**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C.  20549**

 

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**FORM 10-Q**

 

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

 

**For the Quarterly Period endedDecember 31, 2002**

 

**CommissionFile Number: 0-19972**

 

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**HFFINANCIAL CORP.**

(Exact name ofregistrant 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 February 14, 2003there were 3,296,056 issued and outstanding shares of the Registrant’s CommonStock, with $.01 par value.

 

 

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**HF FINANCIAL CORP.**

 

**Form 10-Q**

 

**Tableof Contents**

 
| **PART  I** |
|-------------|
|        |   |
| Item 1.     | Financial Statements  (Unaudited): |
|        |   |
|        | Consolidated  Statements of Financial Condition  As of December 31, 2002 and June 30, 2002 |
|        |   |
|        | Consolidated  Statements of Income for the  Three and Six Months Ended December 31, 2002 and 2001 |
|        |   |
|        | Consolidated  Statements of Cash Flows for the  Six Months Ended December 31, 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 |

 

 

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**HF FINANCIAL CORP. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION**

**(Dollars in Thousands)**

 
|                                                                                                                                                     |   | **December  31,   2002** |    | **June 30,   2002** |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------|---------|---------------------|--------|
|                                                                                                                                                     |   | **(Unaudited)**          |    |                |   |
| **ASSETS**                                                                                                                                               |   |                     |    |                |   |
| Cash and cash equivalents                                                                                                                                |   | $                        | 42,036  |                | $      | 27,546 |   |
| Securities available for  sale                                                                                                                           |   | 101,011                  |    | 89,136              |   |
| Loans and leases receivable                                                                                                                              |   | 553,137                  |    | 564,275             |   |
| Loans held for sale                                                                                                                                      |   | 68,806                   |    | 6,559               |   |
| Allowance for loan and  lease losses                                                                                                                     |   | (4,722                   | )       | (4,461              | )      |
| Net loans and leases  receivable                                                                                                                         |   | 617,221                  |    | 566,373             |   |
|                                                                                                                                                     |   |                     |    |                |   |
| Accrued interest receivable                                                                                                                              |   | 4,764                    |    | 4,410               |   |
| Office properties and  equipment, net of accumulated depreciation                                                                                        |   | 13,613                   |    | 13,714              |   |
| Foreclosed real estate and  other properties                                                                                                             |   | 1,696                    |    | 1,672               |   |
| Prepaid expenses and other  assets                                                                                                                       |   | 14,782                   |    | 8,505               |   |
| Mortgage servicing rights                                                                                                                                |   | 3,610                    |    | 3,467               |   |
| Deferred income taxes                                                                                                                                    |   | 3,239                    |    | 2,831               |   |
| Goodwill, net                                                                                                                                            |   | 5,000                    |    | 4,604               |   |
| Other intangible assets,  net                                                                                                                            |   | 200                      |    | 659                 |   |
| Total assets                                                                                                                                             |   | $                        | 807,172 |                | $      | 722,917 |   |
|                                                                                                                                                     |   |                     |    |                |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                           |   |                     |    |                |   |
| **LIABILITIES**                                                                                                                                          |   |                     |    |                |   |
| Deposits                                                                                                                                                 |   | $                        | 630,888 |                | $      | 562,596 |   |
| Advances from Federal Home  Loan Bank and other borrowings                                                                                               |   | 86,021                   |    | 84,308              |   |
| Company obligated  mandatorily redeemable preferred securities of subsidiary trusts that solely  hold subordinated debentures                            |   | 20,000                   |    | 10,000              |   |
| Advances by borrowers for  taxes and insurance                                                                                                           |   | 9,099                    |    | 6,436               |   |
| Accrued interest payable                                                                                                                                 |   | 3,557                    |    | 3,751               |   |
| Accrued benefit liability                                                                                                                                |   | 1,093                    |    | 1,093               |   |
| Other liabilities                                                                                                                                        |   | 6,882                    |    | 6,197               |   |
| Total liabilities                                                                                                                                        |   | 757,540                  |    | 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, 4,916,195 and 4,886,494 shares issued at  December 31, 2002 and June 30, 2002, respectively |   | 49                       |    | 49                  |   |
| Additional paid-in capital                                                                                                                               |   | 16,370                   |    | 16,014              |   |
| Retained earnings,  substantially restricted                                                                                                             |   | 56,691                   |    | 54,516              |   |
| Deferred compensation                                                                                                                                    |   | (374                     | )       | (141                | )      |
| Accumulated other  comprehensive income (loss):                                                                                                          |   |                     |    |                |   |
| Unrealized gain on  securities available for sale, net of related deferred tax effect                                                                    |   | 79                       |    | 498                 |   |
| Unrecognized pension costs,  net of related deferred tax effect                                                                                          |   | (704                     | )       | (704                | )      |
| Less cost of treasury  stock, 1,617,046 and 1,559,030 shares at December 31, 2002 and June 30, 2002,  respectively                                       |   | (22,479                  | )       | (21,696             | )      |
| Total stockholders’ equity                                                                                                                          |   | 49,632                   |    | 48,536              |   |
| Total liabilities and stockholders’  equity                                                                                                         |   | $                        | 807,172 |                | $      | 722,917 |   |

* *

*See accompanying notes to unaudited consolidated financialstatements.*

 

1

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**HF FINANCIAL CORP. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF INCOME**

**(Dollars in Thousands, Except PerShare Data)**

**(Unaudited)**

 
|                                                                                                      |   | **Three  Months Ended  December 31,** |   | **Six Months  Ended  December 31,** |   |
|-----------------------------------------------------------------------------------------------------------|--------|---------------------------------------|--------|-------------------------------------|--------|
|                                                                                                      |   | **2002**                              |   | **2001**                            |   | **2002** |   | **2001** |   |
|                                                                                                      |   |                                  |   |                                |   |   |   |   |   |
| **Continuing operations:**                                                                                |   |                                  |   |                                |   |   |   |   |   |
| Interest and dividend income:                                                                             |   |                                  |   |                                |   |   |   |   |   |
| Loans and leases receivable                                                                               |   | $                                     | 10,297 |                                | $      | 10,662 |   | $ | 20,798 |   | $ | 22,354 |   |
| Investment securities and interest-bearing deposits                                                       |   | 1,027                                 |   | 1,449                               |   | 2,032 |   | 3,251 |   |
|                                                                                                      |   | 11,324                                |   | 12,111                              |   | 22,830 |   | 25,605 |   |
| Interest expense:                                                                                         |   |                                  |   |                                |   |   |   |   |   |
| Deposits                                                                                                  |   | 3,332                                 |   | 5,090                               |   | 6,720 |   | 11,364 |   |
| Advances from Federal Home Loan Bank and other  borrowings                                                |   | 1,405                                 |   | 1,243                               |   | 2,788 |   | 2,690 |   |
|                                                                                                      |   | 4,737                                 |   | 6,333                               |   | 9,508 |   | 14,054 |   |
| Net interest income                                                                                       |   | 6,587                                 |   | 5,778                               |   | 13,322 |   | 11,551 |   |
| Provision for losses on loans and leases                                                                  |   | 449                                   |   | 543                                 |   | 1,483 |   | 1,066 |   |
| Net interest income after provision for losses on  loans and leases                                       |   | 6,138                                 |   | 5,235                               |   | 11,839 |   | 10,485 |   |
| Noninterest income:                                                                                       |   |                                  |   |                                |   |   |   |   |   |
| Fees on deposits                                                                                          |   | 1,123                                 |   | 1,023                               |   | 2,206 |   | 1,984 |   |
| Gain on sale of loans, net                                                                                |   | 455                                   |   | 407                                 |   | 677 |   | 891 |   |
| Loan servicing income                                                                                     |   | 364                                   |   | 412                                 |   | 768 |   | 1,038 |   |
| Commission and insurance income                                                                           |   | 270                                   |   | 328                                 |   | 542 |   | 631 |   |
| Loan fees and service charges                                                                             |   | 659                                   |   | 390                                 |   | 1,137 |   | 662 |   |
| Gain on sale of securities, net                                                                           |   | —                                |   | 5                                   |   | 350 |   | 5 |   |
| Other                                                                                                     |   | 341                                   |   | 306                                 |   | 601 |   | 563 |   |
|                                                                                                      |   | 3,212                                 |   | 2,871                               |   | 6,281 |   | 5,774 |   |
| Noninterest expense:                                                                                      |   |                                  |   |                                |   |   |   |   |   |
| Compensation and employee benefits                                                                        |   | 4,389                                 |   | 3,844                               |   | 8,493 |   | 7,700 |   |
| Other general and administrative expenses                                                                 |   | 1,616                                 |   | 1,298                               |   | 2,988 |   | 2,645 |   |
| Occupancy and equipment                                                                                   |   | 853                                   |   | 817                                 |   | 1,674 |   | 1,710 |   |
| Amortization of intangible assets                                                                         |   | 22                                    |   | 125                                 |   | 63 |   | 250 |   |
| Federal insurance premiums                                                                                |   | 24                                    |   | 30                                  |   | 47 |   | 55 |   |
| Other                                                                                                     |   | 112                                   |   | 78                                  |   | 190 |   | 149 |   |
|                                                                                                      |   | 7,016                                 |   | 6,192                               |   | 13,455 |   | 12,509 |   |
| Income from continuing operations before income  taxes                                                    |   | 2,334                                 |   | 1,914                               |   | 4,665 |   | 3,750 |   |
| Income tax expense                                                                                        |   | 790                                   |   | 739                                 |   | 1,670 |   | 1,450 |   |
| Income from continuing operations                                                                         |   | 1,544                                 |   | 1,175                               |   | 2,995 |   | 2,300 |   |
|                                                                                                      |   |                                  |   |                                |   |   |   |   |   |
| **Discontinued operations:**                                                                              |   |                                  |   |                                |   |   |   |   |   |
| Income (loss) from operations of discontinued  segment, net of income taxes of $54, $(94), $100 and $(20) |   | 105                                   |   | (183                                | )      | 193 |   | (40 | ) |
| (Loss) on discontinued segment, net of income taxes  of ($111) and $(126)                                 |   | (215                                  | )      | —                              |   | (244 | ) | — |   |
| (Loss) from discontinued operations                                                                       |   | (110                                  | )      | (183                                | )      | (51 | ) | (40 | ) |
| **Net Income**                                                                                            |   | $                                     | 1,434  |                                | $      | 992 |   | $ | 2,944 |   | $ | 2,260 |   |
| **Comprehensive income**                                                                                  |   | $                                     | 1,290  |                                | $      | 654 |   | $ | 2,525 |   | $ | 2,540 |   |
|                                                                                                      |   |                                  |   |                                |   |   |   |   |   |
| **Basic earnings (loss) per share:**                                                                      |   |                                  |   |                                |   |   |   |   |   |
| Income from continuing operations                                                                         |   | $                                     | 0.46   |                                | $      | 0.32 |   | $ | 0.90 |   | $ | 0.62 |   |
| (Loss) from discontinued operations                                                                       |   | (0.03                                 | )      | (0.05                               | )      | (0.02 | ) | (0.01 | ) |
| Net income                                                                                                |   | $                                     | 0.43   |                                | $      | 0.27 |   | $ | 0.88 |   | $ | 0.61 |   |
|                                                                                                      |   |                                  |   |                                |   |   |   |   |   |
| **Diluted earnings (loss) per share:**                                                                    |   |                                  |   |                                |   |   |   |   |   |
| Income from continuing operations                                                                         |   | $                                     | 0.45   |                                | $      | 0.31 |   | $ | 0.89 |   | $ | 0.61 |   |
| (Loss) from discontinued operations                                                                       |   | (0.03                                 | )      | (0.05                               | )      | (0.02 | ) | (0.01 | ) |
| Net income                                                                                                |   | $                                     | 0.42   |                                | $      | 0.26 |   | $ | 0.87 |   | $ | 0.60 |   |

 

*See accompanying notes to unaudited consolidated financialstatements.*

 

2

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**HFFINANCIAL CORP. AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(Dollars inThousands)**

**(Unaudited)**

 
|                                                                                          |   | **Six Months  Ended December 31,** |   |
|-----------------------------------------------------------------------------------------------|--------|------------------------------------|--------|
|                                                                                          |   | **2002**                           |   | **2001** |   |
| **Cash  flows from operating activities**                                                     |   |                               |   |   |   |
| Net income                                                                                    |   | $                                  | 2,944  |   | $ | 2,260 |   |
| Adjustments to reconcile  net income to net cash (used in) operating activities:              |   |                               |   |   |   |
| Provision for losses on  loans and leases                                                     |   | 1,483                              |   | 1,905 |   |
| Depreciation                                                                                  |   | 824                                |   | 817 |   |
| Amortization (accretion)  of premiums and discounts on securities available for sale, net     |   | 402                                |   | (9 | ) |
| Amortization of intangible  assets                                                            |   | 63                                 |   | 250 |   |
| Amortization of mortgage  servicing rights                                                    |   | 182                                |   | 164 |   |
| Amortization of debt issue  costs                                                             |   | 9                                  |   | — |   |
| Stock based compensation                                                                      |   | 123                                |   | 104 |   |
| (Decrease) in deferred  loan fees                                                             |   | (348                               | )      | (185 | ) |
| Loans originated for  resale                                                                  |   | (72,926                            | )      | (38,218 | ) |
| Proceeds from the sale of  loans                                                              |   | 62,441                             |   | 23,845 |   |
| (Gain) on sale of loans,  net                                                                 |   | (677                               | )      | (891 | ) |
| Mortgage servicing rights  capitalized                                                        |   | (62                                | )      | (326 | ) |
| Realized (gain) on sale of  securities, net                                                   |   | (350                               | )      | (5 | ) |
| Losses and provision for  losses on sales of foreclosed real estate and other properties, net |   | 70                                 |   | 75 |   |
| Loss on disposal of office  properties and equipment, net                                     |   | 20                                 |   | 8 |   |
| (Increase) decrease in  accrued interest receivable                                           |   | (354                               | )      | 766 |   |
| (Increase) in prepaid  expenses and other assets                                              |   | (5,986                             | )      | (6,470 | ) |
| Deferred income taxes  (credits)                                                              |   | (151                               | )      | (1 | ) |
| Increase (decrease) in  accrued interest payable and other liabilities                        |   | 491                                |   | (2,861 | ) |
| Net cash (used in)  operating activities                                                      |   | (11,802                            | )      | (18,772 | ) |
|                                                                                          |   |                               |   |   |   |
| **Cash  flows from investing activities**                                                     |   |                               |   |   |   |
| Loans and leases purchased                                                                    |   | (172                               | )      | (7,379 | ) |
| Loans and leases  originated and held                                                         |   | (126,692                           | )      | (74,666 | ) |
| Principal collected on  loans and leases                                                      |   | 85,494                             |   | 127,366 |   |
| Securities available for  sale:                                                               |   |                               |   |   |   |
| Sales and maturities and  calls                                                               |   | 20,001                             |   | 27,443 |   |
| Purchases                                                                                     |   | (45,454                            | )      | (35,365 | ) |
| Repayments                                                                                    |   | 12,850                             |   | 10,385 |   |
| Proceeds from sale of  office properties and equipment                                        |   | 9                                  |   | 1 |   |
| Purchase of office  properties and equipment                                                  |   | (752                               | )      | (334 | ) |
| Purchase of mortgage  servicing rights                                                        |   | (263                               | )      | (331 | ) |
| Proceeds from sale of  foreclosed real estate and other properties, net                       |   | 455                                |   | 449 |   |
| Net cash provided by (used  in) investing activities                                          |   | (54,524                            | )      | 47,569 |   |
|                                                                                          |   |                               |   |   |   |
| **Cash  flows from financing activities**                                                     |   |                               |   |   |   |
| Net increase (decrease) in  deposit accounts                                                  |   | $                                  | 68,292 |   | $ | (19,717 | ) |
| Proceeds of advances from  Federal Home Loan Bank and other borrowings                        |   | 473,250                            |   | 900 |   |
| Payments on advances from  Federal Home Loan Bank and other borrowings                        |   | (471,537                           | )      | (39,255 | ) |
| Proceeds from issuance of  preferred securities of subsidiary trust                           |   | 10,000                             |   | 10,000 |   |
| Payment of debt issue  costs                                                                  |   | (300                               | )      | — |   |
| Increase in advances by  borrowers for taxes and insurance                                    |   | 2,663                              |   | 1,650 |   |
| Purchase of treasury stock                                                                    |   | (783                               | )      | (367 | ) |
| Proceeds from issuance of  common stock                                                       |   | —                             |   | 43 |   |
| Cash dividends paid ($0.23  and $0.22 per share in 2002 and 2001 respectively)                |   | (769                               | )      | (813 | ) |
| Net cash provided by (used  in) financing activities                                          |   | 80,816                             |   | (47,559 | ) |
|                                                                                          |   |                               |   |   |   |
| Increase (decrease) in  cash and cash equivalents                                             |   | 14,490                             |   | (18,762 | ) |
|                                                                                          |   |                               |   |   |   |
| Cash and cash equivalents                                                                     |   |                               |   |   |   |
| Beginning                                                                                     |   | 27,546                             |   | 84,913 |   |
| Ending                                                                                        |   | $                                  | 42,036 |   | $ | 66,151 |   |
|                                                                                          |   |                               |   |   |   |
| Supplemental Disclosures  of Cash Flows Information                                           |   |                               |   |   |   |
| Cash payments for interest                                                                    |   | $                                  | 9,732  |   | $ | 17,299 |   |
| Cash payments for income  and franchise taxes, net                                            |   | 1,998                              |   | 1,761 |   |
|                                                                                          |   |                               |   |   |   |
| Supplemental Schedule of  Noncash Investing and Financing Activities                          |   |                               |   |   |   |
| Loans receivable  reclassified as held for sale                                               |   | $                                  | 51,085 |   | $ | — |   |

 

*See accompanying notes to unaudited consolidated financialstatements.*

 

3

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**HFFINANCIAL CORP. AND SUBSIDIARIES**

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS**

For The Three andSix Months Ended December 31, 2002 and 2001

(Unaudited)

 
| **NOTE  1.** |   | **SELECTED  ACCOUNTING POLICIES** |
|--------------|--------|-----------------------------------|

 

*Basis of presentation:*

 

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

 

The interim consolidatedfinancial statements include the accounts of the Company, its wholly-ownedsubsidiaries, HomeFirst Mortgage Corp. (the “Mortgage Corp.”), HF CardServices, LLC (“HF Card”), HF Financial Group, Inc., HF Financial Capital TrustI (“Trust I”), HF Financial Capital Trust II (“Trust II”), HF Financial CapitalTrust III, Home Federal Bank (formerly known as Home Federal Savings Bank),(the “Bank”) and the Bank’s wholly-owned subsidiaries, Hometown Insurors, Inc.(“Hometown”), Mid America Capital Services, Inc. (“Mid America Leasing”),Mid-America Service Corporation and PMD, Inc. During the quarter ended December 31, 2002, the Company formed one newwholly-owned subsidiary, HF Financial Capital Trust III.  See Note 5.

 

While the credit cardloan portfolio resides in the Bank’s loan portfolio, the results of operationsand discontinuance of the credit card operations are reported in the financialstatements of HF Card and included in the consolidated financial statements ofthe Company.

 
| **NOTE  2.** |   | **DISCONTINUED  OPERATIONS AND SUBSEQUENT SALE** |
|--------------|--------|--------------------------------------------------|

 

During the fourth quarterof fiscal 2002, management committed to a plan to sell the subprime credit cardoperations which were previously reported in the credit card segment of theCompany.  At June 30, 2002, the Companyestimated the net realizable value based on estimates from a third party andreclassified the net realizable value of $1.1 million at that time from loansreceivable to loans held for sale.  TheBank ceased processing subprime credit card applications in March 1999 and hasbeen managing the portfolio from a balance of $18.1 million at June 30, 1999,to the remaining balance of $3.1 million at December 31, 2002.  On December 31, 2002, the Company, throughthe Bank, entered into an agreement to sell the discontinued credit cardoperations to an independent third party and recorded and additional loss fromdiscontinued operations (net of income taxes) for the three and six months endedDecember 31, 2002 of $215,000 and $244,000, respectively.  The sale of the receivables took place as ofthe end of business January 31, 2003, and the Company intends to dissolve HFCard during the third quarter of fiscal 2003.

 

4

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| **NOTE  3.** |   | **REGULATORY  CAPITAL** |
|--------------|--------|-------------------------|

 

The following table setsforth the Bank’s compliance with its capital requirements at December 31, 2002:

 
|                    |   | **Amount**                 |   | **Percent** |   |
|-------------------------|--------|----------------------------|--------|-------------|--------|
|                    |   | **(Dollars in Thousands)** |   |
| Tier  I (core) capital: |   |                       |   |        |   |
| Required                |   | $                          | 31,936 |        | 4.00   | % |
| Actual                  |   | 59,597                     |   | 7.46        |   |
| Excess                  |   | 27,661                     |   | 3.46        |   |
|                    |   |                       |   |        |   |
| Risk-based  capital:    |   |                       |   |        |   |
| Required                |   | $                          | 50,591 |        | 8.00   | % |
| Actual                  |   | 63,224                     |   | 10.00       |   |
| Excess                  |   | 12,633                     |   | 2.00        |   |

 
| **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 December 31, 2002 and 2001 was 3,331,429 and3,682,487, respectively.  The weightedaverage number of common shares outstanding for the six month period endedDecember 31, 2002 and 2001 was 3,333,309 and 3,687,183, 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 December 31, 2002 and 2001was 3,375,921 and 3,756,865, respectively. The weighted average number of common and dilutive potential commonshares outstanding for the six month period ended December 31, 2002 and 2001was 3,367,898 and 3,768,561, respectively.

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

 

On December 19, 2002, theCompany issued 5,000 shares totaling $5.0 million of Company ObligatedMandatorily Redeemable Preferred Securities of HF Financial Capital Trust III(“Trust III”).  Trust III exists for thesole purpose of issuing trust preferred securities and investing the proceedsin subordinated debentures of the Company. These subordinated debentures constitute the sole asset of TrustIII.  The securities provide forcumulative cash distributions calculated at a rate based on three-month LIBORplus 3.35% adjusted quarterly.  TheCompany may, at one or more times, defer interest payments on the capitalsecurities for up to 20 consecutive quarterly periods, but not beyond January7, 2033.  At the end of the deferralperiod, all accumulated and unpaid distributions will be paid.  The capital securities will be redeemed onJanuary 7, 2033; however, the Company has the option to shorten the maturitydate to a date not earlier than January 7, 2008.  Holders of the capital securities have no voting

 

5

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rights, are unsecured, and rank junior in priority of the payment toall of the Company’s indebtedness and senior to the Company’s capital stock.

 
| **NOTE  6.** |   | **SUBSEQUENT  EVENT - FORMATION OF HF SECURITIZATION CORP. AND CONSUMER LOAN SECURITIZATION** |
|--------------|--------|-----------------------------------------------------------------------------------------------|

 

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

 

On January 31, 2003, theBank securitized and sold motor vehicle installment loans with principalbalances totaling $50.0 million for a gain of approximately $300,000 throughHFSC and a newly formed trust, Home Federal Automobile Securitization Trust2003-A (“Automobile Securitization Trust”). As part of the sales transaction, the Bank retains servicingresponsibilities.  In addition, the Bankretains the rights to cash flows remaining after investors in the AutomobileSecuritization Trust have received their contractual payments and has pledged a$1.3 million reserve fund to the Automobile Securitization Trust.  These retained interests are subordinated toinvestors’ interests.  The investors andAutomobile Securitization Trust have no recourse to the Bank’s other assets forfailure of debtors to pay when due.

 

The gain recognized on thesale of these loans is determined by allocating the carrying amount of theloans between the loans sold and the interests retained.  No amount has been allocated to theservicing rights since the servicing fee to be received is deemed to beadequate compensation.

 

6

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| **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 December 31, 2002 the Company had $5.0million of goodwill that ceased amortizing.

 

In October 2002, the FASBissued Statement No. 147, *Acquisitions ofCertain Financial Institutions,* which provides guidance on theaccounting for the acquisition of a financial institution and applies to allacquisitions, except those between two or more mutual enterprises.  The provisions of FASB Statement No. 147reflect the conclusion that the excess of the fair value of liabilities assumedover the fair value of tangible and identifiable intangible assets acquired ina business combination represents goodwill that should be accounted for underFASB Statement No. 142.  Thus, thespecialized accounting guidance in paragraph 5 of FASB Statement No. 72 willnot apply after September 30, 2002 for those acquisitions that meet thedefinition of a business combination. The Company adopted FASB Statement No. 147, effective October 1, 2002,and accordingly reclassified FASB Statement No. 72 unidentifiable intangibleassets to goodwill and no longer amortized these assets after October 1,2002.  The adoption of FASB StatementNo. 147 did not have a material impact on the financial position or results ofoperations of the Company.

 

The Company has completedthe first step of its impairment testing to determine if goodwill isimpaired.  Management is not aware ofany events that would materially impair goodwill at December 31, 2002.  The impact of FASB Statement No. 142 on theCompany’s net income for the three and six months ended December 31, 2002 andDecember 31, 2001 is as follows:

 
|                                          |   | **Three  Months Ended  December 31,** |   | **Six Months  Ended  December 31,** |   |
|-----------------------------------------------|--------|---------------------------------------|--------|-------------------------------------|--------|
|                                          |   | **2002**                              |   | **2001**                            |   | **2002** |   | **2001** |   |
|                                          |   |                                  |   |                                |   |   |   |   |   |
| Reported net income                           |   | $                                     | 1,434  |                                | $      | 992 |   | $ | 2,944 |   | $ | 2,260 |   |
| Addback: goodwill  amortization, net of taxes |   | —                                |   | 64                                  |   | — |   | 130 |   |
| Adjusted net income                           |   | $                                     | 1,434  |                                | $      | 1,056 |   | $ | 2,944 |   | $ | 2,390 |   |
|                                          |   |                                  |   |                                |   |   |   |   |   |
| Basic earnings per share:                     |   |                                  |   |                                |   |   |   |   |   |
| Reported net income                           |   | $                                     | 0.43   |                                | $      | 0.27 |   | $ | 0.88 |   | $ | 0.61 |   |
| Goodwill amortization, net  of taxes          |   | —                                |   | 0.02                                |   | — |   | 0.04 |   |
| Adjusted net income                           |   | $                                     | 0.43   |                                | $      | 0.29 |   | $ | 0.88 |   | $ | 0.65 |   |
|                                          |   |                                  |   |                                |   |   |   |   |   |
| Diluted earnings per share:                   |   |                                  |   |                                |   |   |   |   |   |
| Reported net income                           |   | $                                     | 0.42   |                                | $      | 0.26 |   | $ | 0.87 |   | $ | 0.60 |   |
| Goodwill amortization, net  of taxes          |   | —                                |   | 0.02                                |   | — |   | 0.03 |   |
| Adjusted net income                           |   | $                                     | 0.42   |                                | $      | 0.28 |   | $ | 0.87 |   | $ | 0.63 |   |

 

7

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**ITEM 2.  MANAGEMENT’SDIS****CUSSION 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 which were previously reported in the credit card segment of theCompany.  At June 30, 2002, the Companyestimated the net realizable value based on estimates from a third party andreclassified the net realizable value of $1.1 million at that time from loansreceivable to loans held for sale.  TheBank ceased processing subprime credit card applications in March 1999 and hasbeen managing the portfolio from a balance of $18.1 million at June 30, 1999,to the remaining balance of $3.1 million at December 31, 2002.  On December 31, 2002, the Company, throughthe Bank, entered into an agreement to sell the discontinued credit cardoperations to an independent third party and recorded and additional loss fromdiscontinued operations (net of income taxes) for the three and six monthsended December 31, 2002 of $215,000 and $244,000, respectively.  The sale of the receivables took place as ofthe end of business January 31, 2003, and the Company intends to dissolve HFCard during the third quarter of fiscal 2003.

 

**Forward-Looking Statements**

 

This Form 10-Q and otherreports issued by the Company, including reports filed with the Securities andExchange Commission, contain “forward-looking statements” that deal with futureresults, expectations, plans and performance. In addition, the Company’s management may make forward-lookingstatements orally to the media, securities analysts, investors or others.  These forward-looking statements mightinclude one or more of the following:

 

•                       Projections of income, loss,revenues, earnings or losses per share, dividends, capital expenditures,capital structure, tax benefit or other financial items.

•                       Descriptions of plans orobjectives of management for future operations, products or services andtransactions.

•                       Forecasts of future economicperformance.

•                       Descriptions of assumptionsunderlying 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

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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 December 31, 2002, theCompany had total assets of $807.2 million, an increase of $84.3 million fromthe level at June 30, 2002.  Theincrease in assets was due primarily to increases in loans held for sale of$62.2 million, cash and cash equivalents of $14.5 million, securities availablefor sale of $11.9 million and prepaid expenses and other assets of $6.3 millionoffset by a decrease in loans and leases receivable, net of related allowance,of $11.4 million.  The increase inliabilities of $83.2 million was due to increases in deposits of $68.3 million,the liability for company obligated mandatorily redeemable preferred securitiesof $10.0 million and advances by borrowers for taxes and insurance of $2.7million from the levels at June 30, 2002. In addition, stockholders’ equity increased to $49.6 million at December31, 2002 from $48.5 million at June 30, 2002 primarily due to net income of$2.9 million offset by dividends paid of $769,000.

 

The increase in loansheld for sale was primarily due to the reclassification of $51.1 millionconsumer direct and indirect loans ($50.0 million principal and $1.1 millionrelated deferrals and prepaids) in anticipation of securitization in January2003.  In addition, one- to four-familymortgage loans held for sale into the secondary market increased $11.7 milliondue to increased originations from the levels at June 30, 2002.  See Note 6 and “Asset Quality” for furtherdiscussion.

 

The increase in cash andcash equivalents of $14.5 million was primarily due to increasedliquidity.  See “Liquidity.”

 

The increase insecurities available for sale of $11.9 million was primarily the result ofpurchases of $45.5 million exceeding sales, maturities, calls and repayments of$32.9 million.  The purchases consistedof $40.2 million in variable-rate mortgage-backed securities.  Variable-rate mortgage-backed securitiescomprise 70.8% 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 December 31, 2002.  This investment is limited by Office ofThrift Supervision (“OTS”) regulation to 15.0% of equity of the Bank.  Management is utilizing the purchase oftrust preferred securities to mitigate the Company’s interest rate risk fromthe total issuance of $20.0 million in company obligated mandatorily redeemablepreferred securities through December 31, 2002.

 

The decrease in loans andleases receivable, net of related allowance, of $11.4 million was due primarilyto the reclassification of $51.1 million consumer direct and indirect loans toloans held for sale offset by a $39.7 million increase in purchases andoriginations over sales, amortization and repayments of principal.  Commercial business, commercial real estateand

 

9

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agricultural loan balances increased $23.4 million and consumerindirect loan balances increased $15.1 million over the levels at June 30,2002.  Residential mortgage productionincreased 19.0% for the six months ended December 31, 2002 as compared to the sameperiod in the prior fiscal year.

 

The $68.3 millionincrease in deposits was primarily due to increases in out-of-marketcertificates of deposit of $49.0 million, demand accounts of $8.9 million,in-market certificates of deposits of $5.6 million, savings accounts of $3.5million and money market accounts of $1.3 million.

 

The liability for companyobligated mandatorily redeemable preferred securities increased $10.0 milliondue to the Company issuing additional trust preferred securities through Trust IIand Trust III.  The proceeds from theissuance are primarily utilized for injection of Tier 1 (core) capital into theBank and to provide liquidity for repurchasing Company stock.  See Note 5.

 

The $2.7 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 following tables showthe composition of the Company’s loan and lease and deposit portfolio fromcontinuing operations at the dates indicated. Balances related to discontinued credit card loan operations have beeneliminated for all periods presented.

 
|                                  |   | **At December 31, 2002**    |    | **At June 30, 2002**                    |   |
|---------------------------------------|--------|-----------------------------|---------|-----------------------------------------|--------|
|                                  |   | **Amount**                  |    | **Percent of  Loans in  Each Category** |   | **Amount** |   | **Percent of  Loans in  Each Category** |   |
|                                  |   | **(Dollars  in Thousands)** |    |
|                                  |   |                        |    |                                    |   |   |   |   |   |
| One- to four-family(1)                |   | $                           | 77,448  |                                    | 14.00  | % | $ | 81,118 |   | 14.38 | % |
| Commercial real estate                |   | 102,033                     |    | 18.45                                   | %      | 88,897 |   | 15.75 | % |
| Multi-family real estate              |   | 62,006                      |    | 11.21                                   | %      | 56,677 |   | 10.05 | % |
| Commercial business                   |   | 102,887                     |    | 18.60                                   | %      | 95,447 |   | 16.91 | % |
| Equipment finance leases              |   | 21,948                      |    | 3.97                                    | %      | 22,834 |   | 4.05 | % |
| Consumer(2)                           |   | 142,687                     |    | 25.80                                   | %      | 177,527 |   | 31.46 | % |
| Agricultural                          |   | 42,218                      |    | 7.63                                    | %      | 39,401 |   | 6.98 | % |
| Mobile homes                          |   | 1,910                       |    | 0.34                                    | %      | 2,374 |   | 0.42 | % |
| Total Loans and Leases  Receivable(3) |   | $                           | 553,137 |                                    | 100.00 | % | $ | 564,275 |   | 100.00 | % |

 

----

(1) Excludes $17,139 and$5,444 loans held for sale at December 31, 2002 and June 30, 2002,respectively.

(2)Excludes $51,084 loans held for sale at December 31, 2002.

 
|                                   |   | **At December 31, 2002**    |    | **At June 30, 2002**                       |   |
|----------------------------------------|--------|-----------------------------|---------|--------------------------------------------|--------|
|                                   |   | **Amount**                  |    | **Percent of  Deposits in  Each Category** |   | **Amount** |   | **Percent of  Deposits in  Each Category** |   |
|                                   |   | **(Dollars  in Thousands)** |    |
|                                   |   |                        |    |                                       |   |   |   |   |   |
| Noninterest bearing  checking accounts |   | $                           | 69,621  |                                       | 11.04  | % | $ | 61,355 |   | 10.91 | % |
| Interest bearing accounts              |   | 42,331                      |    | 6.71                                       | %      | 41,669 |   | 7.41 | % |
| Money market accounts                  |   | 159,004                     |    | 25.20                                      | %      | 157,770 |   | 28.04 | % |
| Savings accounts                       |   | 53,895                      |    | 8.54                                       | %      | 50,387 |   | 8.95 | % |
| Certificates of deposit                |   | 306,037                     |    | 48.51                                      | %      | 251,415 |   | 44.69 | % |
| Total Deposits                         |   | $                           | 630,888 |                                       | 100.00 | % | $ | 562,596 |   | 100.00 | % |

 

10

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**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 and sixmonths ended December 31, 2002 and 2001 include fees which are consideredadjustments to yield.  Balances relatedto discontinued credit card loan operations have been reclassified tonon-interest earning assets for all periods presented.

 

11

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|                                          |   | **THREE MONTHS ENDED DECEMBER 31,** |    |
|-----------------------------------------------|--------|-------------------------------------|---------|
|                                          |   | **2002**                            |    | **2001** |   |
|                                          |   | **Average  Outstanding  Balance**   |    | **Interest  Earned/  Paid** |   | **Yield/  Rate** |   | **Average  Outstanding  Balance** |   | **Interest  Earned/  Paid** |   | **Yield/  Rate** |   |
|                                          |   |                                |    |   |   |   |   |   |   |   |   |   |   |
| Interest-earning assets:                      |   |                                |    |   |   |   |   |   |   |   |   |   |   |
| Loans and leases  receivable(1)               |   | $                                   | 610,675 |   | $ | 10,297 |   | 6.69 | % | $ | 543,030 |   | $ | 10,662 |   | 7.79 | % |
| Investment securities(2)(3)                   |   | 99,537                              |    | 976 |   | 3.89 | % | 138,487 |   | 1,386 |   | 3.97 | % |
| FHLB stock                                    |   | 6,332                               |    | 51 |   | 3.20 | % | 6,332 |   | 63 |   | 3.95 | % |
|                                          |   |                                |    |   |   |   |   |   |   |   |   |   |   |
| Total interest-earning  assets                |   | $                                   | 716,544 |   | $ | 11,324 |   | 6.27 | % | $ | 687,849 |   | $ | 12,111 |   | 6.99 | % |
| Noninterest-earning assets                    |   | 55,941                              |    |   |   |   |   | 54,354 |   |   |   |   |   |
| Total assets                                  |   | $                                   | 772,485 |   |   |   |   |   | $ | 742,203 |   |   |   |   |   |
|                                          |   |                                |    |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing  liabilities:                |   |                                |    |   |   |   |   |   |   |   |   |   |   |
| Deposits:                                     |   |                                |    |   |   |   |   |   |   |   |   |   |   |
| Checking and money market                     |   | $                                   | 191,148 |   | $ | 673 |   | 1.40 | % | $ | 182,195 |   | $ | 963 |   | 2.10 | % |
| Savings                                       |   | 34,052                              |    | 61 |   | 0.71 | % | 35,944 |   | 115 |   | 1.27 | % |
| Certificates of deposit                       |   | 295,611                             |    | 2,598 |   | 3.49 | % | 299,554 |   | 4,012 |   | 5.31 | % |
| Total deposits                                |   | $                                   | 520,811 |   | $ | 3,332 |   | 2.54 | % | $ | 517,693 |   | $ | 5,090 |   | 3.90 | % |
| FHLB advances and other  borrowings           |   | 123,812                             |    | 1,405 |   | 4.50 | % | 99,034 |   | 1,243 |   | 4.98 | % |
|                                          |   |                                |    |   |   |   |   |   |   |   |   |   |   |
| Total interest-bearing  liabilities           |   | $                                   | 644,623 |   | $ | 4,737 |   | 2.93 | % | $ | 616,727 |   | $ | 6,333 |   | 4.07 | % |
| Noninterest-bearing  deposits(4)              |   | 58,556                              |    |   |   |   |   | 49,949 |   |   |   |   |   |
| Other liabilities                             |   | 19,791                              |    |   |   |   |   | 21,510 |   |   |   |   |   |
| Total liabilities                             |   | $                                   | 722,970 |   |   |   |   |   | $ | 688,186 |   |   |   |   |   |
| Equity                                        |   | 49,515                              |    |   |   |   |   | 54,017 |   |   |   |   |   |
| Total liabilities and  equity                 |   | $                                   | 772,485 |   |   |   |   |   | $ | 742,203 |   |   |   |   |   |
|                                          |   |                                |    |   |   |   |   |   |   |   |   |   |   |
| Net interest income;  interest rate spread(5) |   |                                |    | $ | 6,587 |   | 3.34 | % |   |   | $ | 5,778 |   | 2.92 | % |
|                                          |   |                                |    |   |   |   |   |   |   |   |   |   |   |
| Net interest margin(5)(6)                     |   |                                |    |   |   | 3.65 | % |   |   |   |   | 3.33 | % |

 

----

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

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

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

(4)     Previously reported ininterest-bearing liabilities under checking and money market. Rates have beenrestated for all periods presented to reflect change in classification.

(5)     Percentages for the threemonths ended December 31, 2002 and December 31, 2001 have been annualized.

(6)     Net interest margin is netinterest income divided by average interest-earning assets.

 

12

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|                                          |   | **SIX MONTHS  ENDED DECEMBER 31,** |    |
|-----------------------------------------------|--------|------------------------------------|---------|
|                                          |   | **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)               |   | $                                  | 596,240 |   | $ | 20,798 |   | 6.92 | % | $ | 554,325 |   | $ | 22,354 |   | 8.00 | % |
| Investment securities(2)(3)                   |   | 93,489                             |    | 1,933 |   | 4.10 | % | 140,879 |   | $ | 3,123 |   | 4.40 | % |
| FHLB stock                                    |   | 6,683                              |    | 99 |   | 2.94 | % | 6,332 |   | 128 |   | 4.01 | % |
|                                          |   |                               |    |   |   |   |   |   |   |   |   |   |   |
| Total interest-earning  assets                |   | $                                  | 696,412 |   | $ | 22,830 |   | 6.50 | % | $ | 701,536 |   | $ | 25,605 |   | 7.24 | % |
| Noninterest-earning assets                    |   | 51,699                             |    |   |   |   |   | 52,336 |   |   |   |   |   |
| Total assets                                  |   | $                                  | 748,111 |   |   |   |   |   | $ | 753,872 |   |   |   |   |   |
|                                          |   |                               |    |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing  liabilities:                |   |                               |    |   |   |   |   |   |   |   |   |   |   |
| Deposits:                                     |   |                               |    |   |   |   |   |   |   |   |   |   |   |
| Checking and money market                     |   | $                                  | 190,449 |   | $ | 1,412 |   | 1.47 | % | $ | 176,373 |   | $ | 2,332 |   | 2.62 | % |
| Savings                                       |   | 37,402                             |    | 162 |   | 0.86 | % | 38,497 |   | 369 |   | 1.90 | % |
| Certificates of deposit                       |   | 274,752                            |    | 5,146 |   | 3.72 | % | 308,911 |   | 8,663 |   | 5.56 | % |
| Total deposits                                |   | $                                  | 502,603 |   | $ | 6,720 |   | 2.65 | % | $ | 523,781 |   | $ | 11,364 |   | 4.30 | % |
| FHLB advances and other  borrowings           |   | 121,180                            |    | 2,788 |   | 4.56 | % | 104,910 |   | 2,690 |   | 5.09 | % |
|                                          |   |                               |    |   |   |   |   |   |   |   |   |   |   |
| Total interest-bearing  liabilities           |   | $                                  | 623,783 |   | $ | 9,508 |   | 3.02 | % | $ | 628,691 |   | $ | 14,054 |   | 4.43 | % |
| Noninterest-bearing  deposits(4)              |   | 55,734                             |    |   |   |   |   | 48,644 |   |   |   |   |   |
| Other liabilities                             |   | 19,212                             |    |   |   |   |   | 22,773 |   |   |   |   |   |
| Total liabilities                             |   | $                                  | 698,729 |   |   |   |   |   | $ | 700,108 |   |   |   |   |   |
| Equity                                        |   | 49,382                             |    |   |   |   |   | 53,764 |   |   |   |   |   |
| Total liabilities and  equity                 |   | $                                  | 748,111 |   |   |   |   |   | $ | 753,872 |   |   |   |   |   |
|                                          |   |                               |    |   |   |   |   |   |   |   |   |   |   |
| Net interest income;  interest rate spread(5) |   |                               |    | $ | 13,322 |   | 3.48 | % |   |   | $ | 11,551 |   | 2.81 | % |
|                                          |   |                               |    |   |   |   |   |   |   |   |   |   |   |
| Net interest margin(5)(6)                     |   |                               |    |   |   | 3.79 | % |   |   |   |   | 3.27 | % |

 

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

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

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

(4)     Previously reported ininterest-bearing liabilities under checking and money market. Rates have beenrestated for all periods presented to reflect change in classification.

(5)     Percentages for the sixmonths ended December 31, 2002 and December 31, 2001 have been annualized.

(6)     Net interest margin is netinterest income divided by average interest-earning assets.

 

13

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**Rate/Volume Analysis 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 December 31,**     |   | **Six Months  Ended December 31,** |   |
|-------------------------------------|--------|------------------------------------------|--------|------------------------------------|--------|
|                                |   | **2002 vs  2001**                        |   | **2002 vs  2001**                  |   |
|                                |   | **Increase  (Decrease)  Due to  Volume** |   | **(Decrease)  Due to  Rate**       |   | **Total  Increase  (Decrease)** |   | **Increase  (Decrease)  Due to  Volume** |   | **(Decrease)  Due to  Rate** |   | **Total  Increase  (Decrease)** |   |
|                                |   | **(Dollars in Thousands)**               |   |
| Interest-earning assets:            |   |                                     |   |                               |   |   |   |   |   |   |   |   |   |
| Loans and leases  receivable(1)     |   | $                                        | 1,328  |                               | $      | (1,693 | ) | $ | (365 | ) | $ | 1,690 |   | $ | (3,246 | ) | $ | (1,556 | ) |
| Other investment  securities(2)     |   | (390                                     | )      | (20                                | )      | (410 | ) | (1,051 | ) | (139 | ) | (1,190 | ) |
| FHLB stock                          |   | —                                   |   | (12                                | )      | (12 | ) | 7 |   | (36 | ) | (29 | ) |
|                                |   |                                     |   |                               |   |   |   |   |   |   |   |   |   |
| Total interest-earning  assets      |   | $                                        | 938    |                               | $      | (1,725 | ) | $ | (787 | ) | $ | 646 |   | $ | (3,421 | ) | $ | (2,775 | ) |
|                                |   |                                     |   |                               |   |   |   |   |   |   |   |   |   |
| Interest-bearing  liabilities:      |   |                                     |   |                               |   |   |   |   |   |   |   |   |   |
| Deposits:                           |   |                                     |   |                               |   |   |   |   |   |   |   |   |   |
| Checking and money market           |   | $                                        | 47     |                               | $      | (337 | ) | $ | (290 | ) | $ | 186 |   | $ | (1,106 | ) | $ | (920 | ) |
| Savings                             |   | (6                                       | )      | (48                                | )      | (54 | ) | (10 | ) | (197 | ) | (207 | ) |
| Certificates of deposit             |   | (53                                      | )      | (1,361                             | )      | (1,414 | ) | (958 | ) | (2,559 | ) | (3,517 | ) |
| Total deposits                      |   | (12                                      | )      | (1,746                             | )      | (1,758 | ) | (782 | ) | (3,862 | ) | (4,644 | ) |
| FHLB advances and other  borrowings |   | 311                                      |   | (149                               | )      | 162 |   | 417 |   | (319 | ) | 98 |   |
|                                |   |                                     |   |                               |   |   |   |   |   |   |   |   |   |
| Total interest-bearing  liabilities |   | $                                        | 299    |                               | $      | (1,895 | ) | $ | (1,596 | ) | $ | (365 | ) | $ | (4,181 | ) | $ | (4,546 | ) |
|                                |   |                                     |   |                               |   |   |   |   |   |   |   |   |   |
| Net interest income                 |   |                                     |   |                               |   | $ | 809 |   |   |   |   |   | $ | 1,771 |   |

 

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

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

 

14

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**Application of Critical AccountingPolicies**

 

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 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, unforeseenmarket or borrower conditions could result in adjustments and net earningsbeing significantly affected if circumstances differ substantially from theassumptions used in making the final determinations.

 

**Asset Quality**

 

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 is delinquentfor 90 days, the Bank generally will initiate foreclosure proceedings unlessmanagement 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 ofcollection.  Interest collections onnonaccrual loans, for which the ultimate collectibility of principal isuncertain, are applied as principal reductions.

 

Nonperforming assets(nonaccrual loans and leases, accruing loans and leases delinquent more than 90days and foreclosed assets) decreased to $9.6 million at December 31, 2002 from

 

15

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$11.5 million at June 30, 2002, a decrease of $1.9 million, or16.5%.  In addition, the ratio ofnonperforming assets to total assets, which is one indicator of credit riskexposure, decreased to 1.19% at December 31, 2002 as compared to 1.59% at June30, 2002.

 

Nonaccruing loans andleases decreased 20.6% or $2.1 million to $8.1 million at December 31, 2002compared to $10.2 million at June 30, 2002. Included in nonaccruing loans and leases at December 31, 2002 were elevenloans totaling $733,000 secured by one- to four-family real estate, four loanstotaling $317,000 secured by commercial real estate, four mobile home loanstotaling $41,000, eighteen commercial business loans totaling $1.3 million,eight agricultural loans totaling $4.8 million, twelve equipment finance leasestotaling $73,000 and fifty-three consumer loans totaling $874,000.  One loan, secured by commercial real estate,in the amount of $2.4 million included in nonaccrual loan balances at June 30,2002 was paid in full during the first quarter of fiscal 2003.  Offsetting the commercial real estate loanpayoff was one large agricultural real estate nonaccrual loan in the amount of$2.4 million during the first quarter of fiscal 2003.  This agricultural loan has been modified as a troubled debtrestructuring with specific allowance reserve allocation and will be closelymonitored for performance.

 

The Company’snonperforming loans and leases, which represent nonaccrual and past due 90 daysand still accruing, have decreased $1.9 million or 17.2% from the levels atJune 30, 2002.  The risk rating systemin place is designed to identify and manage the nonperforming loans andleases.  Commercial and agriculturalloans will have specific impairment valuation if the loans are deemed impaired.  The valuation is based on collateral valuesor based on the present value of expected cash flows.  Loans and leases that are not performing do not necessarilyresult in a loss.

 

As of December 31, 2002,the Company had $398,000 of foreclosed assets. The balance of foreclosed assets at December 31, 2002 consisted of$123,000 in consumer collateral (excluding mobile home loans) and $275,000 insingle-family residences.

 

At December 31, 2002, theCompany had (from continuing operations,including certain loans discussed in this Form 10-Q) criticized $8.6 million ofits assets as special mention and classified $17.7 million of its assets thatmanagement has determined need to be closely monitored because of possiblecredit problems of the borrowers or the cash flows of the securedproperties.  These loans and leases wereconsidered in determining the adequacy of the allowance for loan and leaselosses.  The allowance for  loan and lease losses is established basedon management’s evaluation of the risks inherent in the loan portfolio andchanges in the nature and volume of loan activity.  Such evaluation, which includes a review of all loans and leasesfor which full collectability may not be reasonably assured, considers theestimated fair market value of the underlying collateral, present value ofexpected principal and interest payments, economic conditions, historical lossexperience and other factors that warrant recognition in providing for anadequate loan and lease loss allowance.

 

Although the Company’smanagement believes that the December 31, 2002 recorded allowance for loan andlease losses was adequate to provide for inherent losses on the related loansand leases, there can be no assurance that the allowance existing at December31, 2002 will be adequate in the future.

 

The Company continues togrow its indirect automobile dealer network in South Dakota.  Principal loan balances at December 31, 2002were $80.4 million compared to $53.9 million at December 31, 2001.  The growth is based on a Company strategy toprovide high quality service to dealers and their customers with positioningprimarily in the highest quality credits. The

 

16

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Company expects the transition from higher risk B and C rated creditsto primarily A and B rated credits will produce higher net yield (loan incomeless charge-offs) than the previous strategy.

 

The growth in indirectlending is providing securitization opportunities in the capital markets.  On January 31, 2003, the Company soldapproximately $40.1 million principal of indirect and $9.9 million principal ofdirect automobile receivables in a securitization transaction.  The proceeds will be used in part tocontinue to service the demand of the Company’s dealer network.  The result of the transaction will includethe removal of credit risk on the loans sold from the Company’s balance sheet.

 

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 become doubtful.  Foreclosed assets include assets acquired onsettlement of loans.  The followingtable sets forth the amounts and categories of the Company’s nonperformingassets from continuing operations for the periods indicated.  Balances related to discontinued credit cardloan operations have been eliminated for all periods presented.

 

17

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|                                                                  |   | **Nonperforming  Assets As Of** |   |
|-----------------------------------------------------------------------|--------|---------------------------------|--------|
|                                                                  |   | **December  31,  2002**         |   | **June 30,  2002** |   |
|                                                                  |   | **(Dollars in Thousands)**      |   |
| Nonaccruing loans and  leases:                                        |   |                            |   |   |   |
| One- to four-family                                                   |   | $                               | 733    |   | $ | 886 |   |
| Commercial real estate                                                |   | 317                             |   | 3,678 |   |
| Multi-family                                                          |   | —                          |   | 290 |   |
| Commercial business                                                   |   | 1,345                           |   | 1,872 |   |
| Equipment finance leases                                              |   | 73                              |   | — |   |
| Consumer                                                              |   | 874                             |   | 690 |   |
| Agriculture                                                           |   | 4,752                           |   | 2,801 |   |
| Mobile homes                                                          |   | 41                              |   | 25 |   |
| Total                                                                 |   | 8,135                           |   | 10,242 |   |
|                                                                  |   |                            |   |   |   |
| Accruing loans and leases  delinquent more than 90 days:              |   |                            |   |   |   |
| Commercial business                                                   |   | $                               | 574    |   | $ | 512 |   |
| Equipment finance leases                                              |   | 353                             |   | 229 |   |
| Consumer                                                              |   | 1                               |   | — |   |
| Agriculture                                                           |   | 170                             |   | 165 |   |
| Total                                                                 |   | 1,098                           |   | 906 |   |
|                                                                  |   |                            |   |   |   |
| Foreclosed assets:(1)                                                 |   |                            |   |   |   |
| One- to four-family                                                   |   | 275                             |   | 239 |   |
| Consumer                                                              |   | 123                             |   | 132 |   |
| Mobile homes                                                          |   | —                          |   | 3 |   |
| Total                                                                 |   | 398                             |   | 374 |   |
|                                                                  |   |                            |   |   |   |
| Total nonperforming assets                                            |   | $                               | 9,631  |   | $ | 11,522 |   |
|                                                                  |   |                            |   |   |   |
| Ratio of nonperforming  assets to total assets                        |   | 1.19                            | %      | 1.59 | % |
|                                                                  |   |                            |   |   |   |
| Ratio of nonperforming loans  and leases to total loans and leases(2) |   | 1.48                            | %      | 1.96 | % |

 

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(1)     Total foreclosed assets donot include land held for sale.

(2)     Nonperforming loans andleases include both nonaccruing and accruing loans and leases delinquent more than 90 days.

 

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.

 

18

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|                                                                                                    |   | **Six Months  Ended December 31,** |   |
|---------------------------------------------------------------------------------------------------------|--------|------------------------------------|--------|
|                                                                                                    |   | **2002**                           |   | **2001** |   |
|                                                                                                    |   | **(Dollars  in Thousands)**        |   |
|                                                                                                    |   |                               |   |   |   |
| Balance at beginning of period                                                                          |   | $                                  | 4,461  |   | $ | 5,509 |   |
| Charge-offs:                                                                                            |   |                               |   |   |   |
| One- to four-family                                                                                     |   | (7                                 | )      | (34 | ) |
| Commercial real estate                                                                                  |   | —                             |   | (50 | ) |
| Commercial business                                                                                     |   | (772                               | )      | (236 | ) |
| Equipment finance leases                                                                                |   | (35                                | )      | (35 | ) |
| Consumer                                                                                                |   | (564                               | )      | (620 | ) |
| Agriculture                                                                                             |   | —                             |   | (58 | ) |
| Mobile homes                                                                                            |   | (29                                | )      | (37 | ) |
| Total charge-offs                                                                                       |   | (1,407                             | )      | (1,070 | ) |
|                                                                                                    |   |                               |   |   |   |
| Recoveries:                                                                                             |   |                               |   |   |   |
| One- to four-family                                                                                     |   | —                             |   | 2 |   |
| Commercial real estate                                                                                  |   | —                             |   | 2 |   |
| Commercial business                                                                                     |   | 2                                  |   | — |   |
| Equipment finance leases                                                                                |   | 6                                  |   | 38 |   |
| Consumer                                                                                                |   | 174                                |   | 170 |   |
| Agriculture                                                                                             |   | —                             |   | 8 |   |
| Mobile homes                                                                                            |   | 3                                  |   | 1 |   |
| Total recoveries                                                                                        |   | 185                                |   | 221 |   |
|                                                                                                    |   |                               |   |   |   |
| Net (charge-offs)                                                                                       |   | (1,222                             | )      | (849 | ) |
|                                                                                                    |   |                               |   |   |   |
| Additions charged to operations                                                                         |   | 1,483                              |   | 1,066 |   |
|                                                                                                    |   |                               |   |   |   |
| Balance at end of period                                                                                |   | $                                  | 4,722  |   | $ | 5,726 |   |
|                                                                                                    |   |                               |   |   |   |
| Ratio of net (charge-offs) during the period to  average loans and leases outstanding during the period |   | (0.20                              | )%     | (0.15 | )% |
|                                                                                                    |   |                               |   |   |   |
| Ratio of allowance for loan and lease losses to  total loans and leases at end of period                |   | 0.76                               | %      | 1.05 | % |
|                                                                                                    |   |                               |   |   |   |
| Ratio of allowance for loan and lease losses to  nonperforming loans and leases at end of period(1)     |   | 51.14                              | %      | 91.16 | % |

 

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(1)     Nonperforming loans andleases include both nonaccruing and accruing loans and leases delinquent morethan 90 days.

 

19

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The distribution of theCompany’s allowance for loan and lease losses and impaired loss summary at thedates indicated are summarized in the following tables.  The combination of FASB 5 and FASB 114calculations comprise the Company’s allowance for loan and lease losses.  Balances related to discontinued credit cardloan operations have been eliminated for all periods presented.

 
|                     |   | **FASB 5  Allowance  for loan and  lease losses** |   | **FASB 114  Impaired Loan  Valuation  Allowance** |   | **FASB 5  Allowance  for loan and  lease losses** |   | **FASB 114  Impaired Loan  Valuation  Allowance** |   |
|--------------------------|--------|---------------------------------------------------|--------|---------------------------------------------------|--------|---------------------------------------------------|--------|---------------------------------------------------|--------|
| **Loan Type**            |   | **At  December 31, 2002**                         |   | **At June  30, 2002**                             |   |
|                     |   | **(Dollars in Thousands)**                        |   |
|                     |   |                                              |   |                                              |   |                                              |   |                                              |   |
| One- to four-family      |   | $                                                 | 55     |                                              | $      | —                                            |   | $                                                 | 81     |   | $ | — |   |
| Commercial real estate   |   | 141                                               |   | —                                            |   | 490                                               |   | —                                            |   |
| Multi-family real estate |   | 126                                               |   | —                                            |   | 116                                               |   | —                                            |   |
| Commercial business      |   | 589                                               |   | 422                                               |   | 481                                               |   | 683                                               |   |
| Equipment finance leases |   | 346                                               |   | —                                            |   | 296                                               |   | —                                            |   |
| Consumer                 |   | 1,804                                             |   | —                                            |   | 1,889                                             |   | —                                            |   |
| Agricultural             |   | 123                                               |   | 1,079                                             |   | 78                                                |   | 297                                               |   |
| Mobile homes             |   | 37                                                |   | —                                            |   | 50                                                |   | —                                            |   |
|                     |   |                                              |   |                                              |   |                                              |   |                                              |   |
| Total                    |   | $                                                 | 3,221  |                                              | $      | 1,501                                             |   | $                                                 | 3,481  |   | $ | 980 |   |

 

**FASB114 Impaired Loan Summary**

 

|                    |   | **Number  of Loan  Customers** |   | **Loan  Balance** |   | **Impaired  Loan  Valuation  Allowance** |   |
|-------------------------|--------|--------------------------------|--------|-------------------|--------|------------------------------------------|--------|
| **Loan Type**           |   | **At  December 31, 2002**      |   |
|                    |   | **(Dollars in Thousands)**     |   |
|                    |   |                           |   |              |   |                                     |   |
| Commercial real estate  |   | 1                              |   | $                 | 30     |                                     | $      | — |   |
| Commercial business     |   | 10                             |   | 2,453             |   | 422                                      |   |
| Agriculture real estate |   | 2                              |   | 1,169             |   | 430                                      |   |
| Other agriculture loans |   | 3                              |   | 2,217             |   | 649                                      |   |
|                    |   |                           |   |              |   |                                     |   |
| Total                   |   | 16                             |   | $                 | 5,869  |                                     | $      | 1,501 |   |

 

20

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

 

The allowance for loanand lease losses was $4.7 million at December 31, 2002 as compared to $5.7million at December 31, 2001.  The ratioof the allowance for loan and lease losses to total loans and leases was 0.76%at December 31, 2002 compared to 1.05% at December 31, 2001, a decrease of 27.6%.  The Company’s management has considerednonperforming assets and other assets of concern in establishing the allowancefor loan and lease losses.  The Companycontinues to monitor its allowance for possible loan and lease losses and makefuture additions or reductions in light of the level of loans in its portfolioand as economic conditions dictate.  Thecurrent level of the allowance for loan and lease losses is a result ofmanagement’s assessment of the risks within the portfolio based on the informationrevealed in credit reporting processes. The Company utilizes a risk-ratingsystem on all commercial business, agricultural, construction and multi-familyand commercial real estate loans, including purchased loans.  A periodic credit review is performed on alltypes of loans to establish the necessary reserve based on the estimated riskwithin the portfolio. This assessment of risk takes into account thecomposition of the loan portfolio, historical loss experience for each loancategory, previous loan experience, concentrations of credit, current economicconditions and other factors that in management’s judgment deserve recognition.Regulators have reviewed the Bank’s methodology for determining allowancerequirements on the Bank’s loan portfolio and have made no requiredrecommendations for increases in the allowances during the six months endedDecember 31, 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.

 

21

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**Comparison of the Three Months Ended December 31, 2002 andDecember 31, 2001**

 

**Continued Operations:**

 

*General*.  The Company’s net income from continuingoperations was $1.5 million or $0.46 and $0.45 for basic and diluted earningsper share, respectively, for the three months ended December 31, 2002, a 31.4%increase in earnings compared to $1.2 million or $0.32 for basic earnings pershare and $0.31 for diluted earnings per share for the same period in the priorfiscal year.  Basic and diluted earningsper share from continuing operations increased 43.8% and 45.2%, respectively,for the three months ended December 31, 2002 as compared to the same period inthe prior fiscal year, due to the increase in earnings and decrease in sharesoutstanding as a result of Company stock repurchases.  For the three months ended December 31, 2002, the return onaverage equity from continuing operations was 12.48%, a 43.4% increase comparedto 8.70% for the same period in the prior fiscal year.  For the three months ended December 31,2002, the return on average assets from continuing operations was 0.80%, a27.0% increase compared to 0.63% for the same period in the prior fiscalyear.  As discussed in more detailbelow, the increases were due to a variety of key factors, including increasesin net interest income of $809,000 and noninterest income of $341,000 and adecrease in provision for losses on loans and leases of $94,000 offset byincreases in noninterest expense of $824,000 and income tax expense of $51,000.

 

*Interest and Dividend Income.*  Interest and dividend income was $11.3million for the three months ended December 31, 2002 as compared to $12.1million for the same period in the prior fiscal year, a decrease of $787,000 or6.5%.  A $1.7 million decrease ininterest and dividend income was the result of a 10.3% decrease in the averageyield on interest-earning assets.  Theaverage yield on interest-earning assets was 6.27% for the three months endedDecember 31, 2002 as compared to 6.99% for the same period in the prior fiscalyear.  For the three months endedDecember 31, 2002, the average yield on loans and leases receivable was 6.69%,a decrease of 14.1% from 7.79% 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 December 31, 2002, theprime rate dropped from 6.75% to 4.25%. Average volume increases of $28.7 million in interest-earning assetscontributed to a $938,000 increase in interest and dividend income for thethree months ended December 31, 2002 as compared to the same period in theprior fiscal year.

 

*Interest Expense.*  Interest expense was $4.7 million for thethree months ended December 31, 2002 as compared to $6.3 million for the sameperiod in the prior fiscal year, a decrease of $1.6 million or 25.2%.  A $1.8 million decrease in interest expensewas the result of a 28.0% decrease in the average rate paid on interest-bearingliabilities.  The average rate oninterest-bearing liabilities was 2.93% for the three months ended December 31,2002 as compared to 4.07% for the same period in the prior fiscal year.  For the three months ended December 31,2002, the average rate paid on interest-bearing deposits was 2.54%, a decreaseof 34.9% from 3.90% for the same period in the prior fiscal year.  Average volume increases of $14.7 million inadvances from Federal Home Loan Bank (“FHLB”) and other borrowings contributedto a $198,000 increase in interest expense for the three months ended December31, 2002 as compared to the same period in the prior fiscal year.

 

*Net Interest Income.*The Company’s net interest income from continuing operations for the threemonths ended December 31, 2002 increased $809,000, or 14.0%, to $6.6 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 and in part due to management of fundingliabilities.  The Company’s net interestmargin was 3.65% for the three months ended December 31, 2002, an

 

22

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increase of 9.6% from 3.33% for the same period in the prior fiscalyear.  The Company’s earning assetsbalances declined primarily because higher yielding mortgage loans wererefinancing at lower rates.  The Companyexperienced considerable runoff in its one- to four-family loan portfolio dueprimarily to lower national mortgage rates and average balances on one- tofour-family loans also dropped compared to one year ago due to a $23.1 millionpackage loan sale occurring in the first quarter of fiscal 2002. Certificatesof deposit and money market accounts continued to reprice at lower rates.

 

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

 

During the three monthsended December 31, 2002, the Company recorded a provision for losses on loansand leases of $449,000 compared to $543,000 for the three months ended December31, 2001, a decrease of $94,000.  See“Asset Quality” for further discussion.

 

*Noninterest Income.*  Noninterest income was $3.2 million for thethree months ended December 31, 2002 as compared to $2.9 million for the threemonths ended December 31, 2001, an increase of $341,000  or 11.9%. The increase in noninterest income was due primarily to increases inloan fees and service charges of $269,000 and fees on deposits of $100,000.

 

Loan fees and servicecharges increased 69.0% to $659,000 during the second quarter of fiscal 2003compared to $390,000 for same period in the prior fiscal year.  The increase was primarily due to anincrease in residential mortgage loan production of 13.6% in dollar volume ascompared to the same period one year ago. In a periodic review of fees received and costs to originate loans,management reduced the loan origination fee deferral amount during the firstquarter of fiscal 2003, thus increasing immediate loan origination feeincome.  This change in estimate, whichis accounted for prospectively, resulted in an increase of approximately$260,000 over the same period in the prior year.

 

Fees on depositsincreased 9.8% to $1.1 million during the second quarter of fiscal 2003compared to $1.0 million for the same period in the prior fiscal year primarilydue to a $9.6 million increase in demand deposit account balances at December31, 2002 compared to balances at December 31, 2001 and an increase in monthlyfees charged on savings accounts.

 

*Noninterest Expense.*  Noninterest expense was $7.0 million for thethree months ended December 31, 2002 as compared to $6.2 million for the threemonths ended December 31, 2001, an increase of $824,000 or 13.3%.  The increase in noninterest expense was dueprimarily to increases in compensation and employee benefits of $545,000 andother general and administrative expenses of $318,000 offset by a decrease inamortization of intangible assets of $103,000.

 

Compensation and employeebenefits increased 14.2% to $4.4 million for the three months ended December31, 2002 as compared to $3.8 million for the same period in the prior fiscalyear in part due to increased health insurance claim accruals of $314,000,employee base compensation and variable compensation (performance incentives)of $241,000 and pension costs of $117,000 offset by a reduction of $92,000 incompensation for deferred loan origination

 

23

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costs.  The increase in pensioncosts is primarily due to a combination of higher payroll covered and theinvestment performance of the pension trust account.  Four new in-store locations opened since September 30, 2001attributed to an increase in employee compensation,  related benefits and payroll taxes of $172,000 for the threemonths ended December 31, 2002 as compared to the same period in the priorfiscal year.

 

Other general andadministrative expenses increased 24.5% to $1.6 million for the three monthsended December 31, 2002 as compared to $1.3 million for the same period in theprior fiscal year primarily due to a $123,000 increase in computer and dataprocessing expenses.

 

Amortization ofintangible assets decreased 82.4% or $103,000 for the three months endedDecember 31, 2002 compared to the same period in the prior fiscal year due tocessation of amortization on goodwill. See Note 7.

 

*Income tax expense.*  The Company’s income tax expense for thethree months ended December 31, 2002 increased $51,000 or 6.9% to $790,000compared to $739,000 for the three months ended December 31, 2001.  The increase was primarily due to anincrease in the Company’s pre-tax income from continuing operations of $420,000offset by a reduction in the Company’s effective tax rate due to changes inpermanent tax differences.   Theeffective tax rate was 33.8% and 38.6% for the three months ended December 31,2002 and December 31, 2001, respectively.

 

**DiscontinuedOperations:**

 

*Loss  from discontinued operations. *Loss from discontinuedoperations decreased 39.9% or $73,000 for the three months ended December 31,2002 compared to the same period in the prior fiscal year primarily due to areduction in the credit card loan portfolio and an additional write down of$215,000, net of taxes, to net realizable value.  See Note 2 for further discussion on discontinued operations.

 

**C****omparison ofthe Six Months Ended December 31, 2002 and December 31, 2001**

 

**Continued Operations:**

 

*General*.  The Company’s net income from continuingoperations was $3.0 million or $0.90 and $0.89 for basic and diluted earningsper share, respectively, for the six months ended December 31, 2002, a 30.2%increase in earnings compared to $2.3 million or $0.62 and $0.61 for basic and dilutedearnings per share, respectively, for the same period in the prior fiscalyear.  Basic and diluted earnings pershare increased 45.2% and 45.9%, respectively, for the six months endedDecember 31, 2002 as compared to the same period in the prior fiscal year, dueto the increase in earnings and decrease in shares outstanding as a result ofCompany stock repurchases.  For the sixmonths ended December 31, 2002, the return on average equity from continuingoperations was 12.13%, a 41.7% increase compared to 8.56% for the same periodin the prior fiscal year.  For the sixmonths ended December 31, 2002, the return on average assets from continuingoperations was 0.80%, a 31.1% increase compared to 0.61% for the same period inthe prior fiscal year.  As discussed inmore detail below, the increases were due to a variety of key factors,including increases in net interest income of $1.8 million and noninterestincome of $507,000 offset by increases in provision for losses on loans andleases of $417,000, noninterest expense of $946,000 and income tax expense of$220,000.

 

*Interest and Dividend Income.*  Interest and dividend income was $22.8million for the six months ended December 31, 2002 as compared to $25.6 millionfor the same period in the prior fiscal year, a decrease of $2.8 million or10.8%.  A $3.4 million decrease ininterest and dividend

 

24

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income was the result of a 10.2% decrease in the average yield oninterest-earning assets.  The averageyield on interest-earning assets was 6.50% for the six months ended December31, 2002 as compared to 7.24% for the same period in the prior fiscalyear.  For the six months ended December31, 2002, the average yield on loans and leases receivable was 6.92%, a decreaseof 13.5% from 8.00% for the same period in the prior fiscal year.  The overall decrease in interest anddividend income was primarily due to repricing of loans and investments thatgenerally reflected the decline in national interest rates.  From June 30, 2001 to December 31, 2002, theprime rate dropped from 6.75% to 4.25%. Average volume increases in loans and leases receivable of $41.9 millionresulted in a $1.7 million increase in interest and dividend income offset by adecrease of $47.4 million in investment securities, or $1.1 million decrease ininterest and dividend income as compared to the same period in the prior fiscalyear.   The Company also recorded anadditional net increase to interest income of $190,000 for nonaccrual loaninterest adjustments during the first quarter of fiscal 2003 for two commercialand agricultural loans.  See “AssetQuality”.

 

*Interest Expense.*  Interest expense was $9.5 million for thesix months ended December 31, 2002 as compared to $14.1 million for the sameperiod in the prior fiscal year, a decrease of $4.5 million or 32.3%.  A $3.9 million decrease in interest expensewas the result of a 31.8% decrease in the average rate paid on interest-bearingliabilities.  The average rate oninterest-bearing liabilities was 3.02% for the six months ended December 31,2002 as compared to 4.43% for the same period in the prior fiscal year.  For the six months ended December 31, 2002,the average rate paid on interest-bearing deposits was 2.65%, a decrease of38.4% from 4.30% for the same period in the prior fiscal year.  Average volume decreases of $4.9 million ininterest-bearing liabilities contributed to a $365,000 decrease in interestexpense for the six months ended December 31, 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 six monthsended December 31, 2002 increased $1.8 million, or 15.3%, to $13.3 millioncompared to $11.6 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 and in part due to management of fundingliabilities.  The Company’s net interestmargin was 3.79% for the six months ended December 31, 2002, an increase of15.9% from 3.27% for the same period in the prior fiscal year.  The Company’s earning assets balancesdeclined primarily because higher yielding mortgage loans were refinancing atlower rates.  The Company experiencedconsiderable runoff in its one- to four-family loan portfolio due primarily tolower national mortgage rates and average balances on one- to four-family loansalso dropped compared to one year ago due to a $23.1 million package loan saleoccurring in the first quarter of fiscal 2002. Certificates of deposit andmoney market accounts continued to reprice at lower rates.

 

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

 

During the six monthsended December 31, 2002, the Company recorded a provision for losses on loansand leases of $1.5 million compared to $1.1 million for the six months endedDecember 31, 2001, an increase of $417,000. See “Asset Quality” for further discussion.

 

25

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*Noninterest Income.*  Noninterest income was $6.3 million for thesix months ended December 31, 2002 as compared to $5.8 million for the sixmonths ended December 31, 2001, an increase of $507,000  or 8.8%. The increase in noninterest income was due primarily to increases in loanfees and service charges of $475,000, net gain on sale of securities of $345,000and fees on deposits of $222,000 offset by decreases in loan servicing incomeof $270,000 and net gain on sale of loans of $214,000.

 

Loan fees and servicecharges increased 71.8% to $1.1 million during the first half of fiscal 2003compared to $662,000 for same period in the prior fiscal year.  The increase was primarily due to anincrease in residential mortgage loan production of 19.0% in dollar volume ascompared to the same period one year ago. In a periodic review of fees received and costs to originate loans,management reduced the loan origination fee deferral amount during the firstquarter of fiscal 2003, thus increasing immediate loan origination feeincome.  This change in estimate, whichis accounted for prospectively, resulted in an increase of approximately$430,000 over the same period in the prior year.

 

Net gain on sale ofsecurities increased $345,000 as there were no sales occurring in the firsthalf of fiscal 2002.  Long-termfixed-rate mortgage-backed securities were sold to reduce the potential marketvalue loss of rising interest rates.

 

Fees on depositsincreased 11.2% to $2.2 million during the first half of fiscal 2003 comparedto $2.0 million for the same period in the prior fiscal year primarily due to a$9.6 million increase in demand deposit account balances at December 31, 2002compared to balances at December 31, 2001 and an increase in monthly feescharged on savings accounts.

 

Loan servicing income was$768,000 for the six months ended December 31, 2002 compared to $1.0 millionfor the same period in the prior fiscal year. Net gain on sale of loans was $677,000 for the six months ended December31, 2002 compared to $891,000 for the same period in the prior fiscal year.  The total 25.1% decrease was primarily dueto a $23.1 million package loan sale occurring in the first quarter offiscal  2002.

 

*Noninterest Expense.*  Noninterest expense was $13.5 million forthe six months ended December 31, 2002 as compared to $12.5 million for the sixmonths ended December 31, 2001, an increase of $946,000 or 7.6%.  The increase in noninterest expense was dueprimarily to increases in compensation and employee benefits of $793,000 andother general and administrative expenses of $343,000 offset by a decrease inamortization of intangible assets of $187,000.

 

Compensation and employeebenefits increased 10.3% to $8.5 million for the six months ended December 31,2002 as compared to $7.7 million for the same period in the prior fiscal yearin part due to increased employee base compensation and variable compensation(performance incentives) of $424,000, health insurance claim accruals of$384,000 and pension costs of $230,000 offset by a reduction of $127,000 incompensation for deferred loan origination costs.  The increase in pension costs is primarily due to a combinationof higher 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, related benefits and payroll taxes of approximately $370,000 forthe six months ended December 31, 2002 as compared to the same period in theprior fiscal year.

 

Other  general and administrative expensesincreased 13.0% to $3.0 million for the six months ended December 31, 2002 ascompared to $2.6 million for the same period in the prior

 

26

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fiscal year in part  due to a$298,000 increase in computer and data processing expenses  and a $131,000  increase in charitable contributions offset by a reduction inadvertising expense of $191,000.

 

Amortization ofintangible assets decreased 74.8% or $187,000 for the six months ended December31, 2002 compared to the same period in the prior fiscal year due to cessationof amortization on goodwill.  See Note7.

 

The Company’s propertyand casualty insurance cost increased 18.2% over the previous year whichappears to be in line with industry averages. The Company’s insurance carrier has indicated the terrorist attacks of September11, 2001 was the primary contributor to the increase and suggested the premiumincrease of a similar amount is predicted for next year.  The Company’s property and casualty premiumfor the current year is $52,000 compared to $44,000 for the previous year.

 

*Income tax expense.*  The Company’s income tax expense for the sixmonths ended December 31, 2002 increased $220,000 or 15.2% to $1.7 millioncompared to $1.5 million for the six months ended December 31, 2001.  The increase was primarily due to anincrease in the Company’s pre-tax income from continuing operations of $915,000offset by a reduction in the Company’s effective tax rate due to changes inpermanent tax differences.  Theeffective tax rate was 35.8% and 38.7% for the six months ended December 31,2002 and December 31, 2001, respectively.

 

**DiscontinuedOperations:**

 

*Lossfrom discontinued operations. *Lossfrom discontinued operations increased 27.5% or $11,000 for the six monthsended December 31, 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 $244,000, net of taxes, to net realizable value.  See Note 2 for further discussion ondiscontinued operations.

 

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**Liquidity and 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 six months ended December 31,2002, the Bank increased its borrowings with the FHLB by $1.7 million.  See “Financial Condition Data” for furtherdiscussion.

 

The Bank anticipates thatit will have sufficient funds available to meet current loan commitments.  At December 31, 2002, the Bank hadoutstanding commitments to originate and purchase mortgage and commercial loansof $100.9 million and to sell mortgage loans of $30.4 million.  Commitments by the Company to originateloans are not necessarily executed by the customer.  The Company monitors the ratio of commitments to fundings for usein liquidity management.  At December31, 2002, the Company had outstanding commitments to purchase securitiesavailable for sale of $10.2 million and no commitments to sell securitiesavailable 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 December 31, 2002.  Also, the Bank has implemented arrangementsto acquire out-of- market certificate of deposits as an additional source offunding.  As of December 31, 2002, theBank had $53.4 million in out-of-market deposits.  The Bank may also seek other sources of contingent liquidityincluding additional federal funds purchased lines with correspondent banks andlines of credit with the Federal Reserve Bank. 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 58,016 shares of commonstock were purchased pursuant to this program during the six months endedDecember 31, 2002.

 

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*TrustPreferred Securities.* The Company issued trust preferred securities during the six monthsended December 31, 2002 in order to provide funding for investment into theBank of Tier 1 (core) capital and to provide liquidity for repurchasing Companystock.  The ratio of market price pershare to book value per share affords the Company the opportunity to issuetrust preferred securities and utilize the proceeds to purchase back Companystock which provides accretive earnings per share benefits to shareholders.

 

On December 19, 2002, theCompany issued 5,000 shares totaling $5.0 million of Company Obligated MandatorilyRedeemable Preferred Securities of HF Financial Capital Trust III (“TrustIII”).  Trust III exists for the solepurpose of issuing trust preferred securities and investing the proceeds insubordinated debentures of the Company. These subordinated debentures constitute the sole asset of TrustIII.  The securities provide forcumulative cash distributions calculated at a rate based on three-month LIBORplus 3.35% adjusted quarterly.  TheCompany may, at one or more times, defer interest payments on the capitalsecurities for up to 20 consecutive quarterly periods, but not beyond January7, 2033.  At the end of the deferralperiod, all accumulated and unpaid distributions will be paid.  The capital securities will be redeemed onJanuary 7, 2033; however, the Company has the option to shorten the maturitydate to a date not earlier than January 7, 2008.  Holders of the capital securities have no voting rights, areunsecured, and rank junior in priority of the payment to all of the Company’sindebtedness and senior to the Company’s capital stock.

 

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 December 31, 2002, the Bank met all current capitalrequirements.

 

The OTS has a corecapital requirement for savings institutions comparable to the requirement fornational banks.  The OTS core capitalrequirement is 4.00% of total adjusted assets for thrifts.  The Bank had core capital of 7.46% atDecember 31, 2002.

 

**Impact of 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 due toinflation.  The impact of inflation isreflected in the increased cost of the Bank’s operations. Unlike mostindustrial companies, nearly all the assets and liabilities of the Bank aremonetary in nature.  As a result,interest rates have a greater impact on the Bank’s performance than do theeffects of general levels of inflation. Interest rates do not necessarily move in the same direction or to thesame extent as the prices of goods and services.

 

**Recent Accounting Pronouncements**

 

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

 

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**ITEM 3.  QUANTITATIVEAND****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 theCompany’s business 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.

 

Asset forth below, depending upon the volatility of the rate change, the changein asset or liability mix of the Company or other factors may produce adecrease in net interest margin in an upward moving rate environment even asthe NPV estimate indicates an increase in net value.  The converse situation can also be  expected.  Oneapproach used to quantify interest rate risk is the NPV analysis.  In essence, this analysis calculates thedifference between the present value of the liabilities and the present valueof expected cash flows from assets and off-balance sheet contracts.  The following tables set forth, at June 30,2002 and September 30, 2002 (most recent reports available), an analysis of theCompany’s interest rate risk as measured by the estimated changes in NPVresulting from instantaneous and sustained parallel shifts in the yield curve(+ 300 or -100 basis points, measured in 100 basis point increments).  Due to the abnormally low prevailinginterest rate environment, -200 and -300 NPV were not estimated by the OTS.

 

The data in the followingtables 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” and “Selected Asset and Liability PriceTables as of September 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.  Depending upon the volatility ofthe rate change, the change in asset or liability mix of the Company or otherfactors may produce a decrease in net interest margin in an increasing rateenvironment even as the NPV estimate indicates an increase in net value.  The converse situation can also be  expected. In addition, a change in U.S. Treasury rates in the designated amountsaccompanied by a change in the shape of the Treasury yield curve would causesignificantly different changes to the NPV than indicated below.

 

June 30, 2002

 

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

 

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September 30, 2002

 

|                          |   |                        |   | **Estimated  Increase  (Decrease) in NPV** |   |
|-------------------------------|--------|-----------------------------|--------|--------------------------------------------|--------|
| **Change in  Interest Rates** |   | **Estimated  NPV  Amount**  |   | **Amount**                                 |   | **Percent** |   |
|                          |   |                        |   |                                       |   |   |   |
| **Basis Points**              |   | **(Dollars  in thousands)** |   |                                       |   |
|                          |   |                        |   |                                       |   |   |   |
| +300                          |   |                        | $      | 80,477                                     |   | $ | 251 |   | 0 | % |
| +200                          |   |                        | 82,380 |                                       | 2,154  |   | 3 |   |
| +100                          |   |                        | 82,416 |                                       | 2,190  |   | 3 |   |
| —                        |   |                        | 80,226 |                                       | — |   | — |   |
| -100                          |   |                        | 78,370 |                                       | (1,856 | ) | (2 | ) |
|                               |        |                             |        |                                            |        |  |  |  |  |  |

 

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.

 

**ITEM 4.  CONTROLS****ANDPROCEDURES**

 

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

 

There have been no significant changes in theCompany’s internal controls or in other factors which could significantlyaffect internal controls subsequent to the date the Company carried out itsevaluation.  There were no significantdeficiencies or material weaknesses identified in the evaluation and therefore,no corrective actions were taken.

 

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**PART II**

 

**Item 1.            Legal Proce****edings**

 

The Company, Home Federal and its subsidiaries areinvolved as plaintiff or defendant in various legal actions arising in thenormal course of their businesses. While the ultimate outcome of these proceedings cannot be predicted withcertainty, it is the opinion of management, after consultation with counselrepresenting Home Federal and the Company in the proceedings, that theresolution 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.

 

**Item2.            Changes in Securities andUse of Proceed****s**

 

None

 

**Item3.            Defaults upon SeniorSecurities**

 

None

 

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

 

The following matters were submitted to a voteby the stockholders of HF Financial Corp. at the Annual Meeting of Stockholderson November 20, 2002:

 

a.                    Election ofBoard of Directors of the Company.

 
| Curtis L. Hage*    |   | For: | 2,262,289 |   | Vote Withheld: | 884,749   |
|--------------------|--------|------|-----------|--------|----------------|-----------|
| Jeffrey G. Parker* |   | For: | 2,133,452 |   | Vote Withheld: | 1,013,586 |
| Thomas L. Van Wyhe |   | For: | 2,309,379 |   | Vote Withheld: | 837,659   |

 

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*Terms to expire 2005.

 

Continuing Board of Directors – JoEllen Koerner,Robert L. Hanson, Wm. G. Pederson and Steven R. Sershen.

 

b.                   Adoption of theCompany’s 2002 Stock Option and Incentive Plan.

 

| For:        |   | 1,040,460 |
|-------------|--------|-----------|
| Against:    |   | 1,036,168 |
| Abstain:    |   | 70,299    |
| Non-Voters: |   | 1,204,682 |

 

c.                    Ratificationof the re-appointment of McGladrey & Pullen, LLP as the Company’s auditorsfor the fiscal year ending June 30, 2003.

 

| For:     |   | 2,913,569 |
|----------|--------|-----------|
| Against: |   | 30,336    |
| Abstain: |   | 203,134   |

 

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**Item 5.    Other Inform****ation**

 

None

 

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

 

(a) Exhibits

 
| **Regulation  S-K  Exhibit Number** |   | **Document**                                                                                                 |
|-------------------------------------|--------|--------------------------------------------------------------------------------------------------------------|
| 10.1                                |   | Guarantee  Agreement dated December 19, 2002 by and between HF Financial Corp. and  Wilmington Trust Company |
| 10.2                                |   | Indenture  Agreement dated December 19, 2002 by and between HF Financial Corp. and  Wilmington Trust Company |

 

(b) Reports on Form 8-K

 

TheCompany filed form 8-K, Item 5, “Other Events” with the Securities and ExchangeCommission on December 20, 2002 announcing the issue of 5,000shares totaling $5.0 million of Company Obligated Mandatorily Redeemable Preferred Securities of HF Financial CapitalTrust III on December 19, 2002.

 

No other information is required to be filed underPart II of the form.

 

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**HF FINANCIAL CORP.**

 

**FORM 10-Q**

**SIGN****ATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 

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

 

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**CERTI****FICATION**

 

I, Curtis L. Hage,certify that:

 
| 1.     | I have reviewed this  quarterly report on Form 10-Q of HF Financial Corp;                                                                                                                                                                                                                                                                                                                           |
|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                                                |   |
| 2.     | Based on my knowledge,  this quarterly report does not contain any untrue statement of a material  fact or omit to state a material fact necessary to make the statements made,  in light of the circumstances under which such statements were made, not  misleading with respect to the period covered by this quarterly report;                                                                  |
|   |                                                                                                                                                                                                                                                                                                                                                                                                |   |
| 3.     | Based on my knowledge,  the financial statements, and other financial information included in this  quarterly report, fairly present in all material respects the financial  condition, results of operations and cash flows of the registrant as of, and  for, the periods presented in this quarterly report;                                                                                     |
|   |                                                                                                                                                                                                                                                                                                                                                                                                |   |
| 4.     | The registrant’s other  certifying officers and I are responsible for establishing and maintaining  disclosure controls and procedures (as defined in Exchange Act Rules 13a-14  and 15d-14) for the registrant and we have:                                                                                                                                                                   |
|   |                                                                                                                                                                                                                                                                                                                                                                                                |   |
|   | a)                                                                                                                                                                                                                                                                                                                                                                                                  | designed such  disclosure controls and procedures to ensure that material information  relating to the registrant, including its consolidated subsidiaries, is made  known to us by others within those entities, particularly during the period  in which this quarterly report is being prepared; |
|   |                                                                                                                                                                                                                                                                                                                                                                                                |   |
|   | b)                                                                                                                                                                                                                                                                                                                                                                                                  | evaluated the  effectiveness of the registrant’s disclosure controls and procedures as of a  date within 90 days prior to the filing date of this quarterly report (the  “Evaluation Date”); and |
|   |                                                                                                                                                                                                                                                                                                                                                                                                |   |
|   | c)                                                                                                                                                                                                                                                                                                                                                                                                  | presented in this  quarterly report our conclusions about the effectiveness of the disclosure  controls and procedures based on our evaluation as of the Evaluation Date; |
|   |                                                                                                                                                                                                                                                                                                                                                                                                |   |
| 5.     | The registrant’s other  certifying officers and I have disclosed, based on our most recent  evaluation, to the registrant’s auditors and the audit committee of the  registrant’s board of directors (or persons performing the equivalent  function):                                                                                                                               |
|   |                                                                                                                                                                                                                                                                                                                                                                                                |   |
|   | a)                                                                                                                                                                                                                                                                                                                                                                                                  | all significant  deficiencies in the design or operation of internal controls which could  adversely affect the registrant’s ability to record, process, summarize and  report financial data and have identified for the registrant’s auditors any  material weaknesses in internal controls; and |
|   |                                                                                                                                                                                                                                                                                                                                                                                                |   |
|   | b)                                                                                                                                                                                                                                                                                                                                                                                                  | any fraud, whether or  not material, that involves management or other employees who have a  significant role in the registrant’s internal controls; and |
|   |                                                                                                                                                                                                                                                                                                                                                                                                |   |
| 6.     | The registrant’s other  certifying officers and I have indicated in this quarterly report whether or  not there were significant changes in internal controls or in other factors  that could significantly affect internal controls subsequent to the date of  our most recent evaluation, including any corrective actions with regard to  significant deficiencies and material weaknesses. |

 

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

 

 

**CERTIFICATION**

 

I, Darrel L. Posegate,certify that:

 
| 1.     | I have reviewed this  quarterly report on Form 10-Q of HF Financial Corp;                                                                                                                                                                                                                                                          |
|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                               |   |
| 2.     | Based on my knowledge,  this quarterly report does not contain any untrue statement of a material  fact or omit to state a material fact necessary to make the statements made,  in light of the circumstances under which such statements were made, not  misleading with respect to the period covered by this quarterly report; |
|   |                                                                                                                                                                                                                                                                                                                               |   |
| 3.     | Based on my knowledge,  the financial statements, and other financial information included in this  quarterly report, fairly present in all material respects the financial  condition, results of operations and cash flows of the registrant as of, and  for, the periods presented in this quarterly report;                    |
|   |                                                                                                                                                                                                                                                                                                                               |   |
| 4.     | The registrant’s other  certifying officers and I are responsible for establishing and maintaining  disclosure controls and procedures (as defined in Exchange Act Rules 13a-14  and 15d-14) for the registrant and we have:                                                                                                  |
|   |                                                                                                                                                                                                                                                                                                                               |   |
|   | a)                                                                                                                                                                                                                                                                                                                                 | designed such  disclosure controls and procedures to ensure that material information  relating to the registrant, including its consolidated subsidiaries, is made  known to us by others within those entities, particularly during the period  in which this quarterly report is being prepared; |
|   |                                                                                                                                                                                                                                                                                                                               |   |
|   | b)                                                                                                                                                                                                                                                                                                                                 | evaluated the  effectiveness of the registrant’s disclosure controls and procedures as of a  date within 90 days prior to the filing date of this quarterly report (the  “Evaluation Date”); and |
|   |                                                                                                                                                                                                                                                                                                                               |   |
|   | c)                                                                                                                                                                                                                                                                                                                                 | presented in this  quarterly report our conclusions about the effectiveness of the disclosure  controls and procedures based on our evaluation as of the Evaluation Date; |
|   |                                                                                                                                                                                                                                                                                                                               |   |
| 5.     | The registrant’s other  certifying officers and I have disclosed, based on our most recent  evaluation, to the registrant’s auditors and the audit committee of the  registrant’s board of directors (or persons performing the equivalent  function):                                                              |
|   |                                                                                                                                                                                                                                                                                                                               |   |
|   | a)                                                                                                                                                                                                                                                                                                                                 | all significant  deficiencies in the design or operation of internal controls which could  adversely affect the registrant’s ability to record, process, summarize and  report financial data and have identified for the registrant’s auditors any  material weaknesses in internal controls; and |
|   |                                                                                                                                                                                                                                                                                                                               |   |
|   | b)                                                                                                                                                                                                                                                                                                                                 | any fraud, whether or  not material, that involves management or other employees who have a  significant role in the registrant’s internal controls; and |

 

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| 6. | The registrant’s other  certifying officers and I have indicated in this quarterly report whether or  not there were significant changes in internal controls or in other factors  that could significantly affect internal controls subsequent to the date of  our most recent evaluation, including any corrective actions with regard to  significant deficiencies and material weaknesses. |
|----|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

 
| Date:    February 14, 2003  |   |                                               | /s/ Darrel L.  Posegate |   |
|-------------------------------------------------|--------|----------------------------------------------------|-------------------------|--------|
|                                            |   |                                               |                    |   |
|                                            |   | Darrel L. Posegate                                 |
|                                            |   | Senior Vice President  and Chief Financial Officer |

 

**CERTIFICATIONPURSUANT TO**

**18U.S.C. §1350,**

**AS ADOPTED PURSUANT TO**

**SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002**

 

In connection with theQuarterly Report of HF Financial Corp. (the “Company”) on Form 10-Q for the sixmonths ended December 31, 2002, as filed with the Securities and ExchangeCommission on the date hereof (the “Report”), I, Curtis L. Hage, Chairman,President and Chief Executive Officer of the Company, certify, pursuant to 18U.S.C. §1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of2002, that to the best of my knowledge:

 

(1)          The Report fully complies with the requirements of Section 13(a) or15(d) of the Securities Exchange Act of 1934; and

 

(2)   The information contained in the Reportfairly presents, in all material respects, the financial condition and resultsof operations of the Company.

 

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

 

 

**CERTIFICATION PURSUANT TO**

**18 U.S.C. §1350,**

**AS ADOPTED PURSUANT TO**

**SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002**

 

In connection with theQuarterly Report of HF Financial Corp. (the “Company”) on Form 10-Q for the sixmonths ended December 31, 2002, as filed with the Securities and ExchangeCommission on the date hereof (the “Report”), I, Darrel L. Posegate, SeniorVice President and Chief Financial Officer of the Company, certify, pursuant to18 U.S.C. §1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Actof 2002, that to the best of my knowledge:

 

37

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(1)          The Report fully complies with the requirements of Section 13(a) or15(d) of the Securities Exchange Act of 1934; and

 

(2)   The information contained in the Reportfairly presents, in all material respects, the financial condition and resultsof operations of the Company.

 

 
|   |   | /s/  Darrel L. Posegate                                                 |
|--------|--------|-------------------------------------------------------------------------|
|   |   | Darrel  L. Posegate, Senior Vice President  and Chief Financial Officer |
|   |   |                                                                    |
|   |   | Date:    February 14, 2003                               |

 

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