and held                                                          |   | (76,639                              | )       | (34,745 | ) |
| Principal  collected on loans and leases                                                       |   | 49,224                               |    | 79,775 |   |
| Securities  available for sale:                                                                |   |                                 |    |   |   |
| Sales  and maturities                                                                          |   | 14,406                               |    | 18,395 |   |
| Purchases                                                                                      |   | (31,606                              | )       | (14,027 | ) |
| Repayments                                                                                     |   | 5,823                                |    | 4,848 |   |
| Proceeds  from sale of office properties and equipment                                         |   | 8                                    |    | — |   |
| Purchase  of office properties and equipment                                                   |   | (89                                  | )       | (105 | ) |
| Purchase  of mortgage servicing rights                                                         |   | (120                                 | )       | (148 | ) |
| Proceeds  from sale of foreclosed real estate and other properties, net                        |   | 163                                  |    | 229 |   |
| Net  cash provided by (used in) investing activities                                           |   | (39,002                              | )       | 48,512 |   |
|                                                                                           |   |                                 |    |   |   |
| **Cash  flows from financing activities**                                                      |   |                                 |    |   |   |
| Net (decrease) in deposit  accounts                                                            |   | $                                    | (22,561 | ) | $ | (22,991 | ) |
| Proceeds of advances from  Federal Home Loan  Bank and other borrowings                        |   | 240,500                              |    | 900 |   |
| Payments on advances from  Federal Home Loan  Bank and other borrowings                        |   | (189,444                             | )       | (12,225 | ) |
| Proceeds from issuance of  preferred securities of subsidiary trust                            |   | 5,000                                |    | — |   |
| Payment of debt issue  costs                                                                   |   | (150                                 | )       | — |   |
| Increase in advances by  borrowers for taxes and insurance                                     |   | 4,109                                |    | 2,741 |   |
| Purchase of treasury  stock                                                                    |   | (64                                  | )       | — |   |
| Proceeds from issuance of  common stock                                                        |   | —                               |    | 26 |   |
| Cash dividends paid                                                                            |   | (384                                 | )       | (406 | ) |
| Net cash provided by  (used in) financing activities                                           |   | 37,006                               |    | (31,955 | ) |
|                                                                                           |   |                                 |    |   |   |
| Increase (decrease) in  cash and cash equivalents                                              |   | (5,732                               | )       | 16,874 |   |
|                                                                                           |   |                                 |    |   |   |
| Cash and cash equivalents                                                                      |   |                                 |    |   |   |
| Beginning                                                                                      |   | 27,546                               |    | 84,913 |   |
| Ending                                                                                         |   | $                                    | 21,814  |   | $ | 101,787 |   |
|                                                                                           |   |                                 |    |   |   |
| Supplemental Disclosures  of Cash Flows Information                                            |   |                                 |    |   |   |
| Cash payments for interest                                                                     |   | $                                    | 4,964   |   | $ | 11,927 |   |
| Cash payments for income  and franchise taxes, net                                             |   | 81                                   |    | 151 |   |

 

*See accompanying notes tounaudited consolidated financial statements.*

 

4

----

 

**HFFINANCIAL CORP. AND SUBSIDIARIES**

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS**

For The ThreeMonths Ended September 30, 2002 and 2001

(Unaudited)

 

**NOTE 1.          SELECTED ACCOUNTING POLICIES**

 

*Basisof presentation:*

 

The consolidatedfinancial information of HF Financial Corp. (the “Company”) and its wholly-ownedsubsidiaries included in this Form 10-Q is unaudited.  However, in the opinion of management, adjustments (consisting ofnormal recurring adjustments) necessary for a fair presentation for the interimperiods have been included.  Results forany interim period are not necessarily indicative of results to be expected forthe year.  The accounting and reportingpolicies of the Company and its subsidiaries conform to accounting principlesgenerally accepted in the United States of America (“GAAP”) and to generalpractice within the industry.

 

The interim consolidatedfinancial statements include the accounts of the Company, its wholly-ownedsubsidiaries, HomeFirst Mortgage Corp. (the “Mortgage Corp.”), HF Card ServicesL.L.C. (“HF Card”), HF Financial Group, Inc., HF Capital Trust I (“Trust I”), HF Capital Trust II, Home Federal Bank(formerly known as Home Federal Savings Bank), (the “Bank”) and the Bank’swholly-owned subsidiaries, Hometown Insurors, Inc. (“Hometown”), Mid AmericaCapital Services, Inc. (“Mid America Leasing”), Mid-America Service Corporationand PMD, Inc.  During the quarter endedSeptember 30, 2002, the Company formed two new wholly-owned subsidiaries, HFFinancial Group, Inc., and HF Capital Trust II.  See Notes 5 and 6.

 

**NOTE 2.          DISCONTINUED OPERATIONS**

 

During the fourth quarterof fiscal 2002, management committed to a plan to sell the subprime credit cardoperations through its subsidiary, HF Card, which was previously reported inthe credit card segment of the Company. HF Card ceased processing subprime credit card applications in March1999 and has been managing the portfolio from a balance of $18.1 million atJune 30, 1999, to the remaining balance of $3.4 million at September 30,2002.  The Company is negotiating thesale of the remaining receivables to a third party.  As of September 30, 2002, the Company had not entered into adefinitive agreement for the sale of the remaining receivables.  During the fourth quarter of fiscal 2002,the Company estimated the net realizable value based on estimates from a thirdparty and reclassified the net realizable value of $1.1 million at that timefrom loans receivable to loans held for sale. The Company wrote down the credit card loan portfolio an additional$29,000, net of taxes, during the first quarter of fiscal 2003.  The actual sale of the receivables andliquidation of HF Card is expected to take place in the second quarter offiscal 2003.

 

5

----

 

**NOTE 3.          REGULATORY CAPITAL**

 

The following table sets forth the Bank’s compliancewith its capital requirements at September 30, 2002:

 

|                    |   | **Amount**                 |   | **Percent** |   |
|-------------------------|--------|----------------------------|--------|-------------|--------|
|                    |   | **(Dollars in Thousands)** |   |
| Tier I (core)  capital: |   |                       |   |        |   |
| Required                |   | $                          | 30,147 |        | 4.00   | % |
| Actual                  |   | 55,898                     |   | 7.42        |   |
| Excess                  |   | 25,751                     |   | 3.42        |   |
|                    |   |                       |   |        |   |
| Risk-based  capital:    |   |                       |   |        |   |
| Required                |   | $                          | 48,225 |        | 8.00   | % |
| Actual                  |   | 61,101                     |   | 10.14       |   |
| Excess                  |   | 12,876                     |   | 2.14        |   |

 

**NOTE 4.          EARNINGS PER SHARE**

 

Basic earnings per shareis computed by dividing income available to common stockholders (the numerator)by the weighted-average number of common shares outstanding  (the denominator) during the period.  Shares issued during the period and sharesreacquired during the period are weighted for the portion of the period thatthey were outstanding. The weighted average number of common shares outstandingfor the three month period ended September 30, 2002 and 2001 was 3,335,189 and3,693,785, respectively.

 

Dilutive earnings pershare is similar to the computation of basic earnings per share except that thedenominator is increased to include the number of additional common shares thatwould have been outstanding if the dilutive options outstanding had beenexercised. The weighted average number of common and dilutive potential commonshares outstanding for the three month period ended September 30, 2002 and 2001was 3,364,660 and 3,781,211, respectively.

 
| **NOTE  5.** | **COMPANY  OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARY TRUST  HOLDING SOLELY SUBORDINATED DEBENTURES** |
|--------------|--------------------------------------------------------------------------------------------------------------------------------|

 

On July 11, 2002, theCompany issued 5,000 shares totaling $5.0 million of Company ObligatedMandatorily Redeemable Preferred Securities of HF Financial Capital Trust II(“Trust II”).  Trust II was establishedand exists for the sole purpose of issuing trust preferred securities andinvesting the proceeds in subordinated debentures of the Company.  These subordinated debentures constitute thesole asset of  Trust II.  The securities provide for cumulative cashdistributions calculated at a rate based on three-month LIBOR plus 3.65%.  The Company may, at one or more times, deferinterest payments on the capital securities for up to 20 consecutive quarterlyperiods, but not beyond October 7, 2032. The capital securities will be redeemed on October 7, 2032; however, theCompany has the option to shorten the maturity date to a date not earlier thanJuly 7, 2007.  Holders of the capitalsecurities have no voting rights, are unsecured, and rank junior in priority ofthe payment to all of the Company’s indebtedness and senior to the Company’scapital stock.

 

6

----

 

**NOTE 6.          FORMATION OF HF FINANCIAL GROUP, INC.**

 

During the first quarterof fiscal 2003, the Company formed a new wholly-owned subsidiary, HF FinancialGroup, Inc. (‘HF Group”).  HF Group willhave the exclusive right to market “Syben Services” for the Minneapolis-basedcorporation, Syben Holdings, Inc. within the territory described below.  HF Group will market Syben Services tobusiness customers in a seven state region of South Dakota, Minnesota, Iowa,Nebraska, Missouri, Kansas and North Dakota. Syben Services are internet based services that utilize proprietarysoftware developed to facilitate employee benefits administration, payrollprocessing and management and governmental reporting. The services providedthrough Syben assist employers with the management of their employer sponsoredcompensation and benefit programs.  Thismarketing venture will provide expanded opportunities to serve the Company’sexisting business customers, develop new corporate relationships and increasefee income.

 

HFGroup has been formed to deliver Syben Services.  In addition to marketing Syben Services, the Bank’s subsidiarieswill cross sell the Bank’s services such as Cash Management including directdeposit for payroll, employer sponsored retirement plans from the Bank’s Trustand Investment professionals, and group benefit of health, life, long-termcare, and disability through Hometown.

 

HF Group is incorporatedunder the laws of the State of South Dakota and will be located at theCompany’s main office in Sioux Falls, SD.

 

**NOTE 7.          NEW ACCOUNTING STANDARDS**

 

In July 2001, theFinancial Accounting Standards Board (“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 September 30, 2002 the Company had $4.6million of goodwill that ceased amortizing. In addition, at September 30, 2002 the Company had $618,000 ofidentifiable intangible assets that continued to amortize based on theprovisions of FASB Statement No. 72 and FASB Statement No. 142.

 

The Company has completedthe first step of its impairment testing to determine if goodwill isimpaired.  The Company’s conclusion isthat there is no impairment at September 30, 2002.  The impact of this standard on the Company’s net income for thethree month period ended September 30, 2002 and September 30, 2001 is asfollows:

 
|                            |   | **Three Months Ended September 30,** |   |
|---------------------------------|--------|--------------------------------------|--------|
|                            |   | **2002**                             |   | **2001** |   |
|                            |   |                                 |   |   |   |
| Reported net income             |   | $                                    | 1,510  |   | $ | 1,267 |   |
| Addback: goodwill  amortization |   | —                               |   | 105 |   |
| Adjusted net income             |   | $                                    | 1,510  |   | $ | 1,372 |   |
|                            |   |                                 |   |   |   |
| Basic earnings per share:       |   |                                 |   |   |   |
| Reported net income             |   | $                                    | 0.45   |   | $ | 0.34 |   |
| Goodwill amortization           |   | —                               |   | 0.03 |   |
| Adjusted net income             |   | $                                    | 0.45   |   | $ | 0.37 |   |
|                            |   |                                 |   |   |   |
| Diluted earnings per  share:    |   |                                 |   |   |   |
| Reported net income             |   | $                                    | 0.45   |   | $ | 0.34 |   |
| Goodwill amortization           |   | —                               |   | 0.03 |   |
| Adjusted net income             |   | $                                    | 0.45   |   | $ | 0.37 |   |

 

7

----

 

**ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS**

 

**General**

 

The Company is afinancial services provider and, as such, has inherent risks that must bemanaged in order to achieve net income. Primary risks that affect net income include credit risk, liquidityrisk, operational risk, regulatory compliance risk and reputation risk.  The Company’s net income is derived bymanagement of the net interest margin, the ability to collect fees fromservices provided, by controlling the costs of delivering services and themanagement of loan and lease losses. The primary source of revenues comes from the net interest margin, whichrepresents the difference between income on interest-earning assets (i.e. loansand investment securities) and expense on interest-bearing liabilities (i.e.deposits and borrowed funding).  The netinterest margin is affected by regulatory, economic and competitive factorsthat influence interest rates, loan demand and deposit flows.  Fees earned include charges for depositservices, 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 quarterof fiscal 2002, management committed to a plan to sell the subprime credit cardoperations through its subsidiary, HF Card, which was previously reported inthe credit card segment of the Company. HF Card ceased processing subprime credit card applications in March1999 and has been managing the portfolio from a balance of $18.1 million atJune 30, 1999, to the remaining balance of $3.4 million at September 30,2002.  The Company is negotiating thesale of the remaining receivables to a third party.  As of September 30, 2002, the Company had not entered into adefinitive agreement for the sale of the remaining receivables.  During the fourth quarter of fiscal 2002,the Company estimated the net realizable value based on estimates from a thirdparty and reclassified the net realizable value of $1.1 million at that timefrom loans receivable to loans held for sale. The actual sale of the receivables and liquidation of HF Card isexpected to take place in the second quarter of fiscal 2003.  Results of this discontinuance have beensegregated from continuing operations of the Company.

 

**Forward-Looking Statements**

 

This Form 10-Q andother reports issued by the Company, including reports filed with theSecurities and Exchange Commission, contain “forward-looking statements” thatdeal with future results, expectations, plans and performance.  In addition, the Company’s management maymake forward-looking statements orally to the media, securities analysts,investors or others.  Theseforward-looking statements might include one or more of the following:

 

•      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-lookingstatements can be identified by the fact that they do not relate strictly tohistorical or current facts.  They ofteninclude words such as “optimism”, “look-forward”, “bright”, “believe,”“expect,” “anticipate,” “intend,” “plan,” “estimate,” or words of similarmeaning, or future or conditional verbs such as “will,” “would,” “should,”“could” or “may.”

 

8

----

 

Forward-lookingstatements about the Company’s expected financial results and other plans aresubject to certain risks, uncertainties and assumptions.  These include, but are not limited to,possible legislative changes and adverse economic, business and competitivedevelopments, such as shrinking interest margins; deposit outflows; reduceddemand for financial services and loan products; changes in accounting policiesor guidelines, or in monetary and fiscal policies of the federal government;changes in credit and other risks posed by the Company’s loan portfolios; theability or inability to successfully enter into a definitive agreement for andclose anticipated transactions; technological, computer-related or operationaldifficulties; adverse changes in securities markets; results of litigation; orother significant uncertainties.

 

Forward-lookingstatements speak only as of the date they are made.  The Company does not undertake to update forward-lookingstatements to reflect circumstances or events that occur after the date theforward-looking statements are made.

 

**Financial Condition Data**

 

At September 30, 2002,the Company had total assets of $762.5 million, an increase of $39.6 millionfrom the level at June 30, 2002.  Theincrease in assets was due primarily to increases in loans and leases receivable,net of related allowance, of $26.6 million, securities available for sale of $11.1 million and loans held for saleof $6.7 million offset by a decrease in cash and cash equivalents of $5.7million.  The increase in liabilities of$38.7 million was due to increases in advances from the Federal Home Loan Bank(“FHLB”) and other borrowings of $51.1 million,  the liability for company obligated mandatorily redeemablepreferred securities of $5.0 million and advances by borrowers for taxes andinsurance of $4.1 million offset by a decrease in deposits of $22.6 millionfrom the levels at June 30, 2002.  Inaddition, stockholders’ equity increased to $49.4 million at September 30, 2002from $48.5 million at June 30, 2002 primarily due to net income of $1.5 millionoffset by dividends paid of $384,000.

 

The increase in loans andleases receivable, net of related allowance, of $26.6 million was due primarilyto purchases and originations exceeding sales, amortization and repayments ofprincipal.  Commercial business,commercial real estate and agricultural loan balances increased $18.3 millionand consumer indirect loan balances increased $7.8 million over the levels atJune 30, 2002.  Residential mortgageproduction increased 28.3% for the three months ended September 30, 2002 ascompared to the same period in the prior fiscal year.

 

The increase insecurities available for sale of $11.1 million was primarily the result ofpurchases of $31.6 million exceeding sales, maturities and calls of $20.2million.  The purchases consisted of$27.0 million in variable-rate mortgage-backed securities.  Variable-rate mortgage-backed securitiescomprise 63.9% of the Company’s securities available for sale portfolio.  Included in the securities purchases was$4.0 million of trust preferred securities for a total of $9.0 millioninvestment in trust preferred securities at September 30, 2002.  This investment is limited by Office ofThrift Supervision (“OTS”) regulation to 15.0% of equity of the Bank.  Management is utilizing the purchase of trustpreferred securities to mitigate the Company’s interest rate risk from thetotal issuance of $15.0 million in company obligated mandatorily redeemablepreferred securities at September 30, 2002.

 

The $6.7 million increasein loans held for sale was primarily due to an increase in loans originated forsale into the secondary market during the three months ended September 30,2002.

 

 

9

----

 

Advances from the FHLBand other borrowings increased $51.1 million primarily due to draws of $240.5million on advances from the FHLB exceeding paydowns on advances and otherborrowings of $189.4 million.  Theincrease in borrowings was necessary to fund asset growth.

 

The liability for companyobligated mandatorily redeemable preferred securities increased $5.0 milliondue to the Company issuing additional trust preferred securities through TrustII.  The proceeds from the issuance areprimarily utilized for injection of Tier 1 (core) capital into the Bank and toprovide liquidity for repurchasing Company stock.  See Note 5.

 

The $4.1 million increasein advances by borrowers for taxes and insurance was due primarily to thereceipt of escrow payments in excess of amounts paid out.  The major escrow payments are primarily paidsemiannually in April and October.

 

The $22.6 milliondecrease in deposits was primarily due to a decrease in savings accounts of$20.9 million (of which $20.7 million were public fund deposits) and moneymarket accounts of $14.8 million offset by an increase in demand accounts of$8.5 million and certificates of deposit of $4.7 million.  The overall net decrease in demand and moneymarket accounts included a decrease in public fund accounts of $12.0 millioncompared to the levels at June 30, 2002.

 

10

----

 

**Analysisof Net Interest Income**

 

Net interest incomerepresents the difference between income on interest-earning assets and expenseon interest-bearing liabilities.  Netinterest income depends upon the volume of interest-earning assets andinterest-bearing liabilities and the interest rates earned or paid on them.

 

*Average Balances, Interest Rates andYields.*  The followingtable presents for the periods indicated, the total dollar amount of interestincome from average interest-earning assets and the resulting yields, as wellas the interest expense on average interest-bearing liabilities, expressed bothin dollars and rates, and the net interest margin.  The table does not reflect any effect of income taxes.  All average balances are monthly averagebalances and include the balances of nonaccruing loans.  The yields and costs for the three monthsended September 30, 2002 and 2001 include fees which are considered adjustmentsto yield.  Balances related to discontinuedcredit card loan operations have been reclassified to non-interest earningassets for all periods presented.

 
|                                                                                                                          |   | **THREE MONTHS ENDED SEPTEMBER 30,** |    |
|-------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------------------|---------|
|                                                                                                                          |   | **2002**                             |    | **2001** |   |
|                                                                                                                          |   | **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)                                                                                               |   | $                                    | 581,730 |   | $ | 10,501 |   | 7.16 | % | $ | 565,622 |   | $ | 11,692 |   | 8.20 | % |
| Investment  securities(2)(3)                                                                                                  |   | 88,109                               |    | 957 |   | 4.31 | % | 143,272 |   | 1,737 |   | 4.81 | % |
| FHLB  stock                                                                                                                   |   | 6,363                                |    | 48 |   | 2.99 | % | 6,332 |   | 65 |   | 4.07 | % |
|                                                                                                                          |   |                                 |    |   |   |   |   |   |   |   |   |   |   |
| Total  interest-earning assets                                                                                                |   | $                                    | 676,202 |   | $ | 11,506 |   | 6.75 | % | $ | 715,226 |   | $ | 13,494 |   | 7.49 | % |
| Noninterest-earning  assets                                                                                                   |   | 47,510                               |    |   |   |   |   | 50,313 |   |   |   |   |   |
| Total  assets                                                                                                                 |   | $                                    | 723,712 |   |   |   |   |   | $ | 765,539 |   |   |   |   |   |
|                                                                                                                          |   |                                 |    |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing  liabilities:                                                                                                |   |                                 |    |   |   |   |   |   |   |   |   |   |   |
| Deposits:                                                                                                                     |   |                                 |    |   |   |   |   |   |   |   |   |   |   |
| Checking  and money market                                                                                                    |   | $                                    | 189,719 |   | $ | 739 |   | 1.55 | % | $ | 170,593 |   | $ | 1,369 |   | 3.18 | % |
| Savings                                                                                                                       |   | 40,752                               |    | 101 |   | 0.98 | % | 41,050 |   | 254 |   | 2.45 | % |
| Certificates  of deposit                                                                                                      |   | 253,892                              |    | 2,548 |   | 3.98 | % | 318,267 |   | 4,651 |   | 5.80 | % |
| Total  deposits                                                                                                               |   | $                                    | 484,363 |   | $ | 3,388 |   | 2.78 | % | $ | 529,910 |   | $ | 6,274 |   | 4.70 | % |
| FHLB  advances and other borrowings                                                                                           |   | 104,371                              |    | 1,169 |   | 4.44 | % | 110,790 |   | 1,447 |   | 5.18 | % |
| Company  obligated mandatorily redeemable preferred securities of subsidiary trusts  that solely hold subordinated debentures |   | 14,176                               |    | 214 |   | 5.99 | % | — |   | — |   | 0.00 | % |
|                                                                                                                          |   |                                 |    |   |   |   |   |   |   |   |   |   |   |
| Total  interest-bearing liabilities                                                                                           |   | $                                    | 602,910 |   | $ | 4,771 |   | 3.14 | % | $ | 640,700 |   | $ | 7,721 |   | 4.78 | % |
| Noninterest-bearing  deposits(4)                                                                                              |   | 52,909                               |    |   |   |   |   | 47,291 |   |   |   |   |   |
| Other  liabilities                                                                                                            |   | 18,633                               |    |   |   |   |   | 24,037 |   |   |   |   |   |
| Total  liabilities                                                                                                            |   | $                                    | 674,452 |   |   |   |   |   | $ | 712,028 |   |   |   |   |   |
| Equity                                                                                                                        |   | 49,260                               |    |   |   |   |   | 53,511 |   |   |   |   |   |
| Total  liabilities and equity                                                                                                 |   | $                                    | 723,712 |   |   |   |   |   | $ | 765,539 |   |   |   |   |   |
|                                                                                                                          |   |                                 |    |   |   |   |   |   |   |   |   |   |   |
| Net  interest income; interest rate spread(5)                                                                                 |   |                                 |    | $ | 6,735 |   | 3.61 | % |   |   | $ | 5,773 |   | 2.71 | % |
|                                                                                                                          |   |                                 |    |   |   |   |   |   |   |   |   |   |   |
| Net  interest margin(5)(6)                                                                                                    |   |                                 |    |   |   | 3.95 | % |   |   |   |   | 3.20 | % |

 

----

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

(2)   Includesprimarily U.S. Government and agency securities and FHLB daily time.

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

(4)   Previouslyreported in interest-bearing liabilities under checking and money market. Rateshave been restated for all periods presented to reflect change inclassification.

(5)   Percentagesfor the three months ended September 30, 2002 and September 30, 2001 have beenannualized.

(6)   Netinterest margin is net interest income divided by average interest-earningassets.

 

11

----

 

**Rate/VolumeAnalysis of Net Interest Income**

 

The following schedulepresents the dollar amount of changes in interest income and interest expensefor major components of interest-earning assets and interest-bearingliabilities.  It distinguishes betweenthe increases and decreases due to fluctuating outstanding balances that aredue to the levels and volatility of interest rates.  For each category of interest-earning assets and interest-bearingliabilities, information is provided on changes attributable to (i) changes involume (i.e., changes in volume multiplied by old rate) and (ii) changes inrate (i.e., changes in rate multiplied by old volume).  For purposes of this table, changesattributable to both rate and volume, which cannot be segregated, have beenallocated proportionately to the change due to volume and the change due torate.

 
|                                                                                                                          |   | **Three  Months Ended September 30,**    |   |
|-------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------------------|--------|
|                                                                                                                          |   | **2002 vs  2001**                        |   |
|                                                                                                                          |   | **Increase  (Decrease)  Due to  Volume** |   | **Increase  (Decrease)  Due to  Rate** |   | **Total  Increase  (Decrease)** |   |
|                                                                                                                          |   | **(Dollars  in Thousands)**              |   |
| Interest-earning  assets:                                                                                                     |   |                                     |   |   |   |   |   |
| Loans  and leases receivable(1)                                                                                               |   | $                                        | 333    |   | $ | (1,524 | ) | $ | (1,191 | ) |
| Other  investment securities(2)                                                                                               |   | (669                                     | )      | (111 | ) | (780 | ) |
| FHLB  stock                                                                                                                   |   | —                                   |   | (17 | ) | (17 | ) |
|                                                                                                                          |   |                                     |   |   |   |   |   |
| Total  interest-earning assets                                                                                                |   | $                                        | (336   | ) | $ | (1,652 | ) | $ | (1,988 | ) |
|                                                                                                                          |   |                                     |   |   |   |   |   |
| Interest-bearing  liabilities:                                                                                                |   |                                     |   |   |   |   |   |
| Deposits:                                                                                                                     |   |                                     |   |   |   |   |   |
| Checking  and money market                                                                                                    |   | $                                        | 153    |   | $ | (783 | ) | $ | (630 | ) |
| Savings                                                                                                                       |   | (2                                       | )      | (151 | ) | (153 | ) |
| Certificates  of deposit                                                                                                      |   | (941                                     | )      | (1,162 | ) | (2,103 | ) |
| Total  deposits                                                                                                               |   | (790                                     | )      | (2,096 | ) | (2,886 | ) |
| FHLB  advances and other borrowings                                                                                           |   | (84                                      | )      | (194 | ) | (278 | ) |
| Company  obligated mandatorily redeemable preferred securities of subsidiary trusts  that solely hold subordinated debentures |   | 214                                      |   | — |   | 214 |   |
|                                                                                                                          |   |                                     |   |   |   |   |   |
| Total  interest-bearing liabilities                                                                                           |   | $                                        | (660   | ) | $ | (2,290 | ) | $ | (2,950 | ) |
|                                                                                                                          |   |                                     |   |   |   |   |   |
| Net  interest income                                                                                                          |   |                                     |   |   |   | $ | 962 |   |

 

----

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

(2)   Includesprimarily U. S. Government and agency securities and FHLB daily time.

 

12

----

 

**Applicationof Critical Accounting Policies**

 

GAAP requires managementto utilize estimates when reporting financial results.  The Company has identified the policydiscussed below as a Critical Accounting Policy because the accounting estimaterequires management to make certain assumptions about matters that may beuncertain 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 for Loan andLease Losses – GAAP requires the Company to set aside reserves or maintain anallowance against inherent loan and lease losses in the loan and leaseportfolio.  Management must develop aconsistent and systematic approach to estimate the appropriate balances thatwill cover the inherent losses.  Due tothe uncertainty of future events, the approach includes a process that maydiffer significantly from other methodologies and still produce an estimatethat is in accordance with GAAP.

 

The allowance is compiledby utilizing the Company’s loan risk rating system which is structured toidentify any weaknesses in the loan portfolio. The risk rating system has evolved to a process whereby managementbelieves the system will properly identify the credit risk associated with theloan portfolio.  Due to the segmentingof loans for the allowance calculation, the estimate of the allowance for loanand lease losses could change materially if the loan risk rating system wouldnot properly identify the strength of a large or a few large loancustomers.  Although management believesthat it uses the best information available to determine the allowance,unforeseen market or borrower conditions could result in adjustments and netearnings being significantly affected if circumstances differ substantiallyfrom the assumptions used in making the final determinations.

 

**AssetQuality**

 

Whena borrower fails to make a required payment on real estate secured loans within10 to 15 days after the payment is due, the Bank generally institutescollection procedures by issuing a late notice.  The customer is contacted again when the payment is 30 days pastdue.  In the case of consumer loans, theborrower is sent a notice when a loan is 10 days past due and is contacted bytelephone when a loan is 30 days past due. In most cases, delinquencies are cured promptly; however, if a loan hasbeen delinquent for more than 30 days, the Bank attempts additional written aswell as verbal contacts and, if necessary, personal contact with the borrowerin order to determine the reason for the delinquency and to effect a cure, and,where appropriate, reviews the condition of the property and the financialcircumstances of the borrower.  Basedupon the results of any such investigation, the Bank may: (i) accept arepayment program which under appropriate circumstances could involve anextension in the case of consumer loans for the arrearage from the borrower,(ii) seek evidence, in the form of a listing contract, of efforts by theborrower to sell the property if the borrower has stated that he is attemptingto sell, or (iii) initiate foreclosure proceedings. When a loan payment isdelinquent for 90 days, the Bank generally will initiate foreclosureproceedings unless management is satisfied the credit problem is correctable.

 

Loans are generallyclassified 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.

 

Nonperforming assetsincreased to $11.6 million at September 30, 2002 from $11.5 million at June 30,2002, an increase of $79,000, or 0.7%. Although nonperforming assets increased slightly from the levels at June30, 2002, the ratio of nonperforming assets to total assets, which is oneindicator of credit risk exposure, decreased to 1.52% at September 30, 2002 ascompared to 1.59% at June 30, 2002.

 

13

----

 

Nonaccruing loans andleases decreased 5.1% or $524,000 to $9.7 million at September 30, 2002compared to $10.2 million at June 30, 2002. Included in nonaccruing loans and leases at September 30, 2002 weretwelve loans totaling $704,000 secured by one- to four-family real estate, fiveloans in the amount of $1.3 million secured by commercial real estate, threemobile home loans totaling $22,000, twenty commercial business loans totaling$1.9 million, eight agricultural loans totaling $4.8 million, eight equipmentfinance leases totaling $89,000 and fifty-nine consumer loans totaling$939,000.  One loan, secured bycommercial real estate, in the amount of $2.4 million included in nonaccrualloan balances at June 30, 2002 was paid in full during the first quarter offiscal 2003.  Offsetting the commercialreal estate loan payoff was one large agricultural real estate nonaccrual loanin the amount of $2.4 million during the first quarter of fiscal 2003.  This agricultural loan has been modified asa troubled debt restructuring with specific allowance reserve allocation andwill be closely monitored for performance.

 

The Company’snonperforming loans and leases, which represent nonaccrual and past due 90 daysand still accruing, have increased $86,000 or 0.8% from the levels at June 30,2002.  The risk rating system in placeis designed to identify and manage the nonperforming loans and leases.  Commercial and agricultural loans andequipment finance leases will have specific reserve allocations 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.  Theincrease in nonperforming loans and leases is also related to a few largecommercial and agricultural loans that have been analyzed for collateral valueand appropriate loss reserves have been allocated.

 

As of September 30, 2002,the Company had $367,000 of foreclosed assets. The balance of foreclosed assets at September 30, 2002 consisted of$121,000 in consumer collateral (excluding mobile home loans), $4,000 in mobilehomes and $242,000 in single-family residences.

 

At September 30, 2002,the Company had (from continuing operations,including certain loans discussed in this Form 10-Q) criticized $11.3 millionof its assets as special mention, classified $10.5 million as substandard  and approximately $6.8 million as doubtfulthat management has determined need to be closely monitored because of possiblecredit problems of the borrowers or the cash flows of the securedproperties.  These loans were consideredin determining the adequacy of the allowance for loan and lease losses.  The allowance for  loan losses is established based on management’s evaluation ofthe risks inherent in the loan portfolio and changes in the nature and volumeof loan activity.  Such evaluation,which includes a review of all loans for which full collectability may not bereasonably assured, considers the estimated fair market value of the underlyingcollateral, present value of expected principal and interest payments, economicconditions, historical loss experience and other factors that warrantrecognition in providing for an adequate loan and lease loss allowance.

 

Although the Company’smanagement believes that the September 30, 2002 recorded allowance for loan andlease losses was adequate to provide for probable losses on the related loansand leases, there can be no assurance that the allowance existing at September30, 2002 will be adequate in the future.

 

14

----

 

In accordance with theCompany’s internal classification of assets policy, management evaluates theloan and lease portfolio on a monthly basis to identify loss potential anddetermines the adequacy of the allowance for loan and lease lossesquarterly.  Loans are placed onnonaccrual status when the collection of principal and/or interest becomedoubtful.  Foreclosed assets includeassets acquired on settlement of loans. The following table sets forth the amounts and categories of theCompany’s nonperforming assets from continuing operations for the periodsindicated.  Balances related todiscontinued credit card loan operations have been eliminated for all periodspresented.

 
|                                                                  |   | **Nonperforming Assets As Of** |   |
|-----------------------------------------------------------------------|--------|--------------------------------|--------|
|                                                                  |   | **September 30,  2002**        |   | **June 30,  2002** |   |
|                                                                  |   | **(Dollars  in Thousands)**    |   |
| Nonaccruing  loans and leases:                                        |   |                           |   |   |   |
| One-  to four-family                                                  |   | $                              | 704    |   | $ | 886 |   |
| Commercial  real estate                                               |   | 1,294                          |   | 3,678 |   |
| Multi-family                                                          |   | —                         |   | 290 |   |
| Commercial  business                                                  |   | 1,890                          |   | 1,872 |   |
| Equipment  finance leases                                             |   | 89                             |   | — |   |
| Consumer                                                              |   | 939                            |   | 690 |   |
| Agriculture                                                           |   | 4,780                          |   | 2,801 |   |
| Mobile  homes                                                         |   | 22                             |   | 25 |   |
| Total                                                                 |   | 9,718                          |   | 10,242 |   |
|                                                                  |   |                           |   |   |   |
| Accruing  loans and leases delinquent more than 90 days:              |   |                           |   |   |   |
| Commercial  real estate                                               |   | 3                              |   | — |   |
| Commercial  business                                                  |   | 660                            |   | 512 |   |
| Equipment  finance leases                                             |   | 57                             |   | 229 |   |
| Agriculture                                                           |   | 796                            |   | 165 |   |
| Total                                                                 |   | 1,516                          |   | 906 |   |
|                                                                  |   |                           |   |   |   |
| Foreclosed  assets:(1)                                                |   |                           |   |   |   |
| One-  to four-family                                                  |   | 242                            |   | 239 |   |
| Consumer                                                              |   | 121                            |   | 132 |   |
| Mobile  homes                                                         |   | 4                              |   | 3 |   |
| Total                                                                 |   | 367                            |   | 374 |   |
|                                                                  |   |                           |   |   |   |
| Total  nonperforming assets                                           |   | $                              | 11,601 |   | $ | 11,522 |   |
|                                                                  |   |                           |   |   |   |
| Ratio  of nonperforming assets to total assets                        |   | 1.52                           | %      | 1.59 | % |
|                                                                  |   |                           |   |   |   |
| Ratio  of nonperforming loans and leases to total loans and leases(2) |   | 1.86                           | %      | 1.96 | % |

 

----

(1)   Totalforeclosed assets do not include land held for sale.

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

 

15

----

 

The following table setsforth information with respect to activity in the Company’s allowance for loanand lease losses from continuing operations during the periods indicated.  Balances related to discontinued credit cardloan operations have been eliminated for all periods presented.

 
|                                                                                                     |   | **Three Months Ended September 30,** |   |
|----------------------------------------------------------------------------------------------------------|--------|--------------------------------------|--------|
|                                                                                                     |   | **2002**                             |   | **2001** |   |
|                                                                                                     |   | **(Dollars in Thousands)**           |   |
|                                                                                                     |   |                                 |   |   |   |
| Balance  at beginning of period                                                                          |   | $                                    | 4,461  |   | $ | 5,509 |   |
| Charge-offs:                                                                                             |   |                                 |   |   |   |
| One-  to four-family                                                                                     |   | —                               |   | (12 | ) |
| Commercial  real estate                                                                                  |   | —                               |   | (50 | ) |
| Commercial  business                                                                                     |   | (53                                  | )      | (134 | ) |
| Equipment  finance leases                                                                                |   | (54                                  | )      | (18 | ) |
| Consumer                                                                                                 |   | (272                                 | )      | (327 | ) |
| Agriculture                                                                                              |   | —                               |   | (58 | ) |
| Mobile  homes                                                                                            |   | (18                                  | )      | (10 | ) |
| Total  charge-offs                                                                                       |   | (397                                 | )      | (609 | ) |
|                                                                                                     |   |                                 |   |   |   |
| Recoveries:                                                                                              |   |                                 |   |   |   |
| Commercial  real estate                                                                                  |   | —                               |   | 2 |   |
| Equipment  finance leases                                                                                |   | 6                                    |   | 26 |   |
| Consumer                                                                                                 |   | 96                                   |   | 86 |   |
| Mobile  homes                                                                                            |   | 2                                    |   | 1 |   |
| Total  recoveries                                                                                        |   | 104                                  |   | 115 |   |
|                                                                                                     |   |                                 |   |   |   |
| Net  (charge-offs)                                                                                       |   | (293                                 | )      | (494 | ) |
|                                                                                                     |   |                                 |   |   |   |
| Additions  charged to operations                                                                         |   | 1,034                                |   | 523 |   |
|                                                                                                     |   |                                 |   |   |   |
| Balance  at end of period                                                                                |   | $                                    | 5,202  |   | $ | 5,538 |   |
|                                                                                                     |   |                                 |   |   |   |
| Ratio  of net (charge-offs) during the period to average loans and leases  outstanding during the period |   | (0.05                                | )%     | (0.09 | )% |
|                                                                                                     |   |                                 |   |   |   |
| Ratio  of allowance for loan and lease losses to total loans and leases at end of  period                |   | 0.86                                 | %      | 1.03 | % |
|                                                                                                     |   |                                 |   |   |   |
| Ratio  of allowance for loan and lease losses to nonperforming loans and leases at  end of period(1)     |   | 46.31                                | %      | 92.52 | % |

 

----

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

 

16

----

 

The distribution of theCompany’s allowance for loan and lease losses at the dates indicated issummarized in the following table. Balances related to discontinued credit card loan operations have beeneliminated for all periods presented.

 
|                     |   | **At September 30,  2002**  |   | **At June 30,  2002** |   |
|--------------------------|--------|-----------------------------|--------|-----------------------|--------|
|                     |   | **Amount**                  |   | **Amount**            |   |
|                     |   | **(Dollars  in Thousands)** |   |
|                     |   |                        |   |                  |   |
| One- to four-family      |   | $                           | 66     |                  | $      | 81 |   |
| Commercial real estate   |   | 268                         |   | 490                   |   |
| Multi-family real estate |   | 126                         |   | 116                   |   |
| Commercial business      |   | 1,283                       |   | 1,164                 |   |
| Equipment finance leases |   | 322                         |   | 296                   |   |
| Consumer                 |   | 1,925                       |   | 1,889                 |   |
| Agricultural             |   | 1,178                       |   | 375                   |   |
| Mobile homes             |   | 34                          |   | 50                    |   |
|                     |   |                        |   |                  |   |
| Total                    |   | $                           | 5,202  |                  | $      | 4,461 |   |

 

The allowance for loanand lease losses was $5.2 million at September 30, 2002 as compared to $5.5million at September 30, 2001.  Theratio of the allowance for loan and lease losses to total loans and leases was0.86% at September 30, 2002 compared to 1.03% at September 30, 2001, a decreaseof 16.4%.  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, currenteconomic conditions and other factors that in management’s judgment deserverecognition. Regulators have reviewed the Bank’s methodology for determiningallowance requirements on the Bank’s loan portfolio and have made no requiredrecommendations for increases in the allowances during the three months endedSeptember 30, 2002.

 

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.

 

Althoughmanagement believes that it uses the best information available to determinethe allowances, unforeseen market conditions could result in adjustments andnet earnings being significantly affected if circumstances differ substantiallyfrom the assumptions used in making the final determinations.  Future additions to the Bank’s allowancesresult from periodic loan, property and collateral reviews and thus cannot bepredicted in advance.

 

17

----

 

**Comparison of the Three Months EndedSeptember 30, 2002 and September 30, 2001**

 

**Continued Operations:**

 

*General*.  The Company’s net income from continuingoperations was $1.5 million or $0.43 for both basic and diluted earnings pershare for the first quarter of fiscal 2003, a 29.1% increase in earningscompared to $1.1 million or $0.30 for both basic and diluted earnings per sharefor the same period in the prior fiscal year. Basic and diluted earnings per share increased 43.3% for the threemonths ended September 30, 2002 as compared to the three months ended September30, 2001, due to the increase in quarter earnings and Company stockrepurchases.  For the three months endedSeptember 30, 2002, the return on average equity from continuing operations was11.78%, a 40.2% increase compared to 8.40% for the same period in the priorfiscal year.  For the three months endedSeptember 30, 2002, the return on average assets from continuing operations was0.80%, a 35.6% increase compared to 0.59% for the same period in the priorfiscal year.  As discussed in moredetail below, the increases were due to a variety of key factors, includingincreases in net interest income of $962,000 and noninterest income of $166,000offset by increases in provision for losses on loans and leases of $511,000,noninterest expense of $121,000 and income tax expense of $169,000.

 

*Interest and Dividend Income.*  Interest and dividend income was $11.5million for the three months ended September 30, 2002 as compared to $13.5million for the same period in the prior fiscal year, a decrease of $2.0 millionor 14.7%.  A $1.7 million decrease ininterest and dividend income was the result of a 9.9% decrease in the averageyield on interest-earning assets.  Theaverage yield on interest-earning assets was 6.75% for the three months endedSeptember 30, 2002 as compared to 7.49% for the same period in the prior fiscalyear.  For the three months endedSeptember 30, 2002, the average yield on loans and leases receivable was 7.16%,a decrease of 12.7% from 8.20% for the same period in the prior fiscalyear.  The overall decrease in interestand dividend income was primarily due to repricing of loans and investmentsthat generally reflected the decline in national interest rates.  From June 30, 2001 to September 30, 2002,the prime rate dropped from 6.75% to 4.75%.  Average volume decreases of $39.0 million in interest-earningassets contributed to a $336,000 decrease in interest and dividend income forthe three months ended September 30, 2002 as compared to the same period in theprior fiscal year.   The Company alsorecorded an additional net increase to interest income of $190,000 fornonaccrual loan interest adjustments during the first quarter of fiscal 2003for two commercial and agricultural loans. See “Asset Quality”.

 

*Interest Expense.*  Interest expense was $4.8 million for thethree months ended September 30, 2002 as compared to $7.7 million for the sameperiod in the prior fiscal year, a decrease of $3.0 million or 38.2%.  A $2.3 million decrease in interest expensewas the result of a 34.3% decrease in the average rate paid on interest-bearingliabilities.  The average rate oninterest-bearing liabilities was 3.14% for the three months ended September 30,2002 as compared to 4.78% for the same period in the prior fiscal year.  For the three months ended September 30,2002, the average rate paid on interest-bearing deposits was 2.78%, a decreaseof 40.9% from 4.70% for the same period in the prior fiscal year.  Average volume decreases of $37.8 million ininterest-bearing liabilities contributed to a $660,000 decrease in interestexpense for the three months ended September 30, 2002 as compared to the sameperiod in the prior fiscal year.

 

*Net Interest Income.*The Company’s net interest income from continuing operations for the threemonths ended September 30, 2002 increased $962,000, or 16.7%, to $6.7 millioncompared to $5.8 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 earning asset balances andnational interest rates were declining. The Company’s net interest margin was 3.95% for the three months endedSeptember 30, 2002, an increase of 23.4% from 3.20% for the same period in theprior fiscal year.  The Company’searning assets balances declined primarily because higher yielding mortgageloans were refinancing at lower rates. The Company experienced considerable runoff in its one- to four-familyloan portfolio due primarily to lower national mortgage rates and averagebalances on one- to four-family loans also dropped compared to one year ago dueto a $23.1 million package loan sale occurring in the first quarter offiscal  2002. Certificates of depositbalances declined and both certificates of deposit and money market accountscontinued to reprice at lower rates.

 

18

----

 

*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 probable 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 the three monthsended September 30, 2002, the Company recorded a provision for losses on loansand leases of $1.0 million compared to $523,000 for the three months endedSeptember 30, 2001, an increase of $511,000. See “Asset Quality” for further discussion.

 

*Noninterest Income.*  Noninterest income was $3.1 million for thethree months ended September 30, 2002 as compared to $2.9 million for the threemonths ended September 30, 2001, an increase of $166,000  or 5.7%. The increase in noninterest income was due primarily to increases in netgain on sale of securities of $350,000, loan fees and service charges of$206,000 and fees on deposits of $122,000 offset by decreases in net gain onsale of loans of $262,000 and loan servicing income of $222,000.

 

Net gain on sale ofsecurities increased $350,000 as there were no sales occurring in the firstquarter of fiscal 2002.  Long-termfixed-rate mortgage-backed securities were sold to reduce the potential marketvalue loss of rising interest rates.

 

Loan fees and servicecharges increased 75.7% to $478,000 during the first quarter of fiscal 2003compared to $272,000 for same period in the prior fiscal year.  The increase was primarily due to anincrease in residential mortgage loan production of 28.3% as compared to thesame period one year ago.  In a periodicreview of costs to originate loans, management reduced the loan origination feedeferral amount, thus increasing immediate loan origination fee income.  This change in estimate, which is accountedfor prospectively, resulted in an increase of approximately $170,000 over thesame period in the prior year.

 

Fees on depositsincreased 12.7% to $1.1 million during the first quarter of fiscal 2003compared to $961,000 for the same period in the prior fiscal year primarily dueto a $19.4 million increase in demand deposit account balances at September 30,2002 compared to balances at September 30, 2001 and an increase in monthly feescharged on savings accounts.

 

Net gain on sale of loanswas $222,000 for the three months ended September 30, 2002 compared to $484,000for the same period in the prior fiscal year. Loan servicing income was $404,000 for the three months ended September30, 2002 compared to $626,000 for the same period in the prior fiscalyear.  The total 43.6% decrease wasprimarily due to a $23.1 million package loan sale occurring in the firstquarter of fiscal  2002.

 

19

----

 

*Noninterest Expense.*  Noninterest expense was $6.4 million for thethree months ended September 30, 2002 as compared to $6.3 million for the threemonths ended September 30, 2001, an increase of $121,000 or 1.9%.  The increase in noninterest expense was dueprimarily to increases in compensation and employee benefits of $248,000 offsetby decreases in amortization of intangible assets of $84,000 and occupancy andequipment of $72,000.

 

Compensation and employeebenefits increased 6.4% to $4.1 million for the three months ended September30, 2002 as compared to $3.9 million for the same period in the prior fiscalyear in part due to increased pension costs of $113,000 due to a combination ofhigher payroll covered and the investment performance of the pension trustaccount.  Four new in-store locationsopened since September 30, 2001 attributed to an increase in employeecompensation and related benefits of $198,000 for the three months endedSeptember 30, 2002 as compared to the same period in the prior fiscal year.

 

Amortization ofintangible assets decreased 67.2% or $84,000 for the three months endedSeptember 30, 2002 compared to the same period in the prior fiscal year due tocessation of amortization on goodwill. See Note 7.

 

Occupancy and equipmentexpense decreased 8.1% or $72,000 for the three months ended September 30, 2002compared to the same period in the prior fiscal year due to a $64,000 reductionin costs associated with office building and equipment repairs, maintenance andrental.

 

The Company expects thecost for property and casualty coverage will be increasing at its next renewaldate due to the terrorists attacks of September 11, 2001.  The Company has been informed by itsproperty and casualty insurance carrier that due to terrorist attacks of September 11, 2001, and the resultingunavailability of reinsurance in the market, insurance contracts will be amended with exclusionary language that willclearly define what is considered war and terrorist activity and excludescoverage for certain war and terrorist actions.  Management believes that these exclusions could have an impact onthe Company’s financial performance should an event such as the events ofSeptember 11, 2001 take place in the Company’s trade territory.

 

*Income tax expense.*  The Company’s income tax expense for thethree months ended September 30, 2002 increased $169,000 or 23.8% to $880,000compared to $711,000 for the three months ended September 30, 2001.  The increase was primarily due to anincrease in the Company’s pre-tax income from continuing operations of $496,000offset by a reduction in the Company’s effective tax rate.   The effective tax rate was 37.8% and 38.7%for the three months ended September 30, 2002 and September 30, 2001,respectively.

 

**DiscontinuedOperations:**

 

*Incomefrom discontinued operations. *Incomefrom discontinued operations decreased 58.7% or $84,000 for the three monthsended September 30, 2002 compared to the same period in the prior fiscal yearprimarily due to a reduction in the credit card loan portfolio and anadditional write down of $29,000, net of taxes, to net realizable value.  See Note 2 for further discussion ondiscontinued operations.

 

20

----

 

**Liquidityand Capital Resources**

 

The Bank’s primarysources of funds are in market deposits, FHLB advances and other borrowings,amortization and repayments of loan principal, mortgage-backed securities andcallable agency securities and, to a lesser extent, sales of mortgage loans,sales and/or maturities of securities, mortgage-backed securities, andshort-term investments.  While scheduledloan payments and maturing securities are relatively predictable, deposit flowsand loan prepayments are more influenced by interest rates, general economicconditions and competition. The Bank attempts to price its deposits to meet itsasset/liability objectives consistent with local market conditions.  Excess balances are invested in overnightfunds.

 

Liquidity management isboth 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.  During the three months ended September 30,2002, the Bank increased its borrowings with the FHLB by $51.1 million.  See “Financial Condition Data” for furtherdiscussion.

 

The Bank anticipates thatit will have sufficient funds available to meet current loan commitments.  At September 30, 2002, the Bank hadoutstanding commitments to originate and purchase mortagage and commercial loansof $55.9 million and to sell mortgage and commercial loans of $33.4million.  At September 30, 2002, theCompany had outstanding commitments to purchase securities available for saleof $5.1 million and no commitments to sell securities available for sale.

 

Although in marketdeposits are the Bank’s primary source of funds, the Bank’s policy has been toutilize borrowings where the funds can be invested in either loans orsecurities 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 toincrease its contingent liquidity sources. The Bank currently has two $10.0 million unsecured lines of federalfunds with correspondent banks.  Therewere no funds drawn on either line of credit at September 30, 2002.  Also, the Bank is implementing arrangementsto acquire out of market certificate of deposits as an additional source offunding.  As of September 30, 2002, theBank had $5.0 million in programmed out of market deposits.  The Bank may also seek other sources ofcontingent liquidity including additional federal funds purchased lines withcorrespondent banks and lines of credit with the FRB.  See “Financial Condition Data” for further analysis.

 

The Company currently hasin effect a stock buy back program in which up to 10.00% of the common stock ofthe Company outstanding on May 1, 2002 may be acquired through April 30,2003.  A total of 5,216 shares of commonstock were purchased pursuant to this program during the three months endedSeptember 30, 2002.

 

On July 11, 2002, theCompany issued 5,000 shares totaling $5.0 million of Company ObligatedMandatorily Redeemable Preferred Securities of HF Financial Capital Trust II(“Trust II”).  Trust II was establishedand exists for the sole purpose of issuing trust preferred securities andinvesting the proceeds in subordinated debentures of the Company.  These subordinated debentures constitute thesole asset of  Trust II.  The securities provide for cumulative cashdistributions calculated at a rate based on three-month LIBOR plus 3.65%.  The Company may, at one or more times, deferinterest payments on the capital securities for up to 20 consecutive quarterlyperiods, but not beyond October 7, 2032. The capital securities will be redeemed on October 7, 2032; however, theCompany has the option to shorten the maturity date to a date not earlier thanJuly 7, 2007.  Holders of the capitalsecurities have no voting rights, are unsecured, and rank junior in priority ofthe payment to all of the Company’s indebtedness and senior to the Company’scapital stock.

 

21

----

 

Savings institutionsinsured by the Federal Deposit Insurance Corporation are required by theFinancial Institutions Reform, Recovery and Enforcement Act of 1989 (“FIRREA”)to meet three regulatory capital requirements. If a requirement is not met, regulatory authorities may take legal oradministrative actions, including restrictions on growth or operations or, inextreme cases, seizure.  Institutionsnot in compliance may apply for an exemption from the requirements and submit arecapitalization plan.  Under thesecapital requirements, at September 30, 2002, the Bank met all current capitalrequirements.

 

The OTS has adopted 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 7.42% atSeptember 30, 2002.

 

**Impactof Inflation and Changing Prices**

 

The ConsolidatedFinancial Statements and Notes thereto presented in this Form 10-Q have beenprepared in accordance with GAAP, which require the measurement of financialposition 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.

 

**RecentAccounting Pronouncements**

 

TheFASB has issued certain Statements of Financial Accounting Standards which haverequired effective dates occurring after the Company’s June 30, 2002 fiscal yearend.  The Company’s financialstatements, including the disclosures in this Form 10-Q, are not expected to bematerially affected by those accounting pronouncements.

 

22

----

 

**ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

Interest rate risk is themost significant market risk affecting the Company.  Other types of market risk, such as foreign currency exchangerate risk and commodity price risk, do not arise in the normal course of the Company’sbusiness activities.

 

The composition of theBank’s balance sheet results in maturity mismatches between interest-earningassets and interest-bearing liabilities. The scheduled maturities of the Bank’s fixed rate interest-earningassets are longer than the scheduled maturities of its fixed rateinterest-bearing liabilities.  Thismismatch exposes the Bank to interest rate risk.  In a rising rate scenario, as measured by the OTS interest raterisk exposure simulation model, the estimated market or portfolio value (“PV”)of the Bank’s assets would decline in value to a greater degree than the changein the PV of the Bank’s liabilities, thereby reducing net portfolio value(“NPV”), the estimated market value of its shareholders’ equity.

 

One approach used toquantify interest rate risk is the NPV analysis.  In essence, this analysis calculates the difference between thepresent value of the liabilities and the present value of expected cash flowsfrom assets and off-balance sheet contracts. The following table sets forth, at June 30, 2002, (most recent reportavailable) an analysis of the Company’s interest rate risk as measured by theestimated changes in NPV resulting from instantaneous and sustained parallelshifts in the yield curve (+ 300 or -100 basis points, measured in 100 basispoint increments).  Due to theabnormally low prevailing interest rate environment, -200 and -300 NPV were notestimated by the OTS.

 

The data in the followingtable is based on assumptions utilized by the OTS in assessing interest raterisk of thrift institutions and published in “Selected Asset and LiabilityPrice Tables as of June 30, 2002”.  Evenif interest rates change in the designated amounts, there can be no assurancethat the Company’s assets and liabilities would perform as set forthbelow.  In addition, a change in U.S.Treasury rates in the designated amounts accompanied by a change in the shapeof the Treasury yield curve would cause significantly different changes to theNPV than indicated below.

 

|                           |   |                         |   | **Estimated  Increase  (Decrease) in NPV** |   |
|--------------------------------|--------|------------------------------|--------|--------------------------------------------|--------|
| **Change in  Interest Rates**  |   | **Estimated  d 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 | ) |
|                                |        |                              |        |                                            |        |  |  |  |  |

 

In managing market riskand the asset/liability mix, the Bank has placed its emphasis on developing aportfolio in which, to the extent practicable, assets and liabilities repricewithin similar periods. The effect of this policy will generally be to reducethe Bank’s sensitivity to interest rate changes.  The goal of this policy is to provide a relatively consistentlevel of net interest income in varying interest rate cycles and to minimizethe potential for significant fluctuations from period to period.

 

23

----

 

**ITEM 4.  CONTROLS ANDPROCEDURES**

 

Duringthe 90-day period prior to the filing date of this report, management,including the Company’s Chairman, President and Chief Executive Officer and theChief Financial Officer, evaluated the effectiveness of the design andoperation of the Company’s disclosure controls and procedures.  Based upon, and as of the date of that evaluation,the Chairman, President and Chief Executive Officer and the Chief FinancialOfficer****concluded that thedisclosure controls and procedures were effective, in all material respects, toensure that information required to be disclosed in the reports the Companyfiles and submits under the Exchange Act is recorded, processed, summarized andreported as and when required.

 

Therehave been no significant changes in the Company’s internal controls or in otherfactors which could significantly affect internal controls subsequent to thedate the Company carried out its evaluation. There were no significant deficiencies or material weaknesses identifiedin the evaluation and therefore, no corrective actions were taken.

 

24

----

 

**PARTII**

 

**Item1.          Legal Proceedings**

 

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.          Changes in Securities and Use of Proceeds**

 

None

 

**Item 3.          Defaults upon Senior Securities**

 

None

 

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

 

None

 

**Item5.          Other Information**

 

None

 

**Item 6.          Exhibits and Reports on Form 8-K**

 

(a) Exhibits

 
| **Regulation S-K  Exhibit Number** |   | **Document**                                                                                            |
|------------------------------------|--------|---------------------------------------------------------------------------------------------------------|
| 10.1                               |   | Guarantee Agreement dated July  11, 2002 by and between HF Financial Corp. and Wilmington Trust Company |
|                               |   |                                                                                                    |
| 10.2                               |   | Indenture Agreement dated July  11, 2002 by and between HF Financial Corp. and Wilmington Trust Company |

 

(b) Reports on Form 8-K

 

None

 

No other information isrequired to be filed under Part II of the form.

 

25

----

 

**HFFINANCIAL CORP.**

 

**FORM 10-Q**

**SIGNATURES**

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 

 
|                                    |                                                                                        |    HF  Financial Corp. |   |
|-----------------------------------------|---------------------------------------------------------------------------------------------|---------------------------------------|--------|
|                                    |                                                                                        |   (Registrant)              |   |
|                                    |                                                                                        |
|                                    |                                                                                        |
| Date:   November 8, 2002 | By:                                                                                         | \s\ Curtis L. Hage                    |   |
|                                    |                                                                                        |
|                                    | Curtis L. Hage, Chairman, President  And Chief Executive Officer  (Duly Authorized Officer) |
|                                    |                                                                                        |
| Date:   November 8, 2002 | By:                                                                                         | \s\ Darrel L. Posegate                |   |
|                                    |                                                                                        |
|                                    | Darrel L. Posegate, Senior Vice President  And Chief Financial Officer                      |
|                                    | (Principal Financial and Accounting Officer)                                                |
|                                         |                                                                                             |                                       |        |  |  |  |

 

26

----

 

**CERTIFICATION**

 

I, Curtis L. Hage, certify that:

 

1.               I have reviewedthis 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)              designed suchdisclosure controls and procedures to ensure that material information relatingto the registrant, including its consolidated subsidiaries, is made known to usby others within those entities, particularly during the period in which thisquarterly 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)              all significantdeficiencies in the design or operation of internal controls which couldadversely affect the registrant’s ability to record, process, summarize andreport financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b)             any fraud, whether ornot material, that involves management or other employees who have a significantrole in the registrant’s internal controls; and

 

6.               The registrant’sother certifying officers and I have indicated in this quarterly report whetheror not there were significant changes in internal controls or in other factorsthat could significantly affect internal controls subsequent to the date of ourmost recent evaluation, including any corrective actions with regard tosignificant deficiencies and material weaknesses.

 
| Date:  | November 8, 2002                                 |   | \s\ Curtis L.  Hage |   |
|--------|--------------------------------------------------|--------|---------------------|--------|
|   | Curtis L. Hage                                   |
|   | Chairman, President and Chief Executive  Officer |

 

27

----

 

**CERTIFICATION**

 

I, Darrel L. Posegate, certify that:

 

1.     I have reviewed this quarterly report on Form 10-Q of HFFinancial 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)              designed suchdisclosure controls and procedures to ensure that material information relatingto the registrant, including its consolidated subsidiaries, is made known to usby others within those entities, particularly during the period in which thisquarterly 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)              all significantdeficiencies in the design or operation of internal controls which couldadversely affect the registrant’s ability to record, process, summarize andreport financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b)             any fraud, whether ornot material, that involves management or other employees who have asignificant role in the registrant’s internal controls; and

 

6.               The registrant’sother certifying officers and I have indicated in this quarterly report whetheror not there were significant changes in internal controls or in other factorsthat could significantly affect internal controls subsequent to the date of ourmost recent evaluation, including any corrective actions with regard tosignificant deficiencies and material weaknesses.

 

 
| Date:  | November 8, 2002                                   |   | \s\ Darrel L.  Posegate |   |
|--------|----------------------------------------------------|--------|-------------------------|--------|
|   |                                               |
|   | Darrel L. Posegate                                 |
|   | Senior Vice President and Chief Financial  Officer |

 

28

----

 

**CERTIFICATION PURSUANT TO18 U.S.C. §1350,****ASADOPTED PURSUANT TOSECTION 906 OF THE SARBANES-OXLEY ACT OF 2002**

 

In connection with theQuarterly Report of HF Financial Corp. (the “Company”) on Form 10-Q for thethree months ended September 30, 2002, as filed with the Securities andExchange Commission on the date hereof (the “Report”), I, Curtis L. Hage,Chairman, President and Chief Executive Officer of the Company, certify,pursuant to 18 U.S.C. §1350, as adopted pursuant to Section 906 of theSarbanes-Oxley Act of 2002, that to the best of my knowledge:

 

(1)     The Report fully complies with the requirements of Section 13(a)or 15(d) of the Securities Exchange Act of 1934; and

 

(2)     The information contained in the Report fairly presents, in allmaterial respects, the financial condition and results of operations of theCompany.

 

 
|   |       \s\  Curtis L. Hage           |             |
|--------|-------------------------------------------------------------------|------------------|
|   | Curtis  L. Hage, Chairman, President  and Chief Executive Officer |
|   |                                                              |             |
|   |                                                              |
|   | Date                                                              | November 8, 2002 |   |
|        |                                                                   |                  |  |  |

 

29

----

 

**CERTIFICATION PURSUANT TO18 U.S.C. §1350,****ASADOPTED PURSUANT TOSECTION 906 OF THE SARBANES-OXLEY ACT OF 2002**

 

 

In connection with theQuarterly Report of HF Financial Corp. (the “Company”) on Form 10-Q for thethree months ended September 30, 2002, as filed with the Securities andExchange Commission on the date hereof (the “Report”), I, Darrel L. Posegate,Senior Vice President and Chief Financial Officer of the Company, certify,pursuant to 18 U.S.C. §1350, as adopted pursuant to Section 906 of theSarbanes-Oxley Act of 2002, that to the best of my knowledge:

 

(1)     The Report fully complies with the requirements of Section 13(a)or 15(d) of the Securities Exchange Act of 1934; and

 

(2)     The information contained in the Report fairly presents, in allmaterial respects, the financial condition and results of operations of theCompany.

 
|   |       \s\  Darrel L. Posegate |             |
|--------|-------------------------------------------------------------|------------------|
|   | Darrel L. Posegate, Senior  Vice President                  |
|   | and Chief Financial Officer                                 |             |
|   |                                                        |
|   | Date                                                        | November 8, 2002 |   |
|        |                                                             |                  |  |  |  |

 

30

----