** **

**UNITEDSTATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-K**

 

**ý****                                  ****ANNUAL REPORTPURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

** **

**For the fiscal year ended June 30, 2002**

 

**OR**

 

**o****                                  ****TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the transition period from                                     to                                     **

 

**Commission file number 0-19972**

 

**HF FINANCIAL CORP.**

(Exactname of registrant as specified in its charter)

 

| **Delaware**                                                    |   | **46-0418532**                        |
|-----------------------------------------------------------------|--------|---------------------------------------|
| (State or other jurisdiction of incorporation  or organization) |   | (I.R.S. Employer  Identification No.) |

 

 

| **225 South Main  Avenue, Sioux Falls, South Dakota** |   | **57104**  |
|-------------------------------------------------------|--------|------------|
| (Address of principal executive offices)              |   | (Zip Code) |

 

**Registrant’s telephone number,including area code:   (605) 333-7556**

 

Securities Registered Pursuant to Section 12(b) of theAct:

 

None

 

Securities Registered Pursuant to Section 12(g) of theAct:

 

 

CommonStock, par value $.01 per share

(Title of class)

 

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports) and (2) has been subjectto such requirements for the past 90 days.

YES ý  NO o

 

Indicate by check mark if disclosure of delinquent filerspursuant to Item 405 of Regulation S-K is not contained herein, and will not becontained, to the best of registrant’s knowledge, in definitive proxy orinformation statements incorporated by reference in Part III of this Form 10-Kor any amendment to this Form 10-K. o

 

As of September 16, 2002 there were 3,329,412 issued andoutstanding shares of the Registrant’s Common Stock.

 

The aggregate market value of the voting stock held bynon-affiliates of the registrant, computed by reference to the average of thebid and asked price of such stock as of September 16, 2002 was $39.5 million(The exclusion from such amount of the market value of the shares owned by anyperson shall not be deemed an admission by the registrant that such person isan affiliate of the Registrant.)

 

**DOCUMENTS INCORPORATED BY REFERENCE**

 

Part III of Form 10-K - Portions of the Proxy Statementfor 2002 Annual Meeting of Stockholders.

 

 

 

**Forward-Looking Statements**

 

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

 

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

*                 Descriptions of plans or objectives ofmanagement for future operations, products or services and transactions.

*      Forecastsof future economic performance.

*      Descriptionsof assumptions underlying or relating to such matters.

 

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

 

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

 

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

 

**PART I**

 

**Item 1.  Business**

 

Thissection should be read in conjunction with Part II, Item 7, “Management’sDiscussion and Analysis of Financial Condition and Results of Operations”, PartII, Item 7A, “Quantitative and Qualitative Disclosures About Market Risk” andPart II, Item 8, “FinancialStatements and Supplementary Data”.

 

**The Company**

 

HF Financial Corp. (the “Company”), a unitary thriftholding company, was formed in November 1991, for the purpose of owning all ofthe outstanding stock of Home Federal Savings Bank, now known as Home FederalBank, (“Home Federal” or the “Bank”) issued in the mutual to stock conversionof Home Federal (the “Conversion”).  TheCompany acquired all of the outstanding stock of the Bank on April 8,1992.  The Company is incorporated underthe laws of the State of Delaware and generally is authorized to engage in anyactivity that is permitted by the Delaware General Corporation Law.  Unless otherwise indicated, all mattersdiscussed in this Form 10-K relate to the Company, and its direct and indirectsubsidiaries, including without limitation, the Bank.  See “Subsidiary Activities” for further information on theCompany’s and Bank’s subsidiary operations.

 

The executive offices of the Company and its direct andindirect subsidiaries are located at 225 South Main Avenue, Sioux Falls, SouthDakota, 57104.  The Company’s telephonenumber is (605) 333-7556.  The Company’sand Bank’s website is located at www.homefederal.com.  Information on this website does not constitute part of this Form10-K.

**The Bank**

 

Home Federal was founded in 1929 and is a federallychartered stock savings bank headquartered in Sioux Falls, South Dakota.  Effective July 1, 2001, the Bank beganoperating under the name Home Federal Bank. The Bank provides full-service consumer and commercial business banking,including an array of financial products, to meet the needs of its marketplace.  The Bank attracts deposits fromthe general public and uses such deposits, together with borrowings and otherfunds, to originate one- to four-family residential, commercial business,consumer, multi–family, commercial real estate, construction andagricultural loans.  The Bank’s consumerloan portfolio includes, among other things, automobile loans, home equityloans, loans secured by deposit accounts and student loans.  The Bank also purchases mortgage-backedsecurities and invests in U.S. Government and agency obligations and otherpermissible investments.  Home Federaldoes not hold any non–investment grade bonds (i.e., “junk bonds”).  The Bank receives loan servicing income onloans serviced for others and commission income from credit-life insurance onconsumer loans.  The Bank, through itswholly-owned subsidiaries, offers annuities, health, life, hazard and otherinsurance products and equipment leasing services.  At June 30, 2002, the Company had an investment in the Bank of$59.0 million.  The Bank had income fromcontinuing operations after taxes of $5.3 million for the 2002 fiscal year.

 

The Bank’s deposits are insured up to applicable limitsby the Savings Association Insurance Fund (“SAIF”), administered by the FederalDeposit Insurance Corporation (“FDIC”), and is subject to primary regulationand examination by the Office of Thrift Supervision (“OTS”).

 

## **Segments**

 

Operating segments are defined as components of anenterprise for which separate financial information is available that isevaluated regularly by the chief operating decision makers in deciding how toallocate resources and in assessing performance.  The primary reporting segment is the Bank.  The Company’s reportable segments do notmeet requirements for separate presentation in the consolidated financialstatements or notes thereto under accounting principals generally accepted inthe United States of America (“GAAP”).

 

**Subsidiary Activities**

 

In addition to the Bank,the Company had three other wholly-owned subsidiaries as of June 30, 2002:  HF Card Services, LLC (“HF Card”), HomeFirstMortgage Corp. (the “Mortgage Corp.”) and HF Capital Trust I (“Trust I”).

 

HF Card, a South Dakotalimited liability company, was established in May 1996 to provide secured,partially-secured and unsecured credit cards nationwide.  The Company announced the discontinuance ofthe subprime credit card operation in June 2002.  At June 30, 2002, the Company had a negative investment in HFCard of $10.6 million.  HF Card had anet loss from discontinued operations before taxes of $3.0 million for the 2002fiscal year, including the write down of the credit card loans to estimated netrealizable value.

 

HF Card ceased processing subprime creditcard applications in March 1999 and has been managing the portfolio from abalance of $18.1 million at June 30, 1999, to the remaining balance of $3.8million at June 30, 2002. The Company is negotiating the sale of the remainingreceivables to a third party.  As ofJune 30, 2002, the Company had not entered into a definitive agreement for thesale of the remaining receivables. The Company estimated the net realizablevalue of the credit card portfolio based on estimates from a third party.  The actual sale of the receivables andliquidation of HF Card is expected to take place in the first half of fiscal2003.  Results of this discontinuancehave been segregated from continuing operations of the Company.  The Company intends to dissolve HF Card uponliquidation.  See Note 2 of  “Notes to Consolidated Financial Statements”and Item 7, “Management’s Discussion and Analysis of Financial Condition andResults of Operations” for further discussion on discontinued operations.

 

The Mortgage Corp. is a South Dakota corporationthat, until the fall of 1998, was engaged in the business of originating one-to four- family residential loans which were sold into the secondarymarket.  At June 30, 2002, the Companyhad a $1,000 investment in the Mortgage Corp. The Mortgage Corp. is not currently engaged in any business activity.  The Mortgage Corp. had income fromcontinuing operations before tax of $51,000 for the 2002 fiscal year due tooperations of its wholly-owned subsidiary, Mid America Capital Services, Inc.(“Mid America Leasing”), during the first quarter of fiscal 2002.  In September 2001, due to regulations onfunding operations of a subsidiary, the Mortgage Corp. assigned all of thestock in Mid America Leasing to the Bank.

In November 2001, the Company formed Trust I.  Trust I 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 Trust I.  At June30, 2002, the Company had a $310,000 investment in Trust I.  Trust I had no income before tax for the2002 fiscal year.

 

In July 2002, theCompany formed HF Capital Trust II (“Trust II”).  Trust II exists for the sole purpose of issuing trust preferredsecurities and investing the proceeds in subordinated debentures of theCompany.  These subordinated debenturesconstitute the sole asset of Trust II. See Note 21 of “Notes to Consolidated Financial Statements” for furtherinformation on this subsequent event.

 

As a federally charteredthrift institution, the Bank is permitted by OTS regulations to invest up to2.00% of its assets in the stock of, or loans to, service corporation subsidiaries.  The Bank may invest an additional 1.00% ofits assets in service corporations where such additional funds are used forinner–city or community development purposes.  The Bank currently has less than 1.00% of its assets ininvestments in its subsidiary service corporations as defined by the OTS.  In addition to investments in servicecorporations, the Bank is permitted to invest an unlimited amount in operatingsubsidiaries engaged solely in activities in which the Bank may engage indirectly.

 

The Bank has fourwholly-owned subsidiaries, Hometown Insurors, Inc. (“Hometown”), Mid AmericaLeasing, Mid–America Service Corporation (“Mid–America”) and PMD,Inc. (“PMD”).

 

Hometown, a South Dakotacorporation located in Sioux Falls, South Dakota, provides a full line ofinsurance products to customers of the Bank and members of the general publicin the Bank’s market area.  Insuranceproducts offered by Hometown include annuities and life, health, homeowners,and auto insurance and, to a lesser extent, certain commercial-relatedinsurance products.  The Bank had aninvestment in Hometown of $219,000 at June 30, 2002.  Hometown had income from continuingoperations before tax of $13,000 for the 2002 fiscal year.  Hometown obtains its funding via aline of credit from the Bank.  Bankingregulations do not limit the amount of funding provided to a subsidiary.  As of June 30, 2002, the Bank had advanced$200,000 on an approved line of credit of $200,000.  Intercompany interest income and interest expense are eliminatedin the preparation of consolidated financial statements.

 

Mid America Leasing, aSouth Dakota corporation located in Sioux Falls, South Dakota, specializes inequipment finance leasing.  At June 30,2002, the Bank had a $3.0 million investment in Mid America Leasing.  Mid America Leasing had income fromcontinuing operations before tax of $188,000 for the 2002 fiscal year.  Mid America Leasing Co.obtains its funding via a line of credit from the Bank.  Banking regulations do not limit the amount offunding provided to a subsidiary.  As ofJune 30, 2002, the Bank had advanced $19.6 million on an approved line ofcredit of $20.0 million.  Intercompanyinterest income and interest expense are eliminated in the preparation ofconsolidated financial statements.

 

Mid-America is a SouthDakota corporation that, until the third quarter of fiscal 2002, providedresidential appraisal services to Home Federal and other lenders in the Bank’smarket area.  The cessation of operationsof Mid-America had no material effect on the consolidated financialstatements.  At June 30, 2002, the Bankhad a $1,000 investment in Mid–America. Mid-America is not currently engaged in any business activity.  Mid–America had income from continuingoperations before tax of $4,000 for the 2002 fiscal year.

 

PMD, a South Dakota corporation located in SiouxFalls, South Dakota, is engaged in the business of buying, selling and managingrepossessed real estate properties.  AtJune 30, 2002, the Bank had a $1,000 investment in PMD.  PMD had no activity during fiscal year 2002.

**Market Area**

 

Based on total assets at June 30, 2002, Home Federal isthe largest thrift institution headquartered in South Dakota.  The Bank has a total of 33 banking centersin its market area and 1 internet branch located at www.homefederal.com.  The Bank’s primary market area includescommunities located in eastern and central South Dakota, including the citiesof Sioux Falls, Brandon, Pierre, Winner, Freeman, Dell Rapids, Hartford,Canton, Parker, Lennox, Mitchell, Aberdeen, Mobridge, Brookings, Redfield,Dakota Dunes, Colman, Crooks, Watertown and Yankton.  During August 2000, the Bank expanded its market area to includea branch in Marshall, Minnesota.  TheBank’s immediate market area features a variety of agri-business, banking,financial services, health care and light manufacturing firms.  The internet branch allows access tocustomers nationwide.

 

Mid America Leasing provides services to customersnationwide.

## ** **

## **Lending Activities**

 

*General*.  The Bank originates fixed-rateand adjustable-rate (“ARM”) loans secured by one- to four-familyresidences.  The Bank originates ARMloans and short-term loans primarily for retention in its portfolio in order toincrease the percentage of loans in its portfolio with more frequent repricingor shorter maturities than fixed-rate mortgage loans.  The Bank has continued to originate fixed–rate mortgageloans in response to customer demand. The Bank has generally sold one- to four-family loans with maturities of15 years or greater into the secondary market with servicing released.  On occasion, the Bank has retained 15-yearfixed-rate loans in its loan portfolio to maintain appropriate assetlevels.  The Bank’s one– to four–familyloans are primarily secured by homes located in its market area in South Dakotaand Minnesota.

 

The Bank also originates consumer, multi–familyresidential and commercial real estate, construction, agricultural andcommercial business loans in its primary market area.  The Bank originates residential and non-owner occupiedconstruction loans that are presold to borrowers or held for sale by localbuilders and, on few occasions, makes land acquisition and developmentloans.  See the Loan and Lease PortfolioComposition tables immediately following this section for further detail.

 

*One– to Four–Family Residential Mortgage Lending*.  Residential loan originationsof this type are generated by the Bank’s marketing efforts, its presentcustomers, walk–in customers and referrals from real estate brokers and builders.  The Bank has focused its lending effortsprimarily on the origination of loans secured by first mortgages onowner-occupied, one- to four-family residences.

 

The Bank currently makes15– and 30–year fixed- and adjustable–rate one- to four–familyresidential mortgage loans in amounts up to 95.00% of the appraised value ofthe collateral property provided that private mortgage insurance is obtained inan amount sufficient to reduce the Bank’s exposure at or below the 80.00%level.  The Bank currently offers an ARMloan which has a fixed rate for the initial 3 to 5 years and converts to a one–yearARM loan for the remainder of the life of the loan.  The Bank also offers a one–year ARM loan with a rate belowthe Bank’s then current fixed–rate loan for a comparable 15- or 30–yearterm loan.  These loans provide for anannual cap and a lifetime cap at a set percent over the fully–indexedrate.  As a consequence of using caps,the interest rates on these loans may not be as rate sensitive as is the Bank’scost of funds.

 

In addition, the Bankoffers a 30–year balloon loan which has a fixed–rate for the first5 or 7 years of the loan term.  At theend of the five– or seven–year period, the loan converts to a 23–or 25–year fixed–rate loan at the then current market rate providedthat the borrower qualifies at the new rate. If the borrower fails to qualify at the new rate, the loan becomespayable in full.  These loans are underwrittento conform to secondary market standards.

 

The Bank also offersfixed–rate 15– through 30–year mortgage loans that conform tosecondary market standards. Interest rates charged on these fixed–rateloans are competitively priced on a daily basis according to marketconditions.  Residential loans generallydo not include prepayment penalties.

The Bank also originates fixed–rate one–to four–family mortgage loans through the South Dakota HousingDevelopment Authority (“SDHDA”) program. These loans generally have terms not to exceed 30 years and are eitherinsured by the Federal Housing Administration (“FHA”), Veteran’s Administration(“VA”) or private mortgage insuror and must have no more than a 80.00% loan tovalue ratio.  The Bank receives anorigination fee of 1.00% of the loan amount from the borrower and a servicingfee generally 0.38% from the SDHDA for these services.  The Bank is the largest servicer of loansfor the SDHDA.  At June 30, 2002, theBank serviced $444.8 million of mortgage loans for the SDHDA.  See Note 6 of “Notes to ConsolidatedFinancial Statements” for information on loan servicing.

 

In underwriting one–to four–family residential real estate loans, Home Federal evaluates boththe borrower’s ability to make monthly payments and the value of the propertysecuring the loan.  Property securingreal estate loans made by Home Federal is appraised by an appraiser pursuant toits appraisal policy.  Home Federalrequires borrowers to obtain title, fire and casualty insurance in an amountnot less than the amount of the loan. Real estate loans originated by the Bank contain a “due–on–sale”clause allowing the Bank to declare the unpaid principal balance due andpayable upon the sale of the collateral property.

 

*Commercial Business Lending*.  In order to serve the needs ofthe local business community and improve the interest rate sensitivity andyield of its assets, the Bank originates commercial loans to localbusinesses.  See “Management’sDiscussion and Analysis of Financial Condition and Results of Operations –Asset/Liability and Risk Management.”   Home Federal’s commercial business lending activities encompass loanswith a variety of purposes and security, including loans to finance accountsreceivable, inventory and equipment and business expansion within the Bank’smarket area.  Generally, Home Federal’scommercial business loans have been to borrowers in its primary lendingareas.  The Bank originates commercialbusiness loans directly and through programs sponsored by the Small BusinessAdministration (“SBA”) of which a portion of such loans are also guaranteed inpart by the SBA.  The Bank generallyoriginates commercial business loans for its portfolio and retains theservicing with respect to such loans. In the future, Home Federal anticipates continued expansion and emphasisof its commercial business lending, subject to market conditions and the HomeOwners’ Loan Act (“the HOLA”) restrictions. Interest rates on commercial business loans adjust or float with adesignated national index plus a specified margin.  See “Regulation—*BusinessActivities*” for HOLA restrictions.

 

Commercial businessloans typically are made on the basis of the borrower’s ability to makerepayment from the cash flow of the borrower’s business.  As a result, the availability of funds forthe repayment of commercial business loans may be substantially dependent onthe success of the business itself (which, in turn, is likely to be dependentupon the general economic environment). The Bank’s commercial business loans are sometimes, but not always,secured by business assets, such as accounts receivable, equipment andinventory.  However, the collateralsecuring the loans may depreciate over time, may be difficult to appraise andmay fluctuate in value based on the success of the business.  Whenever possible, all of the Bank’scommercial business loans include personal guarantees.  In addition, on major loans,the loan officer will perform on site visits, obtain financial statements andperform a financial review of the loan.

 

*Multi–Family and Commercial RealEstate Lending*.  The Bank engages in multi–family and commercial real estatelending primarily in South Dakota and the adjoining mid–westernstates.  These lending activities mayinclude existing property or new construction development or purchased loans.

 

Loans secured by multi–familyand commercial real estate properties are generally larger and involve agreater degree of credit risk than one– to four–family residentialmortgage loans. Because payments on loans secured by multi–family andcommercial real estate properties are often dependent on the successfuloperation or management of the properties, repayment of such loans may besubject to adverse conditions in the real estate market or the economy.  If the cash flow from the project is reduced(for example, if leases are not obtained or renewed), the borrower’s ability torepay the loan may be impaired. In addition, loans secured by property outsideof the Company’s immediate market area may contain a higher degree of risk dueto the fact that the Company may not be as familiar with market conditionswhere such property is located.  TheCompany does not have a material concentration of multi-family or commercialreal estate loans outside of its immediate market area.

The Bank presently originates adjustable–rate,short-term balloon payment, fixed-rate multi-family and commercial real estateloans.  The Bank’s multi–familyand commercial real estate loan portfolio is secured primarily by apartmentbuildings and, to a lesser extent, churches, motels, office buildings, stripshopping centers and nursing homes.  Theterms of such loans are negotiated on a case by case basis.  Commercial real estate loans generally haveterms that do not exceed 25 years.  TheBank has a variety of rate adjustment features, call provisions and other termsin its multi–family and commercial real estate loan portfolio.  Generally, the loans are made in amounts upto 80.00% of the appraised value of the collateral property and with debtservice coverage ratios of 115.00% or higher. The debt service coverage is the ratio of net cash from operationsbefore payment of debt service. However, these percentages may vary depending on the type of securityand the guarantor.  Such loans providefor a negotiated margin over a designated index which is generally the one- tofive-year Treasury Note Rate.  The Bankanalyzes the financial condition of the borrower, the borrower’s credithistory, the borrower’s prior record for producing sufficient income fromsimilar loans, references and the reliability and predictability of the netincome generated by the property securing the loan.  The Bank generally requires personal guarantees ofborrowers.  Depending on thecircumstances of the security of the loan or the relationship with theborrower, the Bank may decide to sell participations in the loan.  The sale of participation interests in aloan are necessitated by the amount of the loan or the limitation of Loans toOne Borrower.  See “Regulation-*Business Activities*” for a discussion ofthe Loans to One Borrower rule.  In returnfor servicing these loans for the participants, the Bank generally receives afee of 0.25% to 0.38%.  Also, income isreceived at loan closing from loan fees and discount points.  Appraisals on properties securing multi–familyand commercial real estate loans originated by the Bank are performed byappraisers approved pursuant to the Bank’s appraisal policy.

 

The FinancialInstitutions Reform, Recovery, and Enforcement Act of 1989 (“FIRREA”) includesa provision that limits the Bank’s non–residential real estate lending(i.e., commercial real estate lending, other than lending on certain multi–familyresidences) to no more than four times its total capital.  This maximum limitation, which at June 30,2002 was $236.18 million, has not materially limited the Bank’s lendingpractices.  See “Regulation-*­Regulatory Capital Requirements*.”

 

Under FIRREA, themaximum amount which Home Federal may lend to any one borrower is 15.00% ofHome Federal’s unimpaired capital and surplus or $8.7 million at June 30, 2002.  Loans in an amount equal to an additional10.00% of unimpaired capital and surplus may be made to the same borrower ifsuch loans are fully secured by readily marketable collateral.  See “Regulation-*Business Activities*” for a discussion of the Loans to OneBorrower rule.

 

*Construction and Development Lending*.  The Bank makes constructionloans to individuals for the construction of their residences as well as tobuilders and, to a lesser extent, developers for the construction of one–to four–family residences and condominiums and the development of one–to four–family lots in the Bank’s primary market area.

 

Construction loans toindividuals for their residences are structured to be converted to permanentloans at the end of the construction phase, which typically runs 6 to 12months.  These construction loans haverates and terms which match the one– to four–family permanent loansoffered by the Bank.  Residentialconstruction loans are generally underwritten pursuant to the same guidelinesused for originating permanent residential loans.

 

The Bank also makesloans to developers for the purpose of developing one– to four–familylots.  These loans typically have termsof one year and carry floating interest rates based on a national designatedindex.  Loan commitment and partialrelease fees are charged.  These loansgenerally provide for the payment of interest and loan fees from loanproceeds.  The principal balance ofthese loans is typically paid down as lots are sold.  At June 30, 2002, the Bank had $6.8 million of development loansincluded in its construction and development loan portfolio.

 

Builder construction anddevelopment loans are obtained principally through continued business fromdevelopers and builders who have previously borrowed from the Bank as well asbroker referrals and direct solicitations of developers and builders.  The application process includes asubmission to the Bank of plans, specifications and costs of the project to beconstructed or developed.  These itemsare used as a basis to determine the appraised value of the subjectproperty.  Loans are based on the lesserof current appraised value and/or the cost of construction (land plusbuilding).

 

The Bank makes loans forthe construction of multi–family residential properties.  Such loans are generally made at adjustablerates which adjust periodically based on the appropriate Treasury Notematurity.  At June 30, 2002, all of theBank’s construction loans were performing in accordance with their terms.

Construction loans are generally originatedwith a maximum loan–to-value ratio of 80.00% and land development loansare generally originated with a maximum loan–to–value ratio of60.00%, based upon an independent appraisal. Because of the uncertainties inherent in estimating development andconstruction costs and the market for the project upon completion, it isrelatively difficult to evaluate accurately the total loan funds required tocomplete a project, the related loan–to–value ratios and thelikelihood of ultimate success of the project. Construction and development loans to borrowers other than owneroccupants also involve many of the same risks discussed above regarding multi–familyand commercial real estate loans and tend to be more sensitive to generaleconomic conditions than many other types of loans.

 

Prior to making acommitment to fund a construction loan, the Bank requires an appraisal of theproperty, or for larger projects, both an appraisal and a study of thefeasibility of the proposed project. The Bank’s construction loan policy provides for the inspection ofproperties by independent in–house and outside inspectors at thecommencement of construction and prior to disbursement of funds during the termof the construction loan.

 

*Consumer Lending*.  Management considers itsconsumer loan products to be an important component of its lendingstrategy.  Specifically, consumer loansgenerally have shorter terms to maturity and carry higher rates of interestthan do one-to four-family residential mortgage loans.  In addition, management believes that theoffering of consumer loan products helps to expand and create stronger ties toits existing customer base, by increasing the number of customer relationshipsand providing cross–marketing opportunities.  For these reasons, Home Federal has continued to focus on theorigination of consumer loans.

 

Home Federal currentlypurchases automobile conditional sales contracts from selected dealers withinits market area as well as originating automobile loans directly.

 

Loans secured by secondmortgages, together with loans secured by all prior liens, are limited to 100%or less of the appraised value of the property securing the loan and generallyhave maximum terms that do not exceed 10 to 15 years.

 

The student loansoriginated by Home Federal are guaranteed as to principal and interest by theSouth Dakota Education Assistance Corporation. Upon the student nearing graduation, Home Federal sells such studentloans with servicing rights released.

 

Consumer loan terms varyaccording to the type of collateral, length of contract and creditworthiness ofthe borrower.  Home Federal offers bothopen– and closed–end credit. Overdraft lending is extended through lines of credit that are tied to achecking account.  The credit lines generallybear interest at 18.00% and are generally limited to no more than $2,000.  Loans secured by deposit accounts at theBank are currently originated for up to 90.00% of the account balance (althoughhistorically the Bank has loaned up to 100.00% of the account balance), with ahold placed on the account restricting the withdrawal of the accountbalance.  The interest rate on suchloans is typically equal to 2.00% above the contract rate.

 

The underwriting standards employed by the Bankfor consumer loans, including mobile home loans, include an application, adetermination of the applicant’s payment history on other debts, and anassessment of the ability to meet existing obligations and payments on theproposed loan.  Althoughcreditworthiness of the applicant is a primary consideration, the underwritingprocess also includes a comparison of the value of the security, if any, inrelation to the proposed loan amount.

 

Consumer loans mayentail greater credit risk than do residential mortgage loans, particularly inthe case of consumer loans which are unsecured or are secured by rapidlydepreciable assets, such as mobile homes, automobiles or boats.  In such cases, any repossessed collateralfor a defaulted consumer loan may not provide an adequate source of repaymentof the outstanding loan balance as a result of the greater likelihood ofdamage, loss or depreciation.  Inaddition, consumer loan collections are dependent on the borrower’s continuingfinancial stability, and thus are more likely to be affected by adversepersonal circumstances. Furthermore, the application of various federal andstate laws, including bankruptcy and insolvency laws, may limit the amountwhich can be recovered on such loans.

*Agricultural Loans.*  In order to serve the needs of the local business community andimprove the interest rate sensitivity and yield of its assets, the Bankoriginates agricultural loans through its agricultural division.  The agricultural division offers loans to itscustomers such as: (1) operating loans which are used to fund operatingexpenses which typically have a one year term and are indexed to the nationalprime rate; (2) term loans on machinery, equipment and breeding stock that mayhave a term up to 7 years and require annual payments; (3) agriculturalfarmland term loans which are used to fund land purchases or refinances; and(4) specialized livestock loans to fund facilities and equipment forconfinement enterprises; (5) loans to fund ethanol plant development.  Agriculture real estate loans typically willhave personal guarantees, a first lien on the real estate, interest ratesadjustable to the national prime rate or Treasury Note rates, and annual,quarterly or monthly payments. Operating and term loans are secured by farm chattels (crops, livestock,machinery, etc.) the operating assets of the borrower.  The Bank also originates agricultural loansdirectly and through programs sponsored by the Farmers Service Agency (“FSA”)of which a portion of such loans are also guaranteed in part by the FSA.

 

Loan customers are required to supply currentfinancial statements, tax returns for the past 3 to 5 years, and cash flowprojections which are updated on an annual basis.  In addition, on major loans, the loan officer will perform anannual farm visit, obtain financial statements and perform a financial reviewof the loan.

**LeasingActivities**

 

*General.*Through its wholly-ownedsubsidiary, Mid America Leasing, the Bank originates commercial and municipalleases.  These products have a fixedinterest rate for the duration of the lease with terms typically ranging from24 - 60 months.  The leases generallyare 100.00% financed with usually only the first or first and last months’payments due at lease inception.  As aresult of the 100.00% financing and fixed interest rate the yield on leases ishigher than similar type lending products.

 

Leases are originated generally in aneight-state area in the upper Midwest but originations can and have expandednationwide.  All leases are secured bythe equipment leased, with personal guaranties normally obtained on commercialleases.

 

*Commercial Leases.*   In order to support the Bank and its customers and to improvethe yield of its assets,  Mid AmericaLeasing originates commercial leases to customers primarily in the upperMidwest.  The Bank offers three types ofcommercial leases: capital, tax and Terminal Rental Adjustment Clause leases(“TRAC”).  TRAC is for larger titledequipment only such as semi-tractors and trailers.  Leases may be structured with a contracted residual of as littleas $1.00 up to 20.00% of the equipment cost. Leases encompass a wide variety of equipment for a variety of commercialuses.   The customer base tends to besmall- to medium-sized businesses that view leasing as another financing optionthat augments their overall operation. Repayment terms tend to be monthly in nature.

 

As with commercial loans, commercial leasestypically are made on the basis of the borrower’s ability to make repaymentfrom the cash flow of their business. As a result, the availability of funds for the repayment of commercialleases may be substantially dependent on the success of the businessitself.  The collateral securing theleases will generally depreciate over time, may be difficult to appraise andmay fluctuate in value based on the success of the business.

 

*Municipal Leases.*   The Bank also originates leases to municipal entities such ascities, counties, and public schools. The lessee must be a political subdivision of the state in order to qualifyas a municipal lease.   Because theinterest income earned on this type of lease is exempt from federal incometaxes, the rate offered to the municipality is usually substantially lower thana comparable commercial lease. Repayment terms generally tend to be on an annual or semi-annual basiscoinciding with the municipality’s tax receipts.  Residuals are $1.00 for municipal leases.

 

Repayment is based on the municipality’sability to levy and collect taxes. Assuming the municipality has a bond rating, that, along with auditedfinancial statements, are the basis for the lease.  On larger leases, bond ratings will be reviewed annually as wellas financial statements.

Loanand Lease Portfolio Composition.  The following table sets forth informationconcerning the composition of the Company’s loan and lease portfolio fromcontinuing operations in dollar amounts and in percentages (before deductionsfor loans in process, deferred fees and discounts and allowance for losses) asof the dates indicated.  Balances relatedto discontinued credit card loan operations have been eliminated for allperiods presented.

 
|                                   |   | **At June  30,**           |    |
|----------------------------------------|--------|----------------------------|---------|
|                                   |   | **2002**                   |    | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
|                                   |   | **Amount**                 |    | **Percent** |   | **Amount** |   | **Percent** |   | **Amount** |   | **Percent** |   | **Amount** |   | **Percent** |   | **Amount** |   | **Percent** |   |
|                                   |   | **(Dollars In Thousands)** |    |
| Real Estate Loans:                     |   |                       |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| One- to four-family (1)                |   | $                          | 79,074  |   | 13.78 | % | $ | 124,951 |   | 21.71 | % | $ | 134,014 |   | 23.62 | % | $ | 138,238 |   | 27.29 | % | $ | 131,062 |   | 29.94 | % |
| Multi-family                           |   | 56,952                     |    | 9.92 |   | 44,378 |   | 7.71 |   | 44,793 |   | 7.89 |   | 47,283 |   | 9.33 |   | 54,560 |   | 12.46 |   |
| Commercial                             |   | 89,111                     |    | 15.53 |   | 73,720 |   | 12.81 |   | 68,556 |   | 12.08 |   | 59,061 |   | 11.66 |   | 38,002 |   | 8.68 |   |
| Agricultural                           |   | 12,722                     |    | 2.22 |   | 12,753 |   | 2.21 |   | 11,669 |   | 2.06 |   | 8,714 |   | 1.72 |   | 5,035 |   | 1.15 |   |
| Construction and development           |   | 12,738                     |    | 2.22 |   | 28,419 |   | 4.94 |   | 35,511 |   | 6.26 |   | 19,696 |   | 3.89 |   | 12,804 |   | 2.93 |   |
| Total real estate loans                |   | 250,597                    |    | 43.67 |   | 284,221 |   | 49.38 |   | 294,543 |   | 51.91 |   | 272,992 |   | 53.89 |   | 241,463 |   | 55.16 |   |
|                                   |   |                       |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Other Loans and Leases:                |   |                       |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Consumer Loans:                        |   |                       |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Mobile home                            |   | 2,365                      |    | 0.41 |   | 3,920 |   | 0.68 |   | 5,676 |   | 1.00 |   | 8,115 |   | 1.60 |   | 11,152 |   | 2.55 |   |
| Automobiles                            |   | 84,782                     |    | 14.77 |   | 78,082 |   | 13.57 |   | 81,092 |   | 14.29 |   | 74,255 |   | 14.66 |   | 66,044 |   | 15.09 |   |
| Deposit account                        |   | 1,597                      |    | 0.28 |   | 1,917 |   | 0.33 |   | 2,360 |   | 0.42 |   | 2,117 |   | 0.42 |   | 2,167 |   | 0.50 |   |
| Student                                |   | 7,340                      |    | 1.28 |   | 6,831 |   | 1.19 |   | 7,146 |   | 1.26 |   | 6,996 |   | 1.38 |   | 6,986 |   | 1.60 |   |
| Junior liens on mortgages              |   | 73,680                     |    | 12.84 |   | 61,397 |   | 10.67 |   | 56,243 |   | 9.91 |   | 46,556 |   | 9.19 |   | 41,599 |   | 9.50 |   |
| Other                                  |   | 8,529                      |    | 1.49 |   | 10,939 |   | 1.90 |   | 11,570 |   | 2.04 |   | 12,304 |   | 2.43 |   | 15,944 |   | 3.64 |   |
| Total consumer loans                   |   | 178,293                    |    | 31.07 |   | 163,086 |   | 28.34 |   | 164,087 |   | 28.92 |   | 150,343 |   | 29.68 |   | 143,892 |   | 32.88 |   |
|                                   |   |                       |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Commercial business                    |   | 95,462                     |    | 16.63 |   | 97,362 |   | 16.92 |   | 87,137 |   | 15.36 |   | 62,315 |   | 12.30 |   | 41,068 |   | 9.38 |   |
| Equipment finance leases               |   | 22,834                     |    | 3.98 |   | 10,509 |   | 1.82 |   | — |   | 0.00 |   | — |   | 0.00 |   | — |   | 0.00 |   |
| Agricultural                           |   | 26,707                     |    | 4.65 |   | 20,370 |   | 3.54 |   | 21,597 |   | 3.81 |   | 20,896 |   | 4.13 |   | 11,292 |   | 2.58 |   |
|                                   |   |                       |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total other loans and leases           |   | 323,296                    |    | 56.33 |   | 291,327 |   | 50.62 |   | 272,821 |   | 48.09 |   | 233,554 |   | 46.11 |   | 196,252 |   | 44.84 |   |
|                                   |   |                       |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total gross loans and leases           |   | 573,893                    |    | 100.00 | % | 575,548 |   | 100.00 | % | 567,364 |   | 100.00 | % | 506,546 |   | 100.00 | % | 437.715 |   | 100.00 | % |
|                                   |   |                       |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Less:                                  |   |                       |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans in process                       |   | (4,678                     | )       |   |   | (3,853 | ) |   |   | (17,374 | ) |   |   | (7,487 | ) |   |   | (5,199 | ) |   |   |
| Deferred fees and discounts            |   | 504                        |    |   |   | (133 | ) |   |   | (356 | ) |   |   | (1,073 | ) |   |   | (1,514 | ) |   |   |
| Allowance for losses                   |   | (4,461                     | )       |   |   | (5,509 | ) |   |   | (5,499 | ) |   |   | (4,518 | ) |   |   | (4,021 | ) |   |   |
| Total loans and leases receivable, net |   | $                          | 565,258 |   |   |   | $ | 566,053 |   |   |   | $ | 544,135 |   |   |   | $ | 493,468 |   |   |   | $ | 426,981 |   |   |   |

 

----

(1)   Includes one- to four-family loans held for sale.

The following tableshows the composition of the Company’s loan and lease portfolio from continuingoperations by fixed- and adjustable-rate at the dates indicated.  Balances related to discontinued credit cardloan operations have been eliminated for all periods presented.

 
|                                        |   | **At June  30,**            |    |
|---------------------------------------------|--------|-----------------------------|---------|
|                                        |   | **2002**                    |    | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
|                                        |   | **Amount**                  |    | **Percent** |   | **Amount** |   | **Percent** |   | **Amount** |   | **Percent** |   | **Amount** |   | **Percent** |   | **Amount** |   | **Percent** |   |
|                                        |   | **(Dollars  In Thousands)** |    |
| Fixed-Rate Loans and Leases:                |   |                        |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Real Estate:                                |   |                        |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| One- to four-family (1)                     |   | $                           | 45,804  |   | 7.98 | % | $ | 78,350 |   | 13.61 | % | $ | 84,478 |   | 14.89 | % | $ | 95,228 |   | 18.80 | % | $ | 69,679 |   | 15.92 | % |
| Multi-family, commercial & construction |   | 44,842                      |    | 7.81 |   | 39,752 |   | 6.91 |   | 36,552 |   | 6.44 |   | 30,954 |   | 6.11 |   | 19,729 |   | 4.51 |   |
| Agricultural                                |   | 1,305                       |    | 0.23 |   | 3,433 |   | 0.60 |   | 2,843 |   | 0.50 |   | 1,505 |   | 0.30 |   | 157 |   | 0.04 |   |
| Total real estate loans                     |   | 91,951                      |    | 16.02 |   | 121,535 |   | 21.12 |   | 123,873 |   | 21.83 |   | 127,687 |   | 25.21 |   | 89,565 |   | 20.47 |   |
|                                        |   |                        |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Consumer (including mobile home loans)      |   | 127,488                     |    | 22.21 |   | 125,955 |   | 21.88 |   | 130,770 |   | 23.05 |   | 121,814 |   | 24.05 |   | 116,409 |   | 26.59 |   |
| Agricultural                                |   | 5,596                       |    | 0.98 |   | 6,007 |   | 1.04 |   | 7,632 |   | 1.35 |   | 4,897 |   | 0.97 |   | 825 |   | 0.19 |   |
| Equipment finance leases                    |   | 22,834                      |    | 3.98 |   | 10,509 |   | 1.82 |   | — |   | 0.00 |   | — |   | 0.00 |   | — |   | 0.00 |   |
| Commercial business                         |   | 21,463                      |    | 3.74 |   | 25,983 |   | 4.52 |   | 25,474 |   | 4.49 |   | 16,675 |   | 3.29 |   | 9,323 |   | 2.13 |   |
| Total fixed-rate loans and leases           |   | 269,332                     |    | 46.93 |   | 289,989 |   | 50.38 |   | 287,749 |   | 50.72 |   | 271,073 |   | 53.52 |   | 216,122 |   | 49.38 |   |
|                                        |   |                        |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Adjustable-Rate Loans:                      |   |                        |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Real estate:                                |   |                        |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| One- to four-family                         |   | 33,270                      |    | 5.80 |   | 46,601 |   | 8.10 |   | 49,536 |   | 8.73 |   | 43,010 |   | 8.49 |   | 61,383 |   | 14.02 |   |
| Multi-family, commercial & construction |   | 113,959                     |    | 19.86 |   | 106,765 |   | 18.55 |   | 112,308 |   | 19.80 |   | 95,086 |   | 18.77 |   | 85,637 |   | 19.57 |   |
| Agricultural                                |   | 11,417                      |    | 1.99 |   | 9,320 |   | 1.62 |   | 9,558 |   | 1.68 |   | 7,209 |   | 1.42 |   | 4,878 |   | 1.11 |   |
| Total real estate loans                     |   | 158,646                     |    | 27.65 |   | 162,686 |   | 28.27 |   | 171,402 |   | 30.21 |   | 145,305 |   | 28.68 |   | 151,898 |   | 34.70 |   |
|                                        |   |                        |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Consumer (including mobile home loans)      |   | 50,805                      |    | 8.85 |   | 37,131 |   | 6.45 |   | 33,317 |   | 5.87 |   | 28,529 |   | 5.63 |   | 27,483 |   | 6.28 |   |
| Agricultural                                |   | 21,111                      |    | 3.68 |   | 14,363 |   | 2.50 |   | 13,233 |   | 2.33 |   | 15,999 |   | 3.16 |   | 10,467 |   | 2.39 |   |
| Commercial business                         |   | 73,999                      |    | 12.89 |   | 71,379 |   | 12.40 |   | 61,663 |   | 10.87 |   | 45,640 |   | 9.01 |   | 31,745 |   | 7.25 |   |
| Total adjustable-rate loans                 |   | 304,561                     |    | 53.07 |   | 285,559 |   | 49.62 |   | 279,615 |   | 49.28 |   | 235,473 |   | 46.48 |   | 221,593 |   | 50.62 |   |
|                                        |   |                        |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total loans and leases                      |   | 573,893                     |    | 100.00 | % | 575,548 |   | 100.00 | % | 567,364 |   | 100.00 | % | 506,546 |   | 100.00 | % | 437,715 |   | 100.00 | % |
|                                        |   |                        |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Less:                                       |   |                        |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans in process                            |   | (4,678                      | )       |   |   | (3,853 | ) |   |   | (17,374 | ) |   |   | (7,487 | ) |   |   | (5,199 | ) |   |   |
| Deferred fees and discounts                 |   | 504                         |    |   |   | (133 | ) |   |   | (356 | ) |   |   | (1,073 | ) |   |   | (1,514 | ) |   |   |
| Allowance for loan losses                   |   | (4,461                      | )       |   |   | (5,509 | ) |   |   | (5,499 | ) |   |   | (4,518 | ) |   |   | (4,021 | ) |   |   |
|                                        |   |                        |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total loans and leases receivable, net      |   | $                           | 565,258 |   |   |   | $ | 566,053 |   |   |   | $ | 544,135 |   |   |   | $ | 493,468 |   |   |   | $ | 426,981 |   |   |   |

 

----

(1)   Includes one- to four-family loans held for sale.

The following schedule illustrates the scheduledprincipal contractual repayments of the Company’s loan and lease portfolio fromcontinuing operations at June 30, 2002. Mortgages which have adjustable or renegotiable interest rates are shownas maturing at the contractual maturity date. The schedule does not reflect the effects of possible prepayments orenforcement of due-on-sale clauses.

 
|                 |   | **Real  Estate**              |   | **Non-Real  Estate** |   |
|----------------------|--------|-------------------------------|--------|----------------------|--------|
|                 |   | **One- to  Four- Family (1)** |   | **Multi-  Family**   |   | **Commercial** |   | **Agricultural** |   | **Construction  & Development** |   | **Consumer  (2)** |   | **Commercial  Business (3)** |   | **Agricultural** |   | **Total** |   |
|                 |   | **(Dollars in Thousands)**    |   |
| Less than 1 year     |   | $                             | 2,158  |                 | $      | 3,525 |   | $ | 8,094 |   | $ | 1,281 |   | $ | 2,043 |   | $ | 44,954 |   | $ | 56,289 |   | $ | 19,033 |   | $ | 137,377 |   |
| 1 to 5 years         |   | 10,296                        |   | 16,916               |   | 46,414 |   | 6,097 |   | 4,484 |   | 131,482 |   | 47,281 |   | 7,273 |   | 270,243 |   |
| Greater than 5 years |   | 66,620                        |   | 36,511               |   | 34,603 |   | 5,344 |   | 6,211 |   | 1,857 |   | 14,726 |   | 401 |   | 166,273 |   |
| Total                |   | $                             | 79,074 |                 | $      | 56,952 |   | $ | 89,111 |   | $ | 12,722 |   | $ | 12,738 |   | $ | 178,293 |   | $ | 118,296 |   | $ | 26,707 |   | $ | 573,893 |   |
|                      |        |                               |        |                      |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

----

(1)   Includes one- to four-family loans held forsale.

(2)   Includesdemand loans, loans having no stated maturity and overdraft loans.

(3)   Includes equipment finance leases.

 

The total amount ofloans due after June 30, 2003 which have predetermined interest rates is $233.6million, while the total amount of loans due after such date which havefloating or adjustable interest rates is $202.9 million.

 

Scheduled contractualprincipal repayments of loans do not reflect the actual life of suchassets.  The average life of loans issubstantially less than their average contractual terms because ofprepayments.  In addition, due-on-saleclauses on loans generally give the Bank the right to declare a conventionalloan immediately due and payable in the event, among other things, that theborrower sells the real property subject to the mortgage and the loan is notrepaid.  The average life of mortgageloans tends to increase, however, when current mortgage loan rates aresubstantially higher than rates on existing mortgage loans and, conversely,decrease when rates on existing mortgages are substantially higher than currentmortgage loan rates.  One- tofour-family mortgage loans have prepaid significantly due to the effect oflower mortgage rates during the last year.

**Nonperforming Assets and Classified Loans**

 

*Nonperforming Assets. *See“Asset Quality” under Management’s Discussion and Analysis for discussion.

 

*Classified Assets*.  Federal regulations providefor the classification of loans and other assets such as debt and equitysecurities considered by the OTS to be of lesser quality as “substandard,”“doubtful” or “loss.” An asset is considered “substandard” if it isinadequately protected by the current net worth and paying capacity of theobligor or of the collateral pledged, if any. “Substandard” assets include those characterized by the “distinctpossibility” that the Bank will sustain “some loss” if the deficiencies are notcorrected.  Assets classified as“doubtful” have all of the weaknesses inherent in those classified“substandard,” with the added characteristic that the weaknesses present make“collection or liquidation in full,” on the basis of currently existing facts,conditions, and values, “highly questionable and improbable.”  Assets classified as “loss” are thoseconsidered “uncollectible” and of such little value that their continuance asassets without the establishment of a specific loss reserve is not warranted.  Assets which do not currently expose theBank to sufficient risk to warrant classification in one of the aforementionedcategories, but possess weaknesses, are required to be designated “specialmention” by management.

 

Whenthe Bank classifies problem assets as “loss, “ it is required either to establisha specific allowance for losses equal to 100% of that portion of the asset soclassified or to charge–off such amount. The Bank’s determination as to the classification of its assets and theamount of its valuation allowances is subject to review by the association’sRegional Director at the regional OTS office, who may order the establishmentof additional general or specific loss allowances.

 

Inconnection with the filing of its periodic reports with the OTS and inaccordance with its classification of assets policy, the Bank regularly reviewsproblem loans in its portfolio to determine whether any loans requireclassification in accordance with applicable regulations.  On the basis of management’s monthly reviewof its assets, at June 30, 2002, the Bank had criticized $9.0 millionof its assets as special mention (including certain loans discussed in thisForm 10-K) and the Bank had classified $18.9 million as substandard (includingcertain loans discussed in this Form 10-K), and approximately $4.4 million asdoubtful.  See “Asset Quality” underManagement’s Discussion and Analysis for further discussion.

 

*Allowance for Loan and LeaseLosses*. See “Application of Critical AccountingPolicies” and “Asset Quality” under Management’s Discussion and Analysis fordiscussion.

**Investment Activities**

 

Home Federal is requiredunder OTS regulation to maintain a sufficient amount of liquid assets.  Liquidity may increase or decrease dependingupon the availability of funds and comparative yields on investments in relationto the return on loans.  Historically,the Bank has maintained its liquid assets above the minimum requirementsimposed by the OTS regulations and at a level believed by management adequateto meet requirements of normal daily activities, repayment of maturing debt andpotential deposit outflows.  As ofJune 30, 2002, the Bank’s liquidity ratio (liquid assets as apercentage of net withdrawable savings deposits and current borrowings) was4.78%. See “Regulation–*Liquidity*.”

 

Federally charteredsavings institutions have the authority to invest in various types of liquidassets, including United States Treasury obligations, securities of variousfederal agencies, certain certificates of deposit of insured banks and savingsinstitutions, certain bankers’ acceptances, repurchase agreements and federalfunds.  Subject to various restrictions,federally chartered savings institutions may also invest their assets incommercial paper, investment grade corporate debt securities and mutual fundswhose assets conform to the investments that a federally chartered savingsinstitution is otherwise authorized to make directly.

 

Generally, theinvestment policy of the Bank is to invest funds among various categories ofinvestments and maturities based upon the Bank’s asset/liability managementpolicies, investment quality and marketability, liquidity needs and performanceobjectives.

 

At June 30, 2002, theCompany’s  investments inmortgage-backed securities totaled $59.7 million, or 8.3% of its total assets.As of such date, the Bank also had a $6.3 million investment in the stock ofthe Federal Home Loan Bank of Des Moines (“FHLB” or “FHLB of Des Moines”) inorder to satisfy the FHLB of Des Moines’ requirement for membership.  It is the Bank’s general policy to purchaseinvestment securities which are U.S. Government securities and federal agencyobligations and other issues rated investment grade.

 

 The composition and maturities of theinvestment securities portfolio, excluding equity securities andmortgage-backed securities, are indicated in the following table.

 
|                                        |       | **At June  30, 2002**                   |       |
|---------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                  | ** ** | **Less than  1  Year  Amortized  Cost** | ** ** | **1 to 5  Years  Amortized  Cost** | ** ** | **5 to 10  Years  Amortized  Cost** | ** ** | **Over 10  Years  Amortized  Cost** | ** ** | **Total  Investment  Securities** |   |
| **Amortized  Cost**                         | ** ** | **Fair Value**                          | ** ** |
|                                        |       | **(Dollars  in Thousands)**             |       |
| Federal agency obligations and corporations |       | $                                       | 4,200      |   | $ | 9,000 |   | $ | 999 |   | $ | 5,000 |   | $ | 19,199 |   | $ | 19,465 |   |
| Tax exempt bonds                            |       | 630                                     |       | 2,764 |   | — |   | 115 |   | 3,509 |   | 3,589 |   |
| Total investment securities                 |       | $                                       | 4,830      |   | $ | 11,764 |   | $ | 999 |   | $ | 5,115 |   | $ | 22,708 |   | $ | 23,054 |   |
|                                        |       |                                    |       |   |   |   |   |   |   |   |   |   |   |
| Weighted average yield                      |       | 6.10                                    | %          | 4.58 | % | 6.02 | % | 3.75 | % | 4.78 | % |   |   |

 

TheCompany’s investment securities portfolio at June 30, 2002 did not containsecurities in excess of 10% of the Company’s stockholders’ equity, excludingthose issued by the United States Government or its agencies.  The Company’s investment securitiesportfolio also did not contain non–investment grade or other corporatedebt securities (i.e., “junk bonds”). In addition, the Company does not invest in derivatives as defined bythe Financial Accounting Standards Board.

 

HomeFederal’s investment security portfolio is managed in accordance with a writteninvestment policy adopted by the Board of Directors.  Investments may be made by the Bank’s officers within specifiedlimits and approved in advance by the Board of Directors for transactions overthese limits.  At the present time, theBank does not have any investments that are held for trading purposes.  At June 30, 2002, the Company has $29.4million of securities available for sale, including FHLB stock of $6.3million.  See Note 4 of “Notes toConsolidated Financial Statements.”

**Sources of Funds**

 

*General*.  The Company’s primary sourcesof funds are in market deposits, FHLB advances and other borrowings,amortization and repayments of loan principal, mortgage–backed securitiesand callable agency securities and, to a lesser extent, sales of mortgageloans, sales and/or maturities of securities, mortgage-backed securities, and short term investments.

 

Borrowingsof the Bank, presently all from the FHLB of Des Moines, may be used on a short–termbasis to compensate for seasonal reductions in deposits or deposit inflows atless than projected levels, and may be used on a longer–term basis tosupport expanded lending activities. The Bank in recent years has not relied on outside borrowings other thanFHLB borrowings.  The availability offunds from loan sales is influenced by general interest rates.  See Notes 9 and 10 of the “Notes toConsolidated Financial Statements” for further detail of the Company’sborrowings.

 

*Deposits*.  The Bank offers a variety ofdeposit accounts having a wide range of interest rates and terms.  The Bank’s deposits consist of statementsavings accounts, NOW and checking accounts, money market and certificateaccounts ranging in terms from 30 days to 5 years.  The Bank primarily solicits deposits from its market area.  The Bank relies primarily on competitivepricing policies, advertising, and customer service to attract and retain thesedeposits.

 

Theflow of deposits is influenced significantly by general economic conditions,changes in money market and prevailing interest rates and competition.

 

Thevariety of deposit accounts offered by the Bank has allowed it to becompetitive in obtaining funds and to respond with flexibility to changes inconsumer demand.  In recent years, theBank has become more susceptible to short–term fluctuations in depositflows as customers have become more interest rate conscious.  The Bank manages the pricing of its depositsin keeping with its asset/liability management and profitabilityobjectives.  Based on its experience,the Bank believes that its statement savings, money market, NOW and checkingaccounts are stable sources of deposits. However, the ability of the Bank to attract and maintain certificates ofdeposit, and the rates paid on these deposits, has been and will continue to besignificantly affected by market conditions.

Thefollowing table sets forth the dollar amount of deposits in the various typesof deposit accounts offered by the Company as of the dates indicated.

 
|                                                                                                        |   | **At June  30,**            |    |
|-------------------------------------------------------------------------------------------------------------|--------|-----------------------------|---------|
|                                                                                                        |   | **2002**                    |    | **2001** |   | **2000** |   |
|                                                                                                        |   | **Amount**                  |    | **Percent**

**of**

**Total** |   | **Amount** |   | **Percent**

**of**

**Total** |   | **Amount** |   | **Percent**

**of**

**Total** |   |
|                                                                                                        |   | **(Dollars  in Thousands)** |    |
| Transaction Accounts:                                                                                       |   |                        |    |   |   |   |   |   |   |   |   |   |   |
| Noninterest bearing accounts                                                                                |   | $                           | 61,355  |   | 10.91 | % | $ | 55,003 |   | 9.15 | % | $ | 46,255 |   | 8.48 | % |
| Interest bearing accounts weighted average rates of 0.39%, 1.39% and  1.95% at June 30, 2002, 2001 and 2000 |   | 41,669                      |    | 7.41 |   | 33,165 |   | 5.52 |   | 31,838 |   | 5.84 |   |
| Savings accounts weighted average rates of 1.13%, 2.81% and 4.33% at  June 30, 2002, 2001 and 2000          |   | 50,387                      |    | 8.95 |   | 49,852 |   | 8.29 |   | 54,492 |   | 9.99 |   |
| Money market accounts weighted average rates of 1.80%, 3.63% and 5.50%  at June 30, 2002, 2001 and 2000     |   | 157,770                     |    | 28.04 |   | 139,467 |   | 23.20 |   | 113,334 |   | 20.77 |   |
|                                                                                                        |   |                        |    |   |   |   |   |   |   |   |   |   |   |
| Total transaction accounts                                                                                  |   | 311,181                     |    | 55.31 |   | 277,487 |   | 46.16 |   | 245,919 |   | 45.08 |   |
|                                                                                                        |   |                        |    |   |   |   |   |   |   |   |   |   |   |
| Certificates of Deposit:                                                                                    |   |                        |    |   |   |   |   |   |   |   |   |   |   |
|                                                                                                        |   |                        |    |   |   |   |   |   |   |   |   |   |   |
| 0.00 - 3.99%                                                                                                |   | 140,428                     |    | 24.96 |   | 5,077 |   | 0.85 |   | 2 |   | 0.00 |   |
| 4.00 - 4.99%                                                                                                |   | 29,089                      |    | 5.17 |   | 58,086 |   | 9.66 |   | 11,115 |   | 2.04 |   |
| 5.00 - 5.99%                                                                                                |   | 29,752                      |    | 5.29 |   | 85,687 |   | 14.25 |   | 145,834 |   | 26.73 |   |
| 6.00 - 6.99%                                                                                                |   | 34,167                      |    | 6.07 |   | 121,228 |   | 20.16 |   | 135,453 |   | 24.83 |   |
| 7.00 - 7.99%                                                                                                |   | 17,979                      |    | 3.20 |   | 53,642 |   | 8.92 |   | 6,971 |   | 1.28 |   |
| 8.00 - 8.99%                                                                                                |   | —                      |    | 0.00 |   | — |   | 0.00 |   | 86 |   | 0.02 |   |
| 9.00% and greater                                                                                           |   | —                      |    | 0.00 |   | — |   | 0.00 |   | 117 |   | 0.02 |   |
|                                                                                                        |   |                        |    |   |   |   |   |   |   |   |   |   |   |
| Total certificates of deposit                                                                               |   | 251,415                     |    | 44.69 |   | 323,720 |   | 53.84 |   | 299,578 |   | 54.92 |   |
| Total deposits                                                                                              |   | $                           | 562,596 |   | 100.00 | % | $ | 601,207 |   | 100.00 | % | $ | 545,497 |   | 100.00 | % |

The following table setsforth the amount of the Company’s certificates of deposit and other deposits bytime remaining until maturity as of June 30, 2002.

 
|                                        |       | **Maturity**                |       |                   |       |
|---------------------------------------------|------------|-----------------------------|------------|------------------------|------------|
| ** **                                  | ** ** | **3 Months  or Less******   | ** ** | **3 to 6  Months****** | ** ** | **6 to 12  Months****** | ** ** | **Over  12 Months****** | ** ** | **Total****** | ** ** |
|                                        |       | **(Dollars  in Thousands)** |       |
| Certificates of deposit less than $100,000  |       | $                           | 33,701     |                   | $          | 37,449 |   | $ | 56,207 |   | $ | 75,331 |   | $ | 202,688 |   |
|                                        |       |                        |       |                   |       |   |   |   |   |   |   |
| Certificates of deposit of $100,000 or more |       | 5,428                       |       | 4,584                  |       | 9,795 |   | 17,708 |   | 37,515 |   |
|                                        |       |                        |       |                   |       |   |   |   |   |   |   |
| Public funds(1)                             |       | 4,194                       |       | 3,459                  |       | 1,956 |   | 1,603 |   | 11,212 |   |
|                                        |       |                        |       |                   |       |   |   |   |   |   |   |
| Total certificates of deposit               |       | $                           | 43,323     |                   | $          | 45,492 |   | $ | 67,958 |   | $ | 94,642 |   | $ | 251,415 |   |

 

----

(1)                                  Includescertificates of deposit of $100,000 or more from governmental and other publicentities.

 

The Bank solicitscertificates of deposit of $100,000 or greater (“jumbo certificates”) fromvarious state, county and local government units which carry rates which are negotiatedat the time of deposit.  See Note 8of “Notes to Consolidated Financial Statements.”  Deposits at June 30, 2002 and 2001 include $37.4 million and$37.1 million, respectively of deposits from one local governmental entity, themajority of which are savings accounts.

*Borrowings*.  Although deposits are theBank’s primary source of funds, the Bank’s policy has been to utilizeborrowings when they are a less costly source of funds or can be invested at apositive rate of return.

 

The Bank’s borrowingsconsist primarily of advances from the FHLB of Des Moines upon the security ofits capital stock of the FHLB of Des Moines and certain pledgable loans,including but not limited to, its mortgage related loans, mortgage–backedsecurities and U.S. Government and other agency securities.  Such advances can be made pursuant toseveral different credit programs, each of which has its own interest rate andrange of maturities.  At June 30, 2002,the Bank’s FHLB advances totaled $83.4 million, representing 12.37% of totalCompany liabilities.  See Note 9 of  “Notes to Consolidated Financial Statements”for further detail of the Company’s borrowings.

 

The following table setsforth the maximum month-end balances and average balances of FHLB advances andother borrowings at the dates indicated.

** **

|                       |   | **Years  Ended June 30,**   |    |
|----------------------------|--------|-----------------------------|---------|
|                       |   | **2002**                    |    | **2001** |   | **2000** |   |
|                       |   | **(Dollars  in Thousands)** |    |
| Maximum Month-End Balance: |   |                        |    |   |   |   |   |
| FHLB advances              |   | $                           | 101,152 |   | $ | 118,631 |   | $ | 120,624 |   |
| Other borrowings           |   | 922                         |    | 10,623 |   | 1,762 |   |
|                       |   |                        |    |   |   |   |   |
| Average Balance:           |   |                        |    |   |   |   |   |
| FHLB advances              |   | $                           | 85,716  |   | $ | 105,207 |   | $ | 107,574 |   |
| Other borrowings           |   | 896                         |    | 7,234 |   | 1,739 |   |

 

The following table setsforth certain information as to the Bank’s FHLB advances and other borrowingsof the Company at the dates indicated.

 

|                                            |   | **June 30,**                |   |
|-------------------------------------------------|--------|-----------------------------|--------|
|                                            |   | **2002**                    |   | **2001** |   | **2000** |   |
|                                            |   | **(Dollars  in Thousands)** |   |
| FHLB advances                                   |   | $                           | 83,434 |   | $ | 100,714 |   | $ | 111,528 |   |
| Other borrowings                                |   | 874                         |   | 7,662 |   | 1,492 |   |
| Total borrowings                                |   | $                           | 84,308 |   | $ | 108,376 |   | $ | 113,020 |   |
|                                            |   |                        |   |   |   |   |   |
| Weighted average interest rate of FHLB advances |   | 5.41                        | %      | 5.69 | % | 5.74 | % |

 

*Trust Preferred Securities. *The Company issued trust preferredsecurities during fiscal 2002 in order to provide funding for investment intothe Bank of Tier I (core) capital and to provide liquidity for repurchasing Companystock.  See Note 10 of  “Notes to Consolidated FinancialStatements”.

 

**Competition**

 

Home Federal facesstrong competition, both in originating real estate, commercial and consumerloans and in attracting deposits. Competition in originating real estate loanscomes primarily from other commercial banks, credit unions and mortgage bankersmaking loans secured by real estate located in the Bank’s market areas.Commercial banks and finance companies provide vigorous competition in consumerlending.  The Bank competes for realestate and other loans principally on the basis of the quality of services itprovides to borrowers, interest rates and loan fees it charges and the types ofloans it originates.

 

The Bank attracts themajority of its deposits through its retail banking offices, primarily from thecommunities in which those retail banking offices are located; therefore,competition for those deposits is principally from other commercial banks andcredit unions located in the same communities. The Bank competes for these deposits by offering a variety of depositaccounts at competitive rates, convenient business hours, and convenient branchlocations with interbranch deposit and withdrawal privileges at each.  According to information contained in reportsprepared by the FDIC, the Bank is the fifth largest financial institution basedon total deposits with approximately 5.00% of the deposit market share inMinnehaha County.  Minnehaha Countyincludes the South Dakota cities of Sioux Falls, Brandon, Dell Rapids, Crooksand Hartford.  In addition, on a limitedbasis, the Bank also attracts out of market deposits nationally through itsinternet branch.

**Employees**

 

At June 30, 2002, theBank had a total of 328 full-time equivalent employees (“FTEs”) including 18FTEs of the Bank’s service corporations. The Bank’s employees are not represented by any collective bargaininggroup.  Management considers itsrelations with its employees to be good.

 

**Regulation**

 

*General*.  The Bank is a federally chartered thrift institution,the deposits of which are federally insured by the Savings AssociationInsurance Fund (the “SAIF”) of the FDIC. Accordingly, the Bank is subject to broad federal regulation andoversight extending to all its operations, by its primary federal regulator,the Office of Thrift Supervision (“OTS”). The Bank is a member of the FHLB of Des Moines and is subject to certainlimited regulation by the Federal Reserve Board.  As the unitary thrift holding company of the Bank, the Companyalso is subject to federal regulation and oversight by the OTS.  The purpose of the regulation of the Companyand other holding companies is to protect subsidiary savings associations wheredeposits are federally insured.

 

Certain of theseregulatory requirements and restrictions are discussed below or elsewhere inthis document.  The following discussionis intended to be a summary of the material statutes, regulations and policiesapplicable to savings associations and their holding companies, and it does notpurport to be a comprehensive discussion of such statutes, regulations andpolicies.

 

*Regulation of Federal SavingsAssociations*.  The OTS has extensive authority over the operations of federalsavings associations, such as the Bank. Pursuant to this authority, the Bank is required to file periodicreports with the OTS and is subject to periodic examinations primarily by theOTS and to a lesser extent by the FDIC. The last examination of the Bank by the OTS concluded on February 28,2002. Examiners may require a federal savings association to provide for highergeneral or specific loan loss–reserves. In 2002, the OTS realigned its regional supervisory structure andapportioned supervisory responsibilities to other regions.  The Company was previously located in the Centralregion and has been reassigned to the Western region.  Regulatory differences between regions should not be significant.

 

*Assessments.*  The OTS has established aschedule for the assessment of fees upon all savings associations to fund theoperations of the OTS. The general assessment, paid on a semiannual basis,is computed by totaling three components: the size of the association on whichthe basic assessment is based; the association’s supervisory condition, whichwould result in an additional assessment based on a percentage of the basicassessment for any savings institution with a composite rating of 3, 4 or 5 inits most recent safety and soundness examination; and the complexity of theassociation’s operations, which would result in an additional assessment basedon a percentage of the basic assessment for any savings association thatmanaged over $1.0 billion in trust assets, serviced for others loansaggregating more than $1.0 billion, or had certain off-balance sheet assetsaggregating more than $1.0 billion.****TheBank’s OTS assessment (standard assessment) for the fiscal year ended June 30,2002 was approximately $147,000.

*Enforcement.*  Under the Federal Deposit Insurance Act (the “FDI Act”), the OTShas primary enforcement responsibility over savings associations and has theauthority to bring enforcement action against all “institution-affiliatedparties,” including any controlling stockholder or any stockholder, attorney,appraiser or accountant who knowingly or recklessly participates in anyviolation of applicable law or regulation or breach of fiduciary duty orcertain other wrongful actions that causes or is likely to cause a more than aminimal loss or other significant adverse effect on an insured savingsassociation.  Civil penalties cover awide range of violations and actions and range from $5,000 for each day duringwhich violations of law, regulations, orders, and certain written agreementsand conditions continue, up to $1.0 million per day for such violations if theperson obtained a substantial pecuniary gain as a result of such violation orknowingly or recklessly caused a substantial loss to the institution.  Criminal penalties for certain financialinstitution crimes include fines of up to $1.0 million and imprisonment for up to30 years.  In addition, regulators havesubstantial discretion to take enforcement action against an institution thatfails to comply with its regulatory requirements, particularly with respect toits capital requirements.  Possibleenforcement actions range from the imposition of a capital plan and capitaldirective to receivership, conservatorship, or the termination of depositinsurance.  Under the FDI Act, the FDIChas the authority to recommend to the Director of OTS that enforcement actionbe taken with respect to a particular savings association.  If action is not taken by the Director ofthe OTS, the FDIC has authority to take such action under certaincircumstances.

 

*Business Activities.*  The Bank derives its lending and investment powers from the HomeOwners’ Loan Act, as amended (the “HOLA”), and the regulations of the OTSthereunder.  Under these laws andregulations, the Bank may invest in mortgage loans secured by residential andcommercial real estate, commercial and consumer loans, certain types of debtsecurities and certain other assets. The Bank may also establish service corporations that may engage inactivities not otherwise permissible for the Bank, including certain realestate equity investments and securities and insurance brokerage.  These investment powers are subject tovarious limitations, including (a) a prohibition against the acquisition of anycorporate debt security that is not rated in one of the four highest ratingcategories; (b) a limit of 400.00% of an association’s capital on the aggregateamount of loans secured by non-residential real estate property; (c) a limit of20.00% of an association’s assets on the aggregate amount of commercial andagricultural loans and leases with the amount of commercial loans in excess of10.00% of assets being limited to small business loans; (d) a limit of 35.00%of an association’s assets on the aggregate amount of consumer loans andacquisitions of certain debt securities; (e) a limit of 5.00% of assets onnon-conforming loans (loans in excess of the specific limitations of the HOLA);and (f) a limit of the greater of 5.00% of assets or an association’s capitalon certain construction loans made for the purpose of financing what is or isexpected to become residential property.

 

Under the HOLA, savingsassociations are generally subject to the same limits on Loans to One Borroweras are imposed on national banks. Generally, under these limits, a savings association may not make a loanor extend credit to a single or related group of borrowers in excess of 15.00%of the association’s unimpaired capital and surplus.  Additional amounts may be lent, not in excess of 10.00% ofunimpaired capital and surplus, if such loans or extensions of credit are fullysecured by readily-marketable collateral. Such collateral is defined to include certain debt and equity securitiesand bullion, but generally does not include real estate.  At June 30, 2002, the Bank’s lending limitunder this restriction was $8.7 million. Home Federal is in compliance with the loans–to–one–borrowerlimitation and had no borrowers in excess of the Loans to One Borrowerrequirements at June 30, 2002.

 

*Safety and Soundness Standards.*  Pursuant to the FDI Act, asamended by FDICIA and the Riegle Community Development and RegulatoryImprovement Act of 1994 (the “Community Development Act”), the OTS and thefederal bank regulatory agencies adopted, a set of guidelines prescribingsafety and soundness standards pursuant to FDICIA, as amended.  The guidelines establish general standardsrelating to internal controls and information systems, internal audit systems,loan documentation, credit underwriting, interest rate exposure, asset growth,asset quality, earnings, and compensation, fees and benefits.  In general, the guidelines require, amongother things, appropriate systems and practices to identify and manage therisks and exposures specified in the guidelines.  The guidelines prohibit excessive compensation as an unsafe andunsound practice and describe compensation as excessive when the amounts paidare unreasonable or disproportionate to the services performed by an executiveofficer, employee, director or principal stockholder.  In addition, the OTS adopted regulations that authorize, but donot require, the OTS to order an institution that has been given notice by theOTS that it is not satisfying any of such safety and soundness standards tosubmit a compliance plan.  If, afterbeing so notified, an institution fails to submit an acceptable compliance planor fails in any material respect to implement an accepted compliance plan, theOTS must issue an order directing action to correct the deficiency and mayissue an order directing other actions of the types to which anundercapitalized association is subject under the “prompt corrective action”provisions of FDICIA.  If an institutionfails to comply with such an order, the OTS may seek to enforce such order injudicial proceedings and to impose civil money penalties.

*Information Sharing.*  On October 26, 2001, the President signedinto law the Uniting and Strengthening America by Providing Appropriate ToolsRequired to Intercept and Obstruct Terrorism Act of 2001 (Public Law 107-56)(the “USA PATRIOT Act of 2001”).  Of themany goals of the USA PATRIOT Act of 2001, the facilitation of informationsharing among governmental entities and financial institutions for the purposeof combating terrorism and money laundering is of paramount importance.  Section 314 of the USA PATRIOT Act of 2001furthers this goal by providing for the sharing of information between thegovernment and financial institutions, and among financial institutionsthemselves.  As with many otherprovisions of the USA PATRIOT Act of 2001, Congress has charged the Departmentof the Treasury with developing regulations to implement theseinformation-sharing provisions.  Section314(a) of the USA PATRIOT Act of 2001 requires regulations encouragingcooperation between financial institutions and the federal government throughthe exchange of information regarding individuals, entities, and organizationsengaged in or reasonably suspected of engaging in terrorist acts or moneylaundering activities.

 

*Customer Identification Programs for Banks. *TheDepartment of the Treasury, through the Financial Crimes Enforcement Network(“FinCEN”), together with the Office of the Comptroller of the Currency(“OCC”), the Board of Governors of the Federal Reserve System (“Board”), theFDIC, the OTS and the National Credit Union Administration (“NCUA”)(collectively, the “Agencies”) are jointly issuing a proposed regulation toimplement section 326 of the USA PATRIOT Act of 2001.  Section 326 requires the Secretary of the Treasury (“Secretary”)to jointly prescribe with each of the Agencies, the Securities and ExchangeCommission (“SEC”), and the Commodity Futures Trading Commission (“CFTC”), aregulation that, at a minimum requires financial institutions to implementreasonable procedures to verify the identity of any person seeking to open anaccount, to the extent reasonable and practicable; maintain records of theinformation used to verify the person’s identity; and determine whether theperson appears on any lists of known or suspected terrorists or terroristorganizations provided to the financial institution by any governmentalagency.  The proposed regulation appliesto banks, savings associations and credit unions.

 

*Insurance of Accounts and Regulation bythe FDIC*.  The Bank is a member of the SAIF, which is administered by theFDIC. Savings deposits are insured up to $100,000 per insured member (asdefined by law and regulation) by the FDIC and such insurance is backed by thefull faith and credit of the United States Government.  As insurer, the FDIC imposes depositinsurance premiums and is authorized to conduct examinations of and to requirereporting by FDIC–insured institutions. It also may prohibit any FDIC–insured institution from engaging inany activity the FDIC determines by regulation or order to pose a serious riskto the FDIC.  The FDIC also has theauthority to initiate enforcement actions against savings associations, aftergiving the OTS an opportunity to take such action, and may terminate thedeposit insurance if it determines that the institution has engaged or isengaging in unsafe or unsound practices, or is in an unsafe or unsoundcondition.

 

Pursuant to FDICIA, the FDIC established arisk based assessment system for determining the deposit insurance assessmentsto be paid by insured depositary institutions. Under the assessment system, the FDIC assigns an institution to one ofthree capital categories based on the institution’s financial information as ofthe quarter ending three months before the beginning of the assessmentperiod.  The three capital categoriesconsist of (a) well-capitalized, (b) adequately capitalized or (c)undercapitalized.  The FDIC also assignsan institution to one of three supervisory subcategories within each capitalgroup.  The supervisory subgroup towhich an institution is assigned is based on a supervisory evaluation provided tothe FDIC by the institution’s primary federal regulator and information thatthe FDIC determines to be relevant to the institution’s financial condition andthe risk posed to the deposit insurance funds. An institution’s assessment rate depends on the capital category andsupervisory category to which it is assigned. Under the regulation, there are nine assessment risk classifications(i.e., combinations of capital groups and supervisory subgroups) to which differentassessment rates are applied.  Assessmentrates currently range from 0.00% of deposits for an institution in the highestcategory (i.e., well capitalized and financially sound, with no more than a fewminor weaknesses) to 0.27% of deposits for an institution in the lowestcategory (i.e., undercapitalized and substantial supervisory concern).  The FDIC is authorized to raise theassessment rates as necessary to maintain the required reserve ratio of1.25%.  As a result of the DepositInsurance Funds Act of 1996 (the “1996 Act”), both the BIF and the SAIFcurrently satisfy the reserve ratio requirement at June 30, 2002.

The 1996 Act also provides that the FDICcannot assess regular insurance assessments for an insurance fund unlessrequired to maintain or to achieve the designated reserve ratio of 1.25%,except on those of its member institutions that are not classified as “wellcapitalized” or that have been found to have “moderately severe” or“unsatisfactory” financial, operational or compliance weaknesses.  The Bank has not been so classified by theFDIC or the OTS.

 

In addition, the 1996 Act expanded theassessment base for the payments on the bonds (the “FICO bonds”) issued in thelate 1980s by the Financing Corporation to recapitalize the now defunct FederalSavings and Loan Insurance Corporation to include the deposits of both BIF- andSAIF-insured institutions beginning January 1, 1997.  Both BIF and SAIF-insured deposits are assessed the same FICOrates.

 

Under the FDI Act, insurance of deposits maybe terminated by the FDIC upon a finding that the institution has engaged inunsafe or unsound practices, is in an unsafe or unsound condition to continueoperations or has violated any applicable law, regulation, rule, order orcondition imposed by the FDIC or the OTS. The management of the Bank does not know of any practice, condition orviolation that might lead to termination of deposit insurance.

 

The FDIC has adoptedregulations that generally prohibit payments to directors, officers andemployees contingent upon termination of their affiliation with an FDIC–insuredinstitution or its holding company (i.e., “golden parachute payments”) if thepayment is received after or in contemplation of, among other things,insolvency, or a determination that the institution or holding company is in “troubledcondition.”  Certain types of employeebenefit plans are not subject to the prohibition.  The regulations would also generally prohibit certainindemnification payments for civil money penalties or other enforcement action.

 

*Regulatory Capital Requirements*.  Federally insured savingsassociations, such as the Bank, are required to maintain a minimum level ofregulatory capital.  The OTS hasestablished capital standards, including a tangible capital requirement, aleverage ratio (or core capital) requirement and a risk–based capitalrequirement applicable to such savings associations.  These capital requirements must be generally as stringent as thecomparable capital requirements for national banks.  The OTS is also authorized to impose capital requirements inexcess of these standards on individual associations on a case–by–casebasis.

 

The capital regulationsrequire tangible capital not less than 1.50% of adjusted total assets (asdefined by regulation).  Tangiblecapital generally includes common stockholders’ equity and retained earnings,and certain noncumulative perpetual preferred stock and related earnings onwithdrawable accounts and deposits that qualify as core capital.  In addition, all intangible assets, otherthan a limited amount of purchased mortgage servicing rights and othercategories must be deducted from tangible capital.  At June 30, 2002, Home Federal had $3.5 million of unamortizedloan servicing rights, none of which were required to be deducted from tangiblecapital.

 

The OTS regulationsestablish special capitalization requirements for savings associations that ownsubsidiaries.  Under these regulationscertain subsidiaries are consolidated for capital purposes and others areexcluded from assets and capital.  Indetermining compliance with the capital requirements, all subsidiaries engagedsolely in activities permissible for national banks or engaged in certain otheractivities solely as agent for its customers such as mortgage bankingactivities are “includable” subsidiaries that are consolidated for capitalpurposes in proportion to the association’s level of ownership, including theassets of includable subsidiaries in which the association has a minorityinterest that is not consolidated for GAAP purposes.  All subsidiaries of the Bank are includable subsidiaries.

 

The capital standardsalso require core capital equal to at least 4.00% of adjusted total assets (asdefined by regulation).  Core capitalgenerally consists of tangible capital plus certain intangible assets, and upto 25% of other intangibles which meet certain separate salability and marketvaluation tests.  At June 30, 2002, theBank had $5.3 million in intangible assets which were subject to these tests.  The amount of servicing rights includable ascore capital is limited to 50.00% of such capital. At June 30, 2002, the Bankhad Tier I (core) capital equal to $53.3 million, or 7.44% of adjusted totalassets, which is $24.6 million above the minimum leverage ratio requirement of4.00% as in effect on that date.

 

The OTS risk–basedcapital requirement requires savings associations to have total capital of atleast 8.00% of risk–weighted assets. Total capital consists of core capital, as defined above, andsupplementary capital.  Supplementarycapital consists of certain permanent and maturing capital instruments that donot qualify as core capital and general valuation loan and lease lossallowances up to a maximum of 1.25% of risk-weighted assets.  Supplementary capital may be used to satisfythe risk–based requirement only to the extent of core capital up to100.00% of core capital.  AtJune 30, 2002, Home Federal had no capital instruments that qualified assupplementary capital and $4.5 million of general loss reserves, which was notin excess of 1.25% of risk-weighted assets.

Certain exclusions fromcapital and assets are required to be made for the purpose of calculating totalcapital, in addition to the adjustments required for calculating corecapital.  Such exclusions consist ofequity investments (as defined by regulation) and that portion of land loansand nonresidential construction loans in excess of an 80% loan–to–valueratio and reciprocal holdings of qualifying capital instruments.  Home Federal had no such exclusions fromcapital and assets at June 30, 2002.

 

In determining theamount of risk–weighted assets, all assets, including certain off–balancesheet items, will be multiplied by the appropriate risk weight based on therisks inherent in the type of assets. The risk weights assigned by the OTS for principal categories of assetsare (i) 0.00% for cash and securities issued by the U.S. Government orunconditionally backed by the full faith and credit of the U.S. Government,(ii) 20.00% for securities (other than equity securities) issued by U.S.Government sponsored agencies, high quality mortgage-backed securities  and mortgage–backed securities issuedby, or fully guaranteed as to principal and interest by, the FNMA or the FHLMCexcept for those classes with residual characteristics or stripped mortgaged–relatedsecurities, (iii) 50.00% for prudently underwritten permanent one– tofour–family first lien mortgage loans not more than 90 days delinquentand having a loan–to–value ratio of not more than 80.00% atorigination unless insured to such ratio by an insurer approved by FNMA orFHLMC, and (iv) 100.00% for all other loans and investments, including consumerloans, commercial loans, repossessed and loans more than 90 days past due andall other assets.

 

On June 30, 2002, theBank had total risk-based capital of $57.7 million (including $53.3 million incore capital and $4.5 million in qualifying supplementary capital) and risk–weightedassets of $575.3 million (including $1.3 million in converted off–balancesheet assets), or total capital of 10.04% of risk–weighted assets.  This amount was $11.7 million above the8.00% requirement in effect on that date.

 

Thefollowing table sets forth Home Federal’s compliance with its capitalrequirements at June 30, 2002.

 
|                    |   | **Amount****(2)**           |       | **Percent of  Applicable  Assets(1)** |       |
|-------------------------|--------|-----------------------------|------------|---------------------------------------|------------|
|                    |   | **(Dollars  in Thousands)** |       |
| GAAP capital            |   | $                           | 59,044     |                                  | 8.17       | % |
|                    |   |                        | ** ** |                                  | ** ** |
| Tier I (core) capital   |   | $                           | 53,284     |                                  | 7.44       | % |
| Required                |   | 28,656                      |       | 4.00                                  |       |
| Excess over requirement |   | $                           | 24,628     |                                  | 3.44       | % |
|                    |   |                        |       |                                  |       |
| Risk-based capital(3)   |   | $                           | 57,745     |                                  | 10.04      | % |
| Required                |   | 46,023                      |       | 8.00                                  |       |
| Excess over requirement |   | $                           | 11,722     |                                  | 2.04       | % |

 

----

(1)                                  Tier I (core) capital figures are determined as a percentage of totaladjusted assets; risk–based capital figures are determined as apercentage of risk-weighted assets.

 

(2)                                  The Bank’s investment in its subsidiaries is included for purposes ofcalculating regulatory capital.

 

(3)                                  Includes qualifying supplementary capital of $4.5 million.

Under FDICIA all theFederal banking agencies, including the OTS, must revise their risk–basedcapital requirements to ensure that such requirements account for interest raterisk, concentration of credit risk and the risks of non–traditionalactivities, and that they reflect the actual performance of and expected losson multi–family loans.

 

*Prompt Corrective Action Standards.*  The OTS and the FDIC areauthorized and, under certain circumstances, required to take certain actionsagainst any association that fails to meet its capital requirements. The OTS isgenerally required to take action to restrict the activities of an“undercapitalized association” (generally defined to be one with less thaneither a 4.00% core ratio, a Tier 1 risked–based capital ratio or an8.00% risk-based capital ratio).  Anysuch association must submit a capital restoration plan and until such plan isapproved by the OTS may not increase its assets, acquire another institution,establish a branch or engage in any new activities, and generally may not makecapital distributions.  The OTS isauthorized to impose the additional restrictions, discussed below that areapplicable to significantly undercapitalized associations.

 

As a condition to theapproval of the capital restoration plan, any company controlling anundercapitalized association must agree that it will enter into a limitedcapital maintenance guarantee with respect to the institution’s achievement ofits capital requirements.

 

Any savings associationthat fails to comply with its capital plan or is “significantlyundercapitalized” (i.e., Tier 1 risk-based or core capital ratios of less than3.00% or a risk–based capital ratio of less than 6.00%) must be subjectto one or more of the additional specified actions and operating restrictionsmandated by FDICIA.  These actions andrestrictions include requiring the issuance of additional voting securities;limitations on asset growth; mandated asset reduction; changes in seniormanagement; divestiture, merger or acquisition of the association; restrictionson executive compensation; and any other action the OTS deems appropriate.

 

An association thatbecomes “critically undercapitalized” (i.e., a tangible capital ratio of 2.00%or less) is subject to further restrictions on its activities in addition tothose applicable to significantly undercapitalized associations.  The FDIC must restrict the activities of acritically undercapitalized association and, among other things, prohibit any materialtransaction outside the ordinary course of business or engaging in certaintransactions with affiliates, without the approval of the FDIC.  The OTS must appoint a receiver (orconservator with the concurrence of the FDIC) for a savings association, withcertain limited exceptions, within 90 days after it becomes criticallyundercapitalized.

 

Any undercapitalizedassociation is also subject to other possible enforcement actions by the OTS orthe FDIC.  Such actions could include acapital directive, a cease–and–desist order, civil money penalties,the establishment of restrictions on all aspects of the association’soperations or the appointment of a receiver or conservator or a forced mergerinto another institution.  The groundsfor appointment of a conservator or receiver include substantially insufficientcapital and losses or likely losses that will deplete substantially all capitalwith no reasonable prospect for replenishment of capital without federalassistance.

 

If the OTS determinesthat an association is in an unsafe or unsound condition or is engaged in anunsafe or unsound practice it is authorized to reclassify a well–capitalizedassociation as an adequately capitalized association and if the association isadequately capitalized, to impose the restrictions applicable to an undercapitalizedassociation.

 

The imposition by theOTS or the FDIC of any of these measures on the Bank may have a substantialadverse effect on the Bank’s and the Company’s operations and profitability andthe value of the Company’s Common Stock. The Company’s shareholders do not have preemptive rights, and therefore,if the Company is directed by the OTS or the FDIC to issue additional shares ofCommon Stock, such issuance may result in the dilution in the percentage ofownership of the Company of those persons owning shares of the Company’s CommonStock.

 

*Limitations on Dividends and OtherCapital Distributions*.  OTS regulations impose various restrictionsor requirements on associations with respect to their ability to pay dividendsor make other distributions of capital. OTS regulations prohibit an association from declaring or paying anydividends or from repurchasing any of its stock if, as a result, the regulatorycapital of the association would be reduced below the amount required to bemaintained for the liquidation account established in connection with itsmutual to stock conversion.

The OTS imposes variousrestrictions or requirements on the Bank’s ability to make capitaldistributions, including cash dividends. A savings institution that is thesubsidiary of a savings and loan holding company must file an application or anotice with the OTS at least 30 days before making a capital distribution. TheBank must file an application for prior approval if the total amount of itscapital distributions, including the proposed distribution, for the applicablecalendar year would exceed an amount equal to the Bank’s net income for thatyear plus retained net income for the previous two years. However, a savingsassociation subsidiary of a savings and loan holding company, such as the Bank,will continue to have to file a notice, unless the specific capitaldistribution requires an application.

 

The OTS may disapproveof a notice or application if:

 

•                    theBank would be undercapitalized following the distribution;

•                    theproposed capital distribution raises safety and soundness concerns; or

•                    thecapital distribution would violate a prohibition contained in any statute,regulation or agreement.

 

*Liquidity*.  All savings associations,including Home Federal, are required to maintain a sufficient amount of liquidassets to ensure its safe and sound operation. For a discussion of what the Bank includes in liquid assets, see“Management’s Discussion and Analysis of Financial Condition and Results ofOperations – Liquidity and Capital Resources.”  At June 30, 2002, the Bank’s overall liquid asset ratiowas 4.78%.

 

*Branching.*  Subject to certain limitations,the HOLA and the OTS regulations permit federally chartered savingsassociations to establish branches in any state of the United States.  The authority to establish such branches isavailable (a) in states that expressly authorize branches of savingsassociations located in another state or (b) to an association that qualifiesas a “domestic building and loan association” under the Internal Revenue Codeof 1986, which imposes qualification requirements similar to those for a“qualified thrift lender” under the HOLA. See “QTL Test.”  The authorityfor a federal savings association to establish an interstate branch networkwould facilitate a geographic diversification of the association’sactivities.  This authority under theHOLA and the OTS regulations preempts any state law purporting to regulatebranching by federal savings associations.

 

*Community Reinvestment.*  Under the CommunityReinvestment Act (the “CRA”), as implemented by OTS regulations, a savingsassociation has a continuing and affirmative obligation consistent with itssafe and sound operation to help meet the credit needs of its entire community,including low and moderate income neighborhoods.  The CRA does not establish specific lending requirements orprograms for financial institutions nor does it limit an institution’sdiscretion to develop the types of products and services that it believes are bestsuited to its particular community, consistent with the CRA.  The CRA requires the OTS, in connection withits examination of a savings association, to assess the association’s record ofmeeting the credit needs of its community and to take such record into accountin its evaluation of certain applications by such association.  The CRA also requires all institutions tomake public disclosure of their CRA ratings. The Association received an “Outstanding” CRA rating in its most recent examination.

 

The CRA regulations ratean institution based on its actual performance in meeting community needs.  In particular, the rating system focuses onthree tests:  (a) a lending test, toevaluate the institution’s record of making loans in its assessment areas; (b)an investment test, to evaluate the institution’s record of investing incommunity development projects, affordable housing, and programs benefiting lowor moderate income individuals and businesses; and (c) a service test, toevaluate the institution’s delivery of services through its branches, ATMs andother offices.  The amended CRAregulations also clarify how an institution’s CRA performance would beconsidered in the application process.

 

*Qualified Thrift Lender Test*.  All savings associations, includingthe Bank, are required to meet a qualified thrift lender (“QTL”) test to avoidcertain restrictions on their operations. This test requires a savings association to have at least 65.00% of itsportfolio assets (which consists of total assets less the sum of goodwill andother intangible assets, properties used to conduct the savings association’sbusiness and specified liquid assets not exceeding 20.00% of total assets) inqualified thrift investments on a monthly average for 9 out of every 12 monthson a rolling basis.  At June 30, 2002,the Bank maintained 78.09% of its portfolio assets in qualified thriftinvestments, and thus met the test.  TheBank has met the QTL test since its inception.

Loans and mortgage–backedsecurities secured by domestic residential housing, FHLB stock, credit cardloans, educational loans and certain small business loans as well as certainobligations of the Federal Savings and Loan Insurance Corporation (“FSLIC”),the FDIC and certain other related entities may be included in qualifyingthrift investments without limit.  FHLMCand FNMA stock and certain other housing–related and non–residentialreal estate loans and investments, including loans to develop churches, nursinghomes, hospitals and schools, and consumer loans and investments insubsidiaries engaged in housing–related activities may also be included,in varying amounts, not to exceed 20.00% of portfolio assets.

 

Any savings associationthat fails to meet the QTL test must either convert to a national bank charteror operate under certain restrictions on its activities, unless it requalifiesas a QTL and thereafter remains a QTL. If any association that fails the QTL test is controlled by a holdingcompany, then within one year after the failure, the holding company mustregister as a bank holding company and become subject to all restrictions onbank holding companies.  See “HoldingCompany Regulation.”

 

*Transactions with Affiliates*.  The Bank’s authority to engagein transactions with its “affiliates” is limited by the OTS regulations and bySections 23A and 23B of the Federal Reserve Act (the “FRA”).  In general, an affiliate of the Associationis any company that controls the Association or any other company that is controlledby a company that controls the Association, excluding the Association’ssubsidiaries other than those that are insured depository institutions.  The OTS regulations prohibit a savingsassociation (a) from lending to any of its affiliates that is engaged inactivities that are not permissible for bank holding companies under Section4(c) of the BHC Act and (b) from purchasing the securities of any affiliateother than a subsidiary.  Section 23Alimits the aggregate amount of transactions with any individual affiliate to10.00% of the capital and surplus of the savings association and also limitsthe aggregate amount of transactions with all affiliates to 20.00% of thesavings association’s capital and surplus. Extensions of credit to affiliates are required to be secured bycollateral in an amount and of a type described in Section 23A, and thepurchase of low quality assets from affiliates is generally prohibited.  Section 23B provides that certaintransactions with affiliates, including loans and asset purchases, must be onterms and under circumstances, including credit standards, that aresubstantially the same or at least as favorable to the association as thoseprevailing at the time for comparable transactions with non-affiliatedcompanies.  In the absence of comparabletransactions, such transactions may only occur under terms and circumstances,including credit standards, that in good faith would be offered to or wouldapply to non-affiliated companies.

 

The Association’s authority to extend credit toits directors, executive officers, and 10.00% shareholders, as well as toentities controlled by such persons, is currently governed by the requirementsof Sections 22(g) and 22(h) of the FRA and Regulation O of the FRBthereunder.  Among other things, theseprovisions require that extensions of credit to insiders (a) be made on termsthat are substantially the same as, and follow credit underwriting proceduresthat are not less stringent than, those prevailing for comparable transactionswith unaffiliated persons and that do not involve more than the normal risk ofrepayment or present other unfavorable features and (b) not exceed certainlimitations on the amount of the association’s capital.  In addition, extensions of credit in excessof certain limits must be approved by the association’s board of directors.

 

Certain transactionswith directors, officers or controlling persons are also subject to conflict ofinterest regulations enforced by the OTS. These conflict of interest regulations and other statutes also impose restrictionson loans to such persons and their related interests.  Among other things, such loans must be made on termssubstantially the same as those for loans to unaffiliated individuals.

 

*Real Estate Lending Standards.*  The OTS and the other federalbanking agencies adopted regulations to prescribe standards for extensions ofcredit that (a) are secured by real estate or (b) are made for the purpose offinancing the construction of improvements on real estate.  The OTS regulations require each savingsassociation to establish and maintain written internal real estate lendingstandards that are consistent with safe and sound banking practices andappropriate to the size of the association and the nature and scope of its realestate lending activities.  Thestandards also must be consistent with accompanying OTS guidelines, whichinclude loan-to-value ratios for the different types of real estate loans.  Associations are also permitted to make alimited amount of loans that do not conform to the proposed loan-to-value limitationsso long as such exceptions are reviewed and justified appropriately.  The guidelines also list a number of lendingsituations in which exceptions to the loan-to-value standards are justified.

*Privacy Regulations.*  Under OTS regulations adopted pursuant to the Gramm-Leach-BlileyAct of 1999 (“GLB Act”), the Bank is required to adopt proceduresto protect customers’ “nonpublic personal information.”  The new regulations generally require thatthe Bank disclose its privacy policy, including identifying with whom it sharesa customer’s “nonpublic personal information,” to customers at the time ofestablishing the customer relationship and annually thereafter.  In addition, the Bank is required to provideits customers with the ability to “opt-out” of having it share their personalinformation with unaffiliated third parties and not to disclose account numbersor access codes to nonaffiliated third parties for marketing purposes.  The Bank currently has a privacy protectionpolicy in place, which has been reviewed, for compliance with the regulations.

 

*Holding Company Regulation*.  The Company is a unitary thrift holding company subject toregulatory oversight by the OTS.  Assuch, the Company is registered with and files reports with the OTS and is subjectto regulation and examination by the OTS. Underthe GLB Act, any company which becomes a unitary savings and loan holdingcompany pursuant to a charter application filed with the OTS after May 4, 1999is prohibited from engaging in non-financial activities or affiliating withnon-financial companies.  All unitarysavings and loan holding companies in existence prior to May 4, 1999, such asthe Company, are “grandfathered” under the GLB Act and may continue to operateas a unitary savings and loan holding company without any limitations in thetypes of business activities in which it can engage at the holding companylevel, provided the Bank continues to satisfy the QTL Test.  In addition, the OTS hasenforcement authority over the Company and its non–savings associationsubsidiaries which also permits the OTS to restrict or prohibit activities thatare determined to be a serious risk to the subsidiary savings association.

 

As a “grandfathered”unitary thrift holding company, the Company generally is not subject toactivity restrictions.  If the Companyacquires control of another savings association as a separate subsidiary, itwould become a multiple savings and loan holding company, and the activities ofthe Company and any of its subsidiaries (other than the Bank or any other SAIF–insuredsavings association) would become subject to such restrictions unless suchother associations each qualify as a QTL and were acquired in a supervisoryacquisition.

 

If the Bank fails theQTL test, the Company must obtain the approval of the OTS prior to continuingafter such failure, directly or through its other subsidiaries, any businessactivity other than those approved for multiple savings and loan holdingcompanies or their subsidiaries.  Inaddition, within one year of such failure the Company must register as, andwill become subject to, the restrictions applicable to bank holdingcompanies.  The activities authorizedfor a bank holding company are more limited than are the activities authorizedfor a unitary or multiple savings and loan holding company.  See “Qualified Thrift Lender Test.”

 

In addition, for grandfathered savings and loanholding companies, such as the Company, the GLB Act also prohibits the sale ofsuch entities to nonfinancial companies. This prohibition is intended to restrict the transfer of grandfatheredrights to other entities and, thereby, prevent evasion of the limitation on thecreation of new unitary savings and loan holding companies.

 

*Federal Securities Law*.  The stock of the Company isregistered with the Securities and Exchange Commission (“SEC”) under theSecurities Exchange Act of 1934, as amended (the “Exchange Act”).  The Company is subject to the information,proxy solicitation, insider trading restrictions and other requirements of theSEC under the Exchange Act.

 

Company stock held bypersons who are affiliates (generally officers, directors and principalstockholders) of the Company may not be resold without registration or unlesssold in accordance with certain resale restrictions.  If the Company meets specified current public informationrequirements, each affiliate of the Company is able to sell in the publicmarket, without registration, a limited number of shares in any three–monthperiod.

 

*Federal Reserve System*.  . Under the Federal ReserveBoard’s (FRB) regulations, the Bank is required to maintainnon-interest-earning reserves against its transaction accounts. FRB regulationsgenerally require that (a) reserves of 3.00% must be maintained againstaggregate transaction accounts of $41.3 million or less, subject to adjustmentby the FRB, and (b) a reserve of $1.2 million plus 10.00% (subject toadjustment by the Federal Reserve Board between 8.00% and 14.00%) must bemaintained against that portion of total transaction accounts in excess of$41.3 million. The first $5.7 million of otherwise reservable balances areexempted from the reserve requirements. The Bank is in compliance with thesereserve requirements. Because required reserves must be maintained in the formof either vault cash, a noninterest bearing account at a Federal Reserve Bank,or a passthrough account as defined by the Federal Reserve Board, the effect ofthis reserve requirement is to reduce the Bank’s interest-earning assets to theextent that the requirement exceeds vault

Savings associations areauthorized to borrow from the FRB”discount window,” but FRB regulations requireassociations to exhaust other reasonable alternative sources of funds,including FHLB borrowings, before borrowing from the FRB.

 

*Federal Home Loan Bank System*.  The Bank is a member of theFHLB of Des Moines, which is one of 12 regional FHLBs, that administers thehome financing credit function of savings associations.  Each FHLB serves as a reserve or centralbank for its members within its assigned region.  It is funded primarily from proceeds derived from the sale ofconsolidated obligations of the FHLB System. It makes loans to members (i.e., advances) in accordance with policiesand procedures established by the board of directors of the FHLB.  These policies and procedures are subject tothe regulation and oversight of the Federal Housing Finance Board.  All advances from the FHLB are required tobe fully secured by sufficient collateral as determined by the FHLB.  In addition, all long–term advancesare required to provide funds for residential home financing.

 

As a member, HomeFederal is required to purchase and maintain stock in the FHLB of DesMoines.  At June 30, 2002, Home Federalhad $6.3 million in FHLB stock, which was in compliance with thisrequirement.  In past years, the Bankhas received substantial dividends on its FHLB stock.  Over the past five fiscal years such dividend yields have averaged5.88% and were 3.52% for fiscal year 2002. For the fiscal year ended June 30, 2002, dividends paid by the FHLB ofDes Moines to Home Federal totaled approximately $223,000, which constitutes a$128,000 decrease in the amount of dividends received in fiscal 2001.  This reduction is primarily due to adecrease in interest rates from the prior year.

 

Under federal law, theFHLBs are required to provide funds for the resolution of troubled savingsassociations and to contribute to low and moderately–priced housingprograms through direct loans or interest subsidies on advances targeted forcommunity investment and low– and moderate–income housingprojects.  These contributions haveaffected adversely the level of FHLB dividends paid and could continue to do soin the future.  These contributionscould also have an adverse effect on the value of FHLB stock in the future. Areduction in value of the Bank’s FHLB stock may result in a correspondingreduction in Home Federal’s capital.

 

Under the GLB Act,membership in the FHLB system is now voluntary for all federally-charteredsavings associations such as the Bank. Gramm-Leach also replaces the existingredeemable stock structure of the FHLB system with a capital structure thatrequires each FHLB to meet a leverage limit and a risk-based permanent capitalrequirement.  Pursuant to the GLB Act,the new capital plan for the FHLB of Des Moines was approved on July 10, 2002by the Federal Housing Finance Board, which may be implemented as early as July1, 2003, with a deadline to implement the plan by January 10, 2004.

*Sarbanes-Oxley Act.*  On July 31, 2002, President George W. Bush signed into law theSarbanes-Oxley Act of 2002.  TheSarbanes-Oxley Act implements a broad range of corporate governance andaccounting measures for public companies designed to promote honesty andtransparency in corporate America and better protect investors from corporatewrongdoing.  The Sarbanes-Oxley Act’sprincipal legislation includes:

 

•                    the creation ofan independent accounting oversight board;

•                    auditorindependence provisions which restrict non-audit services that accountants mayprovide to their audit clients;

•                    additionalcorporate governance and responsibility measures, including the requirementthat the chief executive officer and chief financial officer certify financialstatements and the expansion of powers of audit committees;

•                    expandeddisclosure requirements, including accelerated reporting of stock transactionsby insiders;

•                    mandatorydisclosure by analysts of potential conflicts of interest; and

•                    a range ofenhanced penalties for fraud and other violations.

 

We do not believe that the Sarbanes-Oxley Actwill have a material adverse affect upon the Company’s operations in the nearterm.

 

**Federal andState Taxation**

 

TheCompany and its direct and indirect subsidiaries file a consolidated federalincome tax return on a fiscal year basis. In addition, Trust I and Trust II are required to file a trust return ona calendar year basis.

 

In addition to theregular income tax, corporations, including savings associations such as theBank, generally are subject to a minimum tax. An alternative minimum tax is imposed at a minimum tax rate of 20.00% onalternative minimum taxable income, which is the sum of a corporation’s regulartaxable income (with certain adjustments) and tax preference items, less anyavailable exemption.  The alternativeminimum tax is imposed to the extent it exceeds the corporation’s regularincome tax and net operating losses can offset no more than 90.00% ofalternative minimum taxable income.

 

To the extent earningsappropriated to a savings association’s bad debt reserves for “qualifying realproperty loans” and deducted for federal income tax purposes exceed theallowable amount of such reserves computed under the experience method and tothe extent of the association’s supplemental reserves for losses on loans(“Excess”), such Excess may not, without adverse tax consequences, be utilizedfor the payment of cash dividends or other distributions to a shareholder(including distributions on redemption, dissolution or liquidation) or for anyother purpose (except to absorb bad debt losses).  As of June 30, 2002, the Bank’s Excess for tax purposes totaledapproximately $4.8 million.

 

The Bank and itsconsolidated subsidiaries have been audited by the IRS with respect toconsolidated federal income tax returns through 1985. With respect to yearsexamined by the IRS, all deficiencies have been satisfied.

 

*South Dakota Taxation*.  The Bank is subject to theSouth Dakota franchise tax to the extent that such corporations are engaged inbusiness in the state of South Dakota. South Dakota does not have a corporateincome tax.  The franchise tax will beimposed at a rate of 6.00% on franchise taxable income which is computed in thesame manner as federal taxable income with some minor variations to comply withSouth Dakota law, other than the carryover of net operating losses which is notpermitted under South Dakota law.  ASouth Dakota return of franchise tax must be filed annually.

 

*Minnesota Taxation.*  The Bank is subject to the Minnesota CorporateIncome tax to the extent that such corporations are engaged in business in thestate of Minnesota.  The CorporateIncome tax is imposed at a rate of 9.8% on corporate taxable income which is computed in the same manner as federaltaxable income with some minor variations to comply with Minnesota law.  A Minnesota return of Corporate Income taxmust be filed annually.

 

*Delaware Taxation*.  As a Delaware holding company,the Company is exempted from Delaware corporate income tax but is required to filean annual report with and pay an annual fee to the State of Delaware.  The Company is also subject to an annualfranchise tax imposed by the State of Delaware.

**Executive Officers of the Company**

The following information as to the business experience duringthe past five years is supplied with respect to executive officers of theCompany and the Bank.

 

*Curtis L. Hage* — Mr. Hage,age 56, is Chairman, President and Chief Executive Officer of the Company.  He was elected Chairman of the Board ofDirectors of the Company in September 1996 and has held the position ofPresident and Chief Executive Officer since February 1991.  Prior to such time, Mr. Hage served asExecutive Vice President of the Bank since 1986.  Since joining the Bank in 1968, he served in various capacitiesprior to being elected Executive Vice President.  Mr. Hage received his M.B.A. from the University of South Dakotaand attended the Graduate School of Savings Institution Management at theUniversity of Texas.

 

*Jack P.Hearst* — Mr. Hearst, age 50, is Executive VicePresident/Chief Operations Officer of the Company.  He joined the Bank in 1999 as Vice President/Credit Cards and waspromoted to Senior Vice President/Subsidiary Operations in October 2000.  Prior to joining the Bank, he was employedby Citicorp-Corporate Control and Risk Assessment as the Audit Director forCiticorp Bankcards, a credit card company. Mr. Hearst received a B.S. from the University of Missouri.

 

*Darrel L.Posegate* — Mr. Posegate, age 44, is Senior Vice President/ChiefFinancial Officer and Treasurer of the Company, a position he has held sinceJanuary 2002.  He was employed as ChiefFinancial Officer for West Des Moines State Bank, Des Moines, IA, a statebanking institution, from 1998 until joining Home Federal.  Prior to that time he was employed asPresident of Liberty Services, Inc., a bank services company, from 1994 to1998.  Mr. Posegate received his B.A.degree from Luther College, Decorah, IA, and is a Certified Public Accountant.

 

*David A. Brown* — Mr. Brown, age 40, isSenior Vice President/Commercial Banking, a position he has held since November1999.  Prior to joining Home Federal,Mr. Brown served as Vice President/Manager Commercial Banking at Firstar Bank,Sioux City, Iowa, a national banking institution, a position he held sinceDecember 1998.  Mr. Brown received hisMasters of Business Administration and a B.S. in Business Administration fromUniversity of South Dakota.

 

*Mary F. Hitzemann* — Ms. Hitzemann, age 49, isSenior Vice President/Human Resources, a position she has held since October1993.  Ms. Hitzemann joined Home Federalin January 1993.  Prior to that time,she was employed as Vice President of Human Resources for Rapid City RegionalHospital from May 1989 to May 1992.  Ms.Hitzemann received her B.A. degree from Augustana College.

 

*Terry L. Kappes* — Mr. Kappes, age 48, isSenior Vice President/Retail Banking, a position he has held sinceJune 1998.  Prior to that time, hewas employed with Bank One - Colorado, Grand Junction, Colorado, a nationalbanking institution, from 1993 until joining Home Federal with his most recentposition being Senior Vice President/Retail Market Manager.  Mr. Kappes served as Senior Vice Presidentfor First Bank System, Billings, Montana from 1988 to 1991 and First Bank ofSouth Dakota, Sioux Falls, South Dakota from 1977 to 1988.  Mr. Kappes received his B.A. degreefrom Oral Roberts University, Tulsa, Oklahoma.

 

*Sharon A.Manuel* — Ms. Manuel, age 52, is Senior VicePresident/Corporate Services, a position she has held since November 2001.  Since joining the Bank in April 1994, sheserved as Vice President/Regional Coordinator in the Retail Banking area aswell as being responsible for the telephone banking department.  She then assumed the responsibility for managingtechnology-orientated projects, such as internet banking, bill payment, debitcard and Home Federal’s internet website. Prior to joining Home Federal, she was employed by Citibank for thirteenyears.  She received a two-year businessdegree from Mankato Business College.

 

*John E.Roers* — Mr. Roers, age 55, is Senior VicePresident/Agricultural Lending, a position he has held since joining HomeFederal on October 31, 1995.  Prior tothat time, he was employed as Agricultural Loan Officer and Department Managerfor Western Bank, Sioux Falls (then First Bank) from June 1981 to October 1996and for Western Bank, Marshall, Minnesota from February 1974 to May 1981.  Mr. Roers received his Bachelor ofScience and Masters of Science from North Dakota State University.

*Mark S. Sivertson***— Mr. Sivertson, age 44, is Senior VicePresident/Trust Officer, a position he has held since July 1996.  He joined Home Federal in February 1995 asVice President/Trust Officer.  Prior tojoining Home Federal, Mr. Sivertson was Vice President and Trust Officer incharge of the Investment Management and Trust Department at Western Bank.  He holds a law degree from the University ofNorth Dakota and the Certified Trust Financial Advisor designation from theAmerican Bankers Association.

 

*Gary L. Smith**—*Mr. Smith, age 48, is Senior VicePresident/Information Systems, a position he has held since July 1998.  Mr. Smith joined Home Federal in 1979 andwas promoted to Vice President in 1988. He received his B.S. from the University of South Dakota.

 

*Natalie A.Solberg**—*Ms. Solberg, age 39, isSenior Vice President/Retail Support. Since joining the Bank in February 1994, she has been responsible formanaging automated telephone banking, deposit operations and retail supportfunctions.  She was promoted to VicePresident/In-Touch Banking in October 1995, and subsequently, held the positionof Vice President/Retail Support.  Priorto joining Home Federal, she was employed by the Bank of New York from October1989 to October 1993.  Ms. Solbergreceived her B.S. from Northern State University.

 

*Michael H. Zimmerman* — Mr. Zimmerman, age 49, isSenior Vice President/Senior Retail Lending Officer, a position he has heldsince joining Home Federal in August 1996. Prior to that time, he was employed as Vice President/Mortgage LoanManager for First Trust and Savings Bank, Cedar Rapids, Iowa from October 1995to August 1996 and as Vice President/Eastern Regional Manager for HomelandSavings Bank FSB, Waterloo, Iowa from May 1995 to October 1995; and as VicePresident/ Manager Real Estate Lending for Homeland Bank, N.A., Waterloo, Iowafrom August 1992 to April 1995.  Mr.Zimmerman received his B.A. from Dana College, Blair, Nebraska.

 

*Cristie M. Lawson**—*Ms. Lawson, age 33, is Vice President/Controllerfor the Bank.  Ms. Lawson joined theBank in March 1995 as Staff Accountant. She has held various positions of increasing responsibility within theAccounting Department and was promoted to her current position in July2000.  Ms. Lawson received her B.A. fromAugustana College.

**Item 2. Properties**

 

The Company and itsdirect and indirect subsidiaries conduct their business at the main officelocated at 225 South Main Avenue, Sioux Falls, South Dakota, 57104.  Currently, the Bank also conducts businessfrom 32 other offices located in its primary market area.  Of such 32 business offices, the Companyowns 19 and leases 13 others.

 

The total net book valueof the Company’s premises and equipment (including land, building, leaseholdimprovements and furniture, fixtures and equipment) at June 30, 2002 was $13.7million.  See Note 7 of “Notes toConsolidated Financial Statements.”

 

**Item 3. Legal Proceedings**

 

The Company, HomeFederal and its subsidiaries are involved as plaintiff or defendant in variouslegal actions arising in the normal course of their businesses.  While the ultimate outcome of theseproceedings cannot be predicted with certainty, it is the opinion ofmanagement, after consultation with counsel representing Home Federal and theCompany in the proceedings, that the resolution of these proceedings should nothave a material effect on the Company’s consolidated financial position orresults of operations.  The Company andits direct and indirect subsidiaries are not aware of any legal actions orproceedings outside of the normal course of business.

 

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

 

No matter was submittedto a vote of security holders, through the solicitation of proxies orotherwise, during the quarter ended June 30, 2002.

 

**PART II**

 

**Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters**

 

**Stock Listing**

 

TheCompany’s Common Stock is traded under the symbol “HFFC” on the NASDAQ NationalMarket System.

 

Thefollowing table sets forth the range of high and low sale prices for theCompany’s Common Stock for each of the fiscal quarters of the two years endedJune 30, 2002 and 2001.  Quotations forsuch periods are as reported by NASDAQ.

 

| **FISCAL  2002** |   | **HIGH** |   | **LOW** |       |
|------------------|--------|----------|--------|---------|------------|
| 1st Quarter      |   | $        | 14.45  |    | $          | 10.89 |   |
| 2nd Quarter      |   | $        | 12.34  |    | $          | 11.00 |   |
| 3rd Quarter      |   | $        | 12.45  |    | $          | 10.86 |   |
| 4th Quarter      |   | $        | 13.45  |    | $          | 12.00 |   |
|             |   |     |   |    |       |
| **FISCAL 2001**  |   | **HIGH** |   | **LOW** | ** ** |
| 1st Quarter      |   | $        | 9.88   |    | $          | 8.50 |   |
| 2nd Quarter      |   | $        | 10.50  |    | $          | 8.50 |   |
| 3rd Quarter      |   | $        | 13.00  |    | $          | 9.91 |   |
| 4th Quarter      |   | $        | 14.85  |    | $          | 9.75 |   |

 

As of September 16,2002, the Company had 542 holders of record of its Common Stock.

 

The transfer agent forthe Company’s Common Stock is Mellon Investor Services, PO Box 3315, SouthHackensack, New Jersey, 07606-1915.

 

**Dividends**

 

On a quarterly basis,the Company paid cash dividends of $0.11 per share throughout fiscal 2002 ascompared to $0.105 per share throughout fiscal 2001.  The Board of Directors intends to continue the payment ofquarterly cash dividends, dependent on the results of operations and financialcondition of the Company, tax considerations, industry standards, economicconditions, general business practices and other factors the Board of Directorsdeems relevant.  On July 24, 2002, theBoard of Directors approved an increase in cash dividends to $0.115 per shareand the Company paid the respective cash dividends on August 21, 2002 toshareholders of record on August 7, 2002. The Company’s ability to pay dividends is dependent on the dividendpayments it receives from its subsidiary, the Bank, which are subject tofederal and state regulations.

 

**Sales of Unregistered Stock**

The Company has had nosales of unregistered stock within the last fiscal year.

**Item 6. Selected Financial Data**

The following table setsforth selected financial data with respect to the Company for the periodsindicated.  This information should beread in conjunction with the Financial Statements and related notes appearingelsewhere in this Form 10-K and “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations.”  The Company’s selected financial statement and operations datafor each of the years set forth below have been derived from financialstatements which have been audited by McGladrey & Pullen, LLP, independentpublic accountants.  

 
|                                                                         |   | **At June  30,**                                  |    |
|------------------------------------------------------------------------------|--------|---------------------------------------------------|---------|
|                                                                         |   | **2002**                                          |    | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
|                                                                         |   | **(Dollars  in Thousands)**                       |    |
| Selected Statement of Financial Condition Data:                              |   |                                              |    |   |   |   |   |   |   |   |   |
| Total assets                                                                 |   | $                                                 | 722,917 |   | $ | 784,002 |   | $ | 724,997 |   | $ | 658,622 |   | $ | 570,979 |   |
| Securities available for sale                                                |   | 29,401                                            |    | 49,969 |   | 60,445 |   | 61,023 |   | 44,232 |   |
| Mortgage-backed securities available for sale                                |   | 59,735                                            |    | 43,750 |   | 53,001 |   | 41,583 |   | 39,647 |   |
| Loans and leases receivable, net                                             |   | 559,814                                           |    | 563,836 |   | 542,494 |   | 492,302 |   | 426,522 |   |
| Loans held for sale                                                          |   | 6,559                                             |    | 7,270 |   | 8,257 |   | 11,755 |   | 9,616 |   |
| Deposits                                                                     |   | 562,596                                           |    | 601,207 |   | 545,497 |   | 510,730 |   | 446,424 |   |
| Advances from FHLB of Des Moines and other borrowings                        |   | 84,308                                            |    | 108,376 |   | 113,020 |   | 81,613 |   | 50,635 |   |
| Stockholders’ equity                                                    |   | 48,536                                            |    | 52,525 |   | 46,943 |   | 48,558 |   | 56,601 |   |
|                                                                         |   |                                              |    |   |   |   |   |   |   |   |   |
|                                                                         |   | **Years Ended June 30,**                          |    |
|                                                                         |   | **2002**                                          |    | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
|                                                                         |   | **(Dollars in Thousands, Except Per Share Data)** |    |
| Selected Statement of Income Data:                                           |   |                                              |    |   |   |   |   |   |   |   |   |
| Interest and dividend income                                                 |   | $                                                 | 48,017  |   | $ | 58,162 |   | $ | 51,653 |   | $ | 44,206 |   | $ | 45,565 |   |
| Interest expense                                                             |   | 23,573                                            |    | 35,051 |   | 29,141 |   | 24,054 |   | 25,285 |   |
| Net interest income                                                          |   | 24,444                                            |    | 23,111 |   | 22,512 |   | 20,152 |   | 20,280 |   |
| Provision for losses on loans and leases                                     |   | 1,905                                             |    | 1,482 |   | 1,682 |   | 1,300 |   | 1,110 |   |
| Net interest income after provision for losses on loans and leases           |   | 22,539                                            |    | 21,629 |   | 20,830 |   | 18,852 |   | 19,170 |   |
| Loan servicing income                                                        |   | 1,858                                             |    | 1,567 |   | 1,381 |   | 1,263 |   | 1,187 |   |
| Gain on sale of loans, net                                                   |   | 1,518                                             |    | 842 |   | 635 |   | 673 |   | 1,085 |   |
| Loan fees and service charges                                                |   | 1,266                                             |    | 982 |   | 1,131 |   | 1,231 |   | 1,184 |   |
| Gain on sale of securities, net                                              |   | 135                                               |    | — |   | 185 |   | 1 |   | 226 |   |
| Other noninterest income                                                     |   | 6,369                                             |    | 6,032 |   | 4,959 |   | 3,835 |   | 3,763 |   |
| Noninterest expense                                                          |   | (25,958                                           | )       | (23,528 | ) | (20,515 | ) | (18,340 | ) | (17,065 | ) |
| Income from continuing operations before income taxes                        |   | 7,727                                             |    | 7,524 |   | 8,606 |   | 7,515 |   | 9,550 |   |
| Income tax expense                                                           |   | 2,856                                             |    | 2,929 |   | 3,077 |   | 2,808 |   | 3,183 |   |
| Income from continuing operations                                            |   | 4,871                                             |    | 4,595 |   | 5,529 |   | 4,707 |   | 6,367 |   |
| Discontinued Operations:                                                     |   |                                              |    |   |   |   |   |   |   |   |   |
| Income (loss) from operations of discontinued segment  (net of income taxes) |   | (246                                              | )       | 12 |   | (262 | ) | (3,656 | ) | 106 |   |
| (Loss) on discontinued segment  (net of income taxes)                        |   | (1,440                                            | )       | — |   | — |   | — |   | — |   |
| Income (loss) from discontinued operations                                   |   | (1,686                                            | )       | 12 |   | (262 | ) | (3,656 | ) | 106 |   |
|                                                                         |   |                                              |    |   |   |   |   |   |   |   |   |
| Net income (loss)                                                            |   | $                                                 | 3,185   |   | $ | 4,607 |   | $ | 5,267 |   | $ | 1,051 |   | $ | 6,473 |   |

 
|                                                                                                       |   | **Years  Ended June 30,**   |   |
|------------------------------------------------------------------------------------------------------------|--------|-----------------------------|--------|
|                                                                                                       |   | **2002**                    |   | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
|                                                                                                       |   | **(Dollars  in Thousands)** |   |
| Basic earnings (loss) per share:                                                                           |   |                        |   |   |   |   |   |   |   |   |   |
| Income from continuing operations                                                                          |   | $                           | 1.39   |   | $ | 1.25 |   | $ | 1.43 |   | $ | 1.12 |   | $ | 1.44 |   |
| Earnings (loss) from discontinued operations                                                               |   | (0.48                       | )      | — |   | (0.07 | ) | (0.87 | ) | 0.02 |   |
| Net income                                                                                                 |   | 0.91                        |   | 1.25 |   | 1.36 |   | 0.25 |   | 1.46 |   |
|                                                                                                       |   |                        |   |   |   |   |   |   |   |   |   |
| Diluted earnings (loss) per share:                                                                         |   |                        |   |   |   |   |   |   |   |   |   |
| Income from continuing operations                                                                          |   | 1.36                        |   | 1.23 |   | 1.41 |   | 1.09 |   | 1.40 |   |
| Earnings (loss) from discontinued operations                                                               |   | (0.47                       | )      | — |   | (0.07 | ) | (0.85 | ) | 0.02 |   |
| Net income                                                                                                 |   | 0.89                        |   | 1.23 |   | 1.34 |   | 0.24 |   | 1.42 |   |
|                                                                                                       |   |                        |   |   |   |   |   |   |   |   |   |
| Dividends per share                                                                                        |   | 0.44                        |   | 0.42 |   | 0.40 |   | 0.37 |   | 0.28 |   |
| Dividends payout ratio from continuing operations                                                          |   | 31.92                       | %      | 33.62 | % | 27.93 | % | 32.10 | % | 19.48 | % |
|                                                                                                       |   |                        |   |   |   |   |   |   |   |   |   |
| Other data from continuing operations: (1)                                                                 |   |                        |   |   |   |   |   |   |   |   |   |
| Interest rate spread (average during period)                                                               |   | 3.22                        | %      | 2.78 | % | 3.13 | % | 3.23 | % | 3.15 | % |
| Net interest margin (2)                                                                                    |   | 3.63                        |   | 3.32 |   | 3.57 |   | 3.72 |   | 3.75 |   |
|                                                                                                       |   |                        |   |   |   |   |   |   |   |   |   |
| Average interest-earning assets to average interest-bearing  liabilities                                   |   | 1.12                        |   | 1.11 |   | 1.10 |   | 1.11 |   | 1.13 |   |
|                                                                                                       |   |                        |   |   |   |   |   |   |   |   |   |
| Equity to total assets (end of period)                                                                     |   | 6.71                        |   | 6.70 |   | 6.47 |   | 7.37 |   | 9.91 |   |
| Equity-to-assets ratio (ratio of average equity to average total  assets)                                  |   | 7.17                        |   | 6.77 |   | 6.85 |   | 8.96 |   | 9.59 |   |
|                                                                                                       |   |                        |   |   |   |   |   |   |   |   |   |
| Nonperforming assets to total assets (end of period)                                                       |   | 1.59                        |   | 0.76 |   | 0.33 |   | 0.23 |   | 0.43 |   |
|                                                                                                       |   |                        |   |   |   |   |   |   |   |   |   |
| Allowance for loan and lease losses to nonperforming loans and leases  (end of period) (3)                 |   | 40.02                       |   | 97.73 |   | 264.63 |   | 432.34 |   | 178.63 |   |
|                                                                                                       |   |                        |   |   |   |   |   |   |   |   |   |
| Allowance for loan and lease losses to total loans and leases (end of  period)                             |   | 0.78                        |   | 0.96 |   | 1.00 |   | 0.91 |   | 0.93 |   |
|                                                                                                       |   |                        |   |   |   |   |   |   |   |   |   |
| Nonperforming loans and leases to total loans and leases (end of  period) (3)                              |   | 1.96                        |   | 0.99 |   | 0.38 |   | 0.21 |   | 0.52 |   |
|                                                                                                       |   |                        |   |   |   |   |   |   |   |   |   |
| Other noninterest expense to average total assets                                                          |   | 3.58                        |   | 3.17 |   | 3.01 |   | 3.11 |   | 2.97 |   |
|                                                                                                       |   |                        |   |   |   |   |   |   |   |   |   |
| Net interest income after provision for losses on loans and leases to  noninterest expense (end of period) |   | 86.83                       |   | 91.93 |   | 101.54 |   | 102.79 |   | 112.34 |   |
|                                                                                                       |   |                        |   |   |   |   |   |   |   |   |   |
| Return on assets  (ratio of  income from continuing operations to average total assets)               |   | 0.67                        |   | 0.62 |   | 0.81 |   | 0.80 |   | 1.11 |   |
| Return on assets  (ratio of  net income to average total assets)                                      |   | 0.44                        |   | 0.62 |   | 0.77 |   | 0.18 |   | 1.13 |   |
|                                                                                                       |   |                        |   |   |   |   |   |   |   |   |   |
| Return on equity (ratio of income from continuing operations to  average equity)                           |   | 9.37                        |   | 9.14 |   | 11.83 |   | 8.91 |   | 11.61 |   |
| Return on equity (ratio of net income to average equity)                                                   |   | 6.13                        |   | 9.16 |   | 11.27 |   | 1.99 |   | 11.73 |   |
|                                                                                                       |   |                        |   |   |   |   |   |   |   |   |   |
| Efficiency Ratio (4)                                                                                       |   | 72.94                       |   | 72.32 |   | 66.60 |   | 67.54 |   | 61.55 |   |
|                                                                                                       |   |                        |   |   |   |   |   |   |   |   |   |
| Number of full-service offices                                                                             |   | 33                          |   | 31 |   | 27 |   | 25 |   | 19 |   |
|                                                                                                            |        |                             |        |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

(1)          All periods presented havebeen restated to eliminate effect of discontinued operations.

(2)          Net interest income dividedby average interest-earning assets.

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

(4)          Total noninterest expensedivided by the sum of net interest income plus total noninterest income.

**Item 7.  Management’sDiscussion and Analysis of Financial Condition and Results of Operations**

 

This section should be read in conjunctionwith Item 8, “Financial Statements and Supplementary Data”, as well as Item 7A,“Quantitative and Qualitative Disclosures About Market Risk” and Part I, Item1, “Business”.

 

**General**

 

The Company is a financial services providerand, as such, has inherent risks that must be managed in order to achieve netincome.  Primary risks that affect netincome include credit risk, liquidity risk, operational risk, regulatorycompliance risk and reputation risk. The Company’s net income is derived by management of the net interestmargin, the ability to collect fees from services provided, by controlling thecosts of delivering services and the management of loan and lease losses.  The primary source of revenues comes fromthe net interest margin, which represents the difference between income oninterest-earning assets (i.e. loans and investment securities) and expense oninterest-bearing liabilities (i.e. deposits and borrowed funding).  The net interest margin is affected byregulatory, economic and competitive factors that influence interest rates,loan demand and deposit flows.  Feesearned include charges for deposit services, trust services and loan services.  Personnel costs are the primary expensesrequired to deliver the services to customers. Other costs include occupancy and equipment and general andadministrative expenses.

 

During the fourth quarter of fiscal 2002, theCompany committed to a plan to discontinue its subprime credit card operationthrough its subsidiary, HF Card.  HFCard ceased processing subprime credit card applications in March 1999 andmanaged the portfolio from a balance of $18.1 million at June 30, 1999 to $3.8million at June 30, 2002.  As of June30, 2002, the Company had not entered into a definitive agreement for the saleof the remaining receivables.  TheCompany estimated the net realizable value of the credit card portfolio basedon estimates from a third party.  The actualsale of the receivables and liquidation of HF Card is expected to take place inthe first half of fiscal 2003.  Resultsof this discontinuance have been segregated from continuing operations of theCompany.  See Note 2 of  “Notes to Consolidated Financial Statements”for further discussion on discontinued operations.

 

**Financial Condition Data**

 

At June 30, 2002,the Company had total assets of $722.9 million, a decrease of $61.1 millionfrom the level at June 30, 2001.  Thedecrease was primarily due to a reduction in certificates of deposit (“CDs”)balances of $72.3 million compared to the prior year.  Approximately $37.7 million CDs were withdrawn due to repricingin the marketplace at rates higher than the Bank viewed prudent given the earlyprepayments and sales of residential real estate loans.  In addition, stockholders’ equity decreasedfrom $52.5 million at June 30, 2001 to $48.5 million at June 30, 2002,primarily due to Company stock repurchases of $5.6 million and payment of cashdividends of $1.6 million offset by net income of $3.2 million.

 

The Companycontinued to reduce the funding mix of CDs to total deposits by emphasizing themoney market accounts.  By decreasingthe CD to total deposit ratios, the Company expects its cost of funds will belower over time.

 

The decrease in securities available for saleof $20.6 million was primarily the result of sales, maturities and callsof  $59.1 million exceeding purchasesof  $38.5 million.

 

The increase in mortgage-backed securitiesavailable for sale of $16.0 million was primarily the result of purchases of$46.1 million exceeding sales, amortization and repayments of principal of$30.4 million.  The Bank’s purchases ofmortgage-backed securities available for sale were comprised primarily of thirtyyear, original maturity, variable-rate mortgage-backed securities.

 

The $38.6 million decrease in deposits wasprimarily due to a decrease in certificates of deposit of $72.3 million offsetby increases in checking accounts of $14.9 million, money market accounts of$18.3 million and savings accounts of $535,000.

 

Advances from the FHLB and other borrowingsdecreased $24.1 million for the year ended June 30, 2002 primarily due toscheduled maturities, payments and amortization on FHLB advances of $106.3 millionwhich were partially offset by the Company obtaining new advances of $89.0million during the fiscal year.

**Analysis of 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 and Yields.*  The following table presents for the periodsindicated, the total dollar amount of interest income from averageinterest-earning assets and the resulting yields, as well as the interestexpense on average interest-bearing liabilities, expressed both in dollars andrates, and the net interest margin.  Thetable does not reflect any effect of income taxes.  All average balances are monthly average balances and include thebalances of nonaccruing loans.  Theyields and costs for the years ended June 30, 2002, 2001 and 2000 include feeswhich are considered adjustments to yield. Balances related to discontinued credit card loan operations have beenreclassified to non-interest earning assets for all periods presented.

 
|                                                                                                                        |       | **Years  Ended June 30,**         |       |
|-----------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|
|                                                                                                                        |       | **2002**                          |       | **2001** |   | **2000** |   |
| ** **                                                                                                                  | ** ** | **Average  Outstanding  Balance** | ** ** | **Interest  Earned/  Paid** | ** ** | **Yield/  Rate** | ** ** | **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)                                                                                             |       | $                                 | 546,055    |   | $ | 42,290 |   | 7.74 | % | $ | 560,208 |   | $ | 50,016 |   | 8.93 | % | $ | 517,849 |   | $ | 44,657 |   | 8.62 | % |
| Mortgage-backed securities                                                                                                  |       | 44,657                            |       | 2,664 |   | 5.97 | % | 49,529 |   | 3,327 |   | 6.72 | % | 51,878 |   | 3,390 |   | 6.53 | % |
| Other investment securities (2) (3)                                                                                         |       | 76,325                            |       | 2,840 |   | 3.72 | % | 79,389 |   | 4,468 |   | 5.63 | % | 55,420 |   | 3,219 |   | 5.81 | % |
| FHLB stock                                                                                                                  |       | 6,332                             |       | 223 |   | 3.52 | % | 6,279 |   | 351 |   | 5.59 | % | 5,898 |   | 387 |   | 6.56 | % |
| Total interest-earning assets                                                                                               |       | $                                 | 673,369    |   | $ | 48,017 |   | 7.13 | % | $ | 695,405 |   | $ | 58,162 |   | 8.36 | % | $ | 631,045 |   | $ | 51,653 |   | 8.19 | % |
| Noninterest-earning assets                                                                                                  |       | 51,132                            |       |   |   |   |   | 46,822 |   |   |   |   |   | 51,206 |   |   |   |   |   |
| Total assets                                                                                                                |       | $                                 | 724,501    |   |   |   |   |   | $ | 742,227 |   |   |   |   |   | $ | 682,251 |   |   |   |   |   |
|                                                                                                                        |       |                              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing liabilities:                                                                                               |       |                              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Deposits:                                                                                                                   |       |                              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Checking and money market                                                                                                   |       | $                                 | 189,705    |   | $ | 3,875 |   | 2.04 | % | $ | 158,639 |   | $ | 7,369 |   | 4.65 | % | $ | 123,385 |   | $ | 5,296 |   | 4.29 | % |
| Savings                                                                                                                     |       | 39,169                            |       | 564 |   | 1.44 | % | 40,212 |   | 1,469 |   | 3.65 | % | 44,976 |   | 1,533 |   | 3.41 | % |
| Certificates of deposit                                                                                                     |       | 279,323                           |       | 13,994 |   | 5.01 | % | 316,994 |   | 19,582 |   | 6.18 | % | 297,788 |   | 16,633 |   | 5.59 | % |
| Total deposits                                                                                                              |       | $                                 | 508,197    |   | $ | 18,433 |   | 3.63 | % | $ | 515,845 |   | $ | 28,420 |   | 5.51 | % | $ | 466,149 |   | $ | 23,462 |   | 5.03 | % |
| FHLB advances and other borrowings                                                                                          |       | 87,512                            |       | 4,766 |   | 5.45 | % | 112,421 |   | 6,631 |   | 5.90 | % | 109,331 |   | 5,679 |   | 5.19 | % |
| Company obligated mandatorily redeemable preferred securities of  subsidiary trust that soley holds subordinated debentures |       | 6,744                             |       | 374 |   | 5.55 | % | — |   | — |   | 0.00 | % | — |   | — |   | 0.00 | % |
| Total interest-bearing liabilities                                                                                          |       | $                                 | 602,453    |   | $ | 23,573 |   | 3.91 | % | $ | 628,266 |   | $ | 35,051 |   | 5.58 | % | $ | 575,480 |   | $ | 29,141 |   | 5.06 | % |
| Noninterest-bearing deposits (4)                                                                                            |       | 48,757                            |       |   |   |   |   | 41,365 |   |   |   |   |   | 38,567 |   |   |   |   |   |
| Other liabilities                                                                                                           |       | 21,323                            |       |   |   |   |   | 22,319 |   |   |   |   |   | 21,459 |   |   |   |   |   |
| Total liabilities                                                                                                           |       | $                                 | 672,533    |   |   |   |   |   | $ | 691,950 |   |   |   |   |   | $ | 635,506 |   |   |   |   |   |
| Equity                                                                                                                      |       | 51,968                            |       |   |   |   |   | 50,277 |   |   |   |   |   | 46,745 |   |   |   |   |   |
| Total liabilities and equity                                                                                                |       | $                                 | 724,501    |   |   |   |   |   | $ | 742,227 |   |   |   |   |   | $ | 682,251 |   |   |   |   |   |
|                                                                                                                        |       |                              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net interest income; interest rate spread                                                                                   |       |                              |       | $ | 24,444 |   | 3.22 | % |   |   | $ | 23,111 |   | 2.78 | % |   |   | $ | 22,512 |   | 3.13 | % |
|                                                                                                                        |       |                              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net interest margin (5)                                                                                                     |       |                              |       |   |   | 3.63 | % |   |   |   |   | 3.32 | % |   |   |   |   | 3.57 | % |

 

----

(1)    Includes interest onaccruing loans 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 thetax exempt nature of municipal securities.

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

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

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

 

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

 
|                                                                                                                         |   | **Years  Ended June 30,**                |   | **Years  Ended June 30,**              |   |
|------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------------------|--------|----------------------------------------|--------|
|                                                                                                                         |   | **2002 vs.  2001**                       |   | **2001 vs.  2000**                     |   |
|                                                                                                                         |   | **(Dollars  in Thousands)**              |   |
|                                                                                                                         |   | **Increase  (Decrease)  Due to  Volume** |   | **Increase  (Decrease)  Due to  Rate** |   | **Total  Increase  (Decrease)** |   | **Increase  (Decrease)  Due to  Volume** |   | **Increase  (Decrease)  Due to  Rate** |   | **Total  Increase  (Decrease)** |   |
| Interest-earning assets:                                                                                                     |   |                                     |   |                                   |   |   |   |   |   |   |   |   |   |
| Loans and leases receivable (1)                                                                                              |   | $                                        | (1,264 | )                                      | $      | (6,462 | ) | $ | (7,726 | ) | $ | 3,653 |   | $ | 1,706 |   | $ | 5,359 |   |
| Mortgage-backed securities                                                                                                   |   | (327                                     | )      | (336                                   | )      | (663 | ) | (153 | ) | 90 |   | (63 | ) |
| Other investment securities (2)                                                                                              |   | (172                                     | )      | (1,456                                 | )      | (1,628 | ) | 1,392 |   | (143 | ) | 1,249 |   |
| FHLB stock                                                                                                                   |   | 3                                        |   | (131                                   | )      | (128 | ) | 25 |   | (61 | ) | (36 | ) |
|                                                                                                                         |   |                                     |   |                                   |   |   |   |   |   |   |   |   |   |
| Total interest-earning assets                                                                                                |   | $                                        | (1,760 | )                                      | $      | (8,385 | ) | $ | (10,145 | ) | $ | 4,917 |   | $ | 1,592 |   | $ | 6,509 |   |
|                                                                                                                         |   |                                     |   |                                   |   |   |   |   |   |   |   |   |   |
| Interest-bearing liabilities:                                                                                                |   |                                     |   |                                   |   |   |   |   |   |   |   |   |   |
| Deposits:                                                                                                                    |   |                                     |   |                                   |   |   |   |   |   |   |   |   |   |
| Checking and money market                                                                                                    |   | $                                        | 1,451  |                                   | $      | (4,945 | ) | $ | (3,494 | ) | $ | 1,507 |   | $ | 566 |   | $ | 2,073 |   |
| Savings                                                                                                                      |   | (38                                      | )      | (867                                   | )      | (905 | ) | (162 | ) | 98 |   | (64 | ) |
| Certificates of deposit                                                                                                      |   | (2,327                                   | )      | (3,261                                 | )      | (5,588 | ) | 1,073 |   | 1,876 |   | 2,949 |   |
| Total deposits                                                                                                               |   | (914                                     | )      | (9,073                                 | )      | (9,987 | ) | 2,418 |   | 2,540 |   | 4,958 |   |
| FHLB advances and other borrowings                                                                                           |   | (1,469                                   | )      | (396                                   | )      | (1,865 | ) | 161 |   | 791 |   | 952 |   |
| Company obligated mandatorily redeemable preferred securities of  subsidiary trust that solely holds subordinated debentures |   | 374                                      |   | —                                 |   | 374 |   | — |   | — |   | — |   |
|                                                                                                                         |   |                                     |   |                                   |   |   |   |   |   |   |   |   |   |
| Total interest-bearing liabilities                                                                                           |   | $                                        | (2,009 | )                                      | $      | (9,469 | ) | $ | (11,478 | ) | $ | 2,579 |   | $ | 3,331 |   | $ | 5,910 |   |
|                                                                                                                         |   |                                     |   |                                   |   |   |   |   |   |   |   |   |   |
| Net interest income increase                                                                                                 |   |                                     |   |                                   |   | $ | 1,333 |   |   |   |   |   | $ | 599 |   |
|                                                                                                                              |        |                                          |        |                                        |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

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

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

# **Application of CriticalAccounting Policies**

 

GAAP requires managementto utilize estimates when reporting financial results.  The Company has identified the policydiscussed below as a Critical Accounting Policy because the accounting estimaterequires management to make certain assumptions about matters that may beuncertain at the time the estimate was made and a different method ofestimating could have been reasonably made that could have a material impact onthe presentation of our financial condition, changes in financial condition orresults 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 estimating 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 compiled by utilizing theCompany’s loan risk rating system which is structured to identify the weaknessof the loan portfolio.  The risk ratingsystem has evolved to a process whereby management believes the system willproperly identify the credit risk associated with the loan portfolio.  Due to the segmenting of loans for theallowance calculation, the estimate of the allowance for loan and lease lossescould change materially if the loan risk rating system would not properly identifythe strength of a large or a few large loan customers.  Although management believes that it usesthe best information available to determine the allowance, unforeseen market orborrower conditions could result in adjustments and net earnings being significantlyaffected if circumstances differ substantially from the assumptions used inmaking the final determinations.

 

**Asset Quality**

 

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

 

Loans are generally classified as nonaccrualwhen there are reasonable doubts as to the collectibility of principal and/orinterest and/or when payment becomes 90 days past due, except loans which arewell secured and in the process of collection. Interest collections on nonaccrual loans, for which the ultimatecollectibility of principal is uncertain, are applied as principal reductions.

 

Nonperforming assets increased to $11.5million at June 30, 2002 from $5.9 million at June 30, 2001, an increase of$5.6 million.  In addition, the ratio ofnonperforming assets to total assets, which is one indicator of credit riskexposure, increased to 1.59% at June 30, 2002 as compared to 0.76% at June 30,2001.

 

Nonaccruing loans and leases increased to$10.2 million at June 30, 2002 from $5.3 million at June 30, 2001, an increaseof $4.9 million. Included in nonaccruing loans and leases at June 30, 2002 werethirteen loans totaling $886,000 secured by one- to four-family real estate,six loans in the amount of $3.7 million secured by commercial real estate,three mobile home loans totaling $25,000, eighteen commercial business loanstotaling $1.9 million, seven agriculture loans totaling $2.8 million, onemulti-family loan totaling $290,000 and forty-one consumer loans totaling$690,000.  See Note 5 of “Notes toConsolidated Financial Statements” for information concerning interest incomeforegone on impaired loans.

 

The Company’s nonperforming loans and leases,which represent nonaccrual and past due 90 days and still accruing, haveincreased $5.5 million from the levels in the prior year.  Management believes the general economicconditions, including the affects of terrorist attacks in September 2001, is aprimary reason for this increase in nonperforming loans and leases.  The risk rating system in place is designedto identify and manage the nonperforming loans and leases.  Commercial and agricultural loans andequipment finance leases will have specific reserve allocations based oncollateral values or based on the present value of expected cash flows.  Loans and leases that are not performing donot necessarily result in a loss.  The increaseis also related to a few large commercial and agricultural loans that have beenanalyzed for collateral value and appropriate loss reserves have beenallocated.

 

As of June 30, 2002, the Company had $374,000of foreclosed assets.  The balance offoreclosed assets at June 30, 2002 consisted of $132,000 in consumer collateral(excluding mobile home loans), $3,000 in mobile homes and $239,000 insingle-family residences.

At June 30, 2002, the Bank had criticized $9.0 million of its assets as special mention(including certain loans discussed in this Form 10-K) and the Bank had classified$18.9 million as substandard (including certain loans discussed in this Form10-K), and approximately $4.4 million as doubtful that management hasdetermined need to be closely monitored because of possible credit problems ofthe borrowers or the cash flows of the secured properties.  These loans were considered in determiningthe adequacy of the allowance for possible loan losses.  The allowance for possible loan losses isestablished based on management’s evaluation of the risks inherent in the loanportfolio and changes in the nature and volume of loan activity.  Such evaluation, which includes a review ofall loans for which full collectability may not be reasonably assured,considers the estimated fair market value of the underlying collateral, presentvalue of expected principal and interest payments, economic conditions,historical loss experience and other factors that warrant recognition inproviding for an adequate loan and lease loss allowance.

 

The Company plans to implement a formal risk-rating system forclassifying leases in the first half of fiscal 2003.

 

Although the Company’s management believes that the June 30, 2002recorded allowance for loan and lease losses was adequate to provide forprobable losses on the related loans and leases, there can be no assurance thatthe allowance existing at June 30, 2002 will be adequate in the future.

In accordance with the Company’s internalclassification of assets policy, management evaluates the loan and leaseportfolio on a monthly basis to identify loss potential and determines theadequacy of the allowance for loan and lease losses quarterly.  Loans are placed on nonaccrual status whenthe collection of principal and/or interest become doubtful.  Foreclosed assets include assets acquired insettlement of loans.  The Company didnot have any material troubled debt restructurings at any of the datespresented.  The following table setsforth the amounts and categories of the Company’s nonperforming assets fromcontinuing operations for the periods indicated.  Balances related to discontinued credit card loan operations havebeen eliminated for all periods presented.

 

|                                                                 |   | **At June  30,**            |      |
|----------------------------------------------------------------------|--------|-----------------------------|-----------|
|                                                                 |   | **2002**                    |      | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
|                                                                 |   | **(Dollars  in Thousands)** |      |
| Nonaccruing loans and leases:                                        |   |                        |      |   |   |   |   |   |   |   |   |
| One- to four-family                                                  |   | $                           |  886 |   | $ | 723 |   | $ | 551 |   | $ | 209 |   | $ | 623 |   |
| Commercial real estate                                               |   | 3,678                       |      | 385 |   | 165 |   | 46 |   | 719 |   |
| Multi-family                                                         |   | 290                         |      | — |   | — |   | — |   | — |   |
| Commercial business                                                  |   | 1,872                       |      | 3,223 |   | 971 |   | 111 |   | 396 |   |
| Consumer(1)                                                          |   | 690                         |      | 518 |   | 317 |   | 359 |   | 482 |   |
| Agricultural                                                         |   | 2,801                       |      | 373 |   | 31 |   | 307 |   | — |   |
| Mobile homes                                                         |   | 25                          |      | 88 |   | 43 |   | 13 |   | 31 |   |
| Total                                                                |   | 10,242                      |      | 5,310 |   | 2,078 |   | 1,045 |   | 2,251 |   |
|                                                                 |   |                        |      |   |   |   |   |   |   |   |   |
| Accruing loans and leases delinquent more than 90 days               |   |                        |      |   |   |   |   |   |   |   |   |
| Multi-family                                                         |   | —                      |      | 304 |   | — |   | — |   | — |   |
| Commercial business                                                  |   | 512                         |      | — |   | — |   | — |   | — |   |
| Equipment finance leases                                             |   | 229                         |      | — |   | — |   | — |   | — |   |
| Agricultural                                                         |   | 165                         |      | 23 |   | — |   | — |   | — |   |
| Total                                                                |   | 906                         |      | 327 |   | — |   | — |   | — |   |
|                                                                 |   |                        |      |   |   |   |   |   |   |   |   |
| Foreclosed assets:                                                   |   |                        |      |   |   |   |   |   |   |   |   |
| One- to four-family                                                  |   | 239                         |      | 203 |   | 214 |   | 366 |   | 22 |   |
| Consumer(1)                                                          |   | 132                         |      | 105 |   | 67 |   | 49 |   | 140 |   |
| Mobile homes                                                         |   | 3                           |      | 2 |   | 15 |   | 49 |   | 67 |   |
| Total (2)                                                            |   | 374                         |      | 310 |   | 296 |   | 464 |   | 229 |   |
|                                                                 |   |                        |      |   |   |   |   |   |   |   |   |
| Total nonperforming assets(3)                                        |   | $                           | 11,522    |   | $ | 5,947 |   | $ | 2,374 |   | $ | 1,509 |   | $ | 2,480 |   |
| Ratio of nonperforming assets to total assets(4)                     |   | 1.59                        | %         | 0.76 | % | 0.33 | % | 0.23 | % | 0.43 | % |
| Ratio of nonperforming loans and leases to total loans and leases(5) |   | 1.96                        | %         | 0.99 | % | 0.38 | % | 0.21 | % | 0.52 | % |
|                                                                      |        |                             |           |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

(1)             Consists of nonperforming consumer loans exclusive of mobile home loansand credit card loans.

(2)             Total foreclosed assets do not include land held for sale.

(3)             Nonperforming assets includenonaccruing loans and leases, accruing loans and leases delinquent more than 90days and foreclosed assets.

(4)             Percentage is calculated based upon total assets of the Company and itsdirect and indirect subsidiaries on a consolidated basis.

(5)             Nonperforming loans and leases includes nonaccruing loans and leases andaccruing loans and leases delinquent more than 90 days.

The following table sets forth informationwith respect to activity in the Company’s allowance for loan and lease lossesfrom continuing operations during the periods indicated.  Balances related to discontinued credit cardloan operations have been eliminated for all periods presented.

 
|                                                                                                    |   | **Years  Ended June 30,**   |   |
|---------------------------------------------------------------------------------------------------------|--------|-----------------------------|--------|
|                                                                                                    |   | **2002**                    |   | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
|                                                                                                    |   | **(Dollars  in Thousands)** |   |
| Balance at beginning of period                                                                          |   | $                           | 5,509  |   | $ | 5,499 |   | $ | 4,518 |   | $ | 4,021 |   | $ | 4,200 |   |
|                                                                                                    |   |                        |   |   |   |   |   |   |   |   |   |
| Charge-offs:                                                                                            |   |                        |   |   |   |   |   |   |   |   |   |
| One- to four-family                                                                                     |   | (38                         | )      | (21 | ) | (92 | ) | (56 | ) | (95 | ) |
| Commercial real estate                                                                                  |   | (76                         | )      | (361 | ) | — |   | (11 | ) | (147 | ) |
| Commercial business                                                                                     |   | (1,484                      | )      | (253 | ) | (54 | ) | (124 | ) | (1,065 | ) |
| Equipment finance leases                                                                                |   | (323                        | )      | (131 | ) | — |   | — |   | — |   |
| Consumer                                                                                                |   | (1,323                      | )      | (1,106 | ) | (827 | ) | (914 | ) | (26 | ) |
| Agriculture                                                                                             |   | (108                        | )      | — |   | (11 | ) | (487 | ) | — |   |
| Mobile homes                                                                                            |   | (55                         | )      | (51 | ) | (56 | ) | (84 | ) | (184 | ) |
| Total charge-offs                                                                                       |   | (3,407                      | )      | (1,923 | ) | (1,040 | ) | (1,676 | ) | (1,517 | ) |
| Recoveries:                                                                                             |   |                        |   |   |   |   |   |   |   |   |   |
| One- to four-family                                                                                     |   | 2                           |   | — |   | 12 |   | 16 |   | 12 |   |
| Commercial real estate                                                                                  |   | 2                           |   | — |   | 6 |   | 46 |   | — |   |
| Commercial business                                                                                     |   | 59                          |   | — |   | — |   | 72 |   | — |   |
| Equipment finance leases                                                                                |   | 45                          |   | 16 |   | — |   | — |   | — |   |
| Consumer                                                                                                |   | 296                         |   | 325 |   | 282 |   | 227 |   | 184 |   |
| Agriculture                                                                                             |   | 28                          |   | — |   | — |   | — |   | — |   |
| Mobile homes                                                                                            |   | 22                          |   | 13 |   | 39 |   | 48 |   | 32 |   |
| Total recoveries                                                                                        |   | 454                         |   | 354 |   | 339 |   | 409 |   | 228 |   |
|                                                                                                    |   |                        |   |   |   |   |   |   |   |   |   |
| Net (charge-offs)                                                                                       |   | (2,953                      | )      | (1,569 | ) | (701 | ) | (1,267 | ) | (1,289 | ) |
|                                                                                                    |   |                        |   |   |   |   |   |   |   |   |   |
| Additions charged to operations                                                                         |   | 1,905                       |   | 1,482 |   | 1,682 |   | 1,300 |   | 1,110 |   |
| Allowance related to assets acquired, net                                                               |   | —                      |   | 97 |   | — |   | 464 |   | — |   |
| Balance at end of period                                                                                |   | $                           | 4,461  |   | $ | 5,509 |   | $ | 5,499 |   | $ | 4,518 |   | $ | 4,021 |   |
|                                                                                                    |   |                        |   |   |   |   |   |   |   |   |   |
| Ratio of net (charge-offs) during the period to average loans and  leases outstanding during the period |   | (0.54                       | )%     | (0.28 | )% | (0.14 | )% | (0.28 | )% | (0.29 | )% |
|                                                                                                    |   |                        |   |   |   |   |   |   |   |   |   |
| Ratio of allowance for loan and lease losses to total loans and  leases at end of period                |   | 0.78                        | %      | 0.96 | % | 1.00 | % | 0.91 | % | 0.93 | % |
|                                                                                                    |   |                        |   |   |   |   |   |   |   |   |   |
| Ratio of allowance for loan and lease losses to nonperforming loans  and leases at end of period(1)     |   | 40.02                       | %      | 97.73 | % | 264.63 | % | 432.34 | % | 178.63 | % |

 

----

(1)         Nonperforming loans and leasesinclude nonaccruing loans and leases and accruing loans and leases delinquentmore than 90 days.

Thedistribution of the Company’s allowance for loan and lease losses at the datesindicated is summarized in the following table.  Balances related to discontinued credit card loan operations havebeen eliminated for all periods presented.

 
|                                       |   | **At June  30,**            |   |
|--------------------------------------------|--------|-----------------------------|--------|
|                                       |   | **2002**                    |   | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
|                                       |   | **Amount (4)**              |   | **Percent of  Loans in  Each  Category to  Total  Loans** |   | **Amount** |   | **Percent of  Loans in  Each  Category to  Total  Loans** |   | **Amount** |   | **Percent of  Loans in  Each  Category to  Total  Loans** |   | **Amount** |   | **Percent of  Loans in  Each  Category to  Total  Loans** |   | **Amount** |   | **Percent of  Loans in  Each  Category to  Total  Loans** |   |
|                                       |   | **(Dollars  in thousands)** |   |
| One-to four-family(1)                      |   | $                           | 81     |   | 16.00 | % | $ | 1,196 |   | 26.65 | % | $ | 1,299 |   | 29.88 | % | $ | 1,233 |   | 31.18 | % | $ | 1,203 |   | 32.87 | % |
| Commercial and multi-family real estate(1) |   | 606                         |   | 25.45 |   | 1,402 |   | 20.52 |   | 1,442 |   | 19.97 |   | 1,124 |   | 20.99 |   | 967 |   | 21.14 |   |
| Commercial business(2)                     |   | 1,460                       |   | 20.61 |   | 1,033 |   | 18.74 |   | 844 |   | 15.36 |   | 556 |   | 12.30 |   | 377 |   | 9.38 |   |
| Consumer(3)                                |   | 1,889                       |   | 30.66 |   | 1,524 |   | 27.66 |   | 1,536 |   | 27.92 |   | 1,269 |   | 28.08 |   | 1,222 |   | 30.33 |   |
| Agricultural                               |   | 375                         |   | 6.87 |   | 317 |   | 5.75 |   | 323 |   | 5.87 |   | 264 |   | 5.85 |   | 150 |   | 3.73 |   |
| Mobile homes                               |   | 50                          |   | 0.41 |   | 37 |   | 0.68 |   | 55 |   | 1.00 |   | 72 |   | 1.60 |   | 102 |   | 2.55 |   |
| Total                                      |   | $                           | 4,461  |   | 100.00 | % | $ | 5,509 |   | 100.00 | % | $ | 5,499 |   | 100.00 | % | $ | 4,518 |   | 100.00 | % | $ | 4,021 |   | 100.00 | % |

 

----

(1)   Includesconstruction loans.

(2)   Includesequipment finance leases.

(3)   Excludesallowance for loan losses relating to mobile home loans.

(4)   The Company migrated its allocationmethodology of reserves by type in 2002 to reflect a more systematic methodbased in part on the Company’s historical chargeoffs by each loan type as comparedto primarily a pro rata allocation based on loan balances in prior years.

The allowance for loan and lease losses was$4.5 million at June 30, 2002 as compared to $5.5 million at June 30,2001.  The ratio of the allowance forloan and lease losses to total loans and leases decreased from 0.96% at June30, 2001 to 0.78% at June 30, 2002.  TheBank’s management has considered nonperforming assets and other assets ofconcern in establishing the allowance for loan and lease losses.  The Bank continues to monitor its allowancefor possible loan and lease losses and make future additions or reductions inlight of the level of loans in its portfolio and as economic conditionsdictate.  Thecurrent level of the allowance for loan and lease losses is a result ofmanagement’s assessment of the risks within the portfolio based on theinformation revealed in credit reporting processes. The Bank utilizes arisk-rating system on all commercial business, agricultural, construction andmulti-family and 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 three year periodended June 30, 2002.

 

Realestate properties acquired throughforeclosure are recorded at the lower of cost or fair value (less a deductionfor disposition costs).  Valuations areperiodically updated by management and a specific provision for losses on suchproperties is established by a charge to operations if the carrying values ofthe properties exceed 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.  See Note 1 of“Notes to Consolidated Financial Statements” for a description of the Bank’spolicy regarding the provision for losses on loans and leases.

**Comparisonof the Years Ended June 30, 2002 and June 30, 2001**

 

**ContinuingOperations**

 

*General*.  The Company’s net income from continuing operations increased$276,000 to $4.9 million for the year ended June 30, 2002 as compared to $4.6million for the year ended June 30, 2001. As discussed in more detail below, the increase was due to a variety ofkey factors, including an increase in net interest income of $1.3 million andan increase in noninterest income of $1.7 million offset by a decrease inoperating expenses of $2.4 million.

 

*Interest Income.*  Interest income decreased $10.1 million from $58.2 million forthe year ended June 30, 2001 to $48.0 million for the year ended June 30,2002.  The decrease in interest incomewas primarily due to repricing of loans and investments that generallyreflected the decline in national interest rates.  From June 30, 2001 to June 30, 2002 the prime rate dropped from6.75% to 4.75%.  The total change of$10.1 million consisted of $8.3 million due to rate changes and $1.8 milliondue to volume changes.  Average loanbalances decreased $14.2 million due to amortizations, prepayments and proceedsfrom sales of loans and leases exceeding originations and purchases.  The Company continues to manage yields bychanging the types of loans that comprise the portfolio to loans that have ahigher yield than single-family real estate loans. Commercial business loans,agricultural business loans and equipment finance leases comprise 25.26% of thetotal loan and lease portfolio at June 30, 2002 as compared to 22.28% at June30, 2001.  The percentages of businesstype loans should remain stable at these levels due to restrictions imposed byHOLA at 20.00% of total Bank assets.  Inaddition, one-to four-family loans comprise 13.78% of the total loan portfolioat June 30, 2002 as compared to 21.71% at June 30, 2001.  The yield on average earning assetsdecreased to 7.13% as compared to 8.36% one year ago.

 

*Interest Expense.*  Interest expense decreased $11.5 million from $35.1 million forthe year ended June 30, 2001 to $23.6 million for the year ended June 30,2002.  The $25.8 million decrease ofaverage interest-bearing liabilities resulted in a $2.0 million decrease ininterest expense.  The average balanceof deposits decreased $7.6 million at June 30, 2002 as compared to the priorfiscal year.  The average rate paid ondeposits decreased to 3.63% as compared to 5.51% one year ago.  The average balance of FHLB advances andother borrowings decreased $24.9 million during fiscal year 2002.  The average rate paid on FHLB advances andother borrowings decreased to 5.45% at June 30, 2002 from 5.90% at June 30,2001.  See “Financial Condition Data”for further discussion.

 

*Net Interest Income.* The Company’s net interestincome from continuing operations for the year ended June 30, 2002 increased$1.3 million, or 5.77%, to $24.4 million compared to $23.1 million for the sameperiod ended June 30, 2001.  Theincrease in net interest income was due primarily to an increasing net interestmargin as earning asset balances and national interest rates were declining.  The Company’s earning asset balancesdeclined primarily because higher yielding mortgage loans were refinancing atlower rates while certificate of deposits funding were refinancing aswell.  The Company experiencedconsiderable runoff in its one- to four-family loan portfolio due primarily tolower national mortgage loan rates.

 

*Provision for Losses on Loans and Leases.* The allowancefor loan and lease losses is maintained at a level which is considered bymanagement to be adequate to absorb probable losses on existing loans andleases that may become uncollectible, based on an evaluation of thecollectability of loans and prior loan loss experience.  The evaluation takes into consideration suchfactors as changes in the nature and volume of the loan portfolio, overallportfolio quality, review of specific problem loans, and current economicconditions that may affect the borrower’s ability to pay.  The allowance for loan and lease losses isestablished through a provision for losses on loans and leases charged toexpense.

 

During the year ended June 30, 2002, theCompany recorded a provision for losses on loans and leases of $1.9million  compared to $1.5 million forthe year ended June 30, 2001, an increase of $423,000.  See “Asset Quality” for further discussion.

 

The allowance for loan and lease losses atJune 30, 2002 was $4.5 million.  Theallowance decreased from the June 30, 2001 balance primarily as a resultcharge-offs exceeding recoveries by $3.0 million offset by the provision forlosses on loans of $1.9 million.  Theratio of allowance for loan and lease losses to nonperforming loans and leasesat June 30, 2002 was 40.02% compared to 97.73% at June 30, 2001.  The allowance for loan and lease losses tototal loans and leases at June 30, 2002 was 0.78% compared to 0.96% at June 30,2001.  The Bank’s management believesthat the June 30, 2002 recorded allowance for loan losses was adequate toprovide for probable losses on the related loans and leases, based on itsevaluation of the collectability of loans and leases and prior loss experience.

 

*Noninterest Income.*  Noninterest income was $11.1 million for the year ended June 30,2002 as compared to $9.4 million for the year ended June 30, 2001.

Fees on deposits increased $300,000 dueprimarily to an increase in volume from deposits acquired in new branchacquisitions/openings during the last half of fiscal 2001 and an increase inmonthly fees charged on savings accounts.

 

Loan servicing income increased $291,000 forthe year ended June 30, 2002 as compared to the same period in the prior fiscalyear primarily due to the package sale of $23.1 million of one- to four-family, 15- and 30-year fixed-rate loans during the first quarter of fiscal2002.

 

Gain on sale of loans increased $676,000 forthe year ended June 30, 2002 as compared to the same period in the prior fiscalyear.  This increase was due toincreased sales into the secondary market, which included $116,000 net gain onthe package sale of $23.1 million one- to four-family, 15- and 30-year fixedrate loans during the first quarter of fiscal 2002.  In addition, the volume of loans originated for resale into thesecondary market increased to $158.3 million as compared to $76.4 million inthe prior fiscal year.

 

Loan fees and service charges increased$284,000 for the year ended June 30, 2002. This increase was primarily due to an increase in loans originated andheld in portfolio of $43.4 million over the prior year.

 

Gain on sale of securities increased $135,000for the year ended June 30, 2001 as compared to the same period in the priorfiscal year.  This increase was due tono sales occurring in the prior fiscal year. Long-term fixed-rate mortgage-backed securities were sold to reduce thepotential market value loss of rising interest rates.

 

*Noninterest Expense.*  Noninterest expense increased $2.4 million from $23.5 million forthe year ended June 30, 2001 to $26.0 million for the year ended June 30,2002.  This increase was primarily dueto an increase in compensation and employee benefits of $2.0 million, anincrease in other general and administrative expenses of $311,000 and anincrease in advertising expense of $293,000 offset by a decrease in federalinsurance premiums of $165,000.

 

The increase in compensation and employeebenefits was primarily related to seven new bank branches opened and one branchacquisition since the first half of fiscal 2001.  In addition, pension costs increased $381,000 for the year endedJune 30, 2002 as compared to the same period in the prior fiscal year due to acombination of higher payroll covered and the investment performance of thepension trust account.

 

The increase in advertising was primarily dueto a new marketing campaign and logo change undertaken in fiscal 2002.

 

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

 

*Income tax expense.*  The Company’s income tax expense for both of the years ended June30, 2002 and June 30, 2001 was $2.9 million, a decrease of $73,000.  This decrease was primarily due to thedecrease in the Company’s effective tax rate from 38.93% at June 30, 2001 to36.96% at June 30, 2002 due to changes in permanent tax differences.

 

## **Discontinued Operations**

 

*Income(loss) from discontinued operations. *The $1.7million loss from discontinued operations for the year ended June 30, 2002 ascompared to income of $12,000 for the prior fiscal year was primarily due tothe write down of the credit card portfolio to net realizable value of $1.1million and one-time closing costs of $108,000.  See Note 2 of “Notes to Consolidated Financial Statements” forfurther discussion on discontinued operations.

## **Comparison of the Years Ended June30, 2001 and June 30, 2000**

 

**ContinuingOperations**

 

*General*.  The Company’s net income from continuing operations decreased$934,000 to $4.6 million for the year ended June 30, 2001 as compared to $5.5million for the year ended June 30, 2000. As discussed in more detail below, this decrease was due primarily to anincrease in interest expense of $5.9 million and an increase in noninterestexpense of $3.0 million.  Thesedecreases to income were partially offset by an increase in interest income of$6.5 million, a decrease in provision for losses on loans and leases of$200,000 and an increase in noninterest income of $1.1 million.

 

*Interest Income.*  Interest income increased $6.5 million from $51.7 million for theyear ended June 30, 2000 to $58.2 million for the year ended June 30,2001.  The $64.4 million increase ofaverage earning assets resulted in a $4.9 million increase in interestincome.  Average loan balances increased$42.4 million due to originations and purchases exceeding amortizations, prepaymentsand sales and from leases and loans acquired in new branch and companyacquisitions and openings during the last half of fiscal 2000 and fiscal2001.  The Company continues to manageyields by changing the types of loans that comprise the portfolio to loans thathave a higher yield than single-family real estate loans.  Commercial business loans, agriculturalbusiness loans and equipment finance leases comprise 22.28% of the total loanportfolio at June 30, 2001 as compared to 19.17% at June 30, 2000.  In addition, one-to four-family loanscomprise 21.71% of the total loan portfolio at June 30, 2001 as compared to23.62% at June 30, 2000.  The yield onaverage earning assets increased to 8.36% as compared to 8.19% one year ago.

 

*Interest Expense.*  Interest expense increased $5.9 million from $29.1 million forthe year ended June 30, 2000 to $35.1 million for the year ended June 30,2001.  The $52.8 million increase ofaverage interest-bearing liabilities resulted in a $2.6 million increase ininterest expense.  The average balanceof deposits increased $49.7 million primarily due to deposits acquired in newbranch acquisitions and openings during the last half of fiscal 2000 and fiscal2001.  The average rate paid on depositsincreased to 5.51% as compared to 5.03% one year ago.  The average balance of FHLB advances and other borrowingsincreased $3.1 million during fiscal year 2001.  The average rate paid on FHLB advances and other borrowingsincreased to 5.90% at June 30, 2001 from 5.19% at June 30, 2000.  See “Financial Condition Data” for furtherdiscussion.

 

*Net Interest Income.* The Company’s net interestincome for the year ended June 30, 2001 increased $599,000, or 2.66%, to $23.1million compared to $22.5 million for the same period ended June 30, 2000.  The increase in net interest income reflectsan overall increase in net earning assets offset by a reduction in the netinterest spread on average earning assets to 2.78% for the period ended June30, 2001 from 3.13% for the same period in 2000.  The decrease in the net interest spread is due primarily to adeclining rate environment.

 

*Provision for Losses on Loans and Leases.* The allowancefor loan and lease losses is maintained at a level which is considered bymanagement to be adequate to absorb probable losses on existing loans andleases that may become uncollectible, based on an evaluation of thecollectability of loans and prior loan loss experience.  The evaluation takes into consideration suchfactors as changes in the nature and volume of the loan portfolio, overallportfolio quality, review of specific problem loans, and current economicconditions that may affect the borrower’s ability to pay.  The allowance for loan and lease losses isestablished through a provision for losses on loans and leases charged toexpense.

 

During the year ended June 30, 2001, theCompany recorded a provision for losses on loans and leases of $1.5million  compared to $1.7 million forthe year ended June 30, 2000, a decrease of $200,000.  See “Asset Quality” for further discussion.

 

The allowance for loan and lease losses was$5.5 million at June 30, 2001 and June 30, 2000.  The ratio of allowance for loan and lease losses to nonperformingloans and leases at June 30, 2001 was 97.73% compared to 264.63% at June 30,2000.  The allowance for loan and leaselosses to total loans and leases at June 30, 2001 was 0.96% compared to 1.00%at June 30, 2000.  The Bank’s managementbelieves that the June 30, 2001 recorded allowance for loan losses was adequateto provide for probable losses on the related loans, based on its evaluation ofthe collectability of loans and prior loss experience.

 

*Noninterest Income.*  Noninterest income was $9.4 million for the year ended June 30,2001 as compared to $8.3 million for the year ended June 30, 2000.

 

Fees on deposits increased $842,000 due to anincrease in volume from deposits acquired in new branch acquisitions/openingsduring the last half of fiscal 2000 and fiscal 2001.

Commission and insurance income from the saleof financial and insurance products increased $182,000 primarily due to agreater emphasis on the production of non-interest income revenue.

 

Gain on sale of loans increased $207,000 forthe year ended June 30, 2001 as compared to the same period in the prior fiscalyear.  This increase was due toincreased sales into the secondary market.

 

Gain on sale of securities decreased $185,000for the year ended June 30, 2001 as compared to the same period in the priorfiscal year.  This decrease was due tono sales occurring in the current fiscal year.

 

*Noninterest Expense.*  Noninterest expense increased $3.0 million from $20.5 million forthe year ended June 30, 2000 to $23.5 million for the year ended June 30,2001.  This increase was primarily froman increase in compensation and employee benefits of $2.2 million, occupancyand equipment of $521,000, advertising expense of $206,000 and amortization ofintangible assets of $113,000.

 

The increase in compensation and employeebenefits, occupancy and equipment and amortization of intangible assets wasprimarily related to seven new bank branches opened and two nonbank operationsacquired since September 1999.

 

*Income tax expense.*  The Company’s income tax expense for the year ended June 30, 2001was $2.9 million compared to $3.1 million for the year ended June 30, 2000, adecrease of $148,000.  This decrease wasprimarily due to the decrease in the Company’s income from continuingoperations before income tax from $8.6 million to $7.5 million offset by anincrease in the Company’s effective tax rate from 35.75% at June 30, 2000 to38.93% at June 30, 2001 due to changes in permanent tax differences.

 

## **Discontinued Operations**

 

*Income(loss) from discontinued operations. *The $12,000income from discontinued operations for the year ended June 30, 2001 ascompared to a loss of $262,000 for the prior fiscal year was primarily due tothe credit card loan portfolio decreasing from $9.6 million at June 30, 2000 to$6.1 million at June 30, 2001.  See Note2 of “Notes to Consolidated Financial Statements” for further discussion ondiscontinued operations.

 

**Liquidity and Capital Resources**

 

The Bank’s primary sources of funds are inmarket deposits, FHLB advances and other borrowings, amortization andrepayments of loan principal, mortgage–backed securities and callableagency securities and, to a lesser extent, sales of mortgage loans, salesand/or maturities of securities, mortgage–backed securities, and short–terminvestments.  While scheduled loanpayments and maturing securities are relatively predictable, deposit flows andloan prepayments are more influenced by interest rates, general economicconditions, and competition. The Bank attempts to price its deposits to meetits asset/liability objectives consistent with local market conditions.  Excess balances are invested in overnightfunds.

 

Federal regulations have historicallyrequired the Bank to maintain minimum levels of liquid assets.  The required percentage has varied from timeto time based upon economic conditions and savings flows and is currently 0.00%of net withdrawable savings deposits and current borrowings.  Liquid assets for purposes of this ratioinclude cash, certain time deposits, U.S. Government and corporate securitiesand other obligations generally having remaining maturities of less than fiveyears.  The Bank has historicallymaintained its liquidity ratio at a level in excess of that required by theseregulations.  At June 30, 2002, theBank’s regulatory liquidity ratio was 4.78%.

 

Liquidity management is both a daily and long–termresponsibility of management.  The Bankadjusts its investments in liquid assets based upon management’s assessment of(i) expected loan demand, (ii) projected loan sales, (iii) expected depositflows, (iv) yields available on interest–bearing deposits, and (v) theobjectives of its asset/liability management program. Excess liquidity isinvested generally in interest–bearing overnight deposits and other short–termgovernment and agency obligations. During fiscal 2002, the Bank decreased its borrowings with the FHLB by$17.3 million.

 

The Bank anticipates that it will havesufficient funds available to meet current loan commitments.  At June 30, 2002, the Bank had outstandingcommitments to originate loans of $45.0 million and to sell loans of $14.7million.  The Bank had no commitments topurchase or sell securities.

Although deposits are the Bank’s primarysource of funds, the Bank’s policy has been to utilize borrowings where thefunds can be invested in either loans or securities at a positive rate ofreturn or to use the funds for short-term liquidity purposes.  During fiscal 2002, the Bank increased theamount of pledgeable loans at the FHLB in order to increase its contingentliquidity sources.  Also, the Bank isimplementing arrangements to acquire out of market certificate of deposits asan additional source of funding.  TheBank may also seek other sources of contingent liquidity including federalfunds purchased lines with correspondent banks and lines of credit with theFRB.  See “Financial Condition Data” forfurther 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 113,800 shares ofcommon stock have been purchased pursuant to this current program and theprevious program in effect during fiscal year 2002.  Pursuant to a series of stock buy back programs initiated by theCompany since 1996, the Company has purchased an aggregate of 1,559,030 sharesof common stock through June 30, 2002.  Included in the aggregate is a block of 340,421 shares of commonstock repurchased in a private transaction on February 13, 2002.

 

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 June 30, 2002, the Bank met all current capitalrequirements.

 

The OTS has adopted a core capitalrequirement for savings institutions comparable to the requirement for nationalbanks.  The OTS core capital requirementis 4.00% of total adjusted assets for thrifts that receive the highestsupervisory rating for safety and soundness. The Bank had core capital of 7.44% at June 30, 2002.

 

At June 30, 2002 and 2001, securities with afair value of $74.2 million and $84.4 million, respectively, were pledged ascollateral for public deposits and other purposes.  Deposits at June 30, 2002 and 2001 include $37.4 million and$37.1 million, respectively, of deposits from one local governmental entity,the majority of which are savings accounts.

 

**Impact of Inflation and ChangingPrices**

 

The Consolidated Financial Statements andNotes thereto presented in this Form 10-K have been prepared in accordance withaccounting principles generally accepted in the United States of America, whichrequire the measurement of financial position and operating results in terms ofhistorical dollars without considering the change in the relative purchasingpower of money over time due to inflation. The impact of inflation is reflected in the increased cost of the Bank’soperations. Unlike most industrial companies, nearly all the assets andliabilities of the Bank are monetary in nature.  As a result, interest rates have a greater impact on the Bank’sperformance than do the effects of general levels of inflation.  Interest rates do not necessarily move inthe same direction or to the same extent as the prices of goods and services.

 

**Effect ofNew Accounting Standards**

 

Recent accounting pronouncements:  In July, 2001, the Financial Accounting Standards Board (“FASB”)issued two statements - Statement 141, *BusinessCombinations*, and Statement 142, *Goodwilland Other Intangible Assets*, which will impact the Company’saccounting for its reported goodwill.

 

Statement 141:

•                    Eliminates the poolingmethod for accounting for business combinations.

•                    Requires that intangible assetsthat meet certain criteria be reported separately from goodwill.

•                    Requires negative goodwillarising from a business combination to be recorded as an extraordinary gain.

 

Statement 142:

•                    Eliminates the amortizationof goodwill and other intangibles that are determined to have an indefinitelife.

•                    Requires, at a minimum,annual impairment tests for goodwill and other intangible assets that aredetermined to have an indefinite life.

•                    Requires the carrying valueof goodwill which exceeds its implied fair value to be recognized as animpairment loss.

 

Upon adoption of these Statements, the Company is required to:

•                    Evaluate its existingintangible assets and goodwill that were acquired in prior businesscombinations and to make any necessary reclassifications in order to conform tothe new criteria.

•                    Reassess the useful lives ofintangible assets and adjust the remaining amortization periods accordingly.

•                    Recognize any remainingnegative goodwill as income.

The provisions of FASB Statement 141 apply to all business combinationsinitiated after June 30, 2001 and all business combinations accounted for bythe purchase method for which the date of acquisition is July 1, 2001, orlater.  The provisions of FASB Statement142 were implemented by the Company in the first quarter of its 2003 fiscalyear.  Upon initial adoption of FASBStatement 142, the Company will stop amortizing goodwill which will reduceamortization expense on current goodwill by approximately $391,000 in fiscalyear 2003.

 

InAugust 2001, the FASB issued Statement 144, *Accountingfor the Impairment or Disposal of Long-Lived Assets. *This Statement addresses financial accounting andreporting for the impairment or disposal of long-lived assets.  This Statement supersedes FASB Statement No.121, *Accounting for the Impairment ofLong-Lived Assets and for Long-Lived Assets to Be Disposed Of,*andthe accounting and reporting provisions of APB Opinion No. 30, *Reporting the Results of Operations — Reporting theEffects of Disposal of a Segment of a Business, and Extraordinary, Unusual andInfrequently Occurring Events and Transactions,*for the disposal ofa segment of a business (as previously defined in that Opinion).  The provisions of this Statement areeffective for financial statements issued for fiscal years beginning afterDecember 15, 2001, and interim periods within those fiscal years, with earlyapplication encouraged.  The provisionsof this Statement generally are to be applied prospectively.  During fiscal year 2002, the Company adoptedthe provisions of Statement 144 to record discontinued operations of the creditcard portfolio.

 

InJune 2002, the FASB issued Statement 146, *Accountingfor Costs Associated with Exit or Disposal Activities. *This Statement addressesfinancial accounting and reporting for costs associated with exit or disposalactivities and nullifies Emerging Issues Task Force (“EITF”) Issue No. 94-3,“Liability Recognition for Certain Employee Termination Benefits and OtherCosts to Exit an Activity (including Certain Costs Incurred in aRestructuring).”  The provisions of thisStatement are effective for exit or disposal activities that are initiatedafter December 31, 2002.  The adoptionof Statement No. 146 is not expected to have a material effect on the financialposition or results of operations of the Company.

**Asset/Liability and Risk Management**

 

Interest rate risk is the most significant marketrisk affecting the Company.  Other typesof market risk, such as foreign currency exchange rate risk and commodity pricerisk, do not arise in the normal course of the Company’s businessactivities.  The Bank, like otherfinancial institutions, is subject to interest rate risk to the extent that itsinterest–bearing liabilities with short- and medium-term maturitiesmature or reprice more rapidly than its interest-earning assets. The Companydoes not currently engage in trading activities or use derivative instrumentsto control interest rate risk although it may in the future, if necessary, tomanage interest rate risk.

 

As a continuing part of its financialstrategy, the Bank considers methods of managing this asset/liability mismatchconsistent with maintaining acceptable levels of net interest income.  In order to properly monitor interest raterisk, the Board of Directors has created an Asset/Liability Committee whoseprincipal responsibilities are to assess the Bank’s asset/liability mix andrecommend strategies to the Board that will enhance income while managing theBank’s vulnerability to changes in interest rates.

 

In managing market risk and theasset/liability mix, the Bank has placed its emphasis on developing a portfolioin which, to the extent practicable, assets and liabilities reprice withinsimilar periods. 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.

 

One approach used to quantify interest raterisk is the net portfolio value (“NPV”) analysis.  In essence, this analysis calculates the difference between thepresent value of the liabilities and the present value of expected cash flowsfrom assets and off-balance sheet contracts. The following table sets forth, at June 30, 2002, 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 prevailing interestrate environment, -200 and -300 NPV were not estimated by the OTS.

 

The data in the following tables is based onassumptions utilized by the OTS in assessing interest rate risk of thriftinstitutions and published in “Selected Asset and Liability Price Tables as ofJune 30, 2002”.  Even if interest rateschange in the designated amounts, there can be no assurance that the Company’sassets and liabilities would perform as set forth below.  In addition, a change in U.S. Treasury ratesin the designated amounts accompanied by a change in the shape of the Treasuryyield curve would cause significantly different changes to the NPV thanindicated below.

 

|                          |   |                       |   | **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 | ) |
|                               |        |                            |        |                                            |        |  |  |  |  |

**Item 7A.   Quantitative and Qualitative Disclosures About Market Risk**

 

Interest Rate Risk Management

 

The Company ‘s net income is largelydependent on its net interest income. Net interest income is susceptible tointerest rate risk to the degree that interest-bearing liabilities mature orreprice on a different basis than interest-earning assets. Wheninterest-bearing liabilities mature or reprice more quickly thaninterest-earning assets in a given period, a significant increase in marketrates of interest could adversely affect net interest income. Similarly, wheninterest-earning assets mature or reprice more quickly than interest-bearingliabilities, falling interest rates could result in a decrease in net income.

 

In an attempt to manage its exposure tochange in interest rates, management monitors the Company’s interest rate risk.Management’s Asset-Liability Committee meets periodically to review theCompany’s interest rate risk position and profitability, and to recommendadjustments for consideration by executive management. Management also reviewsthe Bank’s securities portfolio, formulates investment strategies, and overseesthe timing and implementation of transactions to assure attainment of the Board‘s objectives in the most effective manner. Notwithstanding the Company’sinterest rate risk management activities, the potential for changing interestrates is an uncertainty that can have an adverse effect on net income.

 

In adjusting the Company’s asset/liabilityposition, management attempts to manage the Company’s interest rate risk whileenhancing net interest margins. At times, depending on the level of generalinterest rates, the relationship between long and short-term interest rates,market conditions and competitive factors, management may determine to increasethe Company’s interest rate risk position somewhat in order to increase its netinterest margin. The Company’s results of operations and net portfolio valuesremain vulnerable to increases in interest rates and to fluctuations in thedifference between long- and short-term interest rates.

 

Consistent with the asset/liabilitymanagement philosophy described above, the Company has taken several steps tomanage its interest rate risk. First, the Company has structured the securityportfolio to shorten the repricing of its interest-earning assets. TheCompany’s recent purchases of mortgage-backed securities and securitiesavailable for sale have had either short or medium terms to maturity oradjustable interest rates. At June 30, 2002, the Company had securitiesavailable for sale of $16.6 million with contractual maturities of five yearsor less and adjustable rate mortgage-backed securities of $45.7 million.Mortgage-backed securities amortize and experience prepayments ofprincipal.  The Company has receivedaverage cash flows from principal paydowns, maturities, sales and calls of allsecurities available for sale of $54.3 million annually over the past threefiscal years. The Company also controls interest rate risk reduction byemphasizing non-certificate depositor accounts. The Board and managementbelieve that such accounts carry a lower cost than certificate accounts, andthat a material portion of such accounts may be more resistant to changes ininterest rates than are certificate accounts. At June 30, 2002, the Company had$50.4 million of savings accounts, $157.8 million of money market accounts and$103.0 million of checking accounts, representing 55.31% of total depositoraccounts.

 

One approach used to quantify interest raterisk is the net portfolio value (“NPV”) analysis. In essence, this analysiscalculates the difference between the present value of liabilities and thepresent value of expected cash flows from assets and off-balance sheetcontracts.  See Item 7, “Management’sDiscussion and Analysis of Financial Condition and Results of Operations —Asset/Liability and Risk Management” for further discussion.

 

The Company does not currently engage intrading activities or use derivative instruments to control interest rate risk.Even though such activities may be permitted with the approval of the Board ofDirectors, the Company does not intend to engage in such activities in theimmediate future.

 

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

**Item 8. Financial Statements and Supplementary Data**

 

**CONTENTS**
| INDEPENDENT AUDITOR’S  REPORT  ON THE FINANCIAL STATEMENTS |   |   |
|-----------------------------------------------------------------|--------|--------|
|                                                            |   |   |
| CONSOLIDATED FINANCIAL  STATEMENTS                              |   |   |
|                                                            |   |   |
| Statements  of financial condition                              |   |   |
|                                                            |   |   |
| Statements of income                                            |   |   |
|                                                            |   |   |
| Statements  of stockholders’ equity                        |   |   |
|                                                            |   |   |
| Statements of cash  flows                                       |   |   |
|                                                            |   |   |
| Notes to  consolidated financial statements                     |   |   |
|                                                            |   |   |

 

 

 

**INDEPENDENT AUDITOR’S REPORT**

 

 

To the Board of Directorsand Stockholders

HF Financial Corp.

Sioux Falls, South Dakota

 

We have audited theaccompanying consolidated statements of financial condition of HF FinancialCorp. and subsidiaries as of June 30, 2002 and 2001, and the relatedconsolidated statements of income, stockholders’ equity and cash flows for eachof the three years in the period ended June 30, 2002.  These financial statements are the responsibility of theCompany’s management.  Ourresponsibility is to express an opinion on these financial statements based onour audits.

 

We conducted our auditsin accordance with auditing standards generally accepted in the United Statesof America.  Those standards requirethat we plan and perform the audit to obtain reasonable assurance about whetherthe financial statements are free of material misstatement.  An audit includes examining, on a testbasis, evidence supporting the amounts and disclosures in the financialstatements.  An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statementpresentation.  We believe that ouraudits provide a reasonable basis for our opinion.

 

In our opinion, theconsolidated financial statements referred to above present fairly, in allmaterial respects, the financial position of HF Financial Corp. andsubsidiaries as of June 30, 2002 and 2001, and the results of their operationsand their cash flows for each of the three years in the period ended June 30,2002, in conformity with accounting principles generally accepted in the UnitedStates of America.

 

 

Sioux Falls, South Dakota

August 15, 2002

 

 

 

**HF FINANCIAL CORP. AND SUBSIDIARIES**

 

**CONSOLIDATEDSTATEMENTS OF FINANCIAL CONDITION**

**June 30, 2002 and 2001**

**(Dollars in Thousands)**

 
| **ASSETS**                                                                     |   | **2002**    |        | **2001** |   |
|--------------------------------------------------------------------------------|--------|-------------|-------------|----------|--------|
| Cash and cash equivalents                                                      |   | **$**       | **27,546**  |     | $      | 84,913 |   |
|                                                                           |   |        |        |     |   |
| Securities available for sale (Notes 4 and 9)                                  |   | **29,401**  |        | 49,969   |   |
|                                                                           |   |        |        |     |   |
| Mortgage-backed securities available for sale (Note 4)                         |   | **59,735**  |        | 43,750   |   |
|                                                                           |   |        |        |     |   |
| Loans and leases receivable (Notes 5 and 9)                                    |   | **559,814** |        | 563,836  |   |
|                                                                           |   |        |        |     |   |
| Loans held for sale (Note 5)                                                   |   | **6,559**   |        | 7,270    |   |
|                                                                           |   |        |        |     |   |
| Accrued interest receivable                                                    |   | **4,410**   |        | 5,412    |   |
|                                                                           |   |        |        |     |   |
| Office properties and equipment, net of accumulated depreciation  (Note7) |   | **13,714**  |        | 13,756   |   |
|                                                                           |   |        |        |     |   |
| Foreclosed real estate and other properties                                    |   | **1,672**   |        | 1,608    |   |
|                                                                           |   |        |        |     |   |
| Prepaid expenses and other assets                                              |   | **8,505**   |        | 2,720    |   |
|                                                                           |   |        |        |     |   |
| Mortgage servicing rights (Note 6)                                             |   | **3,467**   |        | 2,775    |   |
|                                                                           |   |        |        |     |   |
| Deferred income taxes (Note 11)                                                |   | **2,831**   |        | 2,230    |   |
|                                                                           |   |        |        |     |   |
| Cost in excess of net assets acquired (Note 3)                                 |   | **5,263**   |        | 5,763    |   |
|                                                                           |   |        |        |     |   |
|                                                                           |   | **$**       | **722,917** |     | $      | 784,002 |   |

 

See Notes to Consolidated FinancialStatements.

 

 
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                             |   | **2002**    |        | **2001** |   |
|--------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------|-------------|----------|--------|
| Liabilities                                                                                                                                |   |        |        |     |   |
| Deposits (Note 8)                                                                                                                          |   | **$**       | **562,596** |     | $      | 601,207 |   |
| Advances from Federal Home Loan Bank and otherborrowings (Note 9)                                                                          |   | **84,308**  |        | 108,376  |   |
| Company obligated mandatorily redeemable preferred securities ofsubsidiary trust that solely holds subordinated  debentures (Note 10)      |   | **10,000**  |        | —   |   |
| Advances by borrowers for taxes and insurance                                                                                              |   | **6,436**   |        | 7,337    |   |
| Accrued interest payable                                                                                                                   |   | **3,751**   |        | 7,901    |   |
| Accrued benefit liability (Note 15)                                                                                                        |   | **1,093**   |        | —   |   |
| Other liabilities                                                                                                                          |   | **6,197**   |        | 6,656    |   |
| **Total liabilities**                                                                                                                      |   | **674,381** |        | 731,477  |   |
|                                                                                                                                       |   |        |        |     |   |
| Commitments and Contingencies (Notes 7, 19 and 21)                                                                                         |   |        |        |     |   |
|                                                                                                                                       |   |        |        |     |   |
| Stockholders’ Equity (Notes 11, 12, 13 and 16)                                                                                        |   |        |        |     |   |
| Preferred stock, $.01 par value, 500,000 sharesauthorized, none outstanding                                                                |   | **—**  |        | —   |   |
| Series A Junior Participating Preferred Stock, $1.00 statedvalue, 50,000 shares authorized, none outstanding                               |   | **—**  |        | —   |   |
| Common stock, $.01 par value, 10,000,000 shares authorized, 4,886,494  and 4,786,005 sharesissued at  June 30, 2002 and 2001, respectively |   | **49**      |        | 48       |   |
| Additional paid-in capital                                                                                                                 |   | **16,014**  |        | 15,378   |   |
| Retained earnings, substantially restricted                                                                                                |   | **54,516**  |        | 52,886   |   |
| Deferred compensation (Note 17)                                                                                                            |   | **(141**    | )           | —   |   |
| Accumulated other comprehensive income (loss):                                                                                             |   |        |        |     |   |
| Unrealized gain on securities available for sale, netof related deferred tax effect                                                        |   | **498**     |        | 338      |   |
| Unrecognized pension costs, net of related deferred tax effect                                                                             |   | **(704**    | **)**       | —   |   |
| Less cost of treasury stock, 1,559,030 and 1,105,209 sharesat June 30, 2002 and 2001, respectively                                         |   | **(21,696** | **)**       | (16,125  | )      |
|                                                                                                                                       |   | **48,536**  |        | 52,525   |   |
|                                                                                                                                       |   | **$**       | **722,917** |     | $      | 784,002 |   |

 

 

**HF FINANCIAL CORP. AND SUBSIDIARIES**

 

**CONSOLIDATEDSTATEMENTS OF INCOME**

**Years Ended June 30, 2002, 2001 and 2000**

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

 
|                                                                                               |   | **2002**   |       | **2001**   |       | **2000** |   |
|----------------------------------------------------------------------------------------------------|--------|------------|------------|------------|------------|----------|--------|
| Interest and dividend income:                                                                      |   |       | ** ** |       |       |     |   |
| Loans and leases receivable                                                                        |   | **$**      | **42,290** | ** ** | $          | 50,016   |   | $ | 44,657 |   |
| Mortgage-backed securities                                                                         |   | **2,664**  | ** ** | 3,327      |       | 3,390    |   |
| Investment securities and interest-bearing deposits                                                |   | **3,063**  | ** ** | 4,819      |       | 3,606    |   |
|                                                                                               |   | **48,017** |       | 58,162     | ** ** | 51,653   |   |
|                                                                                               |   |       | ** ** |       |       |     |   |
| Interest expense:                                                                                  |   |       | ** ** |       |       |     |   |
| Deposits                                                                                           |   | **18,433** | ** ** | 28,420     |       | 23,462   |   |
| Advances from Federal Home Loan Bankand other borrowings                                           |   | **5,140**  | ** ** | 6,631      |       | 5,679    |   |
|                                                                                               |   | **23,573** |       | 35,051     | ** ** | 29,141   |   |
| **Net interest income**                                                                            |   | **24,444** | ** ** | 23,111     |       | 22,512   |   |
| Provision for losses on loans and leases                                                           |   | **1,905**  | ** ** | 1,482      |       | 1,682    |   |
| **Net interest income after provision********for  losses on loans and leases**                     |   | **22,539** | ** ** | 21,629     |       | 20,830   |   |
|                                                                                               |   |       | ** ** |       |       |     |   |
| Noninterest income:                                                                                |   |       | ** ** |       |       |     |   |
| Fees on deposits                                                                                   |   | **3,931**  | ** ** | 3,631      |       | 2,789    |   |
| Loan servicing income                                                                              |   | **1,858**  | ** ** | 1,567      |       | 1,381    |   |
| Gain on sale of loans, net                                                                         |   | **1,518**  | ** ** | 842        |       | 635      |   |
| Commission and insurance income                                                                    |   | **1,288**  | ** ** | 1,343      |       | 1,161    |   |
| Loan fees and service charges                                                                      |   | **1,266**  | ** ** | 982        |       | 1,131    |   |
| Trust income                                                                                       |   | **435**    | ** ** | 392        |       | 345      |   |
| Gain on sale of securities, net                                                                    |   | **135**    | ** ** | —     |       | 185      |   |
| Other                                                                                              |   | **715**    | ** ** | 666        |       | 664      |   |
|                                                                                               |   | **11,146** |       | 9,423      | ** ** | 8,291    |   |
|                                                                                               |   |       | ** ** |       |       |     |   |
| Noninterest expense:                                                                               |   |       | ** ** |       |       |     |   |
| Compensation and employee benefits                                                                 |   | **16,388** | ** ** | 14,416     |       | 12,252   |   |
| Other general and administrative expenses                                                          |   | **4,298**  | ** ** | 3,987      |       | 4,027    |   |
| Occupancy and equipment                                                                            |   | **3,359**  | ** ** | 3,451      |       | 2,930    |   |
| Advertising                                                                                        |   | **1,042**  | ** ** | 749        |       | 543      |   |
| Amortization of intangible assets                                                                  |   | **500**    | ** ** | 470        |       | 357      |   |
| Losses and provision for losses and expenses onforeclosed real estate and other properties, net    |   | **263**    | ** ** | 182        |       | 215      |   |
| Federal insurance premiums                                                                         |   | **108**    | ** ** | 273        |       | 191      |   |
|                                                                                               |   | **25,958** |       | 23,528     | ** ** | 20,515   |   |
| **Income from continuing operations before income  taxes**                                         |   | **7,727**  | ** ** | 7,524      |       | 8,606    |   |
| Income tax expense (Note 11)                                                                       |   | **2,856**  | ** ** | 2,929      |       | 3,077    |   |
| **Income from continuing operations**                                                              |   | **4,871**  | ** ** | 4,595      |       | 5,529    |   |
|                                                                                               |   |       | ** ** |       |       |     |   |
| Discontinued operations (Note 2):                                                                  |   |       | ** ** |       |       |     |   |
| Income (loss) from operations of discontinued segment,net of income taxes of $(127), $6 and $(135) |   | **(246**   | **)**      | 12         |       | (262     | )      |
| (Loss) on discontinued segment, net ofincome taxes of $(741)                                       |   | **(1,440** | **)**      | —     |       | —   |   |
| **Income (loss) from discontinued operations**                                                     |   | **(1,686** | **)**      | 12         |       | (262     | )      |
| **Net income**                                                                                     |   | **$**      | **3,185**  | ** ** | $          | 4,607    |   | $ | 5,267 |   |
|                                                                                                    |        |            |            |            |            |          |        |  |  |  |  |

 

See Notes to Consolidated Financial Statements.

 

 

 
|                                         |   | **2002**  |       | **2001**   |   | **2000** |   |
|----------------------------------------------|--------|-----------|------------|------------|--------|----------|--------|
| Basic earnings (loss) per share (Note  14):  |   |      | ** ** |       |   |     |   |
| Income from continuing operations            |   | **$**     | **1.39**   | ** ** | $      | 1.25     |   | $ | 1.43 |   |
| (Loss) from discontinued operations          |   | **(0.48** | **)**      | —     |   | (0.07    | )      |
| Net income                                   |   | **0.91**  | ** ** | 1.25       |   | 1.36     |   |
|                                         |   |      | ** ** |       |   |     |   |
| Diluted earnings (loss) per share (Note 14): |   |      | ** ** |       |   |     |   |
| Income from continuing operations            |   | **1.36**  | ** ** | 1.23       |   | 1.41     |   |
| (Loss) from discontinued operations          |   | **(0.47** | **)**      | —     |   | (0.07    | )      |
| Net income                                   |   | **0.89**  | ** ** | 1.23       |   | 1.34     |   |
|                                              |        |           |            |            |        |          |        |  |  |  |

 

 

 

**HF FINANCIAL CORP. AND SUBSIDIARIES**

 

**CONSOLIDATEDSTATEMENTS OF STOCKHOLDERS’ EQUITY**

**Years Ended June 30, 2002, 2001 and 2000**

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

 
| ** **                                                                             | ** ** | **Common********Stock** | ** **   | **Additional  Paid-In********Capital** | ** ** | **Retained********Earnings** | ** ** | **Deferred********Compensation** | ** **       | **Unearned********Compensation** | ** ** | **Accumulated  Other********Comprehensive********Income  (Loss)** | ** ** | **Treasury**

**Stock** | ** **       | **Total**  | ** ** |
|----------------------------------------------------------------------------------------|------------|-------------------------|--------------|----------------------------------------|------------|------------------------------|------------|----------------------------------|------------------|----------------------------------|------------|-------------------------------------------------------------------|------------|-------------------------|------------------|------------|------------|
| Balance, June 30, 1999                                                                 |       | $                       |  47     |                                   | $          |  15,128                 |       | $                                |  46,101     |                             | $          |  —                                                      |       | $                       |  (226       | )          | $          |  (1,236 | ) | $ |  (11,256 | ) | $ |  48,558 |   |
| Comprehensive income:                                                                  |       |                    |         |                                   |       |                         |       |                             |             |                             |       |                                                              |       |                    |             |       |       |
| Net income                                                                             |       | —                  |         | —                                 |       | 5,267                        |       | —                           |             | —                           |       | —                                                            |       | —                  |             |       |       |
| Net change in unrealized loss on securitiesavailable for sale, net of deferred taxes   |       | —                  |         | —                                 |       | —                       |       | —                           |             | —                           |       | (715                                                              | )          | —                  |             |       |       |
| Comprehensive income                                                                   |       | —                  |         | —                                 |       | —                       |       | —                           |             | —                           |       | —                                                            |       | —                  |             | 4,552      |       |
| Issuance of restricted stock and exercise ofstock options                              |       | 1                       |         | 132                                    |       | —                       |       | —                           |             | —                           |       | —                                                            |       | —                  |             | 133        |       |
| Cash dividends paid ($0.40 per share) on common stock                                  |       | —                  |         | —                                 |       | (1,544                       | )          | —                           |             | —                           |       | —                                                            |       | —                  |             | (1,544     | )          |
| Purchase of treasury stock                                                             |       | —                  |         | —                                 |       | —                       |       | —                           |             | —                           |       | —                                                            |       | (4,869                  | )                | (4,869     | )          |
| Amortization of unearned compensation                                                  |       | —                  |         | —                                 |       | —                       |       | —                           |             | 113                              |       | —                                                            |       | —                  |             | 113        |       |
| Balance, June 30, 2000                                                                 |       | 48                      |         | 15,260                                 |       | 49,824                       |       | —                           |             | (113                             | )          | (1,951                                                            | )          | (16,125                 | )                | 46,943     |       |
| Comprehensive income:                                                                  |       |                    |         |                                   |       |                         |       |                             |             |                             |       |                                                              |       |                    |             |       |       |
| Net income                                                                             |       | —                  |         | —                                 |       | 4,607                        |       | —                           |             | —                           |       | —                                                            |       | —                  |             |       |       |
| Net change in unrealized (loss) on securitiesavailable for sale, net of deferred taxes |       | —                  |         | —                                 |       | —                       |       | —                           |             | —                           |       | 2,289                                                             |       | —                  |             |       |       |
| Comprehensive income                                                                   |       | —                  |         | —                                 |       | —                       |       | —                           |             | —                           |       | —                                                            |       | —                  |             | 6,896      |       |
| Issuance of restricted stock and exercise ofstock options                              |       | —                  |         | 118                                    |       | —                       |       | —                           |             | —                           |       | —                                                            |       | —                  |             | 118        |       |
| Cash dividends paid ($0.42 per share) on common stock                                  |       | —                  |         | —                                 |       | (1,545                       | )          | —                           |             | —                           |       | —                                                            |       | —                  |             | (1,545     | )          |
| Amortization of unearned compensation                                                  |       | —                  |         | —                                 |       | —                       |       | —                           |             | 113                              |       | —                                                            |       | —                  |             | 113        |       |
| Balance, June 30, 2001                                                                 |       | 48                      |         | 15,378                                 |       | 52,886                       |       | —                           |             | —                           |       | 338                                                               |       | (16,125                 | )                | 52,525     |       |
| Comprehensive income:                                                                  |       |                    |         |                                   |       |                         |       |                             |             |                             |       |                                                              |       |                    |             |       |       |
| Net income                                                                             |       | —                  |         | —                                 |       | 3,185                        |       | —                           |             | —                           |       | —                                                            |       | —                  |             |       |       |
| Net change in unrealized gain on securitiesavailable for sale, net of deferred taxes   |       | —                  |         | —                                 |       | —                       |       | —                           |             | —                           |       | 160                                                               |       | —                  |             |       |       |
| Net change in unrecognized pension costs,net of deferred taxes                         |       | —                  |         | —                                 |       | —                       |       | —                           |             | —                           |       | (704                                                              | )          |                    |             |       |       |
| Comprehensive income                                                                   |       | —                  |         | —                                 |       | —                       |       | —                           |             | —                           |       | —                                                            |       | —                  |             | 2,641      |       |
| Issuance of restricted stock and exercise ofstock options (Note 17)                    |       | 1                       |         | 636                                    |       | —                       |       | (169                             | )                | —                           |       | —                                                            |       | —                  |             | 468        |       |
| Cash dividends paid ($0.44 per share) on common stock                                  |       | —                  |         | —                                 |       | (1,555                       | )          | —                           |             | —                           |       | —                                                            |       | —                  |             | (1,555     | )          |
| Purchase of treasury stock                                                             |       | —                  |         | —                                 |       | —                       |       | —                           |             | —                           |       | —                                                            |       | (5,571                  | )                | (5,571     | )          |
| Amortization of deferred compensation                                                  |       | —                  |         | —                                 |       | —                       |       | 28                               |             | —                           |       | —                                                            |       | —                  |             | 28         |       |
| Balance, June 30, 2002                                                                 |       | **$**                   | ** 49** | ** **                             | **$**      | ** 16,014**             | ** ** | **$**                            | ** 54,516** | ** **                       | **$**      | ** (141**                                                    | **)**      | **$**                   | ** —** | ** ** | **$**      | ** (206** | **)** | **$** | ** (21,696** | **)** | **$** | ** 48,536** | ** ** |
|                                                                                        |            |                         |              |                                        |            |                              |            |                                  |                  |                                  |            |                                                                   |            |                         |                  |            |            |  |  |  |  |  |  |  |  |  |

 

See Notes to Consolidated Financial Statements.

 

 

 

**HF FINANCIAL CORP. AND SUBSIDIARIES**

 

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**Years Ended June 30, 2002, 2001 and 2000**

**(Dollars in Thousands)**

 

 
|                                                                                               |   | **2002**     |       | **2001**   |   | **2000** |   |
|----------------------------------------------------------------------------------------------------|--------|--------------|------------|------------|--------|----------|--------|
| Cash Flows From Operating Activities                                                               |   |         | ** ** |       |   |     |   |
| Net income                                                                                         |   | **$**        | **3,185**  | ** ** | $      | 4,607    |   | $ | 5,267 |   |
| Adjustments to reconcile net income to netcash provided by operating activities:                   |   | ** **   | ** ** |       |   |     |   |
| Provision for losses on loans and leases                                                           |   | **2,543**    | ** ** | 2,432      |   | 5,615    |   |
| Depreciation                                                                                       |   | **1,683**    | ** ** | 1,888      |   | 1,652    |   |
| (Amortization) accretion of premiums and discountson securities available for sale, net            |   | **140**      | ** ** | (80        | )      | (25      | )      |
| Amortization of intangible assets                                                                  |   | **500**      | ** ** | 470        |   | 357      |   |
| Amortization of mortgage servicing rights                                                          |   | **347**      | ** ** | 272        |   | 297      |   |
| Amortization of unearned compensation                                                              |   | **—**   | ** ** | 113        |   | 113      |   |
| Amortization of debt issue costs                                                                   |   | **7**        | ** ** | —     |   | —   |   |
| Stock based compensation                                                                           |   | **117**      | ** ** | 100        |   | 98       |   |
| (Decrease) in deferred loan fees                                                                   |   | **(637**     | **)**      | (223       | )      | (717     | )      |
| Loans originated for resale                                                                        |   | **(158,329** | **)**      | (76,395    | )      | (63,790  | )      |
| Proceeds from the sale of loans                                                                    |   | **161,673**  | ** ** | 78,224     |   | 67,923   |   |
| (Gain) on sale of loans, net                                                                       |   | **(1,518**   | **)**      | (842       | )      | (635     | )      |
| Mortgage servicing rights capitalized                                                              |   | **(439**     | **)**      | (174       | )      | (147     | )      |
| Realized (gain) on sale of securities, net                                                         |   | **(135**     | **)**      | —     |   | (185     | )      |
| Losses and provision for losses on sales of foreclosed real  estate and other properties, net |   | **129**      | ** ** | 27         |   | 51       |   |
| Loss on disposal of office properties andequipment, net                                            |   | **8**        | ** ** | 15         |   | 6        |   |
| Change in other assets and liabilities (Note 20)                                                   |   | **(4,359**   | **)**      | 1,668      |   | 2,560    |   |
| **Net cash provided by operating activities**                                                      |   | **4,915**    | ** ** | 12,102     |   | 18,440   |   |
|                                                                                                    |        |              |            |            |        |          |        |  |  |  |

 

See Notes to Consolidated Financial Statements.

 

 

 
|                                                                  |   | **2002**     |        | **2001**   |   | **2000**   |   |
|-----------------------------------------------------------------------|--------|--------------|-------------|------------|--------|------------|--------|
| Cash Flows From Investing Activities                                  |   |         | ** **  |       |   |       |   |
| Loans and leases purchased                                            |   | **$**        | **(33,340** | **)**      | $      | (4,067     | )      | $ | (23,201 | ) |
| Loans and leases originated and held                                  |   | **(249,705** | **)**       | (206,337   | )      | (230,495   | )      |
| Principal collected on loans and leases                               |   | **282,495**  | ** **  | 196,023    |   | 189,570    |   |
| Sale of participation interests in loans                              |   | **—**   | ** **  | **—** |   | 8,650      |   |
| Securities available for sale:                                        |   |         | ** **  |       |   |       |   |
| Sales and maturities                                                  |   | **68,935**   | ** **  | 34,411     |   | 18,440     |   |
| Purchases                                                             |   | **(84,574**  | **)**       | (23,567    | )      | (38,237    | )      |
| Repayments                                                            |   | **20,475**   | ** **  | 12,654     |   | 7,894      |   |
| Purchase of other investments                                         |   | **(5,000**   | **)**       | **—** |   | **—** |   |
| Purchase of bank branches, net of cash andcash equivalents received   |   | **—**   | ** **  | 2,218      |   | 775        |   |
| Purchase of financing lease company, net of cash acquired             |   | **—**   | ** **  | (2,857     | )      | **—** |   |
| Proceeds from sale of office properties and equipment                 |   | **13**       | ** **  | 18         |   | 4          |   |
| Purchase of office properties and equipment                           |   | **(1,662**   | **)**       | (1,754     | )      | (942       | )      |
| Purchase of mortgage servicing rights                                 |   | **(600**     | **)**       | (702       | )      | (582       | )      |
| Proceeds from sale of foreclosed real estateand other properties, net |   | **1,358**    | ** **  | 871        |   | 955        |   |
| Purchase of insurance business                                        |   | **—**   | ** **  | (150       | )      | (300       | )      |
| **Net cash provided by (used in) investing  activities**              |   | **(1,605**   | **)**       | 6,761      |   | (67,469    | )      |
|                                                                  |   |         | ** **  |       |   |       |   |
| Cash Flows From Financing Activities                                  |   |         | ** **  |       |   |       |   |
| Net increase (decrease) in deposit accounts                           |   | **(38,611**  | **)**       | 51,591     |   | 33,373     |   |
| Proceeds of advances from Federal Home LoanBank and other borrowings  |   | **89,900**   | ** **  | 221,174    |   | 288,100    |   |
| Payments on advances from Federal Home LoanBank and other borrowings  |   | **(113,968** | **)**       | (232,399   | )      | (256,693   | )      |
| Payment of debt issue costs                                           |   | **(350**     | **)**       | **—** |   | **—** |   |
| Proceeds from issuance of preferred securitiesof subsidiary trust     |   | **10,000**   | ** **  | **—** |   | **—** |   |
| Increase (decrease) in advances by borrowers for taxesand insurance   |   | **(901**     | **)**       | 794        |   | 373        |   |
| Purchase of treasury stock                                            |   | **(5,571**   | **)**       | **—** |   | (4,869     | )      |
| Proceeds from issuance of common stock                                |   | **379**      | ** **  | 18         |   | 35         |   |
| Cash dividends paid                                                   |   | **(1,555**   | **)**       | (1,545     | )      | (1,544     | )      |
| **Net cash provided by (used in) financing activities**               |   | **(60,677**  | **)**       | 39,633     |   | 58,775     |   |
|                                                                       |        |              |             |            |        |            |        |  |  |  |

 

 

 
|                                                                                              |   | **2002**   |        | **2001**   |   | **2000**   |   |
|---------------------------------------------------------------------------------------------------|--------|------------|-------------|------------|--------|------------|--------|
| **Increase (decrease) in cash and cash equivalents**                                              |   | **$**      | **(57,367** | **)**      | $      | 58,496     |   | $ | 9,746 |   |
|                                                                                              |   |       | ** **  |       |   |       |   |
| Cash and Cash Equivalents                                                                         |   |       | ** **  |       |   |       |   |
| Beginning                                                                                         |   | **84,913** | ** **  | 26,417     |   | 16,671     |   |
| Ending                                                                                            |   | **$**      | **27,546**  | ** ** | $      | 84,913     |   | $ | 26,417 |   |
|                                                                                              |   |       | ** **  |       |   |       |   |
| Supplemental Disclosures of Cash Flows Information                                                |   |       | ** **  |       |   |       |   |
| Cash payments for interest                                                                        |   | **$**      | **27,890**  | ** ** | $      | 34,286     |   | $ | 28,627 |   |
| Cash payments for income and franchise taxes, net                                                 |   | **2,715**  | ** **  | 2,293      |   | 587        |   |
|                                                                                              |   |       | ** **  |       |   |       |   |
| Supplemental Schedule of Noncash Investing and Financing Activities                               |   |       | ** **  |       |   |       |   |
| Foreclosed real estate and other properties acquired insettlement of loans                        |   | **$**      | **379**     | ** ** | $      | 1,097      |   | $ | 902 |   |
| Loans made in connection with the sale of foreclosed realestate and other properties              |   | **—** | ** **  | **—** |   | 28         |   |
| Loans receivable reclassified as held for sale                                                    |   | **1,115**  | ** **  | **—** |   | **—** |   |
| Change in unrealized gain (loss) on securities available for sale                                 |   | **258**    | ** **  | 3,691      |   | (1,273     | )      |
| Deferred income taxes related to change in unrealized gain (loss)on securities available for sale |   | **(98**    | **)**       | (1,402     | )      | 558        |   |
| Change in unrecognized pension costs                                                              |   | **(1,136** | **)**       | **—** |   | **—** |   |
| Deferred income taxes related to change in unrecognizedpension costs                              |   | **432**    | ** **  | **—** |   | **—** |   |
|                                                                                              |   |       | ** **  |       |   |       |   |
| Acquisitions, net of cash and cash equivalents acquired(received), allocated to:                  |   | ** ** | ** **  |       |   |       |   |
| Assets                                                                                            |   |       | ** **  |       |   |       |   |
| Loans and leases receivable                                                                       |   | **$**      | **—**  | ** ** | $      | 10,082     |   | $ | 452 |   |
| Accrued interest receivable                                                                       |   | **—** | ** **  | 7          |   | **—** |   |
| Office properties and equipment                                                                   |   | **—** | ** **  | 206        |   | 29         |   |
| Prepaid expenses and other assets                                                                 |   | **—** | ** **  | 27         |   | **—** |   |
| Deferred income taxes                                                                             |   | **—** | ** **  | 42         |   | **—** |   |
| Cost in excess of net assets acquired                                                             |   | **—** | ** **  | 1,053      |   | 142        |   |
| Liabilities assumed                                                                               |   |       | ** **  |       |   |       |   |
| Deposits                                                                                          |   | **—** | ** **  | (4,119     | )      | (1,394     | )      |
| Accrued interest payable                                                                          |   | **—** | ** **  | **—** |   | (4         | )      |
| Notes payable and other borrowings                                                                |   | **—** | ** **  | (6,581     | )      | **—** |   |
| Other liabilities                                                                                 |   | **—** | ** **  | (78        | )      | **—** |   |
| Net cash paid (received) on acquisitions                                                          |   | **$**      | **—**  | ** ** | $      | 639        |   | $ | (775 | ) |

 

See Notes to Consolidated Financial Statements.

 

 

 

**HF FINANCIAL CORP. AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**(Dollars in Thousands)**

**Note 1.  Summary of Significant Accounting Policies**

The accounting andreporting policies of HF Financial Corp. (the Company) and subsidiaries conformto accounting principles generally accepted in the United States of America andto general practice within the industry. The following is a description of the more significant of those policiesthat the Company follows in preparing and presenting its consolidated financialstatements.

 

Principles ofconsolidation:  The accompanying consolidated financialstatements include the accounts of the Company, the Company’s wholly-ownedsubsidiaries, HomeFirst Mortgage Corp., HF Card Services, LLC (HF Card), andHome Federal Bank (formerly known as Home Federal Savings Bank) (the Bank), andthe Bank’s wholly-owned subsidiaries, Hometown Insurors, Inc., Mid-AmericaService Corporation and PMD, Inc.  Thefinancial statements also include the accounts of Mid America Capital Services,Inc. (Mid America Capital), which at June 30, 2001 was a wholly ownedsubsidiary of HomeFirst Mortgage Corp. During fiscal year 2002, Mid America Capital was transferred from awholly owned subsidiary of HomeFirst Mortgage to a wholly owned subsidiary ofthe Bank with no affect on the consolidated financial statements.  Additionally, during fiscal year 2002, theCompany formed a wholly owned subsidiary named HF Financial Capital Trust I(the Trust).  All intercompany balancesand transactions have been eliminated in consolidation.

 

Basis of financialstatement presentation:  In preparing the financialstatements, management is required to make estimates and assumptions thataffect the reported amounts of assets and liabilities as of the date of thestatement of financial condition and revenues and expenses for the year.  Actual results could differ significantlyfrom those estimates.  A materialestimate that is particularly susceptible to significant change in thenear-term relates to the determination of the allowance for loan and leaselosses.

 

Management believes thatthe allowance for loan and lease losses is adequate.  While management uses available information to recognize possiblelosses on loans and leases, future additions to the allowance may be necessarybased on changes in economic conditions.

 

In addition, variousregulatory agencies, as an integral part of their examination process,periodically review the Bank’s allowance for loan and lease losses.  Such agencies may require the Bank torecognize additions to the allowance based on their judgments about informationavailable to them at the time of their examination.

 

Cash and cash equivalents: For purposes of reporting the statements of cash flows, the Companyincludes as cash equivalents all cash accounts which are not subject towithdrawal restrictions or penalties and time deposits with original maturitiesof 90 days or less.  The Company had nocash equivalents at June 30, 2002 and $60,000 at June 30, 2001.

 

Trust assets: Assets of the trust department, other than trust cash on deposit at theBank, are not included in these financial statements because they are notassets of the Bank.

Securities: Management determines the appropriate classification of securities atthe date individual securities are acquired and evaluates the appropriatenessof such classifications at each statement of financial condition date.

 

Securities available forsale are those debt securities that the Company intends to hold for anindefinite period of time, but not necessarily to maturity, and all equitysecurities.  Any decision to sell asecurity classified as available for sale would be based on various factors,including significant movements in interest rates, changes in the maturity mixof the Company’s assets and liabilities, liquidity needs, regulatory capitalconsiderations, and other similar factors. Securities available for sale are carried at fair value and unrealizedgains or losses are reported as increases or decreases in other comprehensiveincome, net of the related deferred tax effect.

 

Premiums and discounts onsecurities are amortized over the contractual lives of those securities, exceptfor mortgage-backed securities, for which prepayments are probable andpredictable, which are amortized over the estimated expected repayment terms ofthe underlying mortgages.  The method ofamortization results in a constant effective yield on those securities (theinterest method).  Interest on debtsecurities is recognized in income as accrued. Realized gains and losses on the sale of securities are determined usingthe specific identification method.

 

Loans held for sale: Loans receivable which the Bank may sell or intends to sell prior tomaturity are carried at the lower of net book value or fair value on anaggregate basis.  Such loans held forsale include loans receivable that management intends to use as part of itsasset/liability strategy, or that may be sold in response to changes ininterest rates, changes in prepayment risk or other similar factors.

 

Loans and leasesreceivable:  Loans receivable are stated at unpaidprincipal balances, less the allowance for loan losses, and net of deferredloan origination fees, costs and discounts.

 

Discounts and premiums onloans are amortized to income using the interest method over the remainingperiod to contractual maturity, adjusted for prepayments.

 

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.  Uncollectible interest onloans that are impaired or contractually past due is charged off based onmanagement’s periodic evaluation.  Thecharge to interest income is equal to all interest previously accrued, andincome is subsequently recognized only to the extent cash payments are receiveduntil, in management’s judgment, the borrower’s ability to make periodicinterest and principal payments is no longer in doubt, in which case the loanis returned to accrual status.

Loans and leasesreceivable (continued):  The Company’s leasesreceivable are classified as direct finance leases. Under the direct financingmethod of accounting for leases, the total net payments receivable under the leasecontracts and the residual value of the leased equipment, net of unearnedincome, are recorded as a net investment in direct financing leases and theunearned income is recognized each month on a basis which approximates theinterest method. Accrual of interest income is suspended when collection isdoubtful.

 

The allowance for loanand lease losses is established as losses are estimated to have occurredthrough a provision for loan losses charged to earnings.  Loan losses are charged against the allowancewhen management believes the uncollectibility of a loan balance isconfirmed.  Subsequent recoveries, ifany, are credited to the allowance.

 

The allowance for loanlosses is evaluated on a regular basis by management and is based uponmanagement’s periodic review of the collectibility of the loans in light ofhistorical experience, the nature and volume of the loan portfolio, adversesituations that may affect the borrower’s ability to repay, estimated value ofany underlying collateral and prevailing economic conditions.  This evaluation is inherently subjective asit requires estimates that are susceptible to significant revision as moreinformation becomes available.

 

A loan is consideredimpaired when, based on current information and events, it is probable that theCompany will be unable to collect the scheduled payments of principal orinterest when due according to the contractual terms of the loanagreement.  Factors considered bymanagement in determining impairment include payment status, collateral value,and the probability of collecting scheduled principal and interest paymentswhen due.  Loans that experienceinsignificant payment delays and payment shortfalls generally are notclassified as impaired.  Managementdetermines the significance of payment delays and payment shortfalls on acase-by-case basis, taking into consideration all of the circumstancessurrounding the loan and the borrower, including the length of the delay, thereasons for the delay, the borrower’s prior payment record, and the amount ofthe shortfall in relation to the principal and interest owed.  Impairment is measured on a loan by loanbasis for commercial and construction loans by either the present value ofexpected future cash flows discounted at the loan’s effective interest rate,the loan’s obtainable market price, or the fair value of the collateral if theloan is collateral dependent.

 

Large groups of smallerbalance homogeneous loans are collectively evaluated for impairment.  Accordingly, the Company does not separatelyidentify individual consumer and residential loans for impairment disclosures.

Loan origination fees andrelated discounts:  Loan fees and certain direct loanorigination costs are deferred, and the net fee or cost is recognized as anadjustment to interest income using the interest method over the contractuallife of the loans, adjusted for prepayments.

 

Commitment fees and costsrelating to commitments, the likelihood of exercise of which is remote, arerecognized over the commitment period on a straight-line basis.  If the commitment is subsequently exercisedduring the commitment period, the remaining unamortized commitment fee at thetime of exercise is recognized over the life of the loan as an adjustment ofyield.

 

Loan servicing: The cost allocated to mortgage servicing rights purchased or retainedhas been recognized as a separate asset and is being amortized in proportion toand over the period of estimated net servicing income.  Mortgage servicing rights are periodicallyevaluated for impairment based on the fair value of those rights.  Fair values are estimated using discountedcash flows based on current market rates of interest.  For purposes of measuring impairment, the rights are stratifiedby one or more predominant risk characteristics of the underlying loans.  The Bank stratifies its capitalized mortgageservicing rights based on the interest rate of the underlying loans.  The amount of impairment recognized is theamount, if any, by which the amortized cost of the rights for each stratumexceed their fair value.

 

Cost in excess of net assetsacquired (intangibles): Intangibles are the difference between purchase prices and the amountsassigned to the net assets acquired and accounted for under the purchase methodof accounting. Management reassesses the carrying value and remaining life ofintangible assets on an ongoing basis. Whenever events indicate that thecarrying values are impaired, the excess cost over fair value of those assetsis adjusted appropriately. As of June 30, 2002, management believes there is noimpairment with respect to these assets.

 

Foreclosed real estateand other properties:  Real estate and other properties acquiredthrough, or in lieu of, loan foreclosure are initially recorded at lower ofcost or fair value less estimated costs to sell at the date offoreclosure.  Costs relating toimprovement of property are capitalized, whereas costs relating to the holdingof property are expensed.  Valuationsare periodically performed by management, and charge-offs to operations aremade if the carrying value of a property exceeds its estimated fair value lessestimated costs to sell.

 

Land held for developmentis carried at the lower of cost, including cost of improvements and amenities incurred subsequent to acquisition,or fair value less cost to sell.  Costsrelating to the development and improvement of property are capitalized,whereas costs relating to holding property are expensed.  During fiscal year 2002, management’s intentwas changed from developing the property to selling the property, andaccordingly, at June 30, 2002, the property was reclassified as held for salewith no effect on the consolidated financial statements.  The carrying amount of land held for salewas $1,298 at June 30, 2002 and 2001.

Office properties andequipment:  Land is carried at cost.  All other office properties and equipmentare carried at cost, less accumulated depreciation and amortization.  Buildings and improvements and leaseholdimprovements are depreciated primarily on the straight-line method over theestimated useful lives of the assets which is five to fifty years.  Furniture, fixtures, equipment andautomobile are depreciated using both the straight-line and declining balancemethods over the estimated useful lives of the assets which is three to twelveyears.

 

Income taxes: Deferred taxes are provided on an asset and liability method wherebydeferred tax assets are recognized for deductible temporary differences andoperating loss and tax credit carryforwards and deferred tax liabilities arerecognized for taxable temporary differences. Temporary differences are the differences between the reported amountsof assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in theopinion of management, it is more likely than not that some portion or all ofthe deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects ofchanges in tax laws and rates on the date of enactment.

 

Earnings per share (EPS): Basic EPS represents income available to common stockholders divided bythe weighted-average number of common shares outstanding during theperiod.  Diluted EPS reflects additionalcommon shares that would have been outstanding if dilutive potential commonshares had been issued.

 

Segment reporting: Operating segments are defined ascomponents of an enterprise for which separate financial information isavailable that is evaluated regularly by the chief operating decision makers indeciding how to allocate resources and in assessing performance.  The primary reporting segment is the Bank.

 

Fair value of financialinstruments:  The following methods and assumptions wereused by the Company in estimating the fair value of its financial instruments:

 

Cash and cash equivalents: The carrying amounts reported in the statements of financial conditionfor cash and cash equivalents approximate their fair values.

 

Securities: Fair values for investment securities are based on quoted market prices,except for stock in the Federal Home Loan Bank for which fair value is assumedto equal cost.

 

Loans and leases: Approximately 50% of loans at both June 30, 2002 and 2001 arevariable-rate loans that reprice frequently and have no significant change incredit risk.  Fair values on these loansare based on carrying values.  The fairvalues for fixed-rate loans and leases are estimated using discounted cash flowanalyses, using interest rates currently being offered for loans and leaseswith similar terms to borrowers with similar credit quality or from quotedmarket prices of similar loans and leases sold, adjusted for differences inloan and lease characteristics.

Accrued interestreceivable:  The carrying value of accrued interestreceivable approximates its fair value.

 

Mortgage servicing rights: Fair values are estimated using discounted cash flows based on currentmarket rates of interest.

 

Off-statement-of-financial-conditioninstruments: Fairvalues for the Company’s off-statement-of-financial-condition instruments(unused lines of credit and letters of credit), which are based upon feescurrently charged to enter into similar agreements taking into account theremaining terms of the agreements and counterparties’ credit standing, are not significant.

 

Deposits: The fair values for deposits with no defined maturities equal theircarrying amounts which represent the amount payable on demand.  Fair values for fixed-rate certificates ofdeposit are estimated using a discounted cash flow calculation that appliesinterest rates currently being offered on certificates to a schedule ofaggregated expected monthly maturities on certificates of deposit.

 

Borrowed funds: The carrying amounts reported for variable rate advances approximatetheir fair values.  Fair values forfixed-rate advances and other borrowings are estimated using a discounted cashflow calculation that applies interest rates currently being offered onadvances and borrowings with corresponding maturity dates.

 

Preferred securities ofsubsidiary trust:  The carrying amount for Company obligatedmanditorily redeemable preferred securities of subsidiary trust that solelyholds subordinated debentures approximates fair value.

 

Accrued interest payableand advances by borrowers for taxes and insurance: The carrying values of accrued interest payable and advances byborrowers for taxes and insurance approximate their fair values.

 

Stock-based compensation: The Company accounts for stock-based compensation in accordance withAccounting Principles Board (APB) Opinion No. 25.

Recent accountingpronouncements:  In July 2001, the Financial AccountingStandards Board (FASB) issued two statements — Statement 141, *Business Combinations*, and Statement 142, *Goodwill and Other Intangible Assets*, whichwill impact the Company’s accounting for its reported goodwill.

 

Statement 141:

•       Eliminates the poolingmethod for accounting for business combinations.

•       Requires that intangibleassets that meet certain criteria be reported separately from goodwill.

•       Requires negative goodwillarising from a business combination to be recorded as an extraordinary gain.

 

Statement 142:

•       Eliminates theamortization of goodwill and other intangibles that are determined to have anindefinite life.

•       Requires, at a minimum,annual impairment tests for goodwill and other intangible assets that aredetermined to have an indefinite life.

•       Requires the carryingvalue of goodwill which exceeds its implied fair value to be recognized as animpairment loss.

 

Upon adoption of these Statements, theCompany is required to:

•       Evaluate its existingintangible assets and goodwill that were acquired in prior businesscombinations and to make any necessary reclassifications in order to conform tothe new criteria.

•       Reassess the useful livesof intangible assets and adjust the remaining amortization periods accordingly.

•       Recognize any remainingnegative goodwill as income.

 

The provisions of FASB Statement 141 apply toall business combinations initiated after June 30, 2001 and all businesscombinations accounted for by the purchase method for which the date ofacquisition is July 1, 2001, or later. The provisions of FASB Statement 142 were implemented by the Company inthe first quarter of its 2003 fiscal year. Upon initial adoption of FASB Statement 142, the Company will stopamortizing goodwill which will reduce amortization expense on current goodwillby approximately $391 in fiscal year 2003.

In August 2001, the FASB issued Statement144, *Accounting for the Impairment orDisposal of Long-Lived Assets.* This Statement addresses financial accounting and reporting for theimpairment or disposal of long-lived assets. This Statement supersedes FASB Statement No. 121, *Accounting for the Impairment of Long-Lived Assetsand for Long-Lived Assets to Be Disposed Of,* and the accounting andreporting provisions of APB Opinion No. 30, *Reportingthe Results of Operations — Reporting the Effects of Disposal of a Segment of aBusiness, and Extraordinary, Unusual and Infrequently Occurring Events andTransactions*, for the disposal of a segment of a business (aspreviously defined in that Opinion). The provisions of this Statement are effective for financial statementsissued for fiscal years beginning after December 15, 2001, and interim periodswithin those fiscal years, with early application encouraged.  The provisions of this Statement generallyare to be applied prospectively.  Duringfiscal year 2002, the Company adopted the provisions of Statement 144 to recorddiscontinued operations of the credit card portfolio.

 

In June 2002, the FASB issued Statement 146, *Accounting for Costs Associated with Exit or DisposalActivities*.  This Statementaddresses financial accounting and reporting for costs associated with exit ordisposal activities and nullifies Emerging Issues Task Force (EITF) Issue No.94-3, “Liability Recognition for Certain Employee Termination Benefits andOther Costs to Exit an Activity (including Certain Costs Incurred in aRestructuring).”  The provisions of thisStatement are effective for exit or disposal activities that are initiatedafter December 31, 2002.  The adoptionof Statement No. 146 is not expected to have a material effect on the financialposition or results of operations of the Company.

 

**Note 2.  Discontinued Operations**

In June 2002, managementcommitted to a plan to sell the subprime credit card operations through itssubsidiary, HF Card, which was previously reported in the credit card segmentof the Company.  HF Card ceased processingsubprime credit card applications in March 1999 and has been managing theportfolio from a balance of $18,062 at June 30, 1999, to the remaining balanceof $3,765 at June 30, 2002.  The Companyis negotiating the sale of the remaining receivables to a third party.  As of June 30, 2002, the Company had notentered into a definitive agreement for the sale of the remainingreceivables.  The Company estimated thenet realizable value based on estimates from a third party and reclassified thenet realizable value of $1,115 from loans receivable to loans held forsale.  The actual sale of thereceivables and liquidation of HF Card is expected to take place in the firsthalf of fiscal 2003.  Including thewrite down of the credit card portfolio to net realizable value of $1,115 andone-time closing costs of $108, the Company recorded a net loss fromdiscontinued operations of $1,686, net of tax benefit of $868, for the yearended June 30, 2002.  Amounts of revenue(including interest income on loans and noninterest income) and pretax profit(loss) reported in discontinued operations for the years ended June 30, 2002,2001, and 2000 were $2,413 and $(2,554); $3,848 and $18; and $8,457 and $(397),respectively.

**Note 3.  Acquisitions**

** **

During the year endedJune 30, 2001, HomeFirst Mortgage Corp. purchased 100% of the outstandingcapital stock of Mid America Capital Services, Inc., a finance leasing company,for net cash consideration of $2,857. Intangibles of $723 were recorded and are being amortized into expenseby the straight-line method over 10 years. This acquisition was accounted for under the purchase method ofaccounting.

 

Results of operations ofthe acquired entity since the date of acquisition are included in theconsolidated financial statements. Unaudited pro forma consolidated results ofcontinuing operations for the year ended June 30, 2001 as though the entity hadbeen acquired as of the beginning of the fiscal year prior to the acquisitionfollows (in thousands, except per share data):

 
|                         |   | **Year Ended  June 30,** |   |
|------------------------------|--------|--------------------------|--------|
|                         |   | **2001**                 |   | **2000** |   |
| Interest and dividend income |   | $                        | 59,382 |   | $ | 54,395 |   |
| Net income                   |   | 4,551                    |   | 5,071 |   |
| Earnings per share:          |   |                     |   |   |   |
| Basic                        |   | $                        | 1.24   |   | $ | 1.31 |   |
| Diluted                      |   | 1.22                     |   | 1.29 |   |

 

The unaudited pro formacombined summary of operations does not purport to be indicative of the resultswhich actually would have been obtained if the acquisition had been made at thebeginning of the fiscal year prior to the respective acquisition, or of thoseresults which may be obtained in the future. The unaudited pro forma combinedsummary of operations includes the effects of additional interest expense ondebt incurred in connection with the acquisition as if the debt had beenoutstanding since the beginning of the period presented.  In addition, the summary of operationsincludes amortization of the cost in excess of net assets of company acquiredin connection with the acquisition as if it had been acquired as of thebeginning of the periods presented.

 

During the years endedJune 30, 2001 and 2000, several smaller acquisitions were also made. During theyear ended June 30, 2001, the Bank acquired the assets and liabilities of abranch of a local commercial bank and received cash consideration of $2,218, asthe liabilities assumed exceeded the assets acquired. Intangibles of $330 wererecorded and are being amortized to expense by the straight-line method.  This acquisition was treated as a purchasefor accounting purposes, and the results of operations of the acquired branchsince the date of acquisition are included in the consolidated financialstatements.  In 2000, the Bank acquiredthe assets and liabilities of a branch of another local commercial bank, andreceived cash consideration of $775. Also in 2000, Hometown Insurors, Inc. paid $300 to acquire the customerbase of a local insurance agency, and an additional $150 was paid during 2001under contingency provisions of the purchase agreement.  These acquisitions were treated as purchasesfor accounting purposes, and the results of operations of the acquired entitiessince the dates of acquisition are included in the consolidated financialstatements.

**Note 4.  Investments in Securities**

** **

The amortized cost andfair values of investments in securities at June 30, 2002, all of which areclassified as available for sale according to management’s intent, are asfollows:

 
| ** **                                      | ** ** | **Amortized********Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized********(Losses)** | ** ** | **Fair Value** | ** ** |
|-------------------------------------------------|------------|---------------------------|------------|------------------------------|------------|---------------------------------------|------------|----------------|------------|
| Debt securities:                                |       |                      |       |                         |       |                                  |       |           |       |
| U.S. government agenciesand corporations        |       | $                         | 5,999      |                         | $          | 93                                    |       | $              | —     |   | $ | 6,092 |   |
| Federal Home Loan Bank                          |       | 8,200                     |       | 173                          |       | —                                |       | 8,373          |       |
| Municipal bonds                                 |       | 3,509                     |       | 81                           |       | (1                                    | )          | 3,589          |       |
| Corporate note                                  |       | 5,000                     |       | —                       |       | —                                |       | 5,000          |       |
|                                            |       | 22,708                    |       | 347                          |       | (1                                    | )          | 23,054         |       |
| Equity securities:                              |       |                      |       |                         |       |                                  |       |           |       |
| Stock in Federal Home LoanBank of Des Moines    |       | 6,332                     |       | —                       |       | —                                |       | 6,332          |       |
| FNMA common stock                               |       | 8                         |       | —                       |       | (1                                    | )          | 7              |       |
| Federal Agricultural Mortgage common stock |       | 7                         |       | 1                            |       | —                                |       | 8              |       |
|                                            |       | 6,347                     |       | 1                            |       | (1                                    | )          | 6,347          |       |
|                                            |       |                      |       |                         |       |                                  |       |           |       |
| Mortgage-backed securities:                     |       |                      |       |                         |       |                                  |       |           |       |
| GNMA                                            |       | 9,249                     |       | 392                          |       | —                                |       | 9,641          |       |
| REMIC                                           |       | 4,223                     |       | 79                           |       | —                                |       | 4,302          |       |
| FHLMC                                           |       | 15,031                    |       | 75                           |       | (28                                   | )          | 15,078         |       |
| FNMA                                            |       | 30,775                    |       | 42                           |       | (103                                  | )          | 30,714         |       |
|                                            |       | 59,278                    |       | 588                          |       | (131                                  | )          | 59,735         |       |
|                                            |       | $                         | 88,333     |                         | $          | 936                                   |       | $              | (133       | ) | $ | 89,136 |   |

 

The amortized cost and fair values of debtsecurities as of June 30, 2002, by contractual maturity, are shown below.  Expected maturities will differ fromcontractual maturities because the borrowers may have the right to call orprepay obligations with or without call or prepayment penalties.

 
| ** **                             | ** ** | **Amortized********Cost** | ** ** | **Fair Value** | ** ** |
|----------------------------------------|------------|---------------------------|------------|----------------|------------|
| Due in one year or less                |       | $                         | 4,830      |           | $          | 4,877 |   |
| Due after one year through five years  |       | 11,764                    |       | 12,018         |       |
| Due after five years through ten years |       | 999                       |       | 1,028          |       |
| Due after ten years                    |       | 5,115                     |       | 5,131          |       |
|                                   |       | 22,708                    |       | 23,054         |       |
| Mortgage-backed securities             |       | 59,278                    |       | 59,735         |       |
|                                   |       | $                         | 81,986     |           | $          | 82,789 |   |

 

Equity securities havealso been excluded from the maturity table above because they do not havecontractual maturities associated with debt securities.  The Bank, as a member of the Federal HomeLoan Bank system, is required to maintain an investment in capital stock of theFederal Home Loan Bank.  No ready marketexists for the stock, and it has no quoted market value.  For disclosure purposes, such stock isassumed to have a fair value which is equal to cost.

 

The components of othercomprehensive income (loss) — net change in unrealized gain (loss) onsecurities available for sale are as follows:

 
|                                                                                       |   | **Years  Ended June 30,** |   |
|--------------------------------------------------------------------------------------------|--------|---------------------------|--------|
|                                                                                       |   | **2002**                  |   | **2001** |   | **2000** |   |
| Unrealized holding gain (loss) arising during the year                                     |   | $                         | 393    |   | $ | 3,691 |   | $ | (1,088 | ) |
| Less reclassification adjustment for net gainsrealized in net income                       |   | (135                      | )      | — |   | (185 | ) |
| Net change in unrealized gain (loss)before income taxes                                    |   | 258                       |   | 3,691 |   | (1,273 | ) |
| Income (taxes) benefit                                                                     |   | (98                       | )      | (1,402 | ) | 558 |   |
| Other comprehensive income — net change in unrealized gain  (loss) on securities |   | $                         | 160    |   | $ | 2,289 |   | $ | (715 | ) |

 

Proceeds from the sale ofsecurities available for sale in 2002 were $14,831 and resulted in gross gainsof $170 and gross losses of $(35). There were no sales of securities in 2001, and accordingly, no realizedgains or losses.  Proceeds from the saleof securities during 2000 were $5,386 and resulted in gross gains of $201 andgross losses of $(16).

At June 30, 2002 and2001, securities with a fair value of $74,200 and $84,397, respectively, werepledged as collateral for public deposits and other purposes.

 

The amortized costand fair values of investments in securities at June 30, 2001, all of which areclassified as available for sale according to management’s intent, are asfollows:

 
| ** **                                     | ** ** | **Amortized  Cost** | ** ** | **Gross********Unrealized********Gains** | ** ** | **Gross********Unrealized********(Losses)** | ** ** | **Fair Value** | ** ** |
|------------------------------------------------|------------|---------------------|------------|------------------------------------------|------------|---------------------------------------------|------------|----------------|------------|
| Debt securities:                               |       |                |       |                                     |       |                                        |       |           |       |
| U.S. government agenciesand corporations       |       | $                   | 18,236     |                                     | $          | 98                                          |       | $              | (44        | ) | $ | 18,290 |   |
| Federal Home Loan Bank                         |       | 21,708              |       | 167                                      |       | (3                                          | )          | 21,872         |       |
| Municipal bonds                                |       | 3,400               |       | 58                                       |       | (1                                          | )          | 3,457          |       |
|                                           |       | 43,344              |       | 323                                      |       | (48                                         | )          | 43,619         |       |
| Equity securities:                             |       |                |       |                                     |       |                                        |       |           |       |
| Stock in Federal Home LoanBank of Des Moines   |       | 6,332               |       | —                                   |       | —                                      |       | 6,332          |       |
| FNMA common stock                              |       | 8                   |       | —                                   |       | —                                      |       | 8              |       |
| Federal Agricultural Mortgagecommon stock      |       | 7                   |       | 3                                        |       | —                                      |       | 10             |       |
|                                           |       | 6,347               |       | 3                                        |       | —                                      |       | 6,350          |       |
|                                           |       |                |       |                                     |       |                                        |       |           |       |
| Mortgage-backed securities:                    |       |                |       |                                     |       |                                        |       |           |       |
| GNMA                                           |       | 26,485              |       | 391                                      |       | (191                                        | )          | 26,685         |       |
| REMIC                                          |       | 3,367               |       | —                                   |       | (42                                         | )          | 3,325          |       |
| FHLMC                                          |       | 9,545               |       | 113                                      |       | (42                                         | )          | 9,616          |       |
| FNMA                                           |       | 3,328               |       | 34                                       |       | —                                      |       | 3,362          |       |
| Other triple A rated mortgage-backedsecurities |       | 758                 |       | 4                                        |       | —                                      |       | 762            |       |
|                                           |       | 43,483              |       | 542                                      |       | (275                                        | )          | 43,750         |       |
|                                           |       | $                   | 93,174     |                                     | $          | 868                                         |       | $              | (323       | ) | $ | 93,719 |   |

 

**Note5.  Loans and Leases Receivable**

** **

Loans and leases receivable at June 30, 2002and 2001 consist of the following:

 
|                                                        |   | **2002** |    | **2001** |   |
|-------------------------------------------------------------|--------|----------|---------|----------|--------|
| Loans secured by real estate:                               |   |     |    |     |   |
| Residential:                                                |   |     |    |     |   |
| One-to-four family                                          |   | $        | 73,630  |     | $      | 117,681 |   |
| Multi-family                                                |   | 56,952   |    | 44,378   |   |
| Commercial                                                  |   | 89,111   |    | 73,720   |   |
| Agriculture                                                 |   | 12,722   |    | 12,753   |   |
| Construction and development                                |   | 12,738   |    | 28,419   |   |
| Business, consumer and other:                               |   |     |    |     |   |
| Automobile                                                  |   | 84,782   |    | 78,082   |   |
| Commercial business                                         |   | 95,462   |    | 97,362   |   |
| Equipment financing leases                                  |   | 22,834   |    | 10,509   |   |
| Junior liens on mortgages                                   |   | 73,680   |    | 61,397   |   |
| Agriculture                                                 |   | 26,707   |    | 20,370   |   |
| Credit card                                                 |   | —   |    | 6,088    |   |
| Mobile home                                                 |   | 2,365    |    | 3,920    |   |
| Education                                                   |   | 7,340    |    | 6,831    |   |
| Loans on savings accounts                                   |   | 1,597    |    | 1,917    |   |
| Other loans                                                 |   | 8,529    |    | 10,939   |   |
|                                                        |   | 568,449  |    | 574,366  |   |
| Less:                                                       |   |     |    |     |   |
| Undisbursed portion of loans in process                     |   | 4,678    |    | 3,853    |   |
| Deferred loan fees and unearned discounts and premiums, net |   | (504     | )       | 133      |   |
| Allowance for loan and lease losses                         |   | 4,461    |    | 6,544    |   |
|                                                        |   | $        | 559,814 |     | $      | 563,836 |   |

 

Loans held forsale totaling $6,559 at June 30, 2002 consist of one-to-four family fixed-rateloans and credit card loans (Note 2). At June 30, 2001, loans held for sale totaling $7,270 consisted ofone-to-four family fixed-rate loans.

 

Activity in the allowancefor loan and lease losses included in continuing operations is summarized asfollows for the years ended June 30:

 
|                                                                                              |   | **2002** |   | **2001** |   | **2000** |   |
|---------------------------------------------------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Balance, beginning                                                                                |   | $        | 6,544  |     | $      | 8,475    |   | $ | 11,991 |   |
| Provision charged to income                                                                       |   | 1,905    |   | 1,482    |   | 1,682    |   |
| Allowance related to assets acquired, net                                                         |   | —   |   | 97       |   | —   |   |
| Reclassification of allowance for loan losses directly against  credit card loans receivable |   | (577     | )      | —   |   | —   |   |
| Charge offs related to discontinued creditcard loan operations, net                               |   | (458     | )      | (1,941   | )      | (4,497   | )      |
| Other charge offs                                                                                 |   | (3,407   | )      | (1,923   | )      | (1,040   | )      |
| Recoveries                                                                                        |   | 454      |   | 354      |   | 339      |   |
| Balance, ending                                                                                   |   | $        | 4,461  |     | $      | 6,544    |   | $ | 8,475 |   |

 

The following is asummary of information pertaining to impaired loans:

 
|                                          |   | **June 30,**             |   |
|-----------------------------------------------|--------|--------------------------|--------|
|                                          |   | **2002**                 |   | **2001** |   | **2000** |   |
| Impaired loans without a valuation allowance  |   | $                        | — |   | $ | — |   | $ | — |   |
| Impaired loans with a valuation allowance     |   | 3,977                    |   | 3,028 |   | 98 |   |
| Total impaired loans                          |   | $                        | 3,977  |   | $ | 3,028 |   | $ | 98 |   |
|                                          |   |                     |   |   |   |   |   |
| Valuation allowance related to impaired loans |   | $                        | 980    |   | $ | 1,501 |   | $ | 25 |   |
|                                          |   |                     |   |   |   |   |   |
|                                          |   | **Years Ended June 30,** |   |
|                                          |   | **2002**                 |   | **2001** |   | **2000** |   |
| Average investment in impaired loans          |   | $                        | 2,662  |   | $ | 1,614 |   | $ | 146 |   |
|                                          |   |                     |   |   |   |   |   |
| Interest income recognized on impaired loans  |   | $                        | 42     |   | $ | 38 |   | $ | 6 |   |

 

No additionalfunds are committed to be advanced in connection with impaired loans.

**Note 6.  Loan Servicing**

Mortgage loansserviced for others (primarily the South Dakota Housing Development Authority)are not included in the accompanying consolidated statements of financialcondition.  The unpaid principalbalances of mortgage loans serviced for others was $520,250 and $493,657 atJune 30, 2002 and 2001, respectively.

 

Custodial balancesmaintained in connection with the foregoing loan servicing, and included indeposits and advances by borrowers for taxes and insurance, were approximately$2,017 and $1,946 at June 30, 2002 and 2001, respectively.

 

The carryingvalues of mortgage servicing rights were $3,467 and $2,775 at June 30, 2002 and2001, respectively.  The fair values ofthese rights were $5,275 and $5,346 at June 30, 2002 and 2001, respectively.  The fair values of the mortgage servicingrights were estimated as the present value of the expected future cash flowsusing a discount rate of 10% and 15% as of June 30, 2002 and 2001,respectively.  The Company recognizedexpense for amortization of the cost of mortgage servicing rights in the amountof $347, $272 and $297 for the years ended June 30, 2002, 2001 and 2000,respectively.

 

No valuationallowances were provided for mortgage servicing rights capitalized during theyears ended June 30, 2002 and 2001.

 

**Note 7.  Office Properties and Equipment**

Office propertiesand equipment at June 30, 2002 and 2001 consist of the following:

 
|                                           |   | **2002** |   | **2001** |   |
|------------------------------------------------|--------|----------|--------|----------|--------|
| Land                                           |   | $        | 1,958  |     | $      | 1,959 |   |
| Buildings and improvements                     |   | 16,133   |   | 16,051   |   |
| Leasehold improvements                         |   | 1,416    |   | 947      |   |
| Furniture, fixtures, equipment and automobile  |   | 11,411   |   | 10,742   |   |
|                                           |   | 30,918   |   | 29,699   |   |
| Less accumulated depreciation and amortization |   | (17,204  | )      | (15,943  | )      |
|                                           |   | $        | 13,714 |     | $      | 13,756 |   |

 

In addition, theBank leases several branch facilities under operating lease agreements whichrequire minimum rentals totaling $1,246 through the year ending June 30, 2006.

**Note8.  Deposits**

** **

Deposits at June30, 2002 and 2001 consist of the following:

 
|                                  |   | **2002** |    | **2001** |   |
|---------------------------------------|--------|----------|---------|----------|--------|
| Noninterest bearing checking accounts |   | $        | 61,355  |     | $      | 55,003 |   |
| Interest bearing accounts             |   | 41,669   |    | 33,165   |   |
| Money market accounts                 |   | 157,770  |    | 139,467  |   |
| Savings accounts                      |   | 50,387   |    | 49,852   |   |
| Certificates of deposit               |   | 251,415  |    | 323,720  |   |
|                                  |   | $        | 562,596 |     | $      | 601,207 |   |

 

Scheduledmaturities of certificates of deposit are as follows:

 
| Maturing in fiscal year: |   |   |    |
|--------------------------|--------|--------|---------|
| 2003                     |   | $      | 156,773 |   |
| 2004                     |   | 53,810 |    |
| 2005                     |   | 28,908 |    |
| 2006                     |   | 4,696  |    |
| 2007                     |   | 7,098  |    |
| Thereafter               |   | 130    |    |
|                     |   | $      | 251,415 |   |

 

Deposit accounts are insured up to $100 bythe Savings Association Insurance Fund (SAIF) under management of the FederalDeposit Insurance Corporation (FDIC). The aggregate amount of jumbo certificates of deposit with a minimumdenomination of $100 was approximately $46,905 and $64,391 at June 30, 2002 and2001, respectively.  Deposits at June30, 2002 and 2001 include $37,390 and $37,079, respectively, of deposits fromone local governmental entity, the majority of which are savings accounts.

**Note9.  Advances From Federal Home Loan Bankand Other Borrowings**

** **

Advances from theFederal Home Loan Bank of Des Moines at June 30, 2002 and 2001 are summarizedas follows:

 
|                                                       |   | **2002** |   | **2001** |   |
|------------------------------------------------------------|--------|----------|--------|----------|--------|
| Fixed-rate advances (with rates ranging from 4.5% to 6.6%) |   | $        | 67,434 |     | $      | 100,714 |   |
| Variable-rate advance (with a rate of 2.09%)               |   | 16,000   |   | —   |   |
|                                                       |   | $        | 83,434 |     | $      | 100,714 |   |

 

Aggregatematurities of advances, computed based on call date, are as follows:  2003 $47,936; 2004 $13,462; 2005 $11,090;2006 $1,070; 2007 $1,048; and thereafter $8,828.  Prepayment of the callable advances results in a prepayment feeas negotiated between the Bank and the Federal Home Loan Bank.

 

Advances aresecured by stock in the Federal Home Loan Bank of Des Moines, one-to-fourfamily first mortgage loans with balances exceeding 120% of the amount of therelated advances and multi-family first mortgage loans with balances exceeding140% of the amount of the related advances. In order to provide additional borrowing collateral, commercial realestate first mortgage loans with balances exceeding 175% of the amount of therelated advances have also been pledged at the Federal Home Loan Bank.  In addition, home equity line of creditloans and home equity second mortgages (with balances exceeding 200% and 175%of the amount of related advances, respectively) have been pledged to provideborrowing collateral.

 

The Bank had a$20,000 letter of credit from the Federal Home Loan Bank of Des Moines, onwhich nothing was drawn at June 30, 2002 and expired on July 5, 2002.

 

Other borrowingsconsist of the following at  June 30,2002 and 2001:

 

The Company has acontract for deed which requires monthly payments of $9, plus interest at 7.0%,to October 2013.  The contract for deed,which is secured by land held for sale with a carrying value of $1,298, had abalance of $874 and $922 at June 30, 2002 and 2001, respectively.  Aggregate maturities of the contract for deedare as follows:  2003 $53;  2004 $56; 2005 $60; 2006 $65; 2007 $69 andthereafter $571.

In August 2000, theCompany entered into a $3,000 revolving note agreement with an unrelated bank,which had a balance of $0 and $3,000 outstanding at June 30, 2002 and 2001,respectively, and matured in August 2001.

 

Mid AmericaCapital Services, Inc. had a $4,000 line of credit with an unrelated bank,which had a balance of $0 and $3,000 at June 30, 2002 and 2001, respectively,and matured in September 2001.  Mid AmericaCapital Services, Inc. also had notes outstanding to its former stockholderstotaling $0 and $740 at June 30, 2002 and 2001, respectively.

 

**Note 10.  Company Obligated Manditorily RedeemablePreferred Securities of Subsidiary Trust That Solely Holds SubordinatedDebentures**

On November 28,2001, the Company issued 10,000 shares totaling $10.0 million of CompanyObligated Mandatorily Redeemable Preferred Securities of HF Financial CapitalTrust I.  The Trust 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 theTrust.  The securities provide forcumulative cash distributions calculated at a rate based on six-month LIBORplus 3.75% adjusted semi-annually.  TheCompany may, at one or more times, defer interest payments on the capitalsecurities for up to 10 consecutive semi-annual periods, but not beyondDecember 8, 2031.  At the end of thedeferral period, all accumulated and unpaid distributions will be paid.  The capital securities will be redeemed onDecember 8, 2031; however, the Company has the option to shorten the maturitydate to a date not earlier than December 8, 2006.  The capital securities have no voting rights, are unsecured, andrank junior in priority of the payment to all of the Company’s indebtedness andsenior to the Company’s capital stock. Proceeds from trust preferred securities can be injected into the Bankand qualify as Tier I capital for regulatory capital purposes.

 

**Note 11.  Income Tax Matters**

The Company andsubsidiaries file a consolidated federal income tax return on a fiscal yearbasis.  The Bank is allowed bad debtdeductions based on actual charge-offs. In addition, the Trust files a trust return on a calendar year basis.

 

The consolidatedprovision for income taxes from continuing operations consists of the followingfor the years ended June 30:

 
|             |   | **2002** |   | **2001** |   | **2000** |   |
|------------------|--------|----------|--------|----------|--------|----------|--------|
| Current:         |   |     |   |     |   |     |   |
| Federal          |   | $        | 2,039  |     | $      | 1,912    |   | $ | 1,467 |   |
| State            |   | 383      |   | 372      |   | 193      |   |
| Deferred expense |   | 434      |   | 645      |   | 1,417    |   |
|             |   | $        | 2,856  |     | $      | 2,929    |   | $ | 3,077 |   |

 

Income tax expense isdifferent from that calculated at the statutory federal income tax rate topretax income from continuing operations. The reasons for this difference in the tax expense are as follows:

 
|                                               |   | **2002** |   | **2001** |   | **2000** |   |
|----------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Computed "expected" tax expense          |   | $        | 2,704  |     | $      | 2,633    |   | $ | 3,012 |   |
| Increase (decrease) in income taxesresulting from: |   |     |   |     |   |     |   |
| Tax exempt interest income                         |   | (79      | )      | (99      | )      | (82      | )      |
| State taxes, net of federal benefit                |   | 262      |   | 221      |   | 231      |   |
| Benefit of income taxed at lower rates             |   | (75      | )      | (73      | )      | (82      | )      |
| Amortization of intangible assets                  |   | 148      |   | 116      |   | 126      |   |
| Change in valuation allowance                      |   | 38       |   | —   |   | (195     | )      |
| Other, net                                         |   | (142     | )      | 131      |   | 67       |   |
|                                               |   | $        | 2,856  |     | $      | 2,929    |   | $ | 3,077 |   |

 

The components ofthe net deferred tax asset as of June 30, 2002 and 2001 are as follows:

 
|                                                 |   | **2002** |   | **2001** |   |
|------------------------------------------------------|--------|----------|--------|----------|--------|
| Deferred tax assets:                                 |   |     |   |     |   |
| Allowance for loan and leases losses                 |   | $        | 1,425  |     | $      | 2,183 |   |
| Deferred loan fees                                   |   | 73       |   | 105      |   |
| Discounts on loans from acquired associations        |   | 43       |   | 58       |   |
| Accrued expenses                                     |   | 387      |   | 196      |   |
| Net unrecognized pension costs                       |   | 432      |   | —   |   |
| Discontinued operations                              |   | 920      |   | —   |   |
| Other                                                |   | 186      |   | 206      |   |
|                                                 |   | 3,466    |   | 2,748    |   |
| Less valuation allowance                             |   | (82      | )      | (44      | )      |
|                                                 |   | 3,384    |   | 2,704    |   |
|                                                 |   |     |   |     |   |
| Deferred tax liabilities:                            |   |     |   |     |   |
| Net unrealized gain on securities available for sale |   | 305      |   | 207      |   |
| FHLB stock dividends                                 |   | 148      |   | 148      |   |
| Mortgage servicing rights                            |   | 100      |   | —   |   |
| Other                                                |   | —   |   | 119      |   |
|                                                 |   | 553      |   | 474      |   |
|                                                 |   | $        | 2,831  |     | $      | 2,230 |   |

 

Retained earnings at June30, 2002 and 2001, include approximately $4,805 related to the pre-1987allowance for loan losses for which no deferred federal income tax liabilityhas been recognized.  These amountsrepresent an allocation of income to bad debt deductions for tax purposesonly.  If the Bank no longer qualifiesas a bank, or in the event of a liquidation of the Bank, income would becreated for tax purposes only, which would be subject to the then currentcorporate income tax rate.  Theunrecorded deferred income tax liability on the above amount for financialstatement purposes was approximately $1,634 at June 30, 2002 and 2001.

 

**Note 12.  Regulatory Capital**

The Bank issubject to various regulatory capital requirements administered by federalbanking agencies.  Failure to meetminimum capital requirements can initiate certain mandatory — and possibly additional discretionary — actions by regulators that, ifundertaken, could have a direct material effect on the Bank’s financialstatements.  Under capital adequacyguidelines and the regulatory framework for prompt corrective action, the Bankmust meet specific capital guidelines that involve quantitative measures of theBank’s assets, liabilities, and certain off-balance-sheet items as calculatedunder regulatory accounting practices. The Bank’s capital amounts and classification are also subject toqualitative judgments by the regulators about components, risk weightings, andother factors.

 

Quantitativemeasures established by regulation to ensure capital adequacy require the Bankto maintain minimum amounts and ratios (set forth in the following table) oftotal and Tier I capital (as defined in the regulations) to risk-weightedassets (as defined), and of Tier I capital (as defined) to adjusted totalassets (as defined).  Managementbelieves, as of June 30, 2002 and 2001, that the Bank meets all capitaladequacy requirements to which it is subject.

 

As of June 30,2002, the most recent notification from the Office of Thrift Supervision (OTS)categorized the Bank as “adequately capitalized” under the regulatory frameworkfor prompt corrective action.  To becategorized as adequately capitalized, the Bank must maintain minimum totalrisk-based, Tier I risk-based, and Tier I (core) capital ratios as set forth inthe table.  There are no conditions orevents since that notification that management believes have unfavorablychanged the Bank’s category.

The following tablesummarizes the Bank’s compliance with its regulatory capital requirements atJune 30, 2002 and 2001:

 
| ** **                                              | ** ** | **Actual** | ** ** | **Minimum  Capital********Requirement** | ** ** | **To Be  Adequately********Capitalized  Under********Prompt  Corrective********Action  Provisions** | ** ** |
|---------------------------------------------------------|------------|------------|------------|-----------------------------------------|------------|-----------------------------------------------------------------------------------------------------|------------|
|                                                    |       | **Amount** |       | **Percent**                             |       | **Amount**                                                                                          |       | **Percent** |   | **Amount** |   | **Percent** |   |
| As of June 30, 2002:                                    |       |       |       |                                    |       |                                                                                                |       |   |   |   |   |   |   |
| Tier I (core) capital (toadjusted total assets)         |       | $          | 53,284     |                                    | 7.44       | %                                                                                                   | $          | 28,656 |   | 4.00 | % | $ | 28,656 |   | 4.00 | % |
| Total risk-based capital (to risk-weighted assets) |       | 57,745     |       | 10.04                                   |       | 46,023                                                                                              |       | 8.00 |   | 46,023 |   | 8.00 |   |
| Tangible capital (totangible assets)                    |       | 53,284     |       | 7.44                                    |       | 10,746                                                                                              |       | 1.50 |   | N/A |   | N/A |   |
| Tier 1 (core) capital(to risk-weighted assets)          |       | 53,284     |       | 9.26                                    |       | N/A                                                                                                 |       | N/A |   | 23,011 |   | 4.00 |   |
|                                                    |       |       |       |                                    |       |                                                                                                |       |   |   |   |   |   |   |
| As of June 30, 2001:                                    |       |       |       |                                    |       |                                                                                                |       |   |   |   |   |   |   |
| Tier I (core) capital (toadjusted total assets)         |       | $          | 45,891     |                                    | 5.96       | %                                                                                                   | $          | 30,784 |   | 4.00 | % | $ | 30,784 |   | 4.00 | % |
| Total risk-based capital (torisk-weighted assets)       |       | 52,319     |       | 9.93                                    |       | 42,156                                                                                              |       | 8.00 |   | 42,156 |   | 8.00 |   |
| Tangible capital (totangible assets)                    |       | 45,891     |       | 5.96                                    |       | 11,544                                                                                              |       | 1.50 |   | N/A |   | N/A |   |
| Tier 1 (core) capital(to risk-weighted assets)          |       | 45,891     |       | 8.71                                    |       | N/A                                                                                                 |       | N/A |   | 21,078 |   | 4.00 |   |

 

**Note13.  Stockholders’ Equity**

** **

The Companycurrently has in effect a stock buy back program in which up to 10% of thecommon stock of the Company outstanding on May 1, 2002 may be acquired throughApril 30, 2003.  A total of 113,800shares of common stock have been purchased pursuant to this current program andthe previous program in effect during fiscal year 2002.  Pursuant to a series of stock buy backprograms initiated by the Company since 1996, the Company has purchased anaggregate of 1,559,030 shares of common stock through June 30, 2002.  Included in the aggregate is a block of340,021 shares of common stock repurchased in a private transaction on February13, 2002.

 

The Company hasauthorized 50,000 shares of Preferred Stock, designated as “Series A JuniorParticipating Preferred Stock” with a stated value of $1.00 per share.  Outstanding shares of the Junior PreferredStock are entitled to cumulative dividends. Such shares have voting rights of 100 votes per share and a preferencein liquidation.  The shares are notredeemable after issuance.

 

The Company alsohas preferred share purchase rights (Rights). Each Right entitles theregistered holder to purchase from the Company one one-hundredth of a share ofSeries A Junior Participating Preferred Stock at a price of $65 perone-hundredth of a preferred share, subject to the complete terms as stated inthe Rights Agreement.  The Rights becomeexercisable immediately after the earlier of (i) ten business days following apublic announcement that a person or group has acquired beneficial ownership of20% or more of the outstanding common shares of the Company (subject to certainexclusions), (ii) ten business days following the commencement or announcementof an intention to make a tender offer or exchange offer, the consummation ofwhich would result in the beneficial ownership by a person or group of 20% ormore of such outstanding common shares. The Rights expire on October 22, 2006, which date may be extendedsubject to certain additional conditions.

 

Under currentregulations, the Bank is not permitted to pay dividends on its stock if itsregulatory capital would reduce below (i) the amount required for the liquidationaccount established to provide a limited priority claim to the assets of theBank to qualifying depositors (Eligible Account Holders) at March 31, 1992 whocontinue to maintain deposits at the Bank after its conversion from a federalmutual savings and loan association to a federal stock savings bank pursuant toits Plan of Conversion adopted August 21, 1991, or (ii) the Bank’s regulatorycapital requirements.  Capitaldistributions are limited to the greater of 100% of net income for the year to dateplus 50% of the amount by which the lesser of the institution’s tangible, coreor risk-based capital exceeds its capital requirement for such capitalcommitment, as measured at the beginning of the calendar year or up to 75% ofnet income over the most recent four quarter period.  On August 14, 2002, the Bank sent written notification to the OTSof its intention to pay up to 50% of the Bank’s net income for each quarter inthe year ending June 30, 2003, to the Company.

**Note14.  Earnings Per Share**

** **

A reconciliationof the income and common stock share amounts used in the calculation of basicand diluted earnings per share (EPS) for the fiscal years ended June 30, 2002,2001 and 2000 follow.

 
|                                                                                                     |   | **2002**  |   | **2001**  |   | **2000**  |   |
|----------------------------------------------------------------------------------------------------------|--------|-----------|--------|-----------|--------|-----------|--------|
| Earnings:                                                                                                |   |      |   |      |   |      |   |
| Income from continuing operations                                                                        |   | $         | 4,871  |      | $      | 4,595     |   | $ | 5,529 |   |
| Discontinued operations, net of tax                                                                      |   | (1,686    | )      | 12        |   | (262      | )      |
| Net income                                                                                               |   | $         | 3,185  |      | $      | 4,607     |   | $ | 5,267 |   |
|                                                                                                     |   |      |   |      |   |      |   |
| Basic EPS:                                                                                               |   |      |   |      |   |      |   |
| Weighted average number of commonshares outstanding                                                      |   | 3,512,879 |   | 3,680,796 |   | 3,861,633 |   |
|                                                                                                     |   |      |   |      |   |      |   |
| Earnings per common share:                                                                               |   |      |   |      |   |      |   |
| Income from continuing operations                                                                        |   | $         | 1.39   |      | $      | 1.25      |   | $ | 1.43 |   |
| Discontinued operations, net of tax                                                                      |   | (0.48     | )      | —    |   | (0.07     | )      |
| Net income                                                                                               |   | $         | 0.91   |      | $      | 1.25      |   | $ | 1.36 |   |
|                                                                                                     |   |      |   |      |   |      |   |
| Diluted EPS:                                                                                             |   |      |   |      |   |      |   |
| Weighted average number of common shares outstanding                                                |   | 3,512,879 |   | 3,680,796 |   | 3,861,633 |   |
| Common share equivalents — stock options and stock issuable  under employee compensation plans |   | 67,914    |   | 56,817    |   | 57,986    |   |
| Weighted average number of commonshares and common share equivalents                                     |   | 3,580,793 |   | 3,737,613 |   | 3,919,619 |   |
|                                                                                                     |   |      |   |      |   |      |   |
| Earnings per common share:                                                                               |   |      |   |      |   |      |   |
| Income from continuing operations                                                                        |   | $         | 1.36   |      | $      | 1.23      |   | $ | 1.41 |   |
| Discontinued operations, net of tax                                                                      |   | (0.47     | )      | —    |   | (0.07     | )      |
| Net income                                                                                               |   | $         | 0.89   |      | $      | 1.23      |   | $ | 1.34 |   |

 

Options outstanding of approximately 180,000and 142,000 shares of common stock at weighted average share prices of $14.44and $14.46 during the years ended June 30, 2002 and 2001, respectively, werenot included in the computation of diluted earnings per share because theexercise prices of those instruments exceeded the average market prices of thecommon shares during the years.

**Note15.  Defined Benefit Plan**

** **

The Company has anoncontributory (cash balance) defined benefit pension plan covering allemployees of the Company and its wholly-owned subsidiaries who have attainedthe age of twenty-one and have completed one year of service.  The benefits are based on 6% of eacheligible participant’s annual compensation, plus income earned in the accountsat a rate determined annually based on 30-year treasury note rates.  The Company’s funding policy is to make theminimum annual required contribution plus such amounts as the Company maydetermine to be appropriate from time to time. One hundred percent vesting occurs after five years, and retirement atage 65.

 

Informationrelative to the Company’s defined benefit plan is presented below:

 
|                                   |   | **2002** |   | **2001** |   |
|----------------------------------------|--------|----------|--------|----------|--------|
| Changes in benefit obligations:        |   |     |   |     |   |
| Benefit obligations, beginning         |   | $        | 3,203  |     | $      | 2,792 |   |
| Service cost                           |   | 581      |   | 480      |   |
| Interest cost                          |   | 229      |   | 202      |   |
| Benefits paid                          |   | (189     | )      | (547     | )      |
| Actuarial loss (gain)                  |   | (111     | )      | 276      |   |
| Benefit obligations, ending            |   | $        | 3,713  |     | $      | 3,203 |   |
|                                   |   |     |   |     |   |
| Changes in plan assets:                |   |     |   |     |   |
| Fair value of plan assets, beginning   |   | $        | 2,411  |     | $      | 2,947 |   |
| Actual return on plan assets           |   | (229     | )      | (264     | )      |
| Company contributions                  |   | 423      |   | 275      |   |
| Benefits paid                          |   | (189     | )      | (547     | )      |
| Fair value of plan assets, ending      |   | $        | 2,416  |     | $      | 2,411 |   |
|                                   |   |     |   |     |   |
| Funded status at end of year:          |   |     |   |     |   |
| Plan assets (deficient) of obligations |   | $        | (1,297 | )        | $      | (792 | ) |
| Unrecognized losses                    |   | 1,427    |   | 1,193    |   |
| Unrecognized prior service (benefit)   |   | (90      | )      | (136     | )      |
| Unrecognized transition obligation     |   | 47       |   | 58       |   |
| Prepaid asset at end of year           |   | $        | 87     |     | $      | 323 |   |

 

The components of pensioncost for the years ended June 30 consist of the following:

 
|                                  |   | **2002** |   | **2001** |   | **2000** |   |
|---------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Service cost                          |   | $        | 581    |     | $      | 480      |   | $ | 344 |   |
| Interest cost                         |   | 229      |   | 202      |   | 166      |   |
| Expected return on plan assets        |   | (198     | )      | (240     | )      | (198     | )      |
| Amortization of prior losses          |   | —   |   | 12       |   | 29       |   |
| Amortization of prior service cost    |   | (46      | )      | (46      | )      | (46      | )      |
| Recognized net actuarial losses       |   | 82       |   | —   |   | (70      | )      |
| Amortization of transition obligation |   | 11       |   | 12       |   | 12       |   |
| Total costs recognized in expense     |   | $        | 659    |     | $      | 420      |   | $ | 237 |   |

 

The components inthe balance sheet consist of:

 
|                                                 |   | **2002** |   | **2001** |   |
|------------------------------------------------------|--------|----------|--------|----------|--------|
| Prepaid benefit cost                                 |   | $        | 87     |     | $      | 323 |   |
| Accrued benefit liability                            |   | (1,093   | )      | —   |   |
| Intangible asset                                     |   | (43      | )      | —   |   |
| Accumulated other comprehensive loss                 |   | 1,136    |   | —   |   |
| Net asset recorded in the consolidated balance sheet |   | $        | 87     |     | $      | 323 |   |

 

Theweighted-average post-retirement and pre-retirement discount rates used indetermining the actuarial present value of the benefit obligations were 5.45%and 7.50% for fiscal year 2002 and 6.23% and 7.50% for fiscal year 2001,respectively.  The rate of increase infuture compensation levels used to determine the actuarial present value of thebenefit obligations was 5.5% for both fiscal years 2002 and 2001.  The expected long-term rate of return onplan assets was 8.0% for both fiscal years 2002 and 2001.

**Note16.  Retirement Plan**

** **

The Company had anemployee stock ownership plan (ESOP) covering all full-time employees of theCompany who have attained age 21 and completed one year of service during whichthey worked at least 1,000 hours.  TheESOP included an employee savings plan feature which provided for voluntarycontributions by eligible employees on a tax-deferred basis with no matchingcontribution by the Company.  All sharesowned by the ESOP are included in earnings per share computations, with sharesbeing allocated to eligible employees as the corresponding ESOP debt wasrepaid.  At June 30, 2002, the ESOPholds 246,084 shares, all of which have been allocated to eligible employees.

 

For financialstatement purposes, expense for the ESOP is determined on the percentage ofshares allocated to participants each period (allocations are based onprincipal and interest payments) times the original amount of the debt plus theinterest incurred.

 

During fiscal year2001, the final payment for the ESOP was made. Effective July 1, 2001, the ESOPwas amended and restated, and renamed the HF Financial Corp. Retirement SavingsPlan. The amended plan is intended to be a qualified profit sharing plan with acash or deferred arrangement pursuant to Code Section 401(k) and regulationsissued thereunder. Participation and eligibility requirements are similar tothe previous plan. The amended plan continues to allow voluntary contributionsby eligible employees, and also allows discretionary contributions by theCompany, as determined annually by the Board of Directors.  The total compensation cost charged toexpense related to the retirement plans mentioned above was $216, $113 and $113for 2002, 2001 and 2000, respectively.

**Note17.  Stock-Based Compensation Plans**

** **

The Company hasstock-based compensation plans which are described below.  The Company applies APB Opinion No. 25 andrelated interpretations in accounting for its plans.  Accordingly, no compensation cost has been recognized for grantsunder the fixed stock option plans.  Hadcompensation cost for the Company’s stock-based compensation plans beendetermined based on the grant date fair values of awards (the method describedin FASB Statement No. 123), reported income from continuing operations andearnings per common share would have been reduced to the pro forma amountsshown below:

 
|                                                   |   | **2002** |   | **2001** |   | **2000** |   |
|--------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Income from continuing operations:                     |   |     |   |     |   |     |   |
| As reported                                            |   | $        | 4,871  |     | $      | 4,595    |   | $ | 5,529 |   |
| Pro forma                                              |   | 4,734    |   | 4,456    |   | 5,408    |   |
|                                                   |   |     |   |     |   |     |   |
| Basic earnings per share from continuing operations:   |   |     |   |     |   |     |   |
| As reported                                            |   | 1.39     |   | 1.25     |   | 1.43     |   |
| Pro forma                                              |   | 1.35     |   | 1.21     |   | 1.40     |   |
|                                                   |   |     |   |     |   |     |   |
| Diluted earnings per share from continuing operations: |   |     |   |     |   |     |   |
| As reported                                            |   | 1.36     |   | 1.23     |   | 1.41     |   |
| Pro forma                                              |   | 1.32     |   | 1.19     |   | 1.38     |   |
|                                                        |        |          |        |          |        |          |        |  |  |  |

 

The fair value of eachincentive stock option grant is estimated at the grant date using theBlack-Scholes option-pricing model. No options were granted during fiscal year2000.  The following weighted averageassumptions were used for grants in fiscal years 2002 and 2001,respectively:  a dividend rate as apercentage of stock price of 3.52% and 3.02%; price volatility of 25.00% and26.00%; risk-free interest rates of 4.58% and 5.10% and expected lives of sevenyears for both years.

 

Under theCompany’s stock option and incentive plan (Option Plan), stock options of828,000 common shares, of which 10,000 shares are restricted under a stock pool(see below), may be granted to directors and employees of the Bank.  Options granted under the Option Plan may beeither options that qualify as Incentive Stock Options, as defined in Section422 of the Internal Revenue Code of 1986, as amended (the Code), or optionsthat do not qualify.  The Option Planalso provides for the award of stock appreciation rights, limited stockappreciation rights and restricted stock. During fiscal year 2002, 10,342 shares of the restricted stock wereawarded under the Plan.  These sharesvest 33 1/3% after 3 years, 66 2/3% after 4 years, and 100% after 5 years ofcontinued employment.  The vestingperiod for these shares may accelerate based on the Company meeting certainperformance criteria, in which the shares would vest 25% after year 1, 0% inyear 2, and 25% in each of the next 3 years. The issuance cost of these shares was $129 and is being amortized overthe vesting period of five years, with the unamortized balance included indeferred compensation in the consolidated statements of financialcondition.  During fiscal year 2002, $21was recorded as amortization expense.

At June 30, 2002, 531,076shares of common stock were reserved for issuance under the Option Plan.  The options granted under the Option Planexpire ten years from the date of grant.

 

During fiscal year2001, the Company created a pool of 10,000 restricted shares (Pool). Awardsfrom the Pool are at the discretion of the Chairman of the Board of Directorson a spot basis to employees. The restricted shares vest 33 1/3% after 3 years,66 2/3% after 4 years, and 100% after 5 years of continued employment.  Key provisions of the Pool include: outrightgrant of shares with restrictions as to sale, transfer, and pledging; duringthe restriction period, the grantee receives dividends and has voting rightsrelated to the shares awarded; all nonvested shares are forfeited upontermination.  During 2001, noshares  were issued from the Pool.  During fiscal year 2002, 3,475 shares wereawarded under the Plan.  The issuancecost of these shares was $40 and is being amortized over the vesting period offive years, with the unamortized balance included in deferred compensation inthe consolidated balance sheet.  Duringfiscal year 2002, $7 was recorded as amortization expense.

 

A summary of the statusof the plan and changes during the years ended June 30 are as follows:

 
|                             |       | **2002**   |       | **2001**                                                 |       | **2000**   |       |
|----------------------------------|------------|------------|------------|----------------------------------------------------------|------------|------------|------------|
| **Fixed  Options**               | ** ** | **Shares** | ** ** | **Weighted********Average********Exercise********Price** | ** ** | **Shares** | ** ** | **Weighted********Average********Exercise********Price** | ** ** | **Shares** | ** ** | **Weighted********Average********Exercise********Price** | ** ** |
| Outstanding at beginning of year |       | 342,671    |       | $                                                        | 10.33      |       | 262,047    |   | $ | 10.66 |   | 279,972 |   | $ | 10.72 |   |
| Granted                          |       | 73,725     |       | 12.50                                                    |       | 96,655     |       | 9.38 |   | — |   | — |   |
| Forfeited                        |       | (52,285    | )          | 12.57                                                    |       | (10,589    | )          | 13.52 |   | (11,495 | ) | 15.09 |   |
| Exercised                        |       | (80,192    | )          | 4.73                                                     |       | (5,442     | )          | 3.33 |   | (6,430 | ) | 5.52 |   |
| Outstanding at end of year       |       | 283,919    |       | $                                                        | 12.06      |       | 342,671    |   | $ | 10.33 |   | 262,047 |   | $ | 10.66 |   |

 

Options for183,374, 232,005 and 193,780 shares were exercisable at June 30, 2002, 2001 and2000, respectively.  The weightedaverage fair value of options granted was $2.78 and $2.88 for the fiscal yearsended June 30, 2002 and 2001, respectively.

Fixed options outstandingat June 30, 2002 are summarized as follows:

 

| **Options  Outstanding**      |       | **Options  Exercisable** |       |
|-------------------------------|------------|--------------------------|------------|
| **Number********Outstanding** | ** ** | **Number  Exercisable**  | ** ** | **Remaining  Contractual  Life** | ** ** | **Exercise********Price** | ** ** |
| 4,773                         |       | 4,773                    |       | 2  years |   | $ | 7.33 |   |
| 23,556                        |       | 23,556                   |       | 3  years |   | 8.17 |   |
| 73,148                        |       | 28,812                   |       | 9  years |   | 9.38 |   |
| 300                           |       | 300                      |       | 4  years |   | 9.92 |   |
| 27,420                        |       | 27,420                   |       | 5  years |   | 10.21 |   |
| 336                           |       | 336                      |       | 4  years |   | 11.17 |   |
| 64,845                        |       | 18,162                   |       | 10  years |   | 12.50 |   |
| 47,595                        |       | 38,069                   |       | 7  years |   | 15.38 |   |
| 41,946                        |       | 41,946                   |       | 6  years |   | 16.25 |   |
| 283,919                       |       | 183,374                  |       |   |   |   |   |
|                               |            |                          |            |  |  |  |  |  |

 

The Company has aDirector Restricted Stock Plan (Plan) which provides that awards of restrictedshares of the Company’s common stock be made to outside directors of theCompany.  The Plan is designed to allowfor payment of the annual retainer fee in shares of the Company’s common stock,with the inclusion of an annual cost of living adjustment based on the ConsumerPrice Index.  Each outside director isentitled to all voting, dividend and distribution rights during the restrictionperiod.  The effective date of the Planwas July 1, 1997.  The Plan has 75,000shares allocated to it and is in effect for a period of ten years.  During fiscal years 2002, 2001 and 2000,7,560, 11,249 and 7,252 shares were awarded and $103, $100 and $98 of expensewas incurred under the Plan as the annual retainer for the Company’s Board ofDirectors for the years ending June 30, 2002, 2001 and 2000, respectively.

**Note18.  Financial Instruments**

** **

The Bank is aparty to financial instruments with off-balance-sheet risk in the normal courseof business to meet the financing needs of its customers.  These financial instruments includecommitments to extend credit, standby letters of credit and financial guarantees.  Those instruments involve, to varyingdegrees, elements of credit and interest-rate risk in excess of amountsrecognized in the consolidated statements of financial condition.  The contract or notional amounts of thoseinstruments reflect the extent of the Bank’s involvement in particular classesof financial instruments.

 

The Bank’sexposure to credit loss in the event of nonperformance by the other party tothe financial instrument for commitments to extend credit, standby letters ofcredit, and financial guarantees written is represented by the contractualnotional amount of those instruments. The Bank uses the same credit policies in making commitments andconditional obligations as it does for on-balance-sheet instruments.

 

Unless noted otherwise,the Bank does not require collateral or other security to support financialinstruments with credit risk.

 

Estimated fairvalues of the Company’s financial instruments are as follows:

 
|                                                                             |       | **June 30,**               |       |
|----------------------------------------------------------------------------------|------------|----------------------------|------------|
|                                                                             |       | **2002**                   |       | **2001** |   |
| ** **                                                                       | ** ** | **Carrying********Amount** | ** ** | **Fair Value** | ** ** | **Carrying********Amount** | ** ** | **Fair Value** | ** ** |
| Financial Assets                                                                 |       |                       |       |   |   |   |   |   |   |
| Cash and cash equivalents                                                        |       | $                          | 27,546     |   | $ | 27,546 |   | $ | 84,913 |   | $ | 84,913 |   |
| Securities                                                                       |       | 89,136                     |       | 89,136 |   | 93,719 |   | 93,719 |   |
| Loans and leases                                                                 |       | 566,373                    |       | 575,490 |   | 571,106 |   | 572,358 |   |
| Accrued interest receivable                                                      |       | 4,410                      |       | 4,410 |   | 5,412 |   | 5,412 |   |
| Mortgage servicing rights                                                        |       | 3,467                      |       | 5,275 |   | 2,775 |   | 5,346 |   |
|                                                                             |       |                       |       |   |   |   |   |   |   |
| Financial Liabilities                                                            |       |                       |       |   |   |   |   |   |   |
| Deposits                                                                         |       | 562,596                    |       | 567,323 |   | 601,207 |   | 606,322 |   |
| Preferred securities of subsidiary trust                                         |       | 10,000                     |       | 10,000 |   | — |   | — |   |
| Borrowed funds                                                                   |       | 84,308                     |       | 84,938 |   | 108,376 |   | 109,376 |   |
| Accrued interest payable and advances by borrowers for taxes and  insurance |       | 10,187                     |       | 10,187 |   | 15,238 |   | 15,238 |   |
|                                                                                  |            |                            |            |  |  |  |  |  |  |  |  |  |  |

 

**Note19.  Commitments, Contingencies andCredit Risk**

** **

The Bankoriginates first mortgage, consumer and other loans primarily in eastern SouthDakota and holds residential and commercial real estate loans which werepurchased from other originators of loans located throughout the United States.  The Bank has primarily unsecured credit cardloans which were issued through third parties nationwide to a target customermarket consisting of sub-prime credit customers who have either an insufficientcredit history or a negative credit history. The Bank issued no new credit cards in fiscal years 2002 and 2001 andannounced discontinuation of this operation in fiscal year 2002.  Collateral for substantially all noncreditcard consumer loans are security agreements and/or Uniform Commercial Code(UCC) filings on the purchased asset. At June 30, 2002 and 2001, the Bank has approximately $74 and $99 ofloans sold with recourse to the Federal National Mortgage Association(FNMA).  The collateral securing theseloans are one-to-four family mortgage loans, which are seasoned.  Unused lines of credit amounted to $68,369and $58,880 at June 30, 2002 and 2001, respectively.  Unused letters of credit amounted to $1,221 and $1,213 at June30, 2002 and 2001, respectively.  Thelines of credit and letters of credit are collateralized in substantially thesame manner as loans receivable.

 

The Bank hadoutstanding commitments to originate loans of $44,980 and to sell loans ofapproximately $14,705 at June 30, 2002. The portion of commitments to originate or purchase fixed rate loanstotaled $34,269 with a range in interest rates of 5.7% to 7.6%.  No losses are expected to be sustained inthe fulfillment of any of these commitments.

 

The Company isinvolved in various claims and legal actions arising in the ordinary course ofbusiness.  In the opinion of management,based upon consultation with legal counsel, the ultimate disposition of thesematters will not have a material adverse effect on the Company’s consolidatedfinancial position.

 

**Note 20.  Cash Flow Information**

Changes in otherassets and liabilities for the years ended June 30, 2002, 2001 and 2000 consistof:

 
|                                                                 |   | **2002** |   | **2001** |   | **2000** |   |
|----------------------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| (Increase) decrease in accrued interest receivable                   |   | $        | 1,002  |     | $      | (59      | )      | $ | (515 | ) |
| (Increase) decrease in prepaid expensesand other assets              |   | (485     | )      | (403     | )      | 219      |   |
| Deferred income taxes (credits)                                      |   | (267     | )      | 645      |   | 1,417    |   |
| Increase (decrease) in accrued interestpayable and other liabilities |   | (4,609   | )      | 1,485    |   | 1,439    |   |
|                                                                 |   | $        | (4,359 | )        | $      | 1,668    |   | $ | 2,560 |   |

 

**Note21.  Subsequent Event**

** **

On July 11, 2002, theCompany issued 5,000 shares totaling $5.0 million of Company ObligatedMandatorily Redeemable Preferred Securities of HF Financial Capital TrustII.  The Trust was established andexists for the sole purpose of issuing trust preferred securities and investingthe proceeds in subordinated debentures of the Company.  These subordinated debentures constitute thesole asset of the Trust.  The securitiesprovide for cumulative cash distributions calculated at a rate based onthree-month LIBOR plus 3.65%.  TheCompany may, at one or more times, defer interest payments on the capitalsecurities for up to 20 consecutive quarterly periods, but not beyond October7, 2032.  The capital securities will beredeemed on October 7, 2032; however, the Company has the option to shorten thematurity date to a date not earlier than July 7, 2007.  Holders of the capital securities have novoting rights, are unsecured, and rank junior in priority of the payment to allof the Company’s indebtedness and senior to the Company’s capital stock.

 

**Note 22.  Financial Information of HF Financial Corp.(Parent Only)**

The Company’scondensed balance sheets as of June 30, 2002 and 2001 and related condensedstatements of income and cash flows for each of the years in the three year periodended June 30, 2002 are as follows:

 

CONDENSED BALANCESHEETS

 
|                                      |   | **2002** |   | **2001** |   |
|-------------------------------------------|--------|----------|--------|----------|--------|
| Assets                                    |   |     |   |     |   |
| Cash, all with Home Federal Bank          |   | $        | 238    |     | $      | 610 |   |
| Note receivable, HF Card Services, L.L.C. |   | 8,327    |   | 7,362    |   |
| Investments, marketable securities        |   | 282      |   | 383      |   |
| Investments in subsidiaries               |   | 48,727   |   | 46,784   |   |
| Land held for sale                        |   | 1,298    |   | 1,298    |   |
| Other                                     |   | 1,240    |   | 140      |   |
|                                      |   | $        | 60,112 |     | $      | 56,577 |   |
|                                      |   |     |   |     |   |
| Liabilities                               |   |     |   |     |   |
| Other borrowings                          |   | $        | 11,184 |     | $      | 3,922 |   |
| Other liabilities                         |   | 392      |   | 130      |   |
| Stockholders' equity                      |   | 48,536   |   | 52,525   |   |
|                                      |   | $        | 60,112 |     | $      | 56,577 |   |

 

 

CONDENSEDSTATEMENTS OF INCOME

 
|                               |   | **2002** |   | **2001** |   | **2000** |   |
|------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Interest income                    |   | $        | 605    |     | $      | 751      |   | $ | 649 |   |
| Equity in earnings of subsidiaries |   | 2,335    |   | 4,324    |   | 4,717    |   |
| Other income                       |   | 28       |   | 18       |   | 52       |   |
| Expenses                           |   | (850     | )      | (574     | )      | (328     | )      |
| Income tax benefit                 |   | 1,067    |   | 88       |   | 177      |   |
| Net income                         |   | $        | 3,185  |     | $      | 4,607    |   | $ | 5,267 |   |

 

 

CONDENSEDSTATEMENTS OF CASH FLOWS

 
|                                                                             |   | **2002** |   | **2001** |   | **2000** |   |
|----------------------------------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Cash Flows From Operating Activities                                             |   |     |   |     |   |     |   |
| Net income                                                                       |   | $        | 3,185  |     | $      | 4,607    |   | $ | 5,267 |   |
| Adjustments to reconcile net income to netcash provided by operating activities: |   |     |   |     |   |     |   |
| Amortization of unearned compensation                                            |   | —   |   | 113      |   | 113      |   |
| Amortization of debt issue costs                                                 |   | 7        |   | —   |   | —   |   |
| Equity in (earnings) of subsidiaries                                             |   | (2,335   | )      | (4,324   | )      | (4,717   | )      |
| Cash dividends received from subsidiaries                                        |   | 5,317    |   | 2,703    |   | 4,244    |   |
| Increase (decrease) in liabilities                                               |   | 262      |   | (47      | )      | 138      |   |
| Other, net                                                                       |   | (757     | )      | 4        |   | 782      |   |
| Net cash provided by operating activities                                        |   | 5,679    |   | 3,056    |   | 5,827    |   |
|                                                                             |   |     |   |     |   |     |   |
| Cash Flows From Investing Activities                                             |   |     |   |     |   |     |   |
| Disbursements on note receivable from HF Card                                    |   | (1,505   | )      | (1,383   | )      | (6,624   | )      |
| Repayments on note receivable from HF Card                                       |   | 540      |   | 720      |   | 2,355    |   |
| Proceeds from maturities and sales of securities                                 |   | 101      |   | —   |   | 135      |   |
| Capital contribution to Home Federal Bank                                        |   | (5,300   | )      | (1,650   | )      | —   |   |
| Capital contribution to HomeFirst Mortgage Corp.                                 |   | —   |   | (2,950   | )      | —   |   |
| Net cash (used in) investing activities                                          |   | (6,164   | )      | (5,263   | )      | (4,134   | )      |
|                                                                             |   |     |   |     |   |     |   |
| Cash Flows From Financing Activities                                             |   |     |   |     |   |     |   |
| Purchase of treasury stock                                                       |   | (5,571   | )      | —   |   | (4,869   | )      |
| Cash dividends paid                                                              |   | (1,555   | )      | (1,545   | )      | (1,544   | )      |
| Proceeds from issuance of common stock                                           |   | 637      |   | 118      |   | 133      |   |
| Proceeds from issuance of preferred securities of subsidiary  trust         |   | 10,000   |   | —   |   | —   |   |
| Proceeds from other borrowings                                                   |   | —   |   | 3,000    |   | —   |   |
| Payment of debt issue costs                                                      |   | (350     | )      | —   |   | —   |   |
| Payments on other borrowings                                                     |   | (3,048   | )      | (46      | )      | (43      | )      |
| Net cash provided by (used in) financing activities                         |   | 113      |   | 1,527    |   | (6,323   | )      |
| (Decrease) in cash                                                               |   | (372     | )      | (680     | )      | (4,630   | )      |
|                                                                             |   |     |   |     |   |     |   |
| Cash at beginning of period                                                      |   | 610      |   | 1,290    |   | 5,920    |   |
| Cash at end of period                                                            |   | $        | 238    |     | $      | 610      |   | $ | 1,290 |   |

 

**Note23.  Quarterly Financial Information(Unaudited)**

** **

(Dollars inthousands except per share data)

 
| **(1) Fiscal year 2002**                   |   | **1st Quarter** |   | **2nd Quarter** |   | **3rd Quarter** |   | **4th Quarter********(2)** |   |
|--------------------------------------------|--------|-----------------|--------|-----------------|--------|-----------------|--------|----------------------------|--------|
| Total interest income                      |   | $               | 13,494 |            | $      | 12,111          |   | $                          | 11,067 |   | $ | 11,345 |   |
| Net interest income                        |   | 5,773           |   | 5,778           |   | 6,196           |   | 6,697                      |   |
| Provision for losses on loans and leases   |   | 523             |   | 543             |   | 354             |   | 485                        |   |
| Income from continuing operations          |   | 1,124           |   | 1,175           |   | 1,212           |   | 1,360                      |   |
| Income (loss) from discontinued operations |   | 143             |   | (183            | )      | (103            | )      | (1,543                     | )      |
| Net income (loss)                          |   | 1,267           |   | 992             |   | 1,109           |   | (183                       | )      |
|                                       |   |            |   |            |   |            |   |                       |   |
| Earnings per share — basic:           |   |            |   |            |   |            |   |                       |   |
| Income from continuing operations          |   | $               | 0.30   |            | $      | 0.32            |   | $                          | 0.36   |   | $ | 0.41 |   |
| Discontinued operations, net of tax        |   | 0.04            |   | (0.05           | )      | (0.03           | )      | (0.46                      | )      |
| Net income (loss)                          |   | $               | 0.34   |            | $      | 0.27            |   | $                          | 0.33   |   | $ | (0.05 | ) |
|                                       |   |            |   |            |   |            |   |                       |   |
| Earnings per share — diluted:         |   |            |   |            |   |            |   |                       |   |
| Income from continuing operations          |   | $               | 0.30   |            | $      | 0.31            |   | $                          | 0.36   |   | $ | 0.40 |   |
| Discontinued operations, net of tax        |   | 0.04            |   | (0.05           | )      | (0.03           | )      | (0.45                      | )      |
| Net income (loss)                          |   | $               | 0.34   |            | $      | 0.26            |   | $                          | 0.33   |   | $ | 0.05 |   |
|                                       |   |            |   |            |   |            |   |                       |   |
| **(1) Fiscal year 2001**                   |   | **1st Quarter** |   | **2nd Quarter** |   | **3rd Quarter** |   | **4th Quarter**            |   |
| Total interest income                      |   | $               | 14,442 |            | $      | 14,796          |   | $                          | 14,698 |   | $ | 14,226 |   |
| Net interest income                        |   | 5,739           |   | 5,753           |   | 5,702           |   | 5,917                      |   |
| Provision for losses on loans and leases   |   | 429             |   | 308             |   | 400             |   | 345                        |   |
| Income from continuing operations          |   | 1,107           |   | 1,421           |   | 1,015           |   | 1,052                      |   |
| Income (loss) from discontinued operations |   | 153             |   | (71             | )      | 73              |   | (143                       | )      |
| Net income                                 |   | 1,260           |   | 1,350           |   | 1,088           |   | 909                        |   |
|                                       |   |            |   |            |   |            |   |                       |   |
| Earnings per share — basic:           |   |            |   |            |   |            |   |                       |   |
| Income from continuing operations          |   | $               | 0.30   |            | $      | 0.39            |   | $                          | 0.28   |   | $ | 0.29 |   |
| Discontinued operations, net of tax        |   | 0.04            |   | (0.02           | )      | 0.02            |   | (0.04                      | )      |
| Net income                                 |   | $               | 0.34   |            | $      | 0.37            |   | $                          | 0.30   |   | $ | 0.25 |   |
|                                       |   |            |   |            |   |            |   |                       |   |
| Earnings per share — diluted:         |   |            |   |            |   |            |   |                       |   |
| Income from continuing operations          |   | $               | 0.30   |            | $      | 0.38            |   | $                          | 0.27   |   | $ | 0.28 |   |
| Discontinued operations, net of tax        |   | 0.04            |   | (0.02           | )      | 0.02            |   | (0.04                      | )      |
| Net income                                 |   | $               | 0.34   |            | $      | 0.36            |   | $                          | 0.29   |   | $ | 0.24 |   |

 

----

(1)          Certain amounts forall periods presented have been reclassified to discontinued operations (Note2).

 

(2)         During the fourth quarter offiscal year 2002, the Company recorded a provision of $2,073 and reclassified$577 from the allowance for loan and lease losses directly against credit cardloans receivable and transferred the loans from loans receivable to loans heldfor sale at their estimated net realizable value (Note 2).

**Item 9. Changes in and Disagreements with Accountants on Accounting andFinancial Disclosure**

 

During the Company’s twomost recent fiscal years there have been no disagreements with our accountanton any matter of accounting principle or financial statement disclosure.

 

**PART III**

 

**Item 10.  Directors and Executive Officers of the Registrant**

 

Information regardinguntimely filings pursuant to Section 16 of the Securities Exchange Act of 1934,as amended, is incorporated in this Form 10-K by reference from the Company’sdefinitive Proxy Statement for the Annual Meeting of Stockholders to be held in2002, a copy of which will be filed not later than 120 days after the close ofthe fiscal year.

 

**Directors**

 

Information concerningDirectors of the Company is incorporated in this Form 10-K by reference fromthe definitive Proxy Statement for the Annual Meeting of Stockholders to beheld in 2002, a copy of which will be filed not later than 120 days after theclose of the fiscal year.

 

**Executive officers**

 

Information regardingthe business experience of the executive officers of the Company and the Bankcontained in Part I of this Form 10–K is incorporated herein byreference.

 

**Item 11.  Executive Compensation**

 

Information concerningexecutive compensation is incorporated in this Form 10-K by reference from thedefinitive Proxy Statement for the Annual Meeting of Stockholders to be held in2002, a copy of which will be filed not later than 120 days after the close ofthe fiscal year.  Information containedunder the headings “Board Compensation Committee Report on ExecutiveCompensation” and “Stockholder Return Performance Presentation” is notincorporated in this Form 10-K.

 

**Item 12.  Security Ownership of Certain Beneficial Owners and Management**

 

Information concerningsecurity ownership of certain beneficial owners and management is incorporatedin this Form 10-K by reference from the definitive Proxy Statement for theAnnual Meeting of Stockholders to be held in 2002, a copy of which will befiled not later than 120 days after the close of the fiscal year.

 

**Item 13.  Certain Relationships and Related Transactions**

 

Information concerningcertain relationships and related transactions is incorporated in this Form10-K by reference from the definitive Proxy Statement for the Annual Meeting ofStockholders to be held in 2002, a copy of which will be filed not later than120 days after the close of the fiscal year. Information contained under the headings “Board Compensation CommitteeReport on Executive Compensation” and “Stockholder Return PerformancePresentation” is not incorporated in this Form 10-K.

 

**PART IV**

 

**Item 14.  Exhibits, Financial Statement Schedules, and Reports on Form 8–K**

 

(a)                                  Documentsfiled with this report.

(1)          See “HFFinancial Corp. Index to Consolidated Financial Statements” under Item 8,“Financial Statements and Supplementary Data” of this report.

(2)          Allsupplemental schedules are omitted because of the absence of conditions underwhich they are required or because the information is shown in the ConsolidatedFinancial Statements or notes thereto.

**(a) (3) Exhibits**

 
| **Regulation****S-K Exhibit****Number** |   | **Document**                                                                                                |   | **Reference to****Prior Filing****or Exhibit****Number****Attached  Hereto** |   | **Sequential Page****Number Where  Attached Exhibits****Are Located in This  Form 10-K****Report** |
|-----------------------------------------|--------|-------------------------------------------------------------------------------------------------------------|--------|------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------------------------------|
| 3.1                                     |   | Articles  of Incorporation                                                                                  |   | (1)                                                                          |   | Not Applicable                                                                                     |
| 3.2                                     |   | By-Laws                                                                                                     |   | (1)                                                                          |   | Not Applicable                                                                                     |
| 4.1                                     |   | Rights Agreement                                                                                            |   | (4)                                                                          |   | Not Applicable                                                                                     |
| 10.1                                    |   | Employment Contracts between the Bank and  Curtis L. Hage                                         |   | (1) #                                                                        |   | Not Applicable                                                                                     |
| 10.2                                    |   | Amendment to Employment Contract between the Bank and  Curtis L. Hage                                       |   | (3) #                                                                        |   | Not Applicable                                                                                     |
| 10.3                                    |   | 1991 Stock Option and Incentive Plan                                                                        |   | (2) #                                                                        |   | Not Applicable                                                                                     |
| 10.4                                    |   | Articles of Incorporation of HF Card Services LLC                                                           |   | (3)                                                                          |   | Not Applicable                                                                                     |
| 10.5                                    |   | Amendment to 1991 Stock Option and Incentive Plan                                                           |   | (5) #                                                                        |   | Not Applicable                                                                                     |
| 10.6                                    |   | 1996 Director Restricted Stock Plan                                                                         |   | (5) #                                                                        |   | Not Applicable                                                                                     |
| 10.7                                    |   | Employment Contract between the Bank and  Gene F. Uher                                            |   | (5) #                                                                        |   | Not Applicable                                                                                     |
| 10.8                                    |   | Employment Contract between the Bank and Mark S.  Sivertson                                                 |   | (6) #                                                                        |   | Not Applicable                                                                                     |
| 10.9                                    |   | Employment Contract between the Bank and Michael H.  Zimmerman                                              |   | (6) #                                                                        |   | Not Applicable                                                                                     |
| 10.10                                   |   | Change in Control Contract between the Bank and  Gene F. Uher                                     |   | (6) #                                                                        |   | Not Applicable                                                                                     |
| 10.11                                   |   | Change in Control Contract between the Bank and Mark S.  Sivertson                                          |   | (6) #                                                                        |   | Not Applicable                                                                                     |
| 10.12                                   |   | Change in Control Contract between the Bank and Michael  H. Zimmerman                                       |   | (6) #                                                                        |   | Not Applicable                                                                                     |
| 10.13                                   |   | Amendment to Employment Contract between the Bank and  Gene F. Uher                                         |   | (7) #                                                                        |   | Not Applicable                                                                                     |
| 10.14                                   |   | Employment Contract between the Bank and David A. Brown                                                     |   | (8) #                                                                        |   | Not Applicable                                                                                     |
| 10.15                                   |   | Change in Control Contract between the Bank and David  A. Brown                                             |   | (8) #                                                                        |   | Not Applicable                                                                                     |
| 10.16                                   |   | Guarantee Agreement dated November 28, 2001 by and  between HF Financial Corp. and Wilmington Trust Company |   | (9)                                                                          |   | Not Applicable                                                                                     |
| 10.17                                   |   | Indenture Agreement dated November 28, 2001 by and  between HF Financial Corp. and Wilmington Trust Company |   | (9)                                                                          |   | Not Applicable                                                                                     |
| 10.18                                   |   | Confidential Separation Agreement between the Bank and  Gene F. Uher*                             |   | 10.18 #                                                                      |   |                                                                                               |
| 21.1                                    |   | Subsidiaries of Registrant                                                                                  |   | 21.1                                                                         |   |                                                                                               |
| 23.1                                    |   | Consents  of Experts and Counsel                                                                            |   | 23.1                                                                         |   |                                                                                               |

 

----

(1)             Filed asexhibits to the Company’s Form S–1 registration statement filed onDecember 6, 1991 (File No. 33–44383) pursuant to Section 5 of theSecurities Act of 1933.

(2)             Filedas exhibits to the Company’s Annual Report on Form 10K for the fiscal yearended June 30, 1993.

(3)             Filedas exhibits to the Company’s Annual Report on Form 10K for the fiscal yearended June 30, 1996.

(4)             Filedas Exhibit I to the Company’s filing on Form 8-A, filed on October 28, 1996.

(5)             Filedas exhibits to the Company’s Annual Report on Form 10K for the fiscal yearended June 30, 1997.

(6)             Filedas exhibits to the Company’s Annual Report on Form 10K for the fiscal yearended June 30, 1998.

(7)             Filedas exhibits to the Company’s Annual Report on Form 10K for the fiscal yearended June 30, 1999.

(8)             Filedas exhibits to the Company’s Annual Report on Form 10K for the fiscal yearended June 30, 2001.

(9)             Filedas exhibits to the Company’s Form 10Q for the quarter ended December 31, 2001.

#       Managementor compensatory plan or arrangements required to be filed.

*                    Certainportions of this exhibit have been omitted based upon a request for ordergranting confidential treatment.  Theomitted portions have been filed separately with the Securities and ExchangeCommission.

All of such previouslyfiled documents are hereby incorporated in this Form 10-K by reference inaccordance with Item 601 of Regulation S–K.

** **

**(b) Reports on Form 8–K**

 

The Company filed Form8-K, Item 5, “Other Events” with the Securities and Exchange Commission on May24, 2002 announcing approval by the Company’s Board of Directors to repurchaseup to 10% of its outstanding common stock through April 30, 2003.

 

 

**SIGNATURES**

 

Pursuant to therequirements of Section 15(d) of the Securities Exchange Act of 1934, theRegistrant has duly caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.

 

 
|   |   | HF FINANCIAL CORP.                       |
|--------|--------|------------------------------------------|
|   |   |                                     |
| By     |   | /s/ Curtis L. Hage                       |
|   |   | Curtis L. Hage, Chairman,  President and |
|   |   | Chief Executive Officer                  |
|   |   | (Duly Authorized  Representative)        |

 

Pursuant to therequirements of the Securities Exchange Act of 1934, this report has beensigned below by the following persons in the capacities and on the datesindicated.

 

 
| /s/  Curtis L. Hage                                                                                            |               | /s/  Darrel L. Posegate                                                                                                |
|----------------------------------------------------------------------------------------------------------------|--------------------|------------------------------------------------------------------------------------------------------------------------|
| Curtis L. Hage, Chairman,  President and Chief Executive Officer *(Principal Executive and Operating Officer)* |               | Darrel L. Posegate, Senior  Vice President and Chief Financial Officer *(Principal Financial and Accounting  Officer)* |
|                                                                                                           |               |                                                                                                                   |
| Date:                                                                                                          | September 27, 2002 |                                                                                                                   | Date: | September  27, 2002 |
|                                                                                                           |               |                                                                                                                   |
|                                                                                                           |               |                                                                                                                   |
| /s/  Thomas L. Van Wyhe                                                                                        |               | /s/  Robert L. Hanson                                                                                                  |
| Thomas L. Van Wyhe,  Director                                                                                  |               | Robert L. Hanson, Director                                                                                             |
|                                                                                                           |               |                                                                                                                   |
| Date:                                                                                                          | September 27, 2002 |                                                                                                                   | Date: | September  27, 2002 |
|                                                                                                           |               |                                                                                                                   |
|                                                                                                           |               |                                                                                                                   |
| /s/  Jeffrey G. Parker                                                                                         |               | /s/  JoEllen G. Koerner                                                                                                |
| Jeffrey G. Parker,  Director                                                                                   |               | JoEllen G. Koerner, Ph.D.,  Director                                                                                   |
|                                                                                                           |               |                                                                                                                   |
| Date:                                                                                                          | September 27, 2002 |                                                                                                                   | Date: | September  27, 2002 |
|                                                                                                           |               |                                                                                                                   |
|                                                                                                           |               |                                                                                                                   |
| /s/  William G. Pederson                                                                                       |               |                                                                                                                   |
| William. G. Pederson,  Director                                                                                |               |                                                                                                                   |
|                                                                                                           |               |                                                                                                                   |
| Date:                                                                                                          | September 27, 2002 |                                                                                                                   |   |

** **

 

**CERTIFICATIONS**

 

I, Curtis L. Hage, certify that:

 

1.     I have reviewed this Annual Report on Form 10-K of H.F.Financial Corp.;

 

2.     Based on my knowledge, this Annual Report does not contain anyuntrue statement of a material fact or omit to state a material fact necessaryto make the statements made, in light of the circumstances under which suchstatements were made, not misleading with respect to the period covered by thisannual report; and

 

3.     Based on my knowledge, the financial statements, and otherfinancial information included in this Annual Report, fairly present in allmaterial respects the financial condition, results of operations and cash flowsof the registrant as of, and for, the periods presented in this annual report.

 
| Date:                                                           | September 27, 2002 |   |   |
|-----------------------------------------------------------------|--------------------|--------|--------|
|                                                            |               |   |
| /s/  Curtis L. Hage                                             |               |   |
| Curtis L. Hage, Chairman,  President andChief Executive Officer |               |   |

 

 

I, Darrel L. Posegate, certify that:

 

1.     I have reviewed this Annual Report on Form 10-K of H.F.Financial Corp.;

 

2.     Based on my knowledge, this Annual Report does not contain anyuntrue statement of a material fact or omit to state a material fact necessaryto make the statements made, in light of the circumstances under which suchstatements were made, not misleading with respect to the period covered by thisannual report; and

 

3.     Based on my knowledge, the financial statements, and otherfinancial information included in this Annual Report, fairly present in allmaterial respects the financial condition, results of operations and cash flowsof the registrant as of, and for, the periods presented in this annual report.

 
| Date:                                            | September  27, 2002 |   |   |
|--------------------------------------------------|---------------------|--------|--------|
|                                             |                |   |
| /s/  Darrel L. Posegate                          |                |   |
| Darrel L. Posegate                               |                |   |
| Senior Vice President andChief Financial Officer |                |   |

 

 

**CERTIFICATIONPURSUANT TO**

**18 U.S.C.§1350,**

**AS ADOPTEDPURSUANT TO**

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

 

 

In connection with the Annual Report of H.F. Financial Corp. (the“Company”) on Form 10-K for the year ended June 30, 2002, as filed with theSecurities and Exchange Commission on the date hereof (the “Report”), I, CurtisL. Hage, Chairman, President and Chief Executive Officer of the Company,certify, pursuant to 18 U.S.C. §1350, as adopted pursuant to Section 906 of theSarbanes-Oxley Act of 2002, that to the best of my knowledge:

 

                                                (1)   The Report fully complies with therequirements of Section 13(a) or 15(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:                                                             | September  27, 2002 |   |   |
|                                                                   |                     |        |  |

 

 

 

**CERTIFICATION PURSUANT TO**

**18 U.S.C.§1350,**

**AS ADOPTEDPURSUANT TO**

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

 

 

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

 

                                                (1)   The Report fully complies with therequirements of Section 13(a) or 15(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                          |                |   |
| Vice President and  Chief Financial Officer |                |   |
|                                        |                |   |
| Date:                                       | September  27, 2002 |   |   |
|                                             |                     |        |  |

 

 

**Index to Exhibits**

 
| **Exhibit  Number** | ** ** | ** **                                                            |
|---------------------|------------|-----------------------------------------------------------------------|
|                |       |                                                                  |
| 10.18               |       | Confidential  Separation Agreement between the Bank and Gene F. Uher* |
|                |       |                                                                  |
| 21.1                |       | Subsidiaries  of Registrant                                           |
|                |       |                                                                  |
| 23.1                |       | Consents of Experts and  Counsel                                      |

 

----

*                Certain portions of thisexhibit have been omitted based upon a request for order granting confidentialtreatment.  The omitted portions havebeen filed separately with the Securities and Exchange Commission.