##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-Q
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended September 30, 2007
 OR
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) FOR THE
SECURITIES EXCHANGE ACT OF 1934
 For the transition period from  to
 Commission File Number 0-24100
 HMN FINANCIAL, INC.
  Delaware
    
    41-1777397(State or other jurisdiction of incorporation or organization)
    
    (I.R.S. Employer Identification Number)1016 Civic Center Drive N.W., Rochester, MN
    
    55901(Address of principal executive offices)
    
    (ZIP Code)
 (507) 535-1200
 þ o
  o þ o
 o þ
  Class
    
    Outstanding at October 19, 2007Common stock, $0.01 par value
    
    4,255,617




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##### 



HMN FINANCIAL, INC.
 CONTENTS
  
 PagePART I  FINANCIAL INFORMATIONItem 1: Financial Statements (unaudited)Consolidated Balance Sheets at
September 30, 2007 and December 31, 2006
    
    
    3Consolidated Statements of Income for the
Three Months Ended and Nine Months Ended September 30, 2007 and 2006
    
    
    4Consolidated Statement of Stockholders Equity and Comprehensive
Income for the Nine Month Period Ended September 30, 2007
    
    
    5Consolidated Statements of Cash Flows for
the Nine Months Ended September 30, 2007 and 2006
    
    
    6Notes to Consolidated Financial Statements
    
    
    7Item 2: Managements Discussion and Analysis of Financial
Condition and Results of Operations
    
    
    14Item 3: Quantitative and Qualitative Disclosures about Market Risk
    
    
    22Item 4: Controls and Procedures
    
    
    24PART II  OTHER INFORMATIONItem 1: Legal Proceedings
    
    
    25Item 1A: Risk Factors
    
    
    25Item 2: Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    25Item 3: Defaults Upon Senior Securities
    
    
    25Item 4: Submission of Matters to a Vote of Security Holders
    
    
    25Item 5: Other Information
    
    
    25Item 6: Exhibits
    
    
    25Signatures
    
    
    26CertificationCertificationCertification
  2




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##### Table of Contents



PART I  FINANCIAL STATEMENTS
 
  HMN FINANCIAL, INC. AND SUBSIDIARIES
 
 Consolidated Balance Sheets
 September 30,
    
    
    December 31,2007
    
    
    2006(dollars in thousands)
    
    (unaudited)AssetsCash and cash equivalents
    
    $
    51,916
    
    
    
    43,776Securities available for sale:Mortgage-backed and related securities
(amortized cost $19,538 and $6,671)
    
    
    18,927
    
    
    
    6,178Other marketable securities
(amortized cost $190,185 and $119,940)
    
    
    191,251
    
    
    
    119,962210,178
    
    
    
    126,140Loans held for sale
    
    
    2,153
    
    
    
    1,493Loans receivable, net
    
    
    846,201
    
    
    
    768,232Accrued interest receivable
    
    
    7,350
    
    
    
    5,061Real estate, net
    
    
    2,505
    
    
    
    2,072Federal Home Loan Bank stock, at cost
    
    
    5,580
    
    
    
    7,956Mortgage servicing rights, net
    
    
    1,431
    
    
    
    1,958Premises and equipment, net
    
    
    12,082
    
    
    
    11,372Goodwill
    
    
    3,801
    
    
    
    3,801Core deposit intangible
    
    
    21
    
    
    
    106Prepaid expenses and other assets
    
    
    1,473
    
    
    
    2,943Deferred tax asset
    
    
    2,722
    
    
    
    2,879Total assets
    
    $
    1,147,413
    
    
    
    977,789Liabilities and Stockholders EquityDeposits
    
    $
    936,419
    
    
    
    725,959Federal Home Loan Bank advances
    
    
    97,500
    
    
    
    150,900Accrued interest payable
    
    
    7,827
    
    
    
    1,176Customer escrows
    
    
    1,349
    
    
    
    721Accrued expenses and other liabilities
    
    
    7,018
    
    
    
    5,891Total liabilities
    
    
    1,050,113
    
    
    
    884,647Commitments and contingenciesStockholders equity:Serial preferred stock: ($.01 par value)
authorized 500,000 shares; issued and outstanding none
    
    
    0
    
    
    
    0Common stock ($.01 par value): authorized 11,000,000; issued shares 9,128,662
    
    
    91
    
    
    
    91Additional paid-in capital
    
    
    57,890
    
    
    
    57,914Retained earnings, subject to certain restrictions
    
    
    109,079
    
    
    
    103,643Accumulated other comprehensive income (loss)
    
    
    275
    
    
    
    (284
    )Unearned employee stock ownership plan shares
    
    
    (4,012
    )
    
    
    (4,158
    )Treasury stock, at cost 4,873,045 and 4,813,232 shares
    
    
    (66,023
    )
    
    
    (64,064
    )Total stockholders equity
    
    
    97,300
    
    
    
    93,142Total liabilities and stockholders equity
    
    $
    1,147,413
    
    
    
    977,789
  3




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##### Table of Contents



HMN FINANCIAL, INC. AND SUBSIDIARIES
 
 Consolidated
Statements of Income
 Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,(dollars in thousands, except per share amounts)
    
    2007
    
    
    2006
    
    
    2007
    
    
    2006Interest income:Loans receivable
    
    $
    17,258
    
    
    
    14,962
    
    
    
    49,632
    
    
    
    44,747Securities available for sale:Mortgage-backed and related
    
    
    212
    
    
    
    66
    
    
    
    495
    
    
    
    206Other marketable
    
    
    2,498
    
    
    
    1,512
    
    
    
    6,810
    
    
    
    3,724Cash equivalents
    
    
    250
    
    
    
    546
    
    
    
    972
    
    
    
    1,254Other
    
    
    60
    
    
    
    89
    
    
    
    276
    
    
    
    238Total interest income
    
    
    20,278
    
    
    
    17,175
    
    
    
    58,185
    
    
    
    50,169Interest expense:Deposits
    
    
    9,283
    
    
    
    5,813
    
    
    
    24,506
    
    
    
    16,198Federal Home Loan Bank advances
    
    
    1,182
    
    
    
    1,660
    
    
    
    4,227
    
    
    
    5,130Total interest expense
    
    
    10,465
    
    
    
    7,473
    
    
    
    28,733
    
    
    
    21,328Net interest income
    
    
    9,813
    
    
    
    9,702
    
    
    
    29,452
    
    
    
    28,841Provision for loan losses
    
    
    921
    
    
    
    6,026
    
    
    
    2,404
    
    
    
    7,521Net interest income after provision
for loan losses
    
    
    8,892
    
    
    
    3,676
    
    
    
    27,048
    
    
    
    21,320Non-interest income:Fees and service charges
    
    
    828
    
    
    
    820
    
    
    
    2,306
    
    
    
    2,331Mortgage servicing fees
    
    
    254
    
    
    
    291
    
    
    
    789
    
    
    
    896Securities gains, net
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    48Gain on sales of loans
    
    
    205
    
    
    
    481
    
    
    
    1,189
    
    
    
    1,030Other
    
    
    362
    
    
    
    143
    
    
    
    724
    
    
    
    683Total non-interest income
    
    
    1,649
    
    
    
    1,735
    
    
    
    5,008
    
    
    
    4,988Non-interest expense:Compensation and benefits
    
    
    3,147
    
    
    
    2,706
    
    
    
    9,770
    
    
    
    9,083Occupancy
    
    
    1,127
    
    
    
    1,131
    
    
    
    3,323
    
    
    
    3,335Advertising
    
    
    123
    
    
    
    108
    
    
    
    424
    
    
    
    346Data processing
    
    
    325
    
    
    
    306
    
    
    
    941
    
    
    
    882Amortization of mortgage servicing rights, net
    
    
    169
    
    
    
    208
    
    
    
    540
    
    
    
    661Other
    
    
    1,062
    
    
    
    980
    
    
    
    3,054
    
    
    
    2,836Total non-interest expense
    
    
    5,953
    
    
    
    5,439
    
    
    
    18,052
    
    
    
    17,143Income
(loss) before income tax expense (benefit)
    
    
    4,588
    
    
    
    (28
    )
    
    
    14,004
    
    
    
    9,165Income tax expense (benefit)
    
    
    1,806
    
    
    
    (102
    )
    
    
    5,505
    
    
    
    3,408Net income
    
    $
    2,782
    
    
    
    74
    
    
    
    8,499
    
    
    
    5,757Basic earnings per share
    
    $
    0.74
    
    
    
    0.02
    
    
    
    2.26
    
    
    
    1.50Diluted earnings per share
    
    $
    0.71
    
    
    
    0.02
    
    
    
    2.16
    
    
    
    1.43
  4




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##### Table of Contents



HMN FINANCIAL, INC. AND SUBSIDIARIES
 
 Consolidated Statement of Stockholders Equity and Comprehensive Income
For the Nine-Month Period Ended September 30, 2007
 UnearnedEmployeeAccumulated
    
    StockAdditional
    
    
    
    
    
    Other
    
    Ownership
    
    
    
    
    
    Stock-Common
    
    Paid-in
    
    Retained
    
    Comprehensive
    
    Plan
    
    Treasury
    
    Holders(dollars in thousands)
    
    Stock
    
    Capital
    
    Earnings
    
    Income (Loss)
    
    Shares
    
    Stock
    
    EquityBalance, December 31, 2006
    
    $
    91
    
    
    
    57,914
    
    
    
    103,643
    
    
    
    (284
    )
    
    
    (4,158
    )
    
    
    (64,064
    )
    
    
    93,142Net income
    
    
    
    
    
    
    
    
    
    
    8,499
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    8,499Other comprehensive income, net of tax:Net
unrealized gains on securities available for sale
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    559
    
    
    
    
    
    
    
    
    
    
    
    559Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    9,058Purchase of treasury stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,778
    )
    
    
    (2,778
    )FIN 48 - cumulative effect adjustment
    
    
    
    
    
    
    
    
    
    
    (250
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (250
    )Employee stock options exercised
    
    
    
    
    
    
    (246
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    385
    
    
    
    139Tax benefits of exercised stock options
    
    
    
    
    
    
    99
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    99Unearned compensation restricted stock awards
    
    
    
    
    
    
    (468
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    468
    
    
    
    0Restricted stock awards forfeited
    
    
    
    
    
    
    34
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (34
    )
    
    
    0Stock compensation tax benefits
    
    
    
    
    
    
    32
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    32Amortization of restricted stock awards
    
    
    
    
    
    
    251
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    251Dividends paid
    
    
    
    
    
    
    
    
    
    
    (2,813
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,813
    )Earned employee stock ownership plan shares
    
    
    
    
    
    
    274
    
    
    
    
    
    
    
    
    
    
    
    146
    
    
    
    
    
    
    
    420Balance, September 30, 2007
    
    $
    91
    
    
    
    57,890
    
    
    
    109,079
    
    
    
    275
    
    
    
    (4,012
    )
    
    
    (66,023
    )
    
    
    97,300
  5




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##### Table of Contents



HMN FINANCIAL, INC. AND SUBSIDIARIES
 
 Consolidated
Statements of Cash Flows
 Nine Months EndedSeptember 30,(dollars in thousands)
    
    2007
    
    
    2006Cash flows from operating activities:Net income
    
    $
    8,499
    
    
    
    5,757Adjustments to reconcile net income to cash provided by operating activities:Provision for loan losses
    
    
    2,404
    
    
    
    7,521Depreciation
    
    
    1,429
    
    
    
    1,433Amortization of discounts, net
    
    
    (2,183
    )
    
    
    (1,189
    )Amortization of deferred loan fees
    
    
    (997
    )
    
    
    (1,168
    )Amortization of core deposit intangible
    
    
    85
    
    
    
    85Amortization of mortgage servicing rights
    
    
    540
    
    
    
    661Capitalized mortgage servicing rights
    
    
    (13
    )
    
    
    (147
    )Securities gains, net
    
    
    0
    
    
    
    (48
    )Losses on sales of real estate
    
    
    35
    
    
    
    19Gain on sales of loans
    
    
    (1,189
    )
    
    
    (1,030
    )Proceeds from sales of real estate
    
    
    4,903
    
    
    
    348Proceeds from sales of loans held for sale
    
    
    51,215
    
    
    
    59,652Disbursements on loans held for sale
    
    
    (39,470
    )
    
    
    (58,735
    )Amortization of restricted stock awards
    
    
    251
    
    
    
    141Amortization of unearned ESOP shares
    
    
    146
    
    
    
    145Earned employee stock ownership shares priced above original cost
    
    
    274
    
    
    
    285Stock option compensation
    
    
    32
    
    
    
    48Increase in accrued interest receivable
    
    
    (2,289
    )
    
    
    (199
    )Increase (decrease) in accrued interest payable
    
    
    6,651
    
    
    
    (651
    )Decrease (increase) in other assets
    
    
    1,034
    
    
    
    (4,812
    )Increase (decrease) in other liabilities
    
    
    1,126
    
    
    
    (780
    )Other, net
    
    
    13
    
    
    
    90Net cash provided by operating activities
    
    
    32,496
    
    
    
    7,426Cash flows from investing activities:Proceeds from sales of securities available for sale
    
    
    0
    
    
    
    2,988Principal collected on securities available for sale
    
    
    1,677
    
    
    
    617Proceeds collected on maturities of securities available for sale
    
    
    120,000
    
    
    
    105,500Purchases of securities available for sale
    
    
    (203,067
    )
    
    
    (132,998
    )Purchase of Federal Home Loan Bank stock
    
    
    (999
    )
    
    
    0Redemption of Federal Home Loan Bank stock
    
    
    3,375
    
    
    
    409Net (increase) decrease in loans receivable
    
    
    (96,004
    )
    
    
    46,998Purchases of premises and equipment
    
    
    (2,136
    )
    
    
    (1,189
    )Net cash (used) provided by investing activities
    
    
    (177,154
    )
    
    
    22,325Cash flows from financing activities:Increase in deposits
    
    
    210,923
    
    
    
    9,733Purchase of treasury stock
    
    
    (2,778
    )
    
    
    (2,954
    )Stock options exercised
    
    
    139
    
    
    
    138Excess tax benefits from options exercised
    
    
    99
    
    
    
    47Dividends to stockholders
    
    
    (2,813
    )
    
    
    (2,797
    )Proceeds from Federal Home Loan Bank advances
    
    
    112,100
    
    
    
    0Repayment of Federal Home Loan Bank advances
    
    
    (165,500
    )
    
    
    (10,000
    )Proceeds from Federal Reserve Bank advances
    
    
    2,000
    
    
    
    1,000Repayment of Federal Reserve Bank advances
    
    
    (2,000
    )
    
    
    (1,000
    )Increase in customer escrows
    
    
    628
    
    
    
    52Net cash provided (used) by financing activities
    
    
    152,798
    
    
    
    (5,781
    )Increase in cash and cash equivalents
    
    
    8,140
    
    
    
    23,970Cash and cash equivalents, beginning of period
    
    
    43,776
    
    
    
    47,269Cash and cash equivalents, end of period
    
    $
    51,916
    
    
    
    71,239Supplemental cash flow disclosures:Cash paid for interest
    
    $
    22,083
    
    
    
    21,978Cash paid for income taxes
    
    
    5,482
    
    
    
    6,851Supplemental noncash flow disclosures:Transfer of loans to real estate
    
    
    5,388
    
    
    
    252Loans transferred to loans held for sale
    
    
    11,239
    
    
    
    2,694
  6




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##### Table of Contents



HMN FINANCIAL, INC. AND SUBSIDIARIES
 
 Notes to Consolidated Financial Statements
 September 30, 2007 and 2006
 (1) HMN Financial, Inc.
   (2) Basis of Preparation
   (3) New Accounting Standards
 Accounting for Uncertainty in Income Taxes -
an interpretation of FASB Statement No. 109
 Fair Value Measurements
 7




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##### Table of Contents



The Fair Value Option for Financial Assets and
Financial Liabilities, Including an amendment of FASB Statement No. 115. Fair Value Measurements
 (4) Derivative
Instruments and Hedging Activities
   (5) Comprehensive Income
  For the three months ended September 30,2007
    
    
    2006(Dollars in thousands)
    
    Before tax
    
    
    Tax effect
    
    
    Net of tax
    
    
    Before tax
    
    
    Tax effect
    
    
    Net of taxSecurities available for sale:Gross unrealized gains
arising
during
the period
    
    $
    1,796
    
    
    
    712
    
    
    
    1,084
    
    
    
    801
    
    
    
    317
    
    
    
    484Reclassification of net gains
included in net income
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    0Other comprehensive income
    
    $
    1,796
    
    
    
    712
    
    
    
    1,084
    
    
    
    801
    
    
    
    317
    
    
    
    484
 For the nine months ended September 30,2007
    
    
    2006Before tax
    
    
    Tax effect
    
    
    Net of tax
    
    
    Before tax
    
    
    Tax effect
    
    
    Net of taxSecurities available for sale:Gross unrealized gains arising
during the period
    
    $
    927
    
    
    
    368
    
    
    
    559
    
    
    
    919
    
    
    
    362
    
    
    
    557Reclassification of net gains
included in
net income
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    48
    
    
    
    17
    
    
    
    31Other comprehensive income
    
    $
    927
    
    
    
    368
    
    
    
    559
    
    
    
    871
    
    
    
    345
    
    
    
    526
 (6) Securities
Available For Sale
  8




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##### Table of Contents



Less than twelve months
    
    
    Twelve months or more
    
    
    Total# of
    
    
    Fair
    
    
    Unrealized
    
    
    # of
    
    
    Fair
    
    
    Unrealized
    
    
    Fair
    
    
    Unrealized(Dollars in thousands)
    
    Investments
    
    
    Value
    
    
    Losses
    
    
    Investments
    
    
    Value
    
    
    Losses
    
    
    Value
    
    
    LossesMortgage backed securities:FHLMC
    
    
    1
    
    
    $
    13
    
    
    
    
    
    
    
    1
    
    
    $
    2,430
    
    
    
    (436
    )
    
    $
    2,443
    
    
    
    (436
    )FNMA
    
    
    1
    
    
    
    38
    
    
    
    
    
    
    
    3
    
    
    
    2,854
    
    
    
    (236
    )
    
    
    2,892
    
    
    
    (236
    )Other marketable securities:FNMA
    
    
    1
    
    
    
    9,984
    
    
    
    (9
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    9,984
    
    
    
    (9
    )FHLMC
    
    
    1
    
    
    
    4,991
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,991
    
    
    
    Total temporarily impaired
securities
    
    
    4
    
    
    $
    15,026
    
    
    
    (9
    )
    
    
    4
    
    
    $
    5,284
    
    
    
    (672
    )
    
    $
    20,310
    
    
    
    (681
    )
  (7) Investment in Mortgage Servicing Rights
  Nine Months ended
    
    
    Twelve Months ended
    
    
    Nine Months ended(Dollars in thousands)
    
    Sept. 30, 2007
    
    
    Dec. 31, 2006
    
    
    Sept. 30, 2006Mortgage servicing rightsBalance, beginning of period
    
    $
    1,958
    
    
    
    2,654
    
    
    
    2,654Originations
    
    
    13
    
    
    
    152
    
    
    
    147Amortization
    
    
    (540
    )
    
    
    (848
    )
    
    
    (662
    )Balance, end of period
    
    
    1,431
    
    
    
    1,958
    
    
    
    2,139Fair value of mortgage servicing rights
    
    $
    3,703
    
    
    
    3,823
    
    
    
    4,233
  Weighted
    
    WeightedLoan
    
    Average
    
    AveragePrincipal
    
    Interest
    
    Remaining
    
    Number(Dollars in thousands)
    
    Balance
    
    Rate
    
    Term
    
    of LoansOriginal term 30 year fixed rate
    
    $
    188,809
    
    
    
    5.93
    %
    
    
    315
    
    
    
    1,684Original term 15 year fixed rate
    
    
    156,888
    
    
    
    5.27
    %
    
    
    134
    
    
    
    2,223Adjustable rate
    
    
    3,241
    
    
    
    5.83
    %
    
    
    306
    
    
    
    30
 (8) Intangible
Assets
  Gross
    
    
    
    
    
    
    UnamortizedCarrying
    
    
    Accumulated
    
    
    Intangible(Dollars in thousands)
    
    Amount
    
    
    Amortization
    
    
    AssetsAmortized intangible assets:Mortgage servicing rights
    
    $
    3,920
    
    
    
    (2,489
    )
    
    
    1,431Core deposit intangible
    
    
    1,567
    
    
    
    (1,546
    )
    
    
    21Total
    
    $
    5,487
    
    
    
    (4,035
    )
    
    
    1,452
 9




---



##### Table of Contents



Mortgage
    
    CoreServicing
    
    Deposit(Dollars in thousands)
    
    Rights
    
    Intangible
    
    TotalYear ending December 31,2007
    
    $
    141
    
    
    
    21
    
    
    
    1622008
    
    
    532
    
    
    
    0
    
    
    
    5322009
    
    
    392
    
    
    
    0
    
    
    
    3922010
    
    
    214
    
    
    
    0
    
    
    
    2142011
    
    
    104
    
    
    
    0
    
    
    
    104
  (9) Earnings per Share
  Three months ended September 30,
    
    
    Nine months ended September 30,2007
    
    
    2006
    
    
    2007
    
    
    2006Weighted average number of common shares outstanding
used in basic earnings per common share calculation
    
    
    3,738,462
    
    
    
    3,807,223
    
    
    
    3,755,720
    
    
    
    3,834,973Net dilutive effect of:Options
    
    
    143,492
    
    
    
    181,737
    
    
    
    157,714
    
    
    
    174,474Restricted stock awards
    
    
    17,386
    
    
    
    12,744
    
    
    
    19,223
    
    
    
    13,307Weighted average number of shares outstanding
adjusted for effect of dilutive securities
    
    
    3,899,340
    
    
    
    4,001,704
    
    
    
    3,932,657
    
    
    
    4,022,754Income available to common shareholders
    
    $
    2,781,881
    
    
    
    73,512
    
    
    
    8,499,385
    
    
    
    5,757,288Basic earnings per common share
    
    $
    0.74
    
    
    
    0.02
    
    
    
    2.26
    
    
    
    1.50Diluted earnings per common share
    
    $
    0.71
    
    
    
    0.02
    
    
    
    2.16
    
    
    
    1.43
 (10) Regulatory Capital
    10




---



##### Table of Contents



Required to be
    
    
    
    
    
    
    
    
    
    
    To Be Well CapitalizedAdequately
    
    
    
    
    
    
    
    
    
    
    Under Prompt CorrectiveActual
    
    
    Capitalized
    
    
    Excess Capital
    
    
    Action ProvisionsPercent of
    
    
    
    
    
    
    Percent of
    
    
    
    
    
    
    Percent of
    
    
    
    
    
    
    Percent of(Dollars in thousands)
    
    Amount
    
    
    Assets(1)
    
    
    Amount
    
    
    Assets(1)
    
    
    Amount
    
    
    Assets(1)
    
    
    Amount
    
    
    Assets(1)Bank stockholders equity
    
    $
    92,977Less:Net unrealized gain on certain securities
available for sale
    
    
    (275
    )Goodwill and core deposit intangibles
    
    
    (3,822
    )Disallowed assets
    
    
    (2,518
    )Tier I or core capital
    
    
    86,362Tier I capital to adjusted total assets
    
    
    
    
    
    
    7.60
    %
    
    $
    45,475
    
    
    
    4.00
    %
    
    $
    40,887
    
    
    
    3.60
    %
    
    $
    56,844
    
    
    
    5.00
    %Tier I capital to risk-weighted assets
    
    
    
    
    
    
    10.19
    %
    
    $
    33,907
    
    
    
    4.00
    %
    
    $
    52,455
    
    
    
    6.19
    %
    
    $
    50,861
    
    
    
    6.00
    %Plus:Allowable allowance for loan losses
    
    
    10,596Risk-based capital
    
    $
    96,958
    
    
    
    
    
    
    $
    67,815
    
    
    
    
    
    
    $
    29,143
    
    
    
    
    
    
    $
    84,769Risk-based capital to risk- weighted assets
    
    
    
    
    
    
    11.44
    %
    
    
    
    
    
    
    8.00
    %
    
    
    
    
    
    
    3.44
    %
    
    
    
    
    
    
    10.00
    %
 
 (1)
    
    Based upon the Banks adjusted total assets for the purpose of the tangible and core capital ratios and risk-weighted assets for the purpose of the risk-based capital ratio.  (11) Commitments and Contingencies
   (12) Income Taxes
  11




---



##### Table of Contents



(13) Business Segments
   12




---



##### Table of Contents



Home Federal
    
    
    
    
    
    
    
    
    
    Consolidated(Dollars in thousands)
    
    Savings Bank
    
    Other
    
    Eliminations
    
    TotalAt or for the quarter ended September 30, 2007:Interest income  external customers
    
    $
    20,276
    
    
    
    2
    
    
    
    0
    
    
    
    20,278Non-interest income  external customers
    
    
    1,549
    
    
    
    100
    
    
    
    0
    
    
    
    1,649Intersegment interest income
    
    
    0
    
    
    
    27
    
    
    
    (27
    )
    
    
    0Intersegment non-interest income
    
    
    44
    
    
    
    2,821
    
    
    
    (2,865
    )
    
    
    0Interest expense
    
    
    10,492
    
    
    
    0
    
    
    
    (27
    )
    
    
    10,465Amortization of mortgage servicing rights, net
    
    
    169
    
    
    
    0
    
    
    
    0
    
    
    
    169Other non-interest expense
    
    
    5,634
    
    
    
    194
    
    
    
    (44
    )
    
    
    5,784Income tax expense (benefit)
    
    
    1,832
    
    
    
    (26
    )
    
    
    0
    
    
    
    1,806Net income
    
    
    2,821
    
    
    
    2,782
    
    
    
    (2,821
    )
    
    
    2,782Goodwill
    
    
    3,801
    
    
    
    0
    
    
    
    0
    
    
    
    3,801Total assets
    
    
    1,142,558
    
    
    
    97,981
    
    
    
    (93,126
    )
    
    
    1,147,413At or for the quarter ended September 30, 2006:Interest income  external customers
    
    $
    17,165
    
    
    
    10
    
    
    
    0
    
    
    
    17,175Non-interest income  external customers
    
    
    1,735
    
    
    
    0
    
    
    
    0
    
    
    
    1,735Intersegment interest income
    
    
    3
    
    
    
    0
    
    
    
    (3
    )
    
    
    0Intersegment non-interest income
    
    
    34
    
    
    
    223
    
    
    
    (257
    )
    
    
    0Interest expense
    
    
    7,473
    
    
    
    3
    
    
    
    (3
    )
    
    
    7,473Amortization of mortgage servicing rights, net
    
    
    208
    
    
    
    0
    
    
    
    0
    
    
    
    208Other non-interest expense
    
    
    5,008
    
    
    
    257
    
    
    
    (34
    )
    
    
    5,231Income tax (benefit)
    
    
    (3
    )
    
    
    (99
    )
    
    
    0
    
    
    
    (102
    )Net income
    
    
    225
    
    
    
    72
    
    
    
    (223
    )
    
    
    74Goodwill
    
    
    3,801
    
    
    
    0
    
    
    
    0
    
    
    
    3,801Total assets
    
    
    986,694
    
    
    
    92,742
    
    
    
    (88,178
    )
    
    
    991,258At or for the nine months ended September 30, 2007:Interest income  external customers
    
    $
    58,145
    
    
    
    40
    
    
    
    0
    
    
    
    58,185Non-interest income  external customers
    
    
    4,908
    
    
    
    100
    
    
    
    0
    
    
    
    5,008Intersegment interest income
    
    
    0
    
    
    
    85
    
    
    
    (85
    )
    
    
    0Intersegment non-interest income
    
    
    131
    
    
    
    8,687
    
    
    
    (8,818
    )
    
    
    0Interest expense
    
    
    28,818
    
    
    
    0
    
    
    
    (85
    )
    
    
    28,733Amortization of mortgage servicing rights, net
    
    
    540
    
    
    
    0
    
    
    
    0
    
    
    
    540Other non-interest expense
    
    
    17,090
    
    
    
    553
    
    
    
    (131
    )
    
    
    17,512Income tax expense (benefit)
    
    
    5,642
    
    
    
    (137
    )
    
    
    0
    
    
    
    5,505Net income
    
    
    8,690
    
    
    
    8,496
    
    
    
    (8,687
    )
    
    
    8,499Goodwill
    
    
    3,801
    
    
    
    0
    
    
    
    0
    
    
    
    3,801Total assets
    
    
    1,142,558
    
    
    
    97,981
    
    
    
    (93,126
    )
    
    
    1,147,413At or for the nine months ended September 30, 2006:Interest income  external customers
    
    $
    50,083
    
    
    
    86
    
    
    
    0
    
    
    
    50,169Non-interest income  external customers
    
    
    4,988
    
    
    
    0
    
    
    
    0
    
    
    
    4,988Intersegment interest income
    
    
    3
    
    
    
    0
    
    
    
    (3
    )
    
    
    0Intersegment non-interest income
    
    
    101
    
    
    
    6,052
    
    
    
    (6,153
    )
    
    
    0Interest expense
    
    
    21,328
    
    
    
    3
    
    
    
    (3
    )
    
    
    21,328Amortization of mortgage servicing rights, net
    
    
    661
    
    
    
    0
    
    
    
    0
    
    
    
    661Other non-interest expense
    
    
    16,007
    
    
    
    576
    
    
    
    (101
    )
    
    
    16,482Income tax expense (benefit)
    
    
    3,603
    
    
    
    (195
    )
    
    
    0
    
    
    
    3,408Net income
    
    
    6,055
    
    
    
    5,754
    
    
    
    (6,052
    )
    
    
    5,757Goodwill
    
    
    3,801
    
    
    
    0
    
    
    
    0
    
    
    
    3,801Total assets
    
    
    986,694
    
    
    
    92,742
    
    
    
    (88,178
    )
    
    
    991,258
 13




---



##### Table of Contents



HMN FINANCIAL, INC.
 
 Item 2: MANAGEMENTS DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 Forward-looking Information
  General
   Critical Accounting Policies
  14




---



##### Table of Contents



Allowance for Loan Losses and Related Provision
   Mortgage Servicing Rights
  15




---



##### Table of Contents



Income Taxes
  Accounting for Uncertainty in Income Taxes 
an interpretation of FASB Statement No. 109
 Net Income
   Net Interest Income
  16




---



##### Table of Contents



17




---



##### Table of Contents



For the nine month period endedSeptember 30, 2007
    
    
    September 30, 2006Average
    
    
    Interest
    
    
    
    
    
    
    Average
    
    
    InterestOutstanding
    
    
    Earned/
    
    
    Yield/
    
    
    Outstanding
    
    
    Earned/
    
    
    Yield/(Dollars in thousands)
    
    Balance
    
    
    Paid
    
    
    Rate
    
    
    Balance
    
    
    Paid
    
    
    RateInterest-earning assets:Securities available for sale
    
    $
    190,231
    
    
    
    7,305
    
    
    
    5.13
    %
    
    $
    132,688
    
    
    
    3,930
    
    
    
    3.96
    %Loans held for sale
    
    
    2,368
    
    
    
    110
    
    
    
    6.23
    
    
    
    3,891
    
    
    
    186
    
    
    
    6.39Mortgage loans, net
    
    
    142,034
    
    
    
    6,531
    
    
    
    6.15
    
    
    
    128,880
    
    
    
    5,723
    
    
    
    5.94Commercial loans, net
    
    
    593,080
    
    
    
    37,530
    
    
    
    8.46
    
    
    
    538,096
    
    
    
    32,697
    
    
    
    8.12Consumer loans, net
    
    
    84,248
    
    
    
    5,461
    
    
    
    8.67
    
    
    
    97,346
    
    
    
    6,141
    
    
    
    8.43Cash equivalents
    
    
    25,516
    
    
    
    972
    
    
    
    5.09
    
    
    
    36,218
    
    
    
    1,254
    
    
    
    4.63Federal Home Loan Bank stock
    
    
    6,940
    
    
    
    276
    
    
    
    5.32
    
    
    
    8,266
    
    
    
    238
    
    
    
    3.85Total interest-earning assets
    
    
    1,044,417
    
    
    
    58,185
    
    
    
    7.45
    
    
    
    945,385
    
    
    
    50,169
    
    
    
    7.10Interest-bearing liabilities:Noninterest checking
    
    
    55,607
    
    
    
    0
    
    
    
    0.00
    
    
    
    50,188
    
    
    
    0
    
    
    
    0.00NOW accounts
    
    
    113,733
    
    
    
    2,685
    
    
    
    3.16
    
    
    
    97,138
    
    
    
    1,873
    
    
    
    2.58Savings accounts
    
    
    40,654
    
    
    
    414
    
    
    
    1.36
    
    
    
    67,090
    
    
    
    942
    
    
    
    1.88Money market accounts
    
    
    222,056
    
    
    
    6,314
    
    
    
    3.80
    
    
    
    145,732
    
    
    
    3,527
    
    
    
    3.24Certificates
    
    
    235,787
    
    
    
    7,815
    
    
    
    4.43
    
    
    
    232,604
    
    
    
    6,238
    
    
    
    3.59Brokered deposits
    
    
    193,332
    
    
    
    7,278
    
    
    
    5.03
    
    
    
    134,861
    
    
    
    3,618
    
    
    
    3.59Federal Home Loan Bank advances
    
    
    122,817
    
    
    
    4,227
    
    
    
    4.60
    
    
    
    157,863
    
    
    
    5,130
    
    
    
    4.34Other
    
    
    1,030
    
    
    
    0
    
    
    
    0.00
    
    
    
    927
    
    
    
    0
    
    
    
    0.00Total interest-bearing liabilities
    
    
    985,016
    
    
    
    28,733
    
    
    
    3.90
    
    
    
    886,403
    
    
    
    21,328
    
    
    
    3.22Net interest income
    
    
    
    
    
    $
    29,452
    
    
    
    
    
    
    
    
    
    
    $
    28,841Net interest rate spread
    
    
    
    
    
    
    
    
    
    
    3.55
    %
    
    
    
    
    
    
    
    
    
    
    3.88
    %Net earning assets
    
    $
    59,401
    
    
    
    
    
    
    
    
    
    
    $
    58,982Net interest margin
    
    
    
    
    
    
    
    
    
    
    3.77
    %
    
    
    
    
    
    
    
    
    
    
    4.08
    %Average interest-earning assets to
average interest-bearing liabilities
    
    
    
    
    
    
    106.03
    %
    
    
    
    
    
    
    
    
    
    
    106.65
    %
 Provision for Loan Losses
   18




---



##### Table of Contents



(in thousands)
    
    2007
    
    
    2006Balance at January 1,
    
    $
    9,873
    
    
    $
    8,778Provision
    
    
    2,404
    
    
    
    7,521Charge offs:Commercial loans
    
    
    (16
    )
    
    
    (151
    )Commercial real estate loans
    
    
    (138
    )
    
    
    (7,222
    )Consumer loans
    
    
    (694
    )
    
    
    (235
    )Recoveries
    
    
    123
    
    
    
    55Balance at September 30,
    
    $
    11,552
    
    
    $
    8,746
 Non-Interest Income
   Non-Interest Expense
   19




---



##### Table of Contents



Income Tax Expense
   Non-Performing Assets
  Sept. 30,
    
    
    June 30,
    
    
    Dec. 31,(Dollars in thousands)
    
    2007
    
    
    2007
    
    
    2006Non-Accruing Loans:One-to-four family real estate
    
    $
    2,169
    
    
    
    634
    
    
    
    1,364Commercial real estate
    
    
    11,551
    
    
    
    8,361
    
    
    
    5,296Consumer
    
    
    1,222
    
    
    
    972
    
    
    
    1,254Commercial business
    
    
    2,798
    
    
    
    1,641
    
    
    
    394Total
    
    
    17,740
    
    
    
    11,608
    
    
    
    8,308Other assets
    
    
    34
    
    
    
    44
    
    
    
    44Foreclosed and Repossessed Assets:One-to-four family real estate
    
    
    905
    
    
    
    4,052
    
    
    
    1,422Commercial real estate
    
    
    1,600
    
    
    
    650
    
    
    
    650Consumer
    
    
    0
    
    
    
    11
    
    
    
    0Total non-performing assets
    
    $
    20,279
    
    
    $
    16,365
    
    
    $
    10,424Total as a percentage of total assets
    
    
    1.77
    %
    
    
    1.45
    %
    
    
    1.07
    %Total non-performing loans
    
    $
    17,740
    
    
    $
    11,608
    
    
    $
    8,308Total as a percentage of total loans
receivable, net
    
    
    2.10
    %
    
    
    1.38
    %
    
    
    1.08
    %Allowance for loan loss to non-performing loans
    
    
    65.12
    %
    
    
    92.39
    %
    
    
    118.84
    %
  20




---



##### Table of Contents



Dividends
   Record date
    
    Payable date
    
    Dividend per share
    

Dividend Payout RatioFebruary 16, 2007
    
    March 7, 2007
    
    $0.25
    
    37.31%May 18, 2007
    
    June 7, 2007
    
    $0.25
    
    30.49%August 24, 2007
    
    September 7, 2007
    
    $0.25
    
    36.76%November 23, 2007
    
    December 12, 2007
    
    $0.25
    
    35.21%
   Liquidity
    21




---



##### Table of Contents



Market Risk
  Rate Shock Table
  Other than trading portfolio
    
    Market Value(Dollars in thousands)Basis point change in interest rates
    
    -200
    
    
    -100
    
    
    0
    
    
    +100
    
    
    +200Total market risk sensitive assets
    
    $
    1,154,654
    
    
    
    1,144,320
    
    
    
    1,130,846
    
    
    
    1,115,895
    
    
    
    1,099,709Total market risk sensitive liabilities
    
    
    1,032,099
    
    
    
    1,020,477
    
    
    
    1,010,509
    
    
    
    1,002,381
    
    
    
    995,521Off-balance sheet financial instruments
    
    
    (62
    )
    
    
    (27
    )
    
    
    0
    
    
    
    141
    
    
    
    270Net market risk
    
    $
    122,617
    
    
    
    123,870
    
    
    
    120,337
    
    
    
    113,373
    
    
    
    103,918Percentage change from current market value
    
    
    1.89
    %
    
    
    2.94
    %
    
    
    0.00
    %
    
    
    (5.79
    )%
    
    
    (13.64
    )%
  22




---



##### Table of Contents



Asset/Liability Management
  Projected Change inRate Shock
    
    Net Interest
    
    Percentage(Dollars in thousands)
    
    in Basis Points
    
    Income
    
    Change+200
    
    
    $
    (1,779
    )
    
    
    (4.33
    )%+100
    
    
    
    (756
    )
    
    
    (1.84
    )0
    
    
    
    0
    
    
    
    0.00-100
    
    
    
    (777
    )
    
    
    (1.89
    )-200
    
    
    
    (1,415
    )
    
    
    (3.45
    )
     23




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##### Table of Contents



Item 4: Controls and Procedures
 Evaluation of disclosure controls and procedures.
 Changes in internal controls.
 24




---



##### Table of Contents



HMN FINANCIAL, INC.
 
 PART II  OTHER INFORMATION
 
   
   
    (a) Total
    
    
    
    
    
    
    (c) Total Number of
    
    
    (d) Maximum NumberNumber of
    
    
    
    
    
    
    Shares Purchased as Part
    
    
    of Shares that May YetShares
    
    
    (b) Average Price
    
    
    of Publicly Announced
    
    
    Be Purchased Under the PlansPeriod
    
    Purchased
    
    
    Paid per Share
    
    
    Plans or Programs
    
    
    or ProgramsJuly 1 through July 31, 2007
    
    
    0
    
    
    $
    0
    
    
    
    0
    
    
    
    236,000August 1 through August 31, 2007
    
    
    20,000
    
    
    
    29.23
    
    
    
    20,000
    
    
    
    216,000September 1 through September
30, 2007
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    216,000Total
    
    
    20,000
    
    
    $
    29.23
    
    
    
    20,000
 
   
   
   
   25




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##### Table of Contents



SIGNATURES
  HMN FINANCIAL, INC.RegistrantDate: November 2, 2007
    
    /s/ Michael McNeilMichael McNeil,President/Chief Executive Officer(Principal Executive Officer)(Duly Authorized Representative)Date: November 2, 2007
    
    /s/ Jon EberleJon Eberle,Chief Financial Officer(Principal Financial Officer)
 26




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##### Table of Contents



HMN FINANCIAL, INC.
INDEX TO EXHIBITS
FOR FORM 10-Q
 SequentialReference
    
    Page NumberingRegulation
    
    
    
    to Prior
    
    Where AttachedS-K
    
    
    
    Filing or
    
    Exhibits AreExhibit
    
    
    
    Exhibit
    
    Located in ThisNumber
    
    Document Attached Hereto
    
    Number
    
    Form 10-Q Report3.1
    
    Amended and Restated Articles of Incorporation
    
    *1
    
    N/A3.2
    
    Amended and Restated By-laws
    
    *2
    
    N/A4
    
    Form of Common Stock
Including indentures
    
    *3
    
    N/A31.1
    
    Rule 13a-14(a)/15d-14(a) Certification of CEO
    
    31.1
    
    Filed Electronically31.2
    
    Rule 13a-14(a)/15d-14(a) Certification of CFO
    
    31.2
    
    Filed Electronically32
    
    Section 1350 Certification
of CEO and CFO
    
    32
    
    Filed Electronically
 
 *1
    
    Incorporated by reference to the same numbered exhibit to the Companys Quarterly Report on Form
10-Q for the period ended March 31, 1998 (File No. 0-24100).*2
    
    Incorporated by reference to the same numbered exhibit to the Companys Quarterly Report on Form
10-Q for the period ended June 30, 2007 (File No. 0-24100).*3
    
    Incorporated by reference to the same numbered exhibit to the Companys Registration Statement on
Form S-1 dated April 1, 1994 (File No. 33-77212).
 27