##### 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, 2008
 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
  Large accelerated filer o
    
    Accelerated filer þ
    
    Non-accelerated filer o
    
    Smaller reporting company o(Do not check if a smaller reporting company)
  o þ
  Class
    
    Outstanding at October 10, 2008Common stock, $0.01 par value
    
    4,167,630




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##### 



HMN FINANCIAL, INC.
 CONTENTS
 PagePART I  FINANCIAL INFORMATIONItem 1: Financial Statements (unaudited)Consolidated Balance Sheets at
September 30, 2008 and December 31, 2007
    
    
    3Consolidated Statements of Income for the
Three Months Ended and Nine Months Ended September 30, 2008 and 2007
    
    
    4Consolidated Statement of Stockholders Equity and Comprehensive
Income for the Nine Month Period Ended September 30, 2008
    
    
    5Consolidated Statements of Cash Flows for
the Nine Months Ended September 30, 2008 and 2007
    
    
    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
    
    
    23Item 4: Controls and Procedures
    
    
    25PART II  OTHER INFORMATIONItem 1: Legal Proceedings
    
    
    26Item 1A: Risk Factors
    
    
    26Item 2: Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    26Item 3: Defaults Upon Senior Securities
    
    
    26Item 4: Submission of Matters to a Vote of Security Holders
    
    
    26Item 5: Other Information
    
    
    26Item 6: Exhibits
    
    
    26Signatures
    
    
    27EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32
  2




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##### Table of Contents



PART I  FINANCIAL STATEMENTS
 
  HMN FINANCIAL, INC. AND SUBSIDIARIES
 
 Consolidated Balance Sheets
 September 30,
    
    
    December 31,(dollars in thousands, except per share data)
    
    2008
    
    
    2007(unaudited)AssetsCash and cash equivalents
    
    $
    17,220
    
    
    
    23,718Securities available for sale:Mortgage-backed and related securities
(amortized cost $75,496 and $18,786)
    
    
    74,595
    
    
    
    18,468Other marketable securities
(amortized cost $110,439 and $165,430)
    
    
    111,463
    
    
    
    167,720186,058
    
    
    
    186,188Loans held for sale
    
    
    4,222
    
    
    
    3,261Loans receivable, net
    
    
    873,156
    
    
    
    865,088Accrued interest receivable
    
    
    5,211
    
    
    
    6,893Real estate, net
    
    
    8,798
    
    
    
    2,214Federal Home Loan Bank stock, at cost
    
    
    7,461
    
    
    
    6,198Mortgage servicing rights, net
    
    
    824
    
    
    
    1,270Premises and equipment, net
    
    
    13,442
    
    
    
    12,024Goodwill
    
    
    0
    
    
    
    3,801Prepaid expenses and other assets
    
    
    7,033
    
    
    
    1,680Deferred tax assets, net
    
    
    5,475
    
    
    
    4,719Total assets
    
    $
    1,128,900
    
    
    
    1,117,054Liabilities and Stockholders EquityDeposits
    
    $
    888,848
    
    
    
    888,118Federal Home Loan Bank advances
    
    
    141,500
    
    
    
    112,500Accrued interest payable
    
    
    5,984
    
    
    
    9,515Customer escrows
    
    
    1,098
    
    
    
    866Accrued expenses and other liabilities
    
    
    4,894
    
    
    
    7,927Total liabilities
    
    
    1,042,324
    
    
    
    1,018,926Commitments and contingenciesStockholders equity:Serial
preferred stock: ($.01 per 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
    
    
    57,962
    
    
    
    58,049Retained earnings, subject to certain restrictions
    
    
    100,605
    
    
    
    110,943Accumulated other comprehensive income
    
    
    73
    
    
    
    1,167Unearned employee stock ownership plan shares
    
    
    (3,819
    )
    
    
    (3,965
    )Treasury stock, at cost 4,961,032 and 4,953,045 shares
    
    
    (68,336
    )
    
    
    (68,157
    )Total stockholders equity
    
    
    86,576
    
    
    
    98,128Total liabilities and stockholders equity
    
    $
    1,128,900
    
    
    
    1,117,054
  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 data)
    
    2008
    
    
    2007
    
    
    2008
    
    
    2007Interest income:Loans receivable
    
    $
    14,634
    
    
    
    17,258
    
    
    
    44,573
    
    
    
    49,632Securities available for sale:Mortgage-backed and related
    
    
    360
    
    
    
    212
    
    
    
    797
    
    
    
    495Other marketable
    
    
    1,224
    
    
    
    2,498
    
    
    
    4,641
    
    
    
    6,810Cash equivalents
    
    
    78
    
    
    
    250
    
    
    
    196
    
    
    
    972Other
    
    
    78
    
    
    
    60
    
    
    
    211
    
    
    
    276Total interest income
    
    
    16,374
    
    
    
    20,278
    
    
    
    50,418
    
    
    
    58,185Interest expense:Deposits
    
    
    6,235
    
    
    
    9,283
    
    
    
    20,944
    
    
    
    24,506Federal Home Loan Bank advances
    
    
    1,571
    
    
    
    1,182
    
    
    
    4,047
    
    
    
    4,227Total interest expense
    
    
    7,806
    
    
    
    10,465
    
    
    
    24,991
    
    
    
    28,733Net interest income
    
    
    8,568
    
    
    
    9,813
    
    
    
    25,427
    
    
    
    29,452Provision for loan losses
    
    
    15,790
    
    
    
    921
    
    
    
    18,480
    
    
    
    2,404Net interest income (loss) after provision
for loan losses
    
    
    (7,222
    )
    
    
    8,892
    
    
    
    6,947
    
    
    
    27,048Non-interest income:Fees and service charges
    
    
    1,077
    
    
    
    828
    
    
    
    2,868
    
    
    
    2,306Mortgage servicing fees
    
    
    240
    
    
    
    254
    
    
    
    722
    
    
    
    789Securities gains, net
    
    
    479
    
    
    
    0
    
    
    
    479
    
    
    
    0Gain on sales of loans
    
    
    58
    
    
    
    205
    
    
    
    442
    
    
    
    1,189Other
    
    
    99
    
    
    
    362
    
    
    
    716
    
    
    
    724Total non-interest income
    
    
    1,953
    
    
    
    1,649
    
    
    
    5,227
    
    
    
    5,008Non-interest expense:Compensation and benefits
    
    
    3,010
    
    
    
    3,147
    
    
    
    9,406
    
    
    
    9,770Occupancy
    
    
    1,131
    
    
    
    1,127
    
    
    
    3,424
    
    
    
    3,323Advertising
    
    
    95
    
    
    
    123
    
    
    
    311
    
    
    
    424Data processing
    
    
    399
    
    
    
    325
    
    
    
    1,077
    
    
    
    941Amortization of mortgage servicing rights, net
    
    
    142
    
    
    
    169
    
    
    
    456
    
    
    
    540Goodwill impairment charge
    
    
    0
    
    
    
    0
    
    
    
    3,801
    
    
    
    0Other
    
    
    1,784
    
    
    
    1,062
    
    
    
    4,139
    
    
    
    3,054Total non-interest expense
    
    
    6,561
    
    
    
    5,953
    
    
    
    22,614
    
    
    
    18,052Income (loss) before income tax expense
(benefit)
    
    
    (11,830
    )
    
    
    4,588
    
    
    
    (10,440
    )
    
    
    14,004Income tax expense (benefit)
    
    
    (4,779
    )
    
    
    1,806
    
    
    
    (2,851
    )
    
    
    5,505Net income (loss)
    
    $
    (7,051
    )
    
    
    2,782
    
    
    
    (7,589
    )
    
    
    8,499Basic earnings (loss) per share
    
    $
    (1.93
    )
    
    
    0.74
    
    
    
    (2.08
    )
    
    
    2.26Diluted earnings (loss) per share
    
    $
    (1.93
    )
    
    
    0.71
    
    
    
    (2.08
    )
    
    
    2.16
  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, 2008
  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, 2007
    
    $
    91
    
    
    
    58,049
    
    
    
    110,943
    
    
    
    1,167
    
    
    
    (3,965
    )
    
    
    (68,157
    )
    
    
    98,128Net loss
    
    
    
    
    
    
    
    
    
    
    (7,589
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (7,589
    )Other comprehensive loss, net of tax:Net unrealized losses on securities
available for sale
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,094
    )

    
    
    
    
    
    
    
    
    
    
    (1,094
    )Total comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (8,683
    )Purchase of treasury stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (723
    )
    
    
    (723
    )Unearned compensation restricted stock awards
    
    
    
    
    
    
    (550
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    550
    
    
    
    0Restricted stock awards forfeited
    
    
    
    
    
    
    6
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (6
    )
    
    
    0Stock compensation tax benefits
    
    
    
    
    
    
    25
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    25Amortization of restricted stock awards
    
    
    
    
    
    
    310
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    310Dividends paid
    
    
    
    
    
    
    
    
    
    
    (2,749
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,749
    )Earned employee stock ownership plan shares
    
    
    
    
    
    
    122
    
    
    
    
    
    
    
    
    
    
    
    146
    
    
    
    
    
    
    
    268Balance, September 30, 2008
    
    $
    91
    
    
    
    57,962
    
    
    
    100,605
    
    
    
    73
    
    
    
    (3,819
    )
    
    
    (68,336
    )
    
    
    86,576
  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)
    
    2008
    
    
    2007Cash flows from operating activities:Net income (loss)
    
    $
    (7,589
    )
    
    
    8,499Adjustments to reconcile net income (loss) to cash provided by operating activities:Provision for loan losses
    
    
    18,480
    
    
    
    2,404Depreciation
    
    
    1,288
    
    
    
    1,429Amortization of (discounts) premiums, net
    
    
    101
    
    
    
    (2,183
    )Amortization of deferred loan fees
    
    
    (616
    )
    
    
    (997
    )Amortization of core deposit intangible
    
    
    0
    
    
    
    85Amortization of mortgage servicing rights
    
    
    456
    
    
    
    540Capitalized mortgage servicing rights
    
    
    (10
    )
    
    
    (13
    )Securities gains, net
    
    
    (479
    )
    
    
    0Loss (gain) on sales of real estate
    
    
    (160
    )
    
    
    35Gain on sales of loans
    
    
    (442
    )
    
    
    (1,189
    )Proceeds from sales of real estate
    
    
    6,046
    
    
    
    4,903Proceeds from sales of loans held for sale
    
    
    47,640
    
    
    
    51,215Disbursements on loans held for sale
    
    
    (45,914
    )
    
    
    (39,470
    )Amortization of restricted stock awards
    
    
    310
    
    
    
    251Amortization of unearned ESOP shares
    
    
    146
    
    
    
    146Earned employee stock ownership shares priced above original cost
    
    
    122
    
    
    
    274Stock option compensation
    
    
    25
    
    
    
    32(Increase) decrease in accrued interest receivable
    
    
    1,682
    
    
    
    (2,289
    )(Decrease) increase in accrued interest payable
    
    
    (3,531
    )
    
    
    6,651Goodwill impairment charge
    
    
    3,801
    
    
    
    0(Increase) decrease in other assets
    
    
    (5,371
    )
    
    
    1,034(Decrease) increase in other liabilities
    
    
    (3,091
    )
    
    
    1,126Other, net
    
    
    25
    
    
    
    13Net cash provided by operating activities
    
    
    12,919
    
    
    
    32,496Cash flows from investing activities:Proceeds from sales of securities available for sale
    
    
    10,442
    
    
    
    0Principal collected on securities available for sale
    
    
    2,872
    
    
    
    1,677Proceeds collected on maturities of securities available for sale
    
    
    85,000
    
    
    
    120,000Purchases of securities available for sale
    
    
    (99,442
    )
    
    
    (203,067
    )Purchase of Federal Home Loan Bank stock
    
    
    (5,959
    )
    
    
    (999
    )Redemption of Federal Home Loan Bank stock
    
    
    4,696
    
    
    
    3,375Net increase in loans receivable
    
    
    (40,579
    )
    
    
    (96,004
    )Purchases of premises and equipment
    
    
    (2,725
    )
    
    
    (2,136
    )Net cash used by investing activities
    
    
    (45,695)
    
    
    
    (177,154
    )Cash flows from financing activities:Increase in deposits
    
    
    518
    
    
    
    210,923Purchase of treasury stock
    
    
    (723
    )
    
    
    (2,778
    )Stock options exercised
    
    
    0
    
    
    
    139Excess tax benefits from options exercised
    
    
    0
    
    
    
    99Dividends to stockholders
    
    
    (2,749
    )
    
    
    (2,813
    )Proceeds from borrowings
    
    
    347,700
    
    
    
    114,100Repayment of borrowings
    
    
    (318,700
    )
    
    
    (167,500
    )Increase in customer escrows
    
    
    232
    
    
    
    628Net cash provided by financing activities
    
    
    26,278
    
    
    
    152,798Increase (decrease) in cash and cash equivalents
    
    
    (6,498
    )
    
    
    8,140Cash and cash equivalents, beginning of period
    
    
    23,718
    
    
    
    43,776Cash and cash equivalents, end of period
    
    $
    17,220
    
    
    
    51,916Supplemental cash flow disclosures:Cash paid for interest
    
    $
    28,522
    
    
    
    22,083Cash paid for income taxes
    
    
    5,247
    
    
    
    5,482Supplemental noncash flow disclosures:Transfer of loans to real estate
    
    
    12,476
    
    
    
    5,388Loans transferred to loans held for sale
    
    
    2,170
    
    
    
    11,239
 
 6




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##### Table of Contents



HMN FINANCIAL, INC. AND SUBSIDIARIES
 
 Notes to Consolidated Financial Statements
  September 30, 2008 and 2007
 (1) HMN Financial, Inc.
   (2) Basis of Preparation
   (3) New Accounting Standards
 Noncontrolling Interests in Consolidated Financial
Statements-an amendment of ARB No. 51. ARB No. 51
 Business Combinations. Business Combinations
 7




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##### Table of Contents



Disclosures about Derivative Instruments and Hedging
Activities-an amendment of FASB Statement No. 133.
 The Hierarchy of Generally Accepted Accounting
Principles The Meaning of Present Fairly in
Conformity With Generally Accepted Accounting Principles
 (4) Derivative Instruments and Hedging Activities
   (5) Fair Value Measurements
 Fair Value Measurements
 Level 1
 Level 2
 Level 3
 8




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##### Table of Contents



Carrying value at September 30, 2008(Dollars in thousands)
    
    Total
    
    
    Level 1
    
    
    Level 2
    
    
    Level 3Securities available for sale
    
    $
    186,058
    
    
    
    12,848
    
    
    
    173,210
    
    
    
    0Mortgage loan commitments
    
    
    (74
    )
    
    
    0
    
    
    
    (74
    )
    
    
    0Total
    
    $
    185,985
    
    
    
    12,848
    
    
    
    173,137
    
    
    
    0
  Carrying value at September 30, 2008Nine months endedSeptember 30, 2008(Dollars in thousands)
    
    Total
    
    
    Level 1
    
    
    Level 2
    
    
    Level 3
    
    
    Total gains (losses)Loans held for sale
    
    $
    4,222
    
    
    
    0
    
    
    
    4,222
    
    
    
    0
    
    
    
    (15
    )Mortgage servicing rights
    
    
    824
    
    
    
    0
    
    
    
    824
    
    
    
    0
    
    
    
    2,275Loans (1)
    
    
    42,315
    
    
    
    0
    
    
    
    42,315
    
    
    
    0
    
    
    
    (4,134
    )Real estate, net(2)
    
    
    8,798
    
    
    
    0
    
    
    
    8,798
    
    
    
    0
    
    
    
    (65
    )Total
    
    $
    56,159
    
    
    
    0
    
    
    
    56,159
    
    
    
    0
    
    
    
    (1,939
    )
 
 (1)
    
    Represents carrying value and related specific reserves on loans for which adjustments are
based on the appraised value of the collateral. The carrying value of loans fully charged-off is
zero.(2)
    
    Represents the fair value and related losses of foreclosed real estate and other collateral
owned that were measured at fair value subsequent to their initial classification as foreclosed
assets. (6) Comprehensive Income (Loss)
  For the three months ended September 30,(Dollars in thousands)
    
    2008
    
    2007Before tax
    
    Tax effect
    
    Net of tax
    
    Before tax
    
    Tax effect
    
    Net of taxSecurities available for sale:Net unrealized gains (losses)
arising during the
period
    
    $
    (694
    )
    
    
    (310
    )
    
    
    (384
    )
    
    
    1,796
    
    
    
    712
    
    
    
    1,084Less reclassification of net
gains
included in net income
    
    
    479
    
    
    
    169
    
    
    
    310
    
    
    
    0
    
    
    
    0
    
    
    
    0Other comprehensive income
(loss)
    
    $
    (1,173
    )
    
    
    (479
    )
    
    
    (694
    )
    
    
    1,796
    
    
    
    712
    
    
    
    1,084
 For the nine months ended September 30,2008
    
    2007Before tax
    
    Tax effect
    
    Net of tax
    
    Before tax
    
    Tax effect
    
    Net of taxSecurities available for sale:Net unrealized gains (losses)
arising during the
period
    
    $
    (1,370
    )
    
    
    (586
    )
    
    
    (784
    )
    
    
    927
    
    
    
    368
    
    
    
    559Less reclassification of net
gains included in
net income
    
    
    479
    
    
    
    169
    
    
    
    310
    
    
    
    0
    
    
    
    0
    
    
    
    0Other comprehensive income
(loss)
    
    $
    (1,849
    )
    
    
    (755
    )
    
    
    (1,094
    )
    
    
    927
    
    
    
    368
    
    
    
    559
 9




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##### Table of Contents



(7) Securities Available For Sale
  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
    
    
    11
    
    
    $
    31,226
    
    
    
    (332
    )
    
    
    1
    
    
    $
    2,454
    
    
    
    (398
    )
    
    $
    33,680
    
    
    
    (730
    )FNMA
    
    
    8
    
    
    
    22,408
    
    
    
    (245
    )
    
    
    3
    
    
    
    2,575
    
    
    
    (137
    )
    
    
    24,983
    
    
    
    (382
    )Other marketable securities:FNMA Notes
    
    
    4
    
    
    
    20,080
    
    
    
    (45
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    20,080
    
    
    
    (45
    )Corporate equity
    
    
    1
    
    
    
    350
    
    
    
    (350
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    350
    
    
    
    (350
    )Total temporarily impaired
securities
    
    
    24
    
    
    $
    74,064
    
    
    
    (972
    )
    
    
    4
    
    
    $
    5,029
    
    
    
    (535
    )
    
    $
    79,093
    
    
    
    (1,507
    )
  (8) Mortgage Servicing Rights
  Nine Months ended
    
    
    Twelve Months ended
    
    
    Nine Months ended(Dollars in thousands)
    
    Sept. 30, 2008
    
    
    Dec. 31, 2007
    
    
    Sept. 30, 2007Mortgage servicing rightsBalance, beginning of period
    
    $
    1,270
    
    
    
    1,958
    
    
    
    1,958Originations
    
    
    10
    
    
    
    18
    
    
    
    13Amortization
    
    
    (456
    )
    
    
    (706
    )
    
    
    (540
    )Balance, end of period
    
    
    824
    
    
    
    1,270
    
    
    
    1,431Fair value of mortgage servicing rights
    
    $
    3,099
    
    
    
    3,261
    
    
    
    3,703
  Weighted
    
    WeightedLoan
    
    Average
    
    AveragePrincipal
    
    Interest
    
    Remaining
    
    Number(Dollars in thousands)
    
    Balance
    
    Rate
    
    Term
    
    of LoansOriginal term 30 year fixed rate
    
    $
    198,546
    
    
    
    5.87
    %
    
    285 mos.
    
    
    1,863Original term 15 year fixed rate
    
    
    103,635
    
    
    
    5.17
    %
    
    107 mos.
    
    
    1,699Adjustable rate
    
    
    1,896
    
    
    
    5.92
    %
    
    294 mos.
    
    
    18
  10




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##### Table of Contents



Gross
    
    
    
    
    
    
    UnamortizedCarrying
    
    
    Accumulated
    
    
    Intangible(Dollars in thousands)
    
    Amount
    
    
    Amortization
    
    
    AssetsAmortized intangible assets:Mortgage servicing rights
    
    $
    3,861
    
    
    
    (3,037
    )
    
    
    824Total
    
    $
    3,861
    
    
    
    (3,037
    )
    
    
    824
  MortgageServicing(Dollars in thousands)
    
    RightsYear ending December 31,2008
    
    $
    1172009
    
    
    3622010
    
    
    1982011
    
    
    962012
    
    
    38
  (9) Earnings (loss) per Share
  Three months ended September 30,
    
    
    Nine months ended September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007Weighted average number of common shares outstanding
used in basic earnings per common share calculation
    
    
    3,657
    
    
    
    3,738
    
    
    
    3,651
    
    
    
    3,756Net dilutive effect of:Options
    
    
    0
    
    
    
    143
    
    
    
    0
    
    
    
    158Restricted stock awards
    
    
    0
    
    
    
    17
    
    
    
    0
    
    
    
    19Weighted average number of shares outstanding
adjusted for effect of dilutive securities
    
    
    3,657
    
    
    
    3,898
    
    
    
    3,651
    
    
    
    3,933Income (loss) available to common shareholders
    
    $
    (7,051
    )
    
    
    2,782
    
    
    
    (7,589
    )
    
    
    8,499Basic earnings (loss) per common share
    
    $
    (1.93
    )
    
    
    0.74
    
    
    
    (2.08
    )
    
    
    2.26Diluted earnings (loss) per common share
    
    $
    (1.93
    )
    
    
    0.71
    
    
    
    (2.08
    )
    
    
    2.16
 (10) Regulatory Capital
   11




---



##### 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
    
    $
    82,925Less:Net unrealized gains on certain securities
available for sale
    
    
    (278
    )Tier I or core capital
    
    
    82,647Tier I capital to adjusted total assets
    
    
    
    
    
    
    7.33
    %
    
    $
    45,129
    
    
    
    4.00
    %
    
    $
    37,518
    
    
    
    3.33
    %
    
    $
    56,411
    
    
    
    5.00
    %Tier I capital to risk-weighted assets
    
    
    
    
    
    
    9.52
    %
    
    $
    34,712
    
    
    
    4.00
    %
    
    $
    47,935
    
    
    
    5.52
    %
    
    $
    52,069
    
    
    
    6.00
    %Plus:Allowable allowance for loan losses
    
    
    8,849Risk-based capital
    
    $
    91,496
    
    
    
    
    
    
    $
    69,425
    
    
    
    
    
    
    $
    22,071
    
    
    
    
    
    
    $
    86,781Risk-based capital to risk- weighted assets
    
    
    
    
    
    
    10.54
    %
    
    
    
    
    
    
    8.00
    %
    
    
    
    
    
    
    2.54
    %
    
    
    
    
    
    
    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) Business Segments
   12




---



##### Table of Contents



Home Federal
    
    
    
    
    
    
    
    
    
    Consolidated(Dollars in thousands)
    
    Savings Bank
    
    Other
    
    Eliminations
    
    TotalAt or for the quarter ended September 30, 2008:Interest income  external customers
    
    $
    16,372
    
    
    
    2
    
    
    
    0
    
    
    
    16,374Non-interest income  external customers
    
    
    1,958
    
    
    
    0
    
    
    
    0
    
    
    
    1,958Loss on limited partnerships
    
    
    (5
    )
    
    
    0
    
    
    
    0
    
    
    
    (5
    )Intersegment interest income
    
    
    0
    
    
    
    18
    
    
    
    (18
    )
    
    
    0Intersegment non-interest income
    
    
    44
    
    
    
    (6,952
    )
    
    
    6,908
    
    
    
    0Interest expense
    
    
    7,824
    
    
    
    0
    
    
    
    (18
    )
    
    
    7,806Amortization of mortgage servicing rights, net
    
    
    142
    
    
    
    0
    
    
    
    0
    
    
    
    142Other non-interest expense
    
    
    6,276
    
    
    
    187
    
    
    
    (44
    )
    
    
    6,419Income tax benefit
    
    
    (4,713
    )
    
    
    (66
    )
    
    
    0
    
    
    
    (4,779
    )Net loss
    
    
    (6,951
    )
    
    
    (7,052
    )
    
    
    6,952
    
    
    
    (7,051
    )Goodwill
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    0Total assets
    
    
    1,128,029
    
    
    
    87,461
    
    
    
    (86,590
    )
    
    
    1,128,900At or for the quarter ended September 30, 2007:Interest income  external customers
    
    $
    20,276
    
    
    
    2
    
    
    
    0
    
    
    
    20,278Non-interest income  external customers
    
    
    1,554
    
    
    
    100
    
    
    
    0
    
    
    
    1,654Loss on limited partnerships
    
    
    (5
    )
    
    
    0
    
    
    
    0
    
    
    
    (5
    )Intersegment 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 nine months ended September 30, 2008:Interest income  external customers
    
    $
    50,402
    
    
    
    16
    
    
    
    0
    
    
    
    50,418Non-interest income  external customers
    
    
    5,231
    
    
    
    0
    
    
    
    0
    
    
    
    5,231Loss on limited partnerships
    
    
    (4
    )
    
    
    0
    
    
    
    0
    
    
    
    (4
    )Intersegment interest income
    
    
    0
    
    
    
    69
    
    
    
    (69
    )
    
    
    0Intersegment non-interest income
    
    
    131
    
    
    
    (7,319
    )
    
    
    7,188
    
    
    
    0Interest expense
    
    
    25,060
    
    
    
    0
    
    
    
    (69
    )
    
    
    24,991Amortization of mortgage servicing rights, net
    
    
    456
    
    
    
    0
    
    
    
    0
    
    
    
    456Other non-interest expense
    
    
    21,745
    
    
    
    544
    
    
    
    (131
    )
    
    
    22,158Income tax benefit
    
    
    (2,666
    )
    
    
    (185
    )
    
    
    0
    
    
    
    (2,851
    )Net loss
    
    
    (7,315
    )
    
    
    (7,593
    )
    
    
    7,319
    
    
    
    (7,589
    )Goodwill
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    0Total assets
    
    
    1,128,029
    
    
    
    87,461
    
    
    
    (86,590
    )
    
    
    1,128,900At or for the nine months ended September 30, 2007:Interest income  external customers
    
    $
    58,145
    
    
    
    40
    
    
    
    0
    
    
    
    58,185Non-interest income  external customers
    
    
    4,913
    
    
    
    100
    
    
    
    0
    
    
    
    5,013Loss on limited partnerships
    
    
    (5
    )
    
    
    0
    
    
    
    0
    
    
    
    (5
    )Intersegment 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
    
    
    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
    )
    
    
    1,147,413
 13




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##### Table of Contents



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




---



##### Table of Contents



Outlook
   
    
    Loan originations could continue to fluctuate from period to period, along with related
interest and fee income.
    
    A continuing decrease in the value of real estate may occur. Reduced property prices and a
soft real estate market could negatively affect the volume of home sales, which, in turn, could
affect the construction, residential development, mortgage and home equity loan originations and
prepayments.
    
    A continuation of soft or declining real estate values could also affect the value of the
collateral securing our construction, development and mortgage loans. A decrease in value could, in
turn, lead to increased losses on loans in the event of foreclosures, which would affect our
provisions for loan losses and profitability.
    
    A general slowdown in the economy or a recession may affect our borrowers ability to repay
their loan obligations, which could lead to increased charge-offs and loan loss provisions and/or
less revenue.
    
    If customer demand for real estate loans decreases, our profits may decrease because our
investments, primarily mortgage-related securities, generally earn less income than real estate
loans.
    
    The current unsettled markets may also affect the liquidity and/or value of our real
estate-related investments.
  Critical Accounting Policies
  Allowance for Loan Losses and Related Provision
  15




---



##### Table of Contents



Mortgage Servicing Rights
  Income Taxes
  16




---



##### Table of Contents



Accounting for Uncertainty in Income Taxes  an
interpretation of FASB Statement No. 109
 Net Income (Loss)
   Net Interest Income
  17




---



##### Table of Contents



18




---



##### Table of Contents



For the nine month period endedSeptember 30, 2008
    
    
    September 30, 2007Average
    
    
    Interest
    
    
    
    
    
    
    Average
    
    
    InterestOutstanding
    
    
    Earned/
    
    
    Yield/
    
    
    Outstanding
    
    
    Earned/
    
    
    Yield/(Dollars in thousands)
    
    Balance
    
    
    Paid
    
    
    Rate
    
    
    Balance
    
    
    Paid
    
    
    RateInterest-earning assets:Securities available for sale
    
    $
    145,713
    
    
    
    5,438
    
    
    
    4.99
    %
    
    $
    190,231
    
    
    
    7,305
    
    
    
    5.13
    %Loans held for sale
    
    
    2,600
    
    
    
    117
    
    
    
    6.01
    
    
    
    2,368
    
    
    
    110
    
    
    
    6.23Mortgage loans, net
    
    
    164,661
    
    
    
    7,703
    
    
    
    6.23
    
    
    
    142,034
    
    
    
    6,531
    
    
    
    6.15Commercial loans, net
    
    
    635,397
    
    
    
    32,325
    
    
    
    6.80
    
    
    
    593,080
    
    
    
    37,530
    
    
    
    8.46Consumer loans, net
    
    
    84,181
    
    
    
    4,428
    
    
    
    7.03
    
    
    
    84,248
    
    
    
    5,461
    
    
    
    8.67Cash equivalents
    
    
    17,645
    
    
    
    196
    
    
    
    1.48
    
    
    
    25,516
    
    
    
    972
    
    
    
    5.09Federal Home Loan Bank stock
    
    
    6,927
    
    
    
    211
    
    
    
    4.07
    
    
    
    6,940
    
    
    
    276
    
    
    
    5.32Total interest-earning assets
    
    
    1,057,124
    
    
    
    50,418
    
    
    
    6.37
    
    
    
    1,044,417
    
    
    
    58,185
    
    
    
    7.45Interest-bearing liabilities:NOW accounts
    
    
    124,869
    
    
    
    1,367
    
    
    
    1.46
    
    
    
    113,733
    
    
    
    2,685
    
    
    
    3.16Savings accounts
    
    
    41,642
    
    
    
    345
    
    
    
    1.11
    
    
    
    40,654
    
    
    
    414
    
    
    
    1.36Money market accounts
    
    
    127,299
    
    
    
    2,323
    
    
    
    2.43
    
    
    
    222,056
    
    
    
    6,314
    
    
    
    3.80Certificates
    
    
    244,313
    
    
    
    7,373
    
    
    
    4.03
    
    
    
    235,787
    
    
    
    7,815
    
    
    
    4.43Brokered deposits
    
    
    277,288
    
    
    
    9,536
    
    
    
    4.59
    
    
    
    193,332
    
    
    
    7,278
    
    
    
    5.03Federal Home Loan Bank advances
    
    
    116,209
    
    
    
    4,047
    
    
    
    4.65
    
    
    
    122,817
    
    
    
    4,227
    
    
    
    4.60Total interest-bearing liabilities
    
    
    931,620
    
    
    
    24,991
    
    
    
    3.58
    
    
    
    928,379
    
    
    
    28,733
    
    
    
    4.14Noninterest checking
    
    
    54,731
    
    
    
    
    
    
    
    
    
    
    
    55,607Other noninterest bearing escrow deposits
    
    
    1,107
    
    
    
    
    
    
    
    
    
    
    
    1,030Total interest-bearing liabilities and
Noninterest bearing deposits
    
    $
    987,458
    
    
    
    
    
    
    
    
    
    
    $
    985,016Net interest income
    
    
    
    
    
    $
    25,427
    
    
    
    
    
    
    
    
    
    
    $
    29,452Net interest rate spread
    
    
    
    
    
    
    
    
    
    
    2.79
    %
    
    
    
    
    
    
    
    
    
    
    3.31
    %Net interest margin
    
    
    
    
    
    
    
    
    
    
    3.21
    %
    
    
    
    
    
    
    
    
    
    
    3.77
    %
 Provision for Loan Losses
   19




---



##### Table of Contents



(in thousands)
    
    2008
    
    
    2007Balance at January 1,
    
    $
    12,438
    
    
    $
    9,873Provision
    
    
    18,480
    
    
    
    2,404Charge offs:Commercial loans
    
    
    (12,034
    )
    
    
    (16
    )Commercial real estate loans
    
    
    (2,727
    )
    
    
    (138
    )Consumer loans
    
    
    (633
    )
    
    
    (694
    )Recoveries
    
    
    47
    
    
    
    123Balance at September 30,
    
    $
    15,571
    
    
    $
    11,552
 Non-Interest Income
   Non-Interest Expense
   20




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##### Table of Contents



Income Tax (Benefit) Expense
   Non-Performing Assets
  September 30,
    
    
    June 30,
    
    
    December 31,(Dollars in thousands)
    
    2008
    
    
    2008
    
    
    2007Non-Accruing Loans:One-to-four family real estate
    
    $
    620
    
    
    $
    1,046
    
    
    $
    1,196Commercial real estate
    
    
    32,554
    
    
    
    39,221
    
    
    
    15,641Consumer
    
    
    997
    
    
    
    1,439
    
    
    
    1,094Commercial business
    
    
    2,253
    
    
    
    2,500
    
    
    
    1,723Total
    
    
    36,424
    
    
    
    44,206
    
    
    
    19,654Other assets
    
    
    25
    
    
    
    25
    
    
    
    34Foreclosed and Repossessed Assets:One-to-four family real estate
    
    
    552
    
    
    
    2,731
    
    
    
    901Consumer
    
    
    0
    
    
    
    19
    
    
    
    33Commercial real estate
    
    
    8,247
    
    
    
    1,541
    
    
    
    1,313Total non-performing assets
    
    $
    45,248
    
    
    $
    48,522
    
    
    $
    21,935Total as a percentage of total assets
    
    
    4.01
    %
    
    
    4.49
    %
    
    
    1.96
    %Total non-performing loans
    
    $
    36,424
    
    
    $
    44,206
    
    
    $
    19,654Total as a percentage of total loans receivable, net
    
    
    4.17
    %
    
    
    4.94
    %
    
    
    2.27
    %Allowance for loan loss to non-performing loans
    
    
    42.75
    %
    
    
    33.76
    %
    
    
    63.28
    %Delinquency Data:Delinquencies (1)30+ days
    
    $
    4,354
    
    
    $
    2,491
    
    
    $
    6,41690+ days
    
    
    0
    
    
    
    0
    
    
    
    0Delinquencies as a percentage of
loan and lease portfolio (1)30+ days
    
    
    0.49
    %
    
    
    0.27
    %
    
    
    0.73
    %90+ days
    
    
    0.00
    %
    
    
    0.00
    %
    
    
    0.00
    %
 
 (1)
    
    Excludes non-accrual loans.  21




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##### Table of Contents



Dividends
  Record date
    
    Pay date
    
    Dividend per share
    
    Dividend Payout RatioFebruary 15, 2008
    
    March 7, 2008
    
    $
    0.25
    
    
    
    34.25
    %May 16, 2008
    
    June 6, 2008
    
    $
    0.25
    
    
    
    64.10
    %August 25, 2008
    
    September 8, 2008
    
    $
    0.25
    
    
    
    (44.64
    )%
   Liquidity
and Capital Resources
  22




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##### Table of Contents



Market Risk
  Rate Shock Table
  23




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##### Table of Contents



Other than trading portfolio(Dollars in thousands)
    
    Market ValueBasis point change in interest rates
    
    -100
    
    
    0
    
    
    +100
    
    
    +200Total market risk sensitive assets
    
    $
    1,128,885
    
    
    
    1,109,775
    
    
    
    1,088,878
    
    
    
    1,066,980Total market risk sensitive liabilities
    
    
    1,037,408
    
    
    
    1,024,120
    
    
    
    1,010,896
    
    
    
    998,999Off-balance sheet financial instruments
    
    
    (85
    )
    
    
    0
    
    
    
    164
    
    
    
    310Net market risk
    
    $
    91,562
    
    
    
    85,655
    
    
    
    77,818
    
    
    
    67,671Percentage change from current market value
    
    
    6.90
    %
    
    
    0.00
    %
    
    
    (9.15
    )%
    
    
    (21.00
    )%
   Asset/Liability Management
  Projected Change inRate Shock
    
    Net Interest
    
    Percentage(Dollars in thousands)
    
    in Basis Points
    
    Income
    
    Change+200
    
    
    $
    1,899
    
    
    
    6.16
    %+100
    
    
    
    461
    
    
    
    1.500
    
    
    
    0
    
    
    
    0.00-100
    
    
    
    (821
    )
    
    
    (2.66
    )
 24




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##### Table of Contents



Off-Balance Sheet Arrangements
  
 Item 4: Controls and Procedures
 Evaluation of disclosure controls and procedures.
 Changes in internal controls.
 25




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##### Table of Contents



HMN FINANCIAL, INC.
 
 PART II  OTHER INFORMATION
 
 ITEM 1. Legal Proceedings.
  
 ITEM 1A. Risk Factors.
  
 ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds.
   (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 Programs (1)July 1 through July 31, 2008
    
    
    0
    
    
    $
    N/A
    
    
    
    0
    
    
    
    300,000August 1 through August 31, 2008
    
    
    0
    
    
    
    N/A
    
    
    
    0
    
    
    
    300,000September 1 through September
30, 2008
    
    
    0
    
    
    
    N.A
    
    
    
    0
    
    
    
    300,000Total
    
    
    0
    
    
    $
    N/A
    
    
    
    0
 
 (1)
    
    On July 22, 2008 the Board of Directors authorized the repurchase of up to 300,000 shares of
the Companys common stock. This program expires on January 26, 2010. 
 ITEM 3. Defaults Upon Senior Securities.
  
 ITEM 4. Submission of Matters to a Vote of Security Holders.
  
 ITEM 5. Other Information.
  
 ITEM 6. Exhibits.
  26




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##### Table of Contents



SIGNATURES
  HMN FINANCIAL, INC.
RegistrantDate: November 3, 2008
    /s/ Michael McNeilMichael McNeil,President/Chief Executive Officer

(Principal Executive Officer)

(Duly Authorized Representative)Date: November 3, 2008
    /s/ Jon EberleJon Eberle,Chief Financial Officer

(Principal Financial Officer) 27




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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 Exhibit 3(a) 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 Exhibit 3 to the Companys Current Report on Form 8-K dated August
26, 2008 (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). 28