UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.

FORM 10-Q

[X]	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE 
SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2002

OR

[ ]	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.

(Exact name of Registrant as specified in its Charter)

|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)                             
|Registrant's telephone number, including area code:            |  | (507) 535-1200                         



Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes (X)         	No ( )

Indicate the number of shares outstanding of each of the issuer's common stock as of the latest practicable date.



|Class                         |  | Outstanding at November 6, 2002
|----------------------------- |  | -------------------------------
|Common stock, $0.01 par value |  | 4,449,006                      





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HMN FINANCIAL, INC.

CONTENTS

PART I - FINANCIAL INFORMATIONPageItem 1:
Financial Statements (unaudited)Consolidated Balance Sheets at September 30, 2002 and December 31, 2001
3Consolidated Statements of Income for the Three Months Ended and Nine Months Ended September 30, 2002 and 2001
4Consolidated Statements of Comprehensive Income for the Three Months Ended and Nine Months Ended September 30, 2002 and 2001
5Consolidated Statement of Stockholders' Equity for the Nine Month Period Ended September 30, 2002
6Consolidated Statements of Cash Flows for the Nine Months Ended
September 30, 2002 and 2001
7Notes to Consolidated Financial Statements
8-16Item 2:
Management's Discussion and Analysis of Financial Condition and Results of Operations
17-26Item 3:
Quantitative and Qualitative Disclosures about Market Risk Discussion included in Item 2 under Market Risk
22Item 4:
Controls and Procedures
26PART II - OTHER INFORMATIONItem 1:
Legal Proceedings
28Item 2:
Changes in Securities
28Item 3:
Defaults Upon Senior Securities
28Item 4:
Submission of Matters to a Vote of Security Holders
28Item 5:
Other Information
28Item 6:
Exhibits and Reports on Form 8-K
28Signatures
29


2



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PART I - FINANCIAL STATEMENTS

HMN FINANCIAL, INC. AND SUBSIDIARIESConsolidated Balance Sheets(unaudited)September 30,

December 31,2002

2001AssetsCash and cash equivalents
$
48,020,778

23,019,553Securities available for sale:Mortgage-backed and related securities(amortized cost $62,334,585 and $65,878,534)

61,882,400

66,229,732Other marketable securities(amortized cost $45,181,323 and $53,439,401)

46,810,846

53,665,502108,693,246

119,895,234Loans held for sale

14,418,617

68,017,570Loans receivable, net

508,035,550

471,667,772Accrued interest receivable

3,170,206

3,508,828Federal Home Loan Bank stock, at cost

11,880,500

12,245,000Mortgage servicing rights, net

2,251,335

1,903,636Premises and equipment, net

13,518,659

10,860,756Investment in limited partnerships

1,318,491

1,523,650Goodwill

3,800,938

3,800,938Core deposit intangible

592,375

685,509Prepaid expenses and other assets

3,768,574

3,985,625Total assets
$
719,469,269

721,114,071Liabilities and Stockholders' EquityDeposits
$
422,346,889

421,843,369Federal Home Loan Bank advances

214,300,000

217,800,000Accrued interest payable

742,024

1,017,456Advance payments by borrowers for taxes and insurance

877,566

1,015,570Accrued expenses and other liabilities

5,299,054

6,535,734Deferred tax liabilities

1,143,300

976,900Total liabilities

644,708,833

649,189,029Commitments and contingenciesMinority interest

(419,878)

(236,309)Stockholders' 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

91,287

91,287Additional paid-in capital

58,934,419

59,168,782Retained earnings, subject to certain restrictions

79,198,727

76,956,978Accumulated other comprehensive income

760,839

367,744Unearned employee stock ownership plan shares

(4,979,675)

(5,124,746)Unearned compensation restricted stock awards

0

(7,350)Treasury stock, at cost 4,701,656 and 4,732,521 shares

(58,825,283)

(59,291,344)Total stockholders' equity

75,180,314

72,161,351Total liabilities and stockholders' equity
$
719,469,269

721,114,071


See accompanying notes to consolidated financial statements.

3

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HMN FINANCIAL, INC. AND SUBSIDIARIESConsolidated Statements of Income(unaudited)Three Months EndedSeptember 30,2002                        2001

Nine Months Ended
September 30,
2002                                   2001Interest income:Loans receivable
$
9,502,274

11,057,446

28,271,049

33,605,383Securities available for sale:Mortgage-backed and related

485,086

893,913

1,497,251

3,171,869Other marketable

515,997

441,500

1,952,793

1,931,904Cash equivalents

38,564

65,571

297,916

137,107Other

90,603

117,777

265,305

414,505Total interest income

10,632,524

12,576,207

32,284,314

39,260,768Interest expense:Deposits

2,556,830

4,636,529

8,304,055

14,607,907Federal Home Loan Bank advances

2,616,265

2,851,114

7,788,063

9,199,980Total interest expense

5,173,095

7,487,643

16,092,118

23,807,887Net interest income

5,459,429

5,088,564

16,192,196

15,452,881Provision for loan losses

771,000

300,000

1,801,000

750,000Net interest income after provisionfor loan losses

4,688,429

4,788,564

14,391,196

14,702,881Non-interest income:Fees and service charges

418,115

417,116

1,212,276

1,131,667Mortgage servicing fees

184,769

113,908

521,931

328,139Securities gains (losses), net

376,838

71,338

422,346

(260,958)Gain on sales of loans

432,095

591,881

1,975,124

2,733,313Earnings (losses) in limitedpartnerships

(530,943)

104,896

(203,968)

(523,643)Other

122,539

119,908

531,519

449,859Total non-interest income

1,003,413

1,419,047

4,459,228

3,858,377Non-interest expense:Compensation and benefits

1,986,777

1,924,282

6,006,821

5,879,340Occupancy

801,026

528,192

2,210,714

1,607,983Federal deposit insurance premiums

18,173

19,841

56,280

60,613Advertising

129,254

94,914

418,336

295,057Data processing

272,696

238,728

824,060

710,482Amortization of mortgage servicingrights, net of valuation adjustmentsand servicing costs

502,282

157,850

884,588

493,888Other

844,581

812,812

2,825,635

2,302,096Total noninterest expense

4,554,789

3,776,619

13,226,454

11,349,459Income before income tax expense

1,137,053

2,430,992

5,623,970

7,211,799Income tax expense

312,200

571,285

1,637,400

2,356,185Income before minority interest

824,853

1,859,707

3,986,570

4,855,614Minority interest

(67,012)

(163,373)

(141,306)

(30,493)Net income
$
891,865

2,023,080

4,127,876

4,886,107Basic earnings per share
$
0.24

0.53

1.10

1.30Diluted earnings per share
$
0.22

0.50

1.04

1.23


See accompanying notes to consolidated financial statements.



4

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HMN FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income
	(unaudited)

Three Months Ended September 30,2002

2001Net income
$




891,865





2,023,080Other comprehensive income, net of tax:Unrealized losses on hedging valuation

0





(218,985)Less: minority interest in hedging valuation

0





(91,484)Net unrealized losses on hedging valuation



0





(127,501)Unrealized gains (losses) on securities:Unrealized holding gains (losses) arising during period

1,195,786





(555,035)Less: reclassification adjustment for gainsincluded in net income

243,738





43,038Net unrealized gains (losses) on securities



952,048





(598,073)Other comprehensive income (loss)





952,048





(725,574)Comprehensive income
$




1,843,913





1,297,506








Nine Months Ended September 30,2002

2001Net income
$




4,127,876





4,886,107Other comprehensive income, net of tax:Unrealized losses on hedging valuation

(35,795)





(300,606)Less: minority interest in hedging valuation

(21,950)





(122,173)Net unrealized losses on hedging valuation



(13,845)





(178,433)Unrealized gains on securities:Unrealized holding gains arising during period

680,086





1,388,158Less: reclassification adjustment for gains (losses)included in net income

273,146





(154,550)Net unrealized gains on securities



406,940





1,542,708Other comprehensive income





393,095





1,364,275Comprehensive income
$




4,520,971





6,250,382


See accompanying notes to consolidated financial statements.

5

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HMN FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Statement of Stockholders' Equity

For the Nine Month Period Ended September 30, 2002

(unaudited)



UnearnedAccumulated
Employee
UnearnedAccumulated
Stock
Compensation

TotalAdditional

Other
Ownership
Restricted

Stock-Common
Paid-in
Retained
Comprehensive
Plan
Stock
Treasury
Holders'Stock
Capital
Earnings
Income
Shares
Awards
Stock
EquityBalance, December 31, 2001
$ 91,287
59,168,782
76,956,978
367,744
(5,124,746)
(7,350)
(59,291,344)
72,161,351Net income


4,127,876




4,127,876Other comprehensive income



393,095



393,095Treasury stock purchases






(658,611)
(658,611)Employee stock optionsexercised

(489,175)




1,124,672
635,497Tax benefits of exercisedstock options

148,023





148,023Amortization of restrictedstock awards





7,350

7,350Dividends paid


(1,886,127)




(1,886,127)Earned employee stockownership plan shares

106,789


145,071


251,860Balance, September 30, 2002
$ 91,287
58,934,419
79,198,727
760,839
(4,979,675)
0
(58,825,283)
75,180,314


See accompanying notes to consolidated financial statements.

6

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HMN FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(unaudited)

Nine Months Ended
September 30,2002

2001Cash flows from operating activities:Net income
$
4,127,876

4,886,107Adjustments to reconcile net income to cash provided by operating activities:Provision for loan losses

1,801,000

750,000Depreciation

1,012,082

754,227Amortization of premiums, net

239,534

72,127Amortization of deferred loan fees

(498,149)

(390,794)Amortization of goodwill

0

135,027Amortization of core deposit intangible

93,134

85,802Amortization of other purchase accounting adjustments

7,495

9,025Amortization of mortgage servicing rights and net valuation adjustments

864,573

493,829Capitalized mortgage servicing rights

(1,212,272)

(990,324)Deferred income taxes

(104,400)

125,000Securities (gains) losses, net

(422,346)

260,958Gain on sales of real estate

(1,254)

(17,293)Gain on sales of loans

(1,975,124)

(2,733,403)Proceeds from sale of loans held for sale

202,650,820

568,937,142Disbursements on loans held for sale

(141,643,268)

(623,170,040)Principal collected on loans held for sale

106,603

154,425Amortization of restricted stock awards

7,350

2,450Amortization of unearned ESOP shares

145,071

145,031Earned employee stock ownership shares priced above original cost

106,789

76,850Decrease in accrued interest receivable

338,622

658,288Decrease in accrued interest payable

(275,432)

(475,151)Equity losses of limited partnerships

203,968

523,643Equity (losses) of minority interest

(141,306)

(30,493)Increase in other assets

(94,329)

(2,214,259)Increase (decrease) in other liabilities

(1,441,860)

2,044,898Other, net

29,614

(33,054)Net cash provided (used) by operating activities

63,924,791

(49,939,982)Cash flows from investing activities:Proceeds from sales of securities available for sale

18,036,553

19,135,721Principal collected on securities available for sale

14,077,803

13,667,575Proceeds collected on maturity of securities available for sale

19,900,000

12,695,000Purchases of securities available for sale

(40,055,856)

0Proceeds from sales of loans receivable

0

12,156Net decrease (increase) in loans receivable

(42,391,910)

17,585,021Redemption of Federal Home Loan Bank stock

364,500

0Proceeds from sale of real estate

52,435

316,797Purchases of premises and equipment

(3,681,249)

(1,743,705)Net cash provided (used) by investing activities

(33,697,724)

61,668,565Cash flows from financing activities:Increase in deposits

321,403

7,588,014Purchase of treasury stock

(658,611)

(74,152)Stock options exercised

635,497

475,586Dividends to stockholders

(1,886,127)

(1,347,740)Proceeds from Federal Home Loan Bank advances

0

259,700,000Repayment of Federal Home Loan Bank advances

(3,500,000)

(271,800,000)Minority interest in mortgage services

0

125,000Increase (decrease) in advance payments by borrowers for taxes and insurance

(138,004)

511,738Net cash used by financing activities

(5,225,842)

(4,821,554)Increase in cash and cash equivalents

25,001,225

6,907,029Cash and cash equivalents, beginning of period

23,019,553

14,416,861Cash and cash equivalents, end of period
$
48,020,778

21,323,890Supplemental cash flow disclosures:Cash paid for interest
$
16,367,550

24,283,038Cash paid for income taxes

1,817,500

2,168,000Supplemental noncash flow disclosures:Loans transferred to loans held for sale

4,267,484

1,216,509Transfer of loans to real estate

370,625

86,123


See accompanying notes to consolidated financial statements.

7

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HMN FINANCIAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(unaudited)
	September 30, 2002 and 2001

HMN Financial, Inc. (HMN) is a stock savings bank holding company that owns 100 percent of Home Federal Savings Bank (the Bank or Home Federal). Home Federal has a community banking philosophy and operates retail banking facilities in Minnesota and Iowa. The Bank has two wholly owned subsidiaries, Osterud Insurance Agency, Inc. (OAI) which offers financial planning products and services and Home Federal REIT, Inc. (HFREIT) which invests in real estate loans acquired from the Bank. HMN has another wholly owned subsidiary, SecurityFinance Corporation (SFC) which holds a limited number of commercial loans originated by third parties. The Bank has a 51% owned subsidiary, Home Federal Mortgage Services, LLC (HFMS), which is a mortgage banking and mortgage brokerage business located in Brooklyn Park, Minnesota. The Bank is in the process of liquidating the assets of HFMS and mortgage production has ceased as of September 30, 2002.
The consolidated financial statements included herein are for HMN, SFC, the Bank and the Bank's subsidiaries, OAI, HFREIT and HFMS. All significant intercompany accounts and transactions have been eliminated in consolidation.

(2) Basis of Preparation

8

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(4) Derivative Instruments and Hedging ActivitiesHMN adopted SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, in the first quarter of 2001. In July of 2001, HMN entered into an interest rate swap for $15 million. Under the interest rate swap, HMN pays interest based upon the three month London Inter-Bank Offer Rate (LIBOR) and receives interest payments based upon a fixed rate of 6.0% on a notional value of $15 million in a fair value hedge with no ineffectiveness. The hedge is offsetting a callable certificate of deposit for $15 million that was issued by HMN. In July of 2002, the interest rate swap was called and the corresponding certificate of deposit was also called. As of September 30, 2002, HMN has not entered into any other interest rate swaps. 
HMN originates and purchases single family residential loans for sale into the secondary market and enters into commitments to sell or securitize those loans in order to mitigate the interest rate risk associated with holding the loans until they are sold. At the beginning of the second quarter of 2001, certain commitments to sell Loans Held for Sale were designated as a cash flow hedge of a forecasted transaction and were accounted for in accordance with SFAS No. 133 with no ineffectiveness recognized in the income statement. In the second quarter of 2002 cash flow hedge accounting was discontinued because
HMN ceased delivery of loans under a mortgage backed security program. The mortgage banking operations  in
the Brooklyn Park location were eliminated and some of the activity was moved to
other branches within HMN. 
HMN has commitments outstanding to extend credit to future borrowers or to purchase loans that had not closed prior to the end of the quarter which it intends to sell. These commitments are referred to as its mortgage pipeline. As commitments to originate or purchase loans enter the mortgage pipeline, generally HMN simultaneously enters into commitments to sell the mortgage pipeline into the secondary market. The commitments to originate, purchase or sell loans are derivatives. As a result of marking the mortgage pipeline and the related commitments to sell to market for the third quarter ended September 30, 2002, HMN recorded an increase in Other Assets of $757,633, and an increase in Other Liabilities of $757,633. 
The current commitments to sell Loans Held for Sale are derivatives that do not qualify for hedge accounting. As a result, these derivatives are marked to market. The Loans Held for Sale that are not hedged are recorded at the lower of cost or market. The lower of cost or market and the market value adjustments as of and for the quarter ended September 30, 2002 include loans that do not qualify for hedge accounting. As a result of marking these loans, HMN recorded a decrease to Loans Held for Sale of $1,567 and an increase in Other Liabilities of $188,487, and a net loss in gains or losses on sales of loans of $190,054. The unrealized gains on loans held for sale of $188,487 will not be recognized in income until the loans are sold in the fourth quarter of 2002.(5) Comprehensive IncomeComprehensive income is defined as the change in equity during a period from transactions and other events from nonowner sources. Comprehensive income is the total of net income and other comprehensive income, which for HMN is comprised of unrealized gains and losses on securities available for sale and unrealized gains and losses on hedging activity for loans held for sale and certificates of deposit with matching interest rate swaps. 
There was no hedging activity for the third quarter of 2002 due to the phase down of the mortgage banking operations of HFMS. The gross unrealized holding gains on securities for the third quarter of 2002 was $1,837,000, the income tax expense would have been $641,000 and therefore, the net gain was $1,196,000. The gross reclassification adjustment for the third quarter of 2002 was $377,000, the income tax expense would have been $133,000 and therefore, the net gain was $244,000. The gross unrealized losses in hedging valuation for the third quarter of 2001 was $362,000, the income tax benefit would have been $143,000 and therefore, the net loss was $219,000. The gross minority interest in hedging valuation for the third quarter of 2001 was $151,000, the income tax benefit would have been $60,000 and therefore, the net loss was $91,000. The gross unrealized holding losses on securities for the third quarter of 2001 was $906,000, the incometax benefit would have been $351,000 and therefore, the net loss was $555,000. The gross reclassification adjustment in the third quarter of

9

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2001 was $71,000, the income tax expense would have been $28,000 and therefore, the net reclassification adjustment was a gain of $43,000. 
The gross unrealized losses in hedging valuation for the nine month period ended September 30, 2002 was $45,000, the income tax benefit would have been $9,000 and therefore, the net loss was $36,000. The gross minority interest in hedging valuation for the nine month period ended September 30, 2002 was $22,000. The gross unrealized holding gains on securities for the nine month period ended September 30, 2002 was $1,022,000, the income tax expense would have been $342,000 and therefore, the net gain was $680,000. The gross reclassification adjustment in the nine month period ended September 30, 2002 was $422,000, the income tax benefit would have been $149,000 and therefore, the net loss was $273,000. The gross minority interest in hedging valuation for the nine month period ended September 30, 2001 was $201,000, the income tax benefit would have been $79,000 and therefore, the net loss was $122,000. The gross unrealized holding gains on securities for the nine month period ended September 30, 2001 was $2,319,000, the income tax benefit would have been $931,000 and therefore, the net gain was $1,388,000. The gross reclassification adjustment in the nine month period ended September 30, 2001 was $261,000, the income tax benefit would have been $106,000 and therefore, the net reclassification adjustment was $155,000.(6) Cash DividendOn October 22, 2002 HMN's Board of Directors announced a cash dividend of $0.18 per share, payable on December 11, 2002 to stockholders of record on November 22, 2002.(7) Investment in Mortgage Servicing RightsA summary of mortgage servicing activity is as follows:

Nine Months ended 
Sept. 30, 2002

Twelve Months
ended
Dec. 31, 2001

Nine Months 
ended 
Sept. 30, 2001Mortgage servicing rightsBalance, beginning of period
$
1,922,736

1,188,928

1,188,928Originations

1,212,272

1,458,321

990,324Amortization

(665,173)

(724,513)

(493,829)Balance, end of period

2,469,835

1,922,736

1,685,423Valuation reserveBalance, beginning of period

(19,100)

0

0Additions

(210,000)

(19,100)

(1,988)Reductions

10,600

0

0Balance, end of period

(218,500)

(19,100)

(1,988)Mortgage servicing rights, net
$
2,251,335

1,903,636

1,683,435Fair value of mortgage servicing rights
$
2,262,578

1,939,000

1,842,000




Mortgage servicing costs, which include professional services for valuing mortgage servicing rights, were $20,014 at September 30, 2002, and $11,802 and $15,365 for the nine and twelve months ended in September and December 2001, respectively.

10

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All of the loans being serviced were single family loans serviced for FNMA and FHLMC under the mortgage-backed security program or the individual loan sale program. The following is a summary of the risk characteristics of the loans being serviced at September 30, 2002.

Loan Principal Balance

Weighted Average
Interest Rate

Weighted Average Remaining Term

Number of LoansOriginal term 30 year fixed rate
$
138,360,000

6.97
%
341

1,451Original term 15 year fixed rate

144,673,000

6.39
%
160

2,065Seven year balloon

160,000

6.09
%
127

2Adjustable rate

6,597,000

5.67
%
334

48




(8) Investment in Limited PartnershipsInvestments in limited partnerships were as follows:

Primary partnership activity

September 30, 2002

December 31, 2001Mortgage servicing rights
$
818,022

991,941Common stock of financial institutions

269,863

265,955Low to moderate income housing

230,606

265,754$
1,318,491

1,523,650




During the third quarter of 2002 HMN's proportionate loss from a mortgage servicing partnership was $504,777, its proportionate share of losses from common stock investments in financial institutions was $19,665 and it recognized $6,500 of losses on low income housing partnerships. During 2002 HMN anticipates receiving low income housing credits totaling $84,000, of which $21,000 were credited to current income tax benefits. During the third quarter of 2001 HMN's proportionate gains from a mortgage servicing partnership was $125,879, its proportionate share of losses from the common stock investments in financial institutions was $14,483 and it recognized $6,500 of losses on the low income housing partnerships. During 2001 HMN received low income housing credits totaling $84,000, of which $21,000 were credited to current income tax benefits in the third quarter of 2001.
During the nine month period ended September 30, 2002, HMN's proportionate losses from a mortgage servicing partnership was $173,919, its proportionate share of gains from the common stock investments in financial institutions was $3,907 and it recognized $33,956 of losses on the low income housing partnerships. During 2002 HMN anticipates receiving low income housing credits totaling $84,000, of which $63,000 were credited to current income tax benefits in the nine month period ended September 30, 2002. During the nine month period ended September 30, 2001 HMN's proportionate loss from a mortgage servicing partnership was $483,020, its proportionate share of losses from the common stock investments in financial institutions was $21,123 and it recognized $19,500 of losses on the low income housing partnerships. During 2001 HMN received low income housing credits totaling $84,000, of which $63,000 were credited to current income tax benefits in the nine month period ended September 30, 2001.

11

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(9) Intangible Assets

The gross carrying amount of intangible assets and the associated accumulated amortization at September 30, 2002 is presented in the table below. Amortization expense for intangible assets was $758,307 for the nine months ended September 30, 2002.



Gross





UnamortizedCarrying

Accumulated

Valuation

IntangibleAmount

Amortization

Adjustment

AssetsAmortized intangible assets:Mortgage servicing rights
$
3,633,153

(1,163,318)

(218,500)

2,251,335Core deposit intangible

1,567,000

(974,625)

0

592,375Total
$
5,200,153

(2,137,943)

(218,500)

2,843,710


The following table indicates the estimated future amortization expense for amortized intangible assets:



|                                    
|------------------------------------
|                                    
|                                    
|                                    
|                                    
|Three months ended December 31, 2002
|                                    
|Year ended December 31,             
|2003                                
|2004                                
|2005                                
|2006                                
|2007                                
|                                    

Projections of amortization are based on existing asset balances and the existing interest rate environment as of September 30, 2002. HMN's actual experiences may be significantly different depending upon changes in mortgage interest rates and other market conditions.

(10) "Adjusted" Earnings SFAS No. 142 Transitional Disclosure

Effective January 1, 2002, the amortization of goodwill was discontinued. The table below reconciles reported earnings for the third quarter of 2001 to "adjusted" earnings, which exclude goodwill amortization.

Quarter Ended September 30, 2001QuarterEnded

Reported

Goodwill

AdjustedSeptember 30, 2002

Earnings

Amortization

EarningsIncome before income tax expense
$
1,137,053

2,430,992

45,009

2,476,001Income tax expense

312,200

571,285

0

571,285Income before minority interest

824,853

1,859,707

45,009

1,904,716Minority interest

(67,012)

(163,373)

0

(163,373)Net income
$
891,865

2,023,080

45,009

2,068,089Earnings per common share
$
0.24

0.53

0.02

0.55Diluted earnings per common share
$
0.22

0.50

0.02

0.5212Nine Months Ended September 30, 2001Nine MonthsEnded

Reported

Goodwill

AdjustedSeptember 30, 2002

Earnings

Amortization

EarningsIncome before income tax expense
$
5,623,970

7,211,799

135,027

7,346,826Income tax expense

1,637,400

2,356,185

0

2,356,185Income before minority interest

3,986,570

4,855,614

135,027

4,990,641Minority interest

(141,306)

(30,493)

0

(30,493)Net income
$
4,127,876

4,886,107

135,027

5,021,134Earnings per common share
$
1.10

1.30

0.04

1.34Diluted earnings per common share
$
1.04

1.23

0.03

1.26




(11) Employee Benefits

On July 23, 2002 the Board of Directors of the Bank resolved to freeze the accrual of benefits for existing participants and the addition of new enrollments to the Financial Institutions Retirement Fund (FIRF) as of September 1, 2002. The costs associated with operating the plan from June 30, 2002 to the freeze date of September 1, 2002 are not known at this time and are being calculated by the plan actuaries. Declines in the financial markets during 2002 and 2001 have caused many companies with defined benefit plans to make additional contributions to their plans to offset losses incurred in plan assets.

(12) Earnings per Share

The following table reconciles the weighted average shares outstanding and the income available to common shareholders used for basic and diluted EPS:

Three months ended September 30,

Nine months ended September 30,2002

2001

2002

2001Weighted average number of common shares outstandingUsed in basic earnings per common share calculation

3,790,526

3,785,130

3,757,404

3,751,198Net dilutive effect of:Options

232,790

226,322

224,723

220,716Restricted stock awards

0

435

49

584Weighted average number of shares outstandingAdjusted for effect of dilutive securities

4,023,316

4,011,887

3,982,176

3,972,498Income available to common shareholders
$
891,865

2,023,080

4,127,876

4,886,107Basic earnings per common share
$
0.24

0.53

1.10

1.30Diluted earnings per common share
$
0.22

0.50

1.04

1.23


(13) Regulatory CapitalThe Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on HMN's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulations to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the following table) of Tier I or Core capital and Risk-based capital (as defined in the regulations) to total assets (as defined). Management believes, as of September 30, 2002, that the Bank meets all capital adequacy requirements to which it is subject.

13

---

Management believes that based upon the Bank's capital calculations at September 30, 2002 and other conditions consistent with the Prompt Corrective Actions Provisions of the OTS regulations, the Bank would be categorized as well capitalized.
On September 30, 2002 the Bank's tangible assets and adjusted total assets were $710 million and its risk-weighted assets were $494.2 million. The following table presents the Bank's capital amounts and ratios at September 30, 2002 for actual capital, required capital and excess capital including ratios in order to qualify as being well capitalized under the Prompt Corrective Actions regulations.

To Be WellRequired to be



Capitalized UnderAdequately



Prompt CorrectiveActual


Capitalized



Excess Capital


Actions ProvisionPercent of




Percent of




Percent of




Percent of(in thousands)

Amount

Assets (1)


Amount

Assets (1)


Amount

Assets (1)


Amount

Assets (1)Bank stockholder's equity
$
64,527Plus:Net unrealized loss (gain) on certainsecurities available for saleand cash flow hedges

(778)Less:Goodwill and other intangibles

4,393Excess mortgage servicing rights

316Tier I or core capital

59,040Tier I capital to adjusted total assets



8.32%

$
28,399

4.00%

$
30,641

4.32%

$
35,499

5.00%Tier I capital to risk-weighted assets



11.95%

$
19,767

4.00%

$
39,273

7.95%

$
29,651

6.00%Plus:Allowable allowance for loan losses

4,109Risk-based capital
$
63,149



$
39,534



$
23,615



$
49,418Risk-based capital toRisk-weighted assets



12.78%




8.00%




4.78%




10.00%


(1)

The tangible capital of the Bank was in excess of the minimum 2% required at September 30, 2002 but is not reflected in the table above.

(14) Business Segments

14

---



|                                         
|-----------------------------------------
|                                         
|                                         
|                                         
|                                         
|                                         
|                                         
|(Dollars in thousands)                   
|                                         
|At or for the three-months ended         
|September 30, 2002                       
|Interest income                          
|- external customers                     
|Non-interest income                      
|- external customers                     
|Earnings (loss) on limited partnerships  
|Intersegment interest income             
|Intersegment non-interest income         
|Interest expense                         
|Amortization of mortgage servicing rights
|and net valuation adjustments and        
|servicing costs                          
|Other non-interest expense               
|Income tax expense (benefit)             
|Minority interest                        
|Net income (loss)                        
|Goodwill                                 
|Total assets                             
|Net interest margin                      
|Return on average assets                 
|Return on average realized               
|common equity                            
|                                         
|At or for the three-months ended         
|September 30, 2001                       
|Interest income                          
|- external customers                     
|Non-interest income                      
|- external customers                     
|Earnings (loss) on                       
|Limited partnerships                     
|Intersegment interest income             
|Intersegment non-interest income         
|Interest expense                         
|Amortization of mortgage servicing       
|rights and net valuation adjustments     
|and servicing costs                      
|Other non-interest expense               
|Income tax expense (benefit)             
|Minority interest                        
|Net income (loss)                        
|Goodwill                                 
|Total assets                             
|Net interest margin                      
|Return on average assets                 
|Return on average realized common equity 
|                                         

NM - Not meaningful

15

---







|                                          |  
|----------------------------------------- | -
|                                          |  
|                                          |  
|                                          |  
|                                          |  
|                                          |  
|                                          |  
|(Dollars in thousands)                    |  
|                                          |  
|At or for the nine-months ended           |  
|September 30, 2002                        |  
|Interest income                           |  
|- external customers                      | $
|Non-interest income                       |  
|- external customers                      |  
|Earnings (loss) on limited partnerships   |  
|Intersegment interest income              |  
|Intersegment non-interest income          |  
|Interest expense                          |  
|Amortization of mortgage servicing rights |  
|and net valuation adjustments and         |  
|servicing costs                           |  
|Other non-interest expense                |  
|Income tax expense (benefit)              |  
|Minority interest                         |  
|Net income (loss)                         |  
|Goodwill                                  |  
|Total assets                              |  
|Net interest margin                       |  
|Return on average assets                  |  
|Return on average realized                |  
|common equity                             |  
|                                          |  
|At or for the nine-months ended           |  
|September 30, 2001                        |  
|Interest income                           |  
|- external customers                      | $
|Non-interest income                       |  
|- external customers                      |  
|Earnings (loss) on                        |  
|Limited partnerships                      |  
|Intersegment interest income              |  
|Intersegment non-interest income          |  
|Interest expense                          |  
|Amortization of mortgage servicing        |  
|rights and net valuation adjustments      |  
|and servicing costs                       |  
|Other non-interest expense                |  
|Income tax expense (benefit)              |  
|Minority interest                         |  
|Net income (loss)                         |  
|Goodwill                                  |  
|Total assets                              |  
|Net interest margin                       |  
|Return on average assets                  |  
|Return on average realized common equity  |  
|                                          |  

NM - Not meaningful

16

---





HMN FINANCIAL, INC.
Item 2:                                             	MANAGEMENT'S DISCUSSION AND ANALYSIS
                                            	OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSGeneral

HMN's net income is dependent primarily on its net interest income, which is the difference between interest earned on its loans and investments and the interest paid on interest-bearing liabilities. Net interest income is determined by (i) the difference between the yield earned on interest-earning assets and interest rates paid on interest-bearing liabilities (interest rate spread) and (ii) the relative amounts of interest-earning assets and interest-bearing liabilities. HMN's interest rate spread is affected by regulatory, economic and competitive factors that influence interest rates, loan demand and deposit flows. Net interest margin is calculated by dividing net interest income by the average interest-earning assets and is normally expressed as a percentage. Net interest income and net interest margin are affected by changes in interest rates, the volume and the mix of interest-earning assets and interest-bearing liabilities, and the level of non-performing assets. HMN's net income is also affected by the generation of non-interest income, which primarily consists of gains from the sale of securities, gains from sale of loans, service charges, fees and other income. In addition, net income is affected by the level of operating expenses, provisions made for loan losses and impairment reserve adjustments required on mortgage servicing assets.
The operations of financial institutions, including the Bank, are significantly affected by prevailing economic conditions, competition and the monetary and fiscal policies of governmental agencies. Lending activities are influenced by the demand for and supply of housing and commercial real estate, competition among lenders, the level of interest rates and the availability of funds. Deposit flows and costs of funds are influenced by prevailing market rates of interest primarily on competing investments, the mix of deposit accounts, account maturities and the levels of personal income and savings in the market area of the Bank.

Net Income

HMN's net income for the third quarter of 2002 was $892,000, a decrease of $1.1 million, or 55.9%, compared to net income of $2.0 million for the third quarter of 2001. Basic earnings per share were $0.24 for the quarter ended September 30, 2002, a decrease of $0.29 per share, or 54.7%, from $0.53 basic earnings per share for the same quarter of 2001. Diluted earnings per share were $0.22 for the third quarter of 2002, a decrease of $0.28 or 56.0%, from $0.50 diluted earnings per share for the third quarter of 2001.
HMN's net income for the nine months ended September 30, 2002 was $4.1 million, a decrease of $758,000, or 15.5%, compared to net income of $4.9 million for the same nine month period of 2001. Basic earnings per share were $1.10 for the nine months ended September 30, 2002, a decrease of $0.20 per share or 15.5%, from $1.30 basic earnings per share for the same nine month period of 2001. Diluted earnings per share were $1.04 for the nine months ended September 30, 2002, a decrease of $0.19, or 15.4%, from $1.23 diluted earnings per share for the same nine month period of 2001.

Net Interest Income

Net interest income for the third quarter of 2002 was $5.5 million, an increase of $371,000, or 7.3%, compared to $5.1 million for the third quarter of 2001. Interest income for the third quarter of 2002 was $10.6 million, a decrease of $1.9 million, or 15.5%, compared to $12.5 million for the same period of 2001. Interest income decreased by $540,000 due to a decrease in interest earning assets of $30.5 million from the third quarter of 2001 to the third quarter of 2002. The decrease in average interest-earning assets is the result of HMN using cash to fund the outflow of deposits and the repayment of Federal Home Loan Bank advances. Average deposits declined between the periods as HMN lowered the interest rates it paid on deposits to take advantage of the lower interest rate environment. Interest earning assets also decreased because of increased investments in premises and equipment for four additional banking facilities, the payment of dividends on HMN common stock, and the

17

---



purchase of treasury stock. Interest income decreased by $1.4 million due to lower interest rates on assets being added to the portfolio and also due to a general decline in interest rates from the third quarter of 2001 through the third quarter of 2002. During the 12-month period ended September 30, 2002, the Federal Reserve reduced the Federal Funds interest rate three times and the Wall Street Journal prime rate decreased from 6.00% to 4.75%. As a result, loans with rates that were indexed to prime, such as commercial loans and consumer lines of credit, earned less interest income and the funds generated from fixed rate loans that prepaid during the period were reinvested in loans at lower rates. The yield earned on interest-earning assets decreased from 7.24% at September 30, 2001, to 6.41% at September 30, 2002. 
Interest expense was $5.2 million for the third quarter of 2002, a decrease of $2.3 million, or 30.9%, compared to $7.5 million for the same quarter of 2001. Interest expense on deposits was $2.6 million for the third quarter of 2002, a decrease of $2.1 million, or 44.9%, from $4.6 million for the third quarter of 2001. Interest expense on deposits decreased primarily due to a decrease in the average interest rates that were paid on deposits. Interest expense decreased by $213,000 due to a $19.1 million decrease in the average outstanding deposits between the periods. The outflow of deposits were funded with excess cash made available from prepayments on mortgage loans. Interest expense on Federal Home Loan Bank (FHLB) advances and other borrowed money was $2.6 million for the third quarter of 2002, a decrease of $235,000, or 8.2%, from $2.9 million for the third quarter of 2001. Interest expense decreased due to a decrease in the cost of borrowing from the FHLB including a $187,000 decrease due to declining interest rates between the two periods. The average interest rate paid on the average interest-bearing liabilities was 3.35% during the third quarter of 2002, compared to 4.68% for the third quarter of 2001.
Net interest margin (net interest income divided by average interest earning assets) for the third quarter of 2002 was 3.29%, an increase of 36 basis points, compared to 2.93% for the third quarter of 2001.
Net interest income for the nine month period ended September 30, 2002 was $16.2 million, an increase of $739,000, or 4.8%, compared to $15.5 million for the same period of 2001. Interest income for the nine month period of 2002 was $32.3 million, a decrease of $7 million, or 17.8%, compared to $39.3 million for the same period of 2001. Interest income declined due to a reduction in interest rates and a decline in the average interest earning assets. Interest income declined by $1.4 million due to a $26.3 million net decrease in average interest-earning assets from the nine month period of 2001 to the same nine month period in 2002. The decrease in average interest-earning assets is the result of HMN using cash to fund the outflow of deposits and the repayment of Federal Home Loan Bank advances. Deposits declined between the periods as HMN lowered the interest rates it paid on deposits to take advantage of the lower interest rate environment. Interest income decreased by $5.5 million due to lower interest rates being earned on the loan and investment portfolios. The decline in rates decreased the yield earned on interest earning assets from 7.53% at September 30, 2001 to 6.44% at September 30, 2002. 
Interest expense was $16.1 million for the nine months ended September 30, 2002, a decrease of $7.7 million, or 32.4%, compared to $23.8 million for the same nine month period of 2001. Interest expense on deposits was $8.3 million for the nine months ended September 30, 2002, a decrease of $6.3 million, or 43.2%, from $14.7 million for the same nine month period in 2001. Interest expense on deposits decreased by $336,000 due to a decrease in the average balance of outstanding deposits from the nine month period ended in September of 2002 to the same nine month period in 2001. Interest expense decreased by $6.0 million related to lower rates being paid on deposits. Interest expense on FHLB advances was $7.8 million for the nine month period of 2002, a decrease of $1.4 million, or 15.3%, from $9.2 million for the same period of 2001. Interest expense decreased by $331,000 due to a $8.3 million decrease in the average outstanding advances from the FHLB. The advances were paid off with excess cash made available from prepayments of single family mortgage loans. Interest expense decreased by $1.1 million due to a decrease in the cost of borrowing from the FHLB due to lowering interest rates between the two periods. The average interest rate paid on the average interest-bearing liabilities was 3.46% during the nine months ended September 30, 2002, compared to 4.96% for the same period of 2001.

18

---

Net interest margin (net interest income divided by average interest earning assets) for the nine months ended September 30, 2002, was 3.23%, an increase of 26 basis points, compared to 2.97% for the same period of 2001.

Provision for Loan Losses

*The provision for loan losses for the third quarter ended September 30, 2002 was $771,000, an increase of $471,000, or 157.0%, compared to $300,000 for the third quarter of 2001. The provision for loan losses increased primarily due to the $81 million in growth that was experienced in the commercial and consumer loan portfolios between the periods. Commercial and consumer loans generally require a larger provision due to the greater inherent credit risk of these loans. 
*The provision for loan losses for the nine months ended September 30, 2002 was $1,801,000, an increase of $1,051,000, or 140.1% compared to $750,000 for the same nine month period ended in 2001. The provision is the result of management's evaluation of the composition of the loan portfolio, the historical level of non-performing loans, increases in loan charge-off experience, and its assessment of the general economic conditions in the geographic area where properties securing the loan portfolio are located such as national and regional unemployment data, local single family construction permits and local economic growth rates. Management's evaluation of probable losses inherent in the loan portfolio revealed conditions that resulted in increasing the 2002 loan loss provision compared to the provision for 2001. This increase was due primarily to the $81 million in growth that was experienced in the commercial and consumer loan portfolios between the end of the third quarter of 2001 and the end of the third quarter of 2002. Commercial and consumer loans generally require a larger provision due to the greater inherent credit risk of these loans. HMN will continue to monitor its allowance for losses and adjust it as conditions dictate. Future economic conditions and other unknown factors will impact the need for future provisions for loan losses. As a result, no assurances can be given that increases in the allowance for loan losses will not be required during future periods. 
A reconciliation of HMN's allowance for loan losses is summarized as follows:

2002

2001Balance at January 1,
$ 3,783,112

$  3,143,746Provision
1,801,000

750,000Commercial loan charge offs
(577,125)

(347,308)Consumer loan charge offs
(260,895)

(111,788)Single family mortgage loan charge offs
(44,408)

0Recoveries
19,177

1,540Balance at September 30,
$ 4,720,861

$  3,436,190


Non-Interest Income

Non-interest income was $1.0 million for the third quarter of 2002, a decrease of $416,000, or 29.2%, from $1.4 million for the third quarter of 2001. Non-interest income decreased by $636,000 due to additional losses on investments in limited partnerships. The value of HMN's investment in a limited partnership that invests in mortgage servicing rights declined during the third quarter of 2002 as a result of lowering interest rates. Generally, as interest rates decline the value of fixed rate mortgage servicing rights decreases and as interest rates rise the value of the mortgage servicing rights increases due to changes in the anticipated cash flows from prepayments on the loans being serviced. This decrease was partially offset by an increase of $306,000 in the gains recognized on the sale of investments and an increase of $71,000 in mortgage servicing fees due to the increased number of loans being serviced.* This paragraph contains a forward-looking statement(s). Refer to information regarding Forward-looking Information on page 25 of this discussion.

19

---

Non-interest income was $4.5 million for the nine months ended September 30, 2002, an increase of $601,000, or 15.6%, from $3.9 million for the same nine month period of 2001.Non-interest income increased by $683,000

due to increased gains recognized on the sale of securities. The increase in securities gains is primarily due to the $610,000 impairment loss recognized in the securities portfolio during the first nine months of 2001. Lower losses on investments in limited partnerships increased non-interest income by $320,000. The lower losses resulted because of a less severe drop in interest rates during the nine-month period of 2002 as compared to the nine-month period of 2001. Mortgage servicing fees increased by $194,000 as a result of servicing more loans. Fees and service charges increased by $81,000 and other income increased by $82,000 from the same period in 2001. These increases were partially offset by a decrease of $758,000 in gain on the sale of loans, which was caused primarily by the phase down of the mortgage banking operation in Brooklyn Park during 2002.

Non-Interest Expense

Non-interest expense was $4.6 million for the third quarter of 2002, an increase of $778,000, or 20.6%, from $3.8 million for the third quarter of 2001.Amortization of mortgage servicing rights increased by $344,000, or 218.2%, due to an increase in the number of serviced loans that prepaid during the period and a valuation reserve of $210,000 established on the existing servicing portfolio because the value of the mortgage servicing rights declined due to lowering interest rates. Occupancy expense increased by $273,000, or 51.7%, due to the costs associated with maintaining four additional facilities including the new corporate office. Data processing expense increased by $34,000, or 14.2%, due to the increased costs of various services offered to customers and the increased number of accounts. Advertising expense increased by $34,000 as a result of an increased focus on advertising.

Non-interest expense was $13.2 million for the nine months ended September 30, 2002 an increase of $1.9 million or 16.5%, from $11.3 for the same nine month period of 2001. Occupancy expense increased by $603,000, or 37.5%, as a result of maintaining four additional facilities including the new corporate headquarters. Data processing increased by $114,000 due to the increased costs of various services offered to customers and the increased number of accounts. Amortization of mortgage servicing rights increased by $391,000, or 79.1%, due to an increase in the number of serviced loans that prepaid during the period and a valuation reserve of $210,000 established on the existing servicing portfolio because the value of the mortgage servicing rights declined due to lowering interest rates. Other expenses increased by $524,000 primarily due to $245,000 of reserves established for losses on merchant and other accounts receivables and additional increases in general and administrative expenses relating to operating additional facilities in 2002. Income Tax Expense

Income tax expense was $312,200 for the third quarter of 2002, a decrease of $259,000 compared to $571,000 for the third quarter of 2001. Income tax expense was $1.6 million for the nine months ended September 30, 2002, a decrease of $719,000 compared to $2.4 million for the same nine month period of 2001. The decreases in income taxes are primarily due to the Bank reducing its effective income tax rate through the use of certain state tax planning initiatives and a reduction in taxable income. Non-Performing Assets

The following table sets forth the amounts and categories of non-performing assets in the Bank's portfolio at 
September 30, 2002 and December 31, 2001.

20

---







|                                                    
|----------------------------------------------------
|                                                    
|(Dollars in Thousands)                              
|                                                    
|Non-Accruing Loans                                  
|One-to-four family real estate                      
|Commercial real estate                              
|Consumer                                            
|Commercial business                                 
|                                                    
|Total                                               
|                                                    
|Accruing loans delinquent 90 days or more           
|Other assets                                        
|Foreclosed and Repossessed Assets                   
|One-to-four family real estate                      
|Consumer                                            
|Commercial business                                 
|                                                    
|Total non-performing assets                         
|                                                    
|Total as a percentage of total assets               
|                                                    
|Total non-performing loans                          
|                                                    
|Total as a percentage of total loans receivable, net
|                                                    
|                                                    

Total non-performing assets at September 30, 2002 were $4,721,000, an increase of $959,000, from $3,761,000 at December 31, 2001. The increase in non-performing assets relates primarily to an increase of $1.0 million in non-accruing single-family loans primarily due to the phase down of the mortgage banking operation in Brooklyn Park. Dividends

On October 22, 2002 HMN declared a cash dividend of $0.18 per share, payable on December 11, 2002 to shareholders of record on November 22, 2002. 
During 2002, HMN has declared and paid dividends as follows:



Record date
Payable date
Dividend per share
Dividend Payout RatioFebruary 21, 2002
March 7, 2002
$0.14
100.0%May 23, 2002
June 10, 2002
$0.18
36.0%August 27, 2002
September 10, 2002
$0.18
56.3%




The annualized dividend payout ratio for the past four quarters, ending with the December 11, 2002 payment will be 57.6%.

The declaration of dividends are subject to, among other things, HMN's financial condition and results of operations, the Bank's compliance with its regulatory capital requirements, including the fully phased-in capital requirements, tax considerations, industry standards, economic conditions, regulatory restrictions, general business practices and other factors. Liquidity

21

---

balances of $321,000 for the nine month period. It paid out $3.5 million and $138,000 on advance payments from borrowers for taxes and insurance. HMN received $635,000 related to the exercise of stock options, purchased $659,000 of its own stock, and paid $1,886,000 in dividends to its shareholders.
*HMN has certificates of deposits with outstanding balances of $134.3 million that come due over the next 12 months. Based upon past experience management anticipates that the majority of the deposits will renew for another term. HMN believes that deposits that do not renew will be replaced with deposits from other customers or brokers, or funded with advances from the FHLB, or will be funded through the sale of securities. Management does not anticipate that it will have a liquidity problem due to maturing deposits.

*HMN has $105 million of FHLB advances which mature after September 30, 2003 but have call features that can be exercised by the FHLB during the next 12 months. If the call features are exercised HMN has the option of requesting any advance otherwise available to it pursuant to the Credit Policy of the FHLB. HMN also has $60.0 million of FHLB advances which will mature during the next 12 months. Since HMN has the ability to request another advance to replace the advance that is being called or is maturing, management does not anticipate that it will have a liquidity problem due to advances being called by the FHLB during the next 12 month period.

Market Risk

Market risk is the risk of loss from adverse changes in market prices and interest rates. HMN's market risk arises primarily from interest rate risk inherent in its investing, lending and deposit taking activities. Management actively monitors and manages its interest rate risk exposure. 
HMN's profitability is affected by fluctuations in interest rates. A sudden and substantial increase in interest rates may adversely impact HMN's earnings to the extent that the interest rates borne by assets and liabilities do not change at the same speed, to the same extent, or on the same basis. HMN monitors the projected changes in net interest income that occur if interest rates were to suddenly change up or down. The Rate Shock Table located below in the Asset/Liability Management section of this report discloses HMN's projected changes in net interest income based upon immediate interest rate changes called rate shocks. 
*HMN utilizes a model which uses the discounted cash flows from its interest-earning assets and its interest-bearing liabilities to calculate the current market value of those assets and liabilities. The model also calculates the changes in market value of the interest-earning assets and interest-bearing liabilities due to different interest rate changes. HMN believes that over the next twelve months interest rates could conceivably fluctuate in a range of 200 basis points up or 100 basis points down from where the interest rates were at September 30, 2002. HMN does not have a trading portfolio. The following table discloses the projected changes in market value to HMN's interest-earning assets and interest-bearing liabilities based upon incremental 100 basis point changes in interest rates from interest rates in effect on September 30, 2002.* This paragraph contains a forward-looking statement(s). Refer to information regarding Forward-looking Information on page 25 of this discussion.

22

---



Other than trading portfolio
Market Value(Dollars in thousands)
Basis point change in interest rates

-100

0

+100

+200Cash equivalents
$
48,021

47,983

47,945

47,907Securities available for sale:Fixed-rate CMOs

9,666

9,634

9,178

8,651Variable-rate CMOs

49,436

49,539

49,850

49,147Fixed-rate available for sale mortgage-backed and related securities

2,182

2,135

2,076

2,012Variable-rate available for sale mortgage- backed and related securities

574

575

572

570Fixed-rate available for sale other marketable securities

47,399

46,701

45,215

44,166Variable-rate available for sale other marketable securities

111

110

105

105Federal Home Loan Bank stock

11,892

11,878

11,864

11,851Fixed-rate loans held for sale

15,225

14,381

14,219

14,003Loans receivable, net:Fixed-rate real estate loans

224,624

220,668

214,885

208,648Variable-rate real estate loans

127,748

125,433

122,993

120,957Fixed-rate other loans

80,815

79,926

78,183

76,652Variable-rate other loans

113,240

111,765

108,388

106,023Mortgage servicing rights, net

1,224

2,251

3,657

4,112Investment in limited partnerships

991

1,319

1,653

1,775Total market risk sensitive assets

733,148

724,298

710,783

696,579NOW deposits

62,790

62,790

62,790

62,790Passbook deposits

40,671

40,671

40,671

40,671Money market deposits

47,741

47,741

47,741

47,741Certificate deposits

277,914

274,130

270,437

266,831Fixed-rate Federal Home Loan Bank advances

200,761

193,236

186,110

182,276Variable-rate Federal Home Loan Bank advances

33,958

33,874

33,834

33,794Total market risk sensitive liabilities

663,835

652,442

641,583

634,103Off-balance sheet financial instruments:Commitments to extend credit

1,580

0

(1,580)

(2,257)Commitments to sell or deliver loans

(1,580)

0

1,580

1,499Net market risk
$
69,313

71,856

69,200

63,234Percentage change from current market value

(3.54)
%
0.00
%
(3.70)
%
(12.00)
%


The preceding table was prepared utilizing the following assumptions (the "Model Assumptions") regarding prepayment and decay ratios which were determined by management based upon their review of historical prepayment speeds and future prepayment projections. Fixed rate loans were assumed to prepay at annual rates of between 6% to 46%, depending on the note rate and the period to maturity. Adjustable rate mortgages ("ARMs") were assumed to prepay at annual rates of between 11% and 27%, depending on the note rate and the period to maturity. Growing Equity Mortgage (GEM) loans were assumed to prepay at annual rates of between 6% and 46% depending on the note rate and the period to maturity. Mortgage-backed securities and Collateralized Mortgage Obligations (CMOs) were projected to have prepayments based upon the underlying collateral securing the

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instrument and the related cash flow priority of the CMO tranche owned. Certificate accounts were assumed not to be withdrawn until maturity. Passbook and money market accounts were assumed to decay at an annual rate of 20%. FHLB advances were projected to be called at the first call date where the projected interest rate on similar remaining term advances exceeded the interest rate on HMN's callable advance. 
*Certain shortcomings are inherent in the method of analysis presented in the foregoing table. The interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types of assets and liabilities may lag behind changes in market interest rates. The model assumes that the difference between the current interest rate being earned or paid compared to a treasury instrument or other interest index with a similar term to maturity (the "Interest Spread") will remain constant over the interest changes disclosed in the table. Changes in Interest Spread could impact projected market value changes. Certain assets, such as ARMs, have features which restrict changes in interest rates on a short-term basis and over the life of the assets. The market value of the interest-bearing assets which are approaching their lifetime interest rate caps could be different from the values disclosed in the table. In the event of a change in interest rates, prepayment and early withdrawal levels may deviate significantly from those assumed in calculating the foregoing table. The ability of many borrowers to service their debt may decrease in the event of an interest rate increase.

Asset/Liability Management

*HMN's management reviews the impact that changing interest rates will have on its net interest income projected for the twelve months following September 30, 2002 to determine if its current level of interest rate risk is acceptable. The following table projects the estimated annual impact on net interest income of immediate interest rate changes called rate shocks.



Rate Shock

Net Interest

Percentagein Basis Points

Income

Change+200

24,252,000

10.47 %+100

23,587,000

7.44 %0

21,954,000

0.00 %-100

19,428,000

-11.51 %




The preceding table was prepared utilizing the Model Assumptions regarding prepayment and decay ratios which were determined by management based upon their review of historical prepayment speeds and future prepayment projections. 
*Certain shortcomings are inherent in the method of analysis presented in the foregoing table. In the event of a change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed in calculating the foregoing table. The ability of many borrowers to service their debt may decrease in the event of a substantial increase in interest rates and could impact net interest income.
In an attempt to manage its exposure to changes in interest rates, management closely monitors interest rate risk. The Bank has an Asset/Liability Committee consisting of executive officers which meets at least quarterly to review the interest rate risk position and projected profitability. The committee makes recommendations for adjustments to the asset/liability position of the Bank to the Board of Directors of the Bank. This Committee also reviews the Bank's portfolio, formulates investment strategies and oversees the timing and implementation of transactions to assure attainment of the Board's objectives in the most effective manner. In addition, the Board reviews on a quarterly basis the Bank's asset/liability position, including simulations of the effect on the Bank's capital of various interest rate scenarios.
In managing its asset/liability mix, the Bank, at times, depending on the relationship between long- and short-term interest rates, market conditions and consumer preference, may place more emphasis on managing net interest * This paragraph contains a forward-looking statement(s). Refer to information regarding Forward-looking Information on page 25 of this discussion.

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margin than on better matching the interest rate sensitivity of its assets and liabilities in an effort to enhance net
interest income. Management believes that the increased net interest income resulting from a mismatch in the maturity of its asset and liability portfolios can, during periods of declining or stable interest rates, provide high enough returns to justify the increased exposure to sudden and unexpected increases in interest rates. 
To the extent consistent with its interest rate spread objectives, the Bank attempts to reduce its interest rate risk and has taken a number of steps to restructure its assets and liabilities. The Bank has primarily focused its fixed rate one-to-four family residential lending program on loans with contractual terms of 20 years or less. The Bank generally follows the practice of selling all of its fixed rate single family loans which conform to the secondary market guidelines. HMN has focused its portfolio lending since 1999 on the origination of commercial loan 
products and consumer loans which generally have shorter weighted average terms to maturity and/or interest rates which adjust at least every three years. At times, depending on its interest rate sensitivity, the Bank may sell fixed rate single family loans with shorter contractual maturities than thirty years in order to reduce interest rate risk and record a gain on the sale of loans.

Forward-looking Information

The following paragraphs within Management's Discussion and Analysis of Financial Condition and Results of Operations contain forward-looking statements and actual results may differ materially from the expectations disclosed within this Discussion and Analysis. These forward-looking statements are subject to risks and uncertainties, including those discussed below. HMN assumes no obligations to publicly release results of any revision or updates to these forward-looking statements to reflect future events or unanticipated occurrences.

Provision for Loan Losses

The provision for loan losses for the third quarter ended September 30, 2002 was $771,000, an increase of $471,000, or 157.0%, compared to $300,000 for the third quarter of 2001. The provision for loan losses increased primarily due to the $81 million in growth that was experienced in the commercial and consumer loan portfolios between the periods. Commercial and consumer loans generally require a larger provision due to the greater inherent credit risk of these loans.

The provision for loan losses for the nine months ended September 30, 2002 was $1,801,000, an increase of $1,051,000, or 140.1% compared to $750,000 for the same nine month period ended in 2001. The provision is the result of management's evaluation of the composition of the loan portfolio, the historical level of non-performing loans, increases in loan charge-off experience, and its assessment of the general economic conditions in the geographic area where properties securing the loan portfolio are located such as national and regional unemployment data, local single family construction permits and local economic growth rates. Management's evaluation of probable losses inherent in the loan portfolio revealed conditions that resulted in increasing the 2002 loan loss provision compared to the provision for 2001. This increase was due primarily to the $81 million in growth that was experienced in the commercial and consumer loan portfolios. Commercial and consumer loans generally require a larger provision due to the greater inherent credit risk of these loans. HMN will continue to monitor its allowance for losses and adjust it as conditions dictate. Future economic conditions and other unknown factors will impact the need for future provisions for loan losses. As a result, no assurances can be given that increases in the allowance for loan losses will not be required during future periods.

Liquidity

HMN has certificates of deposits with outstanding balances of $134.3 million that come due over the next 12 months. Based upon past experience management anticipates that the majority of the deposits will renew for another term. HMN believes that deposits that do not renew will be replaced with deposits from other customers or brokers, or funded with advances from the FHLB, or will be funded through the sale of securities. Management does not anticipate that it will have a liquidity problem due to maturing deposits.

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HMN has $105 million of FHLB advances which mature after September 30, 2003 but have call features that can be exercised by the FHLB during the next 12 months. If the call features are exercised HMN has the option of requesting any advance otherwise available to it pursuant to the Credit Policy of the FHLB. HMN also has $60.0 million of FHLB advances which will mature during the next 12 months. Since HMN has the ability to request another advance to replace the advance that is being called or is maturing, management does not anticipate that it will have a liquidity problem due to advances being called by the FHLB during the next 12 month period.

Market Risk

HMN utilizes a model which uses the discounted cash flows from its interest-earning assets and its interest-bearing liabilities to calculate the current market value of those assets and liabilities. The model also calculates the changes in market value of the interest-earning assets and interest-bearing liabilities due to different interest rate changes. HMN believes that over the next twelve months interest rates could conceivably fluctuate in a range of 200 basis points up or 100 basis points down from where the interest rates were at September 30, 2002. HMN does not have a trading portfolio. The following table discloses the projected changes in market value to HMN's interest-earning assets and interest-bearing liabilities based upon incremental 100 basis point changes in interest rates from interest rates in effect on September 30, 2002.

Certain shortcomings are inherent in the method of analysis presented in the foregoing table. The interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types of assets and liabilities may lag behind changes in market interest rates. The model assumes that the difference between the current interest rate being earned or paid compared to a treasury instrument or other interest index with a similar term to maturity (the "Interest Spread") will remain constant over the interest changes disclosed in the table. Changes in Interest Spread could impact projected market value changes. Certain assets, such as ARMs, have features which restrict changes in interest rates on a short-term basis and over the life of the assets. The market value of the interest-bearing assets which are approaching their lifetime interest rate caps could be different from the values disclosed in the table. In the event of a change in interest rates, prepayment and early withdrawal levels may deviate significantly from those assumed in calculating the foregoing table. The ability of many borrowers to service their debt may decrease in the event of an interest rate increase.

Asset/Liability Management

HMN's management reviews the impact that changing interest rates will have on its net interest income projected for the twelve months following September 30, 2002 to determine if its current level of interest rate risk is acceptable. The table in the asset/liability section projects the estimated annual impact on net interest income of immediate interest rate changes called rate shocks.

Certain shortcomings are inherent in the method of analysis presented in the foregoing table. In the event of a change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed in calculating the foregoing table. The ability of many borrowers to service their debt may decrease in the event of a substantial increase in interest rates and could impact net interest income.

Item 4: Controls and ProceduresEvaluation of disclosure controls and procedures. The Company's principal executive officer and its principal financial officer, after evaluating the effectiveness of the Company's disclosure controls and procedures (as defined in Exchange Act Rules 13a-14(c) and 15d-14(c)) on November 7, 2002, have concluded that, as of such date, the Company's disclosure controls and procedures were adequate and effective to ensure that material information relating to the Company and its consolidated subsidiaries would be made known to them by others within those entities.

26

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Changes in internal controls. There were no significant changes in the Company's internal controls or in other factors that could significantly affect the Company's disclosure controls and procedures subsequent to the date of their evaluation, nor were there any significant deficiencies or material weaknesses in the Company's internal controls. As a result, no corrective actions were required or undertaken.

27

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HMN FINANCIAL, INC.
PART II - 		OTHER INFORMATION

ITEM 1.	Legal Proceedings.

None.

ITEM 2.	Changes in Securities and Use of Proceeds.

Not applicable.

ITEM 3.	Defaults Upon Senior Securities.

Not applicable.

ITEM 4.	Submission of Matters to a Vote of Security Holders.

None.

ITEM 5.	Other Information.

None.

ITEM 6.	Exhibits and Reports on Form 8-K.

1. Exhibits. See Index to Exhibits on page 30 of this report.
2. Reports filed on Form 8-K.

None.

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SIGNATURES

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

HMN FINANCIAL, INC.RegistrantDate: November 13, 2002
/s/ Michael McNeilMichael McNeil,President/Chief Executive Officer(Principal Executive Officer)Date: November 13, 2002
/s/ Timothy P. JohnsonTimothy P. Johnson,Chief Financial Officer(Principal Financial Officer)


|
|

CERTIFICATIONS

I, Michael McNeil, President and Chief Executive Officer, certify that:

1.      	I have reviewed this quarterly report on Form 10-Q of HMN Financial, Inc.

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

3.      	Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4.      	The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exhange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a)	designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

b)	evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and

c)	presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5.      	The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):

29

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a)	all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and

b) 	any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and

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



Date: November 13, 2002                   
By /s/ Michael McNeil

President/Chief
Executive Officer



CERTIFICATIONS

I, Timothy P. Johnson, Treasurer and Chief Financial Officer, certify that:

1.      	I have reviewed this quarterly report on Form 10-Q of HMN Financial, Inc.

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

3.      	Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4.      	The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exhange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a)	designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

b)	evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and

c)	presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5.      	The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):

a)	all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and

30

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b)	any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and

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



Date: November 13, 2002                    
By /s/ Timothy P. Johnson

Treasurer and Chief Financial Officer

31

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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
*3
N/AIncluding indentures99.1

Certification Pursuant to 18 U.S.C. Section 1350 by Michael
McNeil
99.1
Filed Electronically99.2

Certification Pursuant to 18 U.S.C. Section 1350 by Timothy
Johnson
99.2
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 September 30, 1997 (File 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).


32

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