##### 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 June 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
(Do not check if a smaller reporting company)
    
    Smaller Reporting Company o
 o þ
  Class
    
    Outstanding at July 22, 2008Common stock, $0.01 par value
    
    4,167,799




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##### 



HMN FINANCIAL, INC.
 CONTENTS
  
 PagePART I  FINANCIAL INFORMATIONItem 1: Financial Statements (unaudited)Consolidated Balance Sheets at June 30, 2008 and December 31, 2007
    
    
    3Consolidated Statements of Income (Loss) for the
Three Months Ended and Six Months Ended June 30, 2008 and 2007
    
    
    4Consolidated Statement of Stockholders Equity and Comprehensive
Income (Loss) for the Six Month Period Ended June 30, 2008
    
    
    5Consolidated Statements of Cash Flows for
the Six Months Ended June 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
Included in Item 2 under Market Risk
    
    
    21Item 4: Controls and Procedures
    
    
    23PART II  OTHER INFORMATIONItem 1: Legal Proceedings
    
    
    24Item 1A: Risk Factors
    
    
    24Item 2: Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    24Item 3: Defaults Upon Senior Securities
    
    
    24Item 4: Submission of Matters to a Vote of Security Holders
    
    
    24Item 5: Other Information
    
    
    25Item 6: Exhibits
    
    
    25Signatures
    
    
    26Certification of CEOCertification of CFOSection 1350 Certification of CEO and CFO
  2




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##### Table of Contents



Part I  FINANCIAL INFORMATION
 
 Item 1: Financial Statements
 HMN FINANCIAL, INC. AND SUBSIDIARIES
 
 Consolidated Balance Sheets
 June 30,
    
    
    December 31,(Dollars in thousands)
    
    2008
    
    
    2007(unaudited)AssetsCash and cash equivalents
    
    $
    14,475
    
    
    
    23,718Securities available for sale:Mortgage-backed and related securities
(amortized cost $17,063 and $18,786)
    
    
    16,659
    
    
    
    18,468Other marketable securities
(amortized cost $105,468 and $165,430)
    
    
    107,167
    
    
    
    167,720123,826
    
    
    
    186,188Loans held for sale
    
    
    3,699
    
    
    
    3,261Loans receivable, net
    
    
    895,713
    
    
    
    865,088Accrued interest receivable
    
    
    6,199
    
    
    
    6,893Real estate, net
    
    
    4,272
    
    
    
    2,214Federal Home Loan Bank stock, at cost
    
    
    7,460
    
    
    
    6,198Mortgage servicing rights, net
    
    
    957
    
    
    
    1,270Premises and equipment, net
    
    
    12,585
    
    
    
    12,024Goodwill
    
    
    0
    
    
    
    3,801Prepaid expenses and other assets
    
    
    1,981
    
    
    
    1,680Deferred tax asset
    
    
    4,996
    
    
    
    4,719Total assets
    
    $
    1,076,163
    
    
    
    1,117,054Liabilities and Stockholders EquityDeposits
    
    $
    832,316
    
    
    
    888,118Federal Home Loan Bank advances
    
    
    137,900
    
    
    
    112,500Accrued interest payable
    
    
    6,607
    
    
    
    9,515Customer escrows
    
    
    965
    
    
    
    866Accrued expenses and other liabilities
    
    
    3,323
    
    
    
    7,927Total liabilities
    
    
    981,111
    
    
    
    1,018,926Commitments and contingenciesStockholders equity:Serial
preferred stock ($.01 par value): authorized 500,000 shares; issued and outstanding none
    
    
    0
    
    
    
    0Common stock
($.01 par value): authorized 11,000,000; issued shares 9,128,662
    
    
    91
    
    
    
    91Additional paid-in capital
    
    
    57,820
    
    
    
    58,049Retained earnings, subject to certain restrictions
    
    
    108,572
    
    
    
    110,943Accumulated other comprehensive income
    
    
    766
    
    
    
    1,167Unearned employee stock ownership plan shares
    
    
    (3,867
    )
    
    
    (3,965
    )Treasury stock, at cost 4,960,863 and 4,953,045 shares
    
    
    (68,330
    )
    
    
    (68,157
    )Total stockholders equity
    
    
    95,052
    
    
    
    98,128Total liabilities and stockholders equity
    
    $
    1,076,163
    
    
    
    1,117,054
  3




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##### Table of Contents



HMN FINANCIAL, INC. AND SUBSIDIARIES
 
 Consolidated Statements of Income (Loss)
 Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,(Dollars in thousands, except per share data)
    
    2008
    
    
    2007
    
    
    2008
    
    
    2007Interest income:Loans receivable
    
    $
    14,419
    
    
    
    16,629
    
    
    
    29,939
    
    
    
    32,374Securities available for sale:Mortgage-backed and related
    
    
    213
    
    
    
    171
    
    
    
    437
    
    
    
    282Other marketable
    
    
    1,507
    
    
    
    2,417
    
    
    
    3,417
    
    
    
    4,313Cash equivalents
    
    
    61
    
    
    
    279
    
    
    
    118
    
    
    
    722Other
    
    
    53
    
    
    
    132
    
    
    
    133
    
    
    
    216Total interest income
    
    
    16,253
    
    
    
    19,628
    
    
    
    34,044
    
    
    
    37,907Interest expense:Deposits
    
    
    6,839
    
    
    
    8,346
    
    
    
    14,709
    
    
    
    15,223Federal Home Loan Bank advances
    
    
    1,239
    
    
    
    1,427
    
    
    
    2,476
    
    
    
    3,045Total interest expense
    
    
    8,078
    
    
    
    9,773
    
    
    
    17,185
    
    
    
    18,268Net interest income
    
    
    8,175
    
    
    
    9,855
    
    
    
    16,859
    
    
    
    19,639Provision for loan losses
    
    
    1,130
    
    
    
    1,028
    
    
    
    2,690
    
    
    
    1,483Net interest income after provision
for loan losses
    
    
    7,045
    
    
    
    8,827
    
    
    
    14,169
    
    
    
    18,156Non-interest income:Fees and service charges
    
    
    998
    
    
    
    781
    
    
    
    1,791
    
    
    
    1,477Loan servicing fees
    
    
    240
    
    
    
    265
    
    
    
    482
    
    
    
    536Gains on sales of loans
    
    
    228
    
    
    
    189
    
    
    
    384
    
    
    
    985Other
    
    
    290
    
    
    
    57
    
    
    
    617
    
    
    
    362Total non-interest income
    
    
    1,756
    
    
    
    1,292
    
    
    
    3,274
    
    
    
    3,360Non-interest expense:Compensation and benefits
    
    
    3,036
    
    
    
    3,262
    
    
    
    6,396
    
    
    
    6,623Occupancy
    
    
    1,161
    
    
    
    1,112
    
    
    
    2,293
    
    
    
    2,196Advertising
    
    
    92
    
    
    
    195
    
    
    
    216
    
    
    
    301Data processing
    
    
    336
    
    
    
    321
    
    
    
    678
    
    
    
    616Amortization of mortgage servicing rights,
net
    
    
    154
    
    
    
    189
    
    
    
    314
    
    
    
    371Goodwill impairment charge
    
    
    3,801
    
    
    
    0
    
    
    
    3,801
    
    
    
    0Other
    
    
    1,220
    
    
    
    1,070
    
    
    
    2,354
    
    
    
    1,992Total non-interest expense
    
    
    9,800
    
    
    
    6,149
    
    
    
    16,052
    
    
    
    12,099Income (loss) before income tax expense
    
    
    (999
    )
    
    
    3,970
    
    
    
    1,391
    
    
    
    9,417Income tax expense
    
    
    1,026
    
    
    
    1,520
    
    
    
    1,928
    
    
    
    3,699Net income (loss)
    
    $
    (2,025
    )
    
    
    2,450
    
    
    
    (537
    )
    
    
    5,718Basic earnings (loss) per share
    
    $
    (0.56
    )
    
    
    0.65
    
    
    
    (0.15
    )
    
    
    1.52Diluted earnings (loss) per share
    
    $
    (0.56
    )
    
    
    0.62
    
    
    
    (0.15
    )
    
    
    1.45
  4




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##### Table of Contents



HMN FINANCIAL, INC. AND SUBSIDIARIES
 
 Consolidated Statement of Stockholders Equity and Comprehensive Income (Loss)
For the Six-Month Period Ended June 30, 2008
 UnearnedEmployeeAccumulated
    
    Stock
    
    
    
    
    
    TotalAdditional
    
    
    
    
    
    Other
    
    Ownership
    
    
    
    
    
    Stock-Common
    
    Paid-in
    
    Retained
    
    Comprehensive
    
    Plan
    
    Treasury
    
    Holders(Dollars in thousands)
    
    Stock
    
    Capital
    
    Earnings
    
    Income
    
    Shares
    
    Stock
    
    EquityBalance, December 31, 2007
    
    $
    91
    
    
    
    58,049
    
    
    
    110,943
    
    
    
    1,167
    
    
    
    (3,965
    )
    
    
    (68,157
    )
    
    
    98,128Net loss
    
    
    
    
    
    
    
    
    
    
    (537
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (537
    )Other comprehensive income (loss), net of tax:Net unrealized losses on securities available
for sale
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (401
    )
    
    
    
    
    
    
    
    
    
    
    (401
    )Total comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (938
    )Purchase of treasury stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (723
    )
    
    
    (723
    )Unearned compensation restricted stock awards
    
    
    
    
    
    
    (550
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    550
    
    
    
    0Stock compensation tax benefits
    
    
    
    
    
    
    17
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    17Amortization of restricted stock awards
    
    
    
    
    
    
    205
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    205Dividends paid
    
    
    
    
    
    
    
    
    
    
    (1,834
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,834
    )Earned employee stock ownership plan shares
    
    
    
    
    
    
    99
    
    
    
    
    
    
    
    
    
    
    
    98
    
    
    
    
    
    
    
    197Balance, June 30, 2008
    
    $
    91
    
    
    
    57,820
    
    
    
    108,572
    
    
    
    766
    
    
    
    (3,867
    )
    
    
    (68,330
    )
    
    
    95,052
  5




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##### Table of Contents



HMN FINANCIAL, INC. AND SUBSIDIARIES
 
 Consolidated Statements of Cash Flows
 Six Months EndedJune 30,(Dollars in thousands)
    
    2008
    
    
    2007Cash flows from operating activities:Net income (loss)
    
    $
    (537
    )
    
    
    5,718Adjustments to reconcile net income (loss) to cash provided by operating activities:Provision for loan losses
    
    
    2,690
    
    
    
    1,483Depreciation
    
    
    872
    
    
    
    959Amortization of discounts, net
    
    
    (477
    )
    
    
    (1,510
    )Amortization of deferred loan fees
    
    
    (421
    )
    
    
    (478
    )Amortization of core deposit intangible
    
    
    0
    
    
    
    57Amortization of mortgage servicing rights
    
    
    314
    
    
    
    371Capitalized mortgage servicing rights
    
    
    (1
    )
    
    
    (10
    )Loss (gain) on sales of real estate
    
    
    (225
    )
    
    
    133Gains on sales of loans
    
    
    (384
    )
    
    
    (985
    )Proceeds from sale of real estate
    
    
    3,916
    
    
    
    1,557Proceeds from sale of loans held for sale
    
    
    34,513
    
    
    
    34,883Disbursements on loans held for sale
    
    
    (32,497
    )
    
    
    (26,616
    )Amortization of restricted stock awards
    
    
    205
    
    
    
    165Amortization of unearned ESOP shares
    
    
    98
    
    
    
    97Earned employee stock ownership shares priced above original cost
    
    
    99
    
    
    
    189Stock option compensation
    
    
    17
    
    
    
    22Decrease (increase) in accrued interest receivable
    
    
    694
    
    
    
    (2,051
    )Increase (decrease) in accrued interest payable
    
    
    (2,908
    )
    
    
    3,230Goodwill impairment charge
    
    
    3,801
    
    
    
    0Decrease (increase) in other assets
    
    
    (291
    )
    
    
    437Decrease in accrued expenses and other liabilities
    
    
    (4,588
    )
    
    
    (1,447
    )Other, net
    
    
    30
    
    
    
    115Net cash provided by operating activities
    
    
    4,920
    
    
    
    16,319Cash flows from investing activities:Principal received on securities available for sale
    
    
    1,741
    
    
    
    967Proceeds from maturities of securities available for sale
    
    
    60,000
    
    
    
    75,000Purchases of securities available for sale
    
    
    0
    
    
    
    (153,376
    )Purchase of Federal Home Loan Bank Stock
    
    
    (4,539
    )
    
    
    (999
    )Redemption of Federal Home Loan Bank Stock
    
    
    3,277
    
    
    
    2,543Net increase in loans receivable
    
    
    (40,752
    )
    
    
    (90,743
    )Purchases of premises and equipment
    
    
    (1,453
    )
    
    
    (562
    )Net cash provided (used) by investing activities
    
    
    18,274
    
    
    
    (167,170
    )Cash flows from financing activities:Increase (decrease) in deposits
    
    
    (55,380
    )
    
    
    199,815Purchase of treasury stock
    
    
    (723
    )
    
    
    (2,194
    )Stock options exercised
    
    
    0
    
    
    
    139Excess tax benefits from options exercised
    
    
    0
    
    
    
    99Dividends to stockholders
    
    
    (1,834
    )
    
    
    (1,886
    )Proceeds from borrowings
    
    
    234,701
    
    
    
    113,100Repayment of borrowings
    
    
    (209,300
    )
    
    
    (166,500
    )Increase in customer escrows
    
    
    99
    
    
    
    94Net cash provided (used) by financing activities
    
    
    (32,437
    )
    
    
    142,667Decrease in cash and cash equivalents
    
    
    (9,243
    )
    
    
    (8,184
    )Cash and cash equivalents, beginning of period
    
    
    23,718
    
    
    
    43,776Cash and cash equivalents, end of period
    
    $
    14,475
    
    
    
    35,592Supplemental cash flow disclosures:Cash paid for interest
    
    $
    20,093
    
    
    
    15,038Cash paid for income taxes
    
    
    4,059
    
    
    
    5,206Supplemental noncash flow disclosures:Transfer of loans to real estate
    
    
    5,760
    
    
    
    4,438Loans transferred to loans held for sale
    
    
    2,097
    
    
    
    10,309
  6




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##### Table of Contents



HMN FINANCIAL, INC. AND SUBSIDIARIES
 
 Notes to Consolidated Financial Statements
 June 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
 Disclosures about Derivative Instruments and Hedging
Activities-an amendment of FASB Statement No. 133.
 7




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##### Table of Contents



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 June 30, 2008(Dollars in thousands)
    
    Total
    
    
    Level 1
    
    
    Level 2
    
    
    Level 3Securities available for sale
    
    $
    123,826
    
    
    
    13,253
    
    
    
    110,573
    
    
    
    0Mortgage loan commitments
    
    
    3
    
    
    
    0
    
    
    
    3
    
    
    
    0Total
    
    $
    123,829
    
    
    
    13,253
    
    
    
    110,576
    
    
    
    0
  Carrying value at June 30, 2008Three months endedJune 30, 2008(Dollars in thousands)
    
    Total
    
    
    Level 1
    
    
    Level 2
    
    
    Level 3
    
    
    Total lossesLoans held for sale
    
    $
    3,699
    
    
    
    0
    
    
    
    3,699
    
    
    
    0
    
    
    
    (7
    )Mortgage servicing rights
    
    
    957
    
    
    
    0
    
    
    
    957
    
    
    
    0
    
    
    
    0Loans (1)
    
    
    44,230
    
    
    
    0
    
    
    
    44,230
    
    
    
    0
    
    
    
    (2,731
    )Real estate, net(2)
    
    
    4,272
    
    
    
    0
    
    
    
    4,272
    
    
    
    0
    
    
    
    (21
    )Total
    
    $
    53,158
    
    
    
    0
    
    
    
    53,158
    
    
    
    0
    
    
    
    (2,759
    )
 
 (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 June 30,2008
    
    
    2007(Dollars in thousands)
    
    Before tax
    
    
    Tax effect
    
    
    Net of tax
    
    
    Before tax
    
    
    Tax effect
    
    
    Net of taxSecurities available for sale:Net unrealized losses
arising during the period
    
    $
    (2,706
    )
    
    
    (1,105
    )
    
    
    (1,601
    )
    
    
    (1,242
    )
    
    
    (492
    )
    
    
    (750
    )Other comprehensive loss
    
    $
    (2,706
    )
    
    
    (1,105
    )
    
    
    (1,601
    )
    
    
    (1,242
    )
    
    
    (492
    )
    
    
    (750
    )
 For the six months ended June 30,2008
    
    
    2007(Dollars in thousands)
    
    Before tax
    
    
    Tax effect
    
    
    Net of tax
    
    
    Before tax
    
    
    Tax effect
    
    
    Net of taxSecurities available for sale:Net unrealized losses
arising during the period
    
    $
    (677
    )
    
    
    (276
    )
    
    
    (401
    )
    
    
    (869
    )
    
    
    (344
    )
    
    
    (525
    )Other comprehensive loss
    
    $
    (677
    )
    
    
    (276
    )
    
    
    (401
    )
    
    
    (869
    )
    
    
    (344
    )
    
    
    (525
    )
 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
    
    
    0
    
    
    $
    0
    
    
    
    0
    
    
    
    1
    
    
    
    
    
    $
    2,450
    
    
    
    (406
    )
    
    $
    2,450
    
    
    
    (406
    )FNMA
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    3
    
    
    
    
    
    
    2,628
    
    
    
    (166
    )
    
    
    2,628
    
    
    
    (166
    )Other marketable securities:Other debt
    
    
    1
    
    
    
    350
    
    
    
    (350
    )
    
    
    0
    
    
    
    
    
    
    0
    
    
    
    0
    
    
    
    350
    
    
    
    (350
    )Total temporarily impaired
securities
    
    
    1
    
    
    $
    350
    
    
    
    (350
    )
    
    
    4
    
    
    
    
    
    $
    5,078
    
    
    
    (572
    )
    
    $
    5,428
    
    
    
    (922
    )
  (8) Investment in Mortgage Servicing Rights
  Six Months ended
    
    
    Twelve Months ended
    
    
    Six Months ended(Dollars in thousands)
    
    June 30, 2008
    
    
    December 31, 2007
    
    
    June 30, 2007Mortgage servicing rights:Balance, beginning of period
    
    $
    1,270
    
    
    
    1,958
    
    
    
    1,958Originations
    
    
    1
    
    
    
    18
    
    
    
    10Amortization
    
    
    (314
    )
    
    
    (706
    )
    
    
    (371
    )Balance, end of period
    
    $
    957
    
    
    
    1,270
    
    
    
    1,597Fair value of mortgage servicing rights
    
    $
    2,915
    
    
    
    3,261
    
    
    
    3,810
  Weighted
    
    WeightedLoan Principal
    
    Average
    
    Average
    
    Number of(Dollars in thousands)
    
    Balance
    
    Interest Rate
    
    Remaining Term
    
    LoansOriginal term 30 year fixed rate
    
    $
    203,211
    
    
    
    5.87
    %
    
    
    288
    
    
    
    1,897Original term 15 year fixed rate
    
    
    108,427
    
    
    
    5.17
    %
    
    
    110
    
    
    
    1,745Adjustable rate
    
    
    2,586
    
    
    
    5.80
    %
    
    
    298
    
    
    
    22
 (9) Intangible Assets
  Gross
    
    
    
    
    
    
    UnamortizedCarrying
    
    
    Accumulated
    
    
    Intangible(Dollars in thousands)
    
    Amount
    
    
    Amortization
    
    
    AssetsAmortized intangible assets:Mortgage servicing rights
    
    $
    3,853
    
    
    
    (2,896
    )
    
    
    957Total
    
    $
    3,853
    
    
    
    (2,896
    )
    
    
    957
 10




---



##### Table of Contents



MortgageServicing(Dollars in thousands)
    
    RightsYear ended December 31,2008
    
    $
    2442009
    
    
    3682010
    
    
    2012011
    
    
    972012
    
    
    38
  (10) Earnings (loss) per Share
  Three Months Ended June 30,
    
    
    Six Months Ended June 30,(dollars in thousands, except per share data)
    
    2008
    
    
    2007
    
    
    2008
    
    
    2007Weighted average number of common shares outstanding
used in basic earnings per common share calculation
    
    
    3,647
    
    
    
    3,752
    
    
    
    3,649
    
    
    
    3,764Net dilutive effect of:Options
    
    
    0
    
    
    
    161
    
    
    
    0
    
    
    
    165Restricted stock awards
    
    
    0
    
    
    
    21
    
    
    
    0
    
    
    
    20Weighted average number of shares outstanding
adjusted for effect of dilutive securities
    
    
    3,647
    
    
    
    3,934
    
    
    
    3,649
    
    
    
    3,949Income (loss) available to common shareholders
    
    $
    (2,025
    )
    
    
    2,450
    
    
    
    (537
    )
    
    
    5,718Basic earnings (loss) per common share
    
    $
    (0.56
    )
    
    
    0.65
    
    
    
    (0.15
    )
    
    
    1.52Diluted earnings (loss) per common share
    
    $
    (0.56
    )
    
    
    0.62
    
    
    
    (0.15
    )
    
    
    1.45
 (11) Regulatory Capital
     11




---



##### Table of Contents



Required to be
    
    
    
    
    
    
    
    
    
    
    To Be Well CapitalizedAdequately
    
    
    
    
    
    
    
    
    
    
    Under Prompt CorrectiveActual
    
    
    Capitalized
    
    
    Excess Capital
    
    
    Actions ProvisionsPercent of
    
    
    
    
    
    
    Percent of
    
    
    
    
    
    
    Percent of
    
    
    
    
    
    
    Percent of(Dollars in thousands)
    
    Amount
    
    
    Assets(1)
    
    
    Amount
    
    
    Assets(1)
    
    
    Amount
    
    
    Assets(1)
    
    
    Amount
    
    
    Assets(1)Bank stockholders equity
    
    $
    92,569Less:Net unrealized gains on certain securities
available for sale
    
    
    (971
    )Tier I or core capital
    
    
    91,598Tier I capital to adjusted total assets
    
    
    
    
    
    
    8.52
    %
    
    $
    42,982
    
    
    
    4.00
    %
    
    $
    48,616
    
    
    
    4.52
    %
    
    $
    53,728
    
    
    
    5.00
    %Tier I capital to risk-weighted assets
    
    
    
    
    
    
    10.56
    %
    
    $
    34,686
    
    
    
    4.00
    %
    
    $
    56,912
    
    
    
    6.56
    %
    
    $
    52,029
    
    
    
    6.00
    %Plus:Allowable allowance for loan losses
    
    
    8,674Risk-based capital
    
    $
    100,272
    
    
    
    
    
    
    $
    69,372
    
    
    
    
    
    
    $
    30,900
    
    
    
    
    
    
    $
    86,715Risk-based capital to risk-weighted assets
    
    
    
    
    
    
    11.56
    %
    
    
    
    
    
    
    8.00
    %
    
    
    
    
    
    
    3.56
    %
    
    
    
    
    
    
    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. (12) Commitments and Contingencies
   (13) Business Segments
   12




---



##### Table of Contents



Home Federal(Dollars in thousands)
    
    Savings Bank
    
    Other
    
    Eliminations
    
    Consolidated TotalAt or for the six months ended June 30, 2008:Interest income  external customers
    
    $
    34,030
    
    
    
    14
    
    
    
    0
    
    
    
    34,044Non-interest income   external customers
    
    
    3,273
    
    
    
    0
    
    
    
    0
    
    
    
    3,273Earnings (loss) on limited partnerships
    
    
    1
    
    
    
    0
    
    
    
    0
    
    
    
    1Intersegment interest income
    
    
    0
    
    
    
    51
    
    
    
    (51
    )
    
    
    0Intersegment non-interest income
    
    
    87
    
    
    
    (367
    )
    
    
    280
    
    
    
    0Interest expense
    
    
    17,236
    
    
    
    0
    
    
    
    (51
    )
    
    
    17,185Amortization of mortgage servicing rights, net
    
    
    314
    
    
    
    0
    
    
    
    0
    
    
    
    314Other non-interest expense
    
    
    15,468
    
    
    
    357
    
    
    
    (87
    )
    
    
    15,738Goodwill impairment charge
    
    
    3,801
    
    
    
    0
    
    
    
    0
    
    
    
    3,801Income tax expense (benefit)
    
    
    2,047
    
    
    
    (119
    )
    
    
    0
    
    
    
    1,928Net loss
    
    
    (364
    )
    
    
    (540
    )
    
    
    367
    
    
    
    (537
    )Total assets
    
    
    1,075,128
    
    
    
    95,950
    
    
    
    (94,915
    )
    
    
    1,076,163At or for the six months ended June 30, 2007:Interest income   external customers
    
    $
    37,869
    
    
    
    38
    
    
    
    0
    
    
    
    37,907Non-interest income external customers
    
    
    3,360
    
    
    
    0
    
    
    
    0
    
    
    
    3,360Intersegment interest income
    
    
    0
    
    
    
    58
    
    
    
    (58
    )
    
    
    0Intersegment non-interest income
    
    
    87
    
    
    
    5,866
    
    
    
    (5,953
    )
    
    
    0Interest expense
    
    
    18,326
    
    
    
    0
    
    
    
    (58
    )
    
    
    18,268Amortization of mortgage servicing rights, net
    
    
    371
    
    
    
    0
    
    
    
    0
    
    
    
    371Other non-interest expense
    
    
    11,456
    
    
    
    359
    
    
    
    (87
    )
    
    
    11,728Income tax expense (benefit)
    
    
    3,810
    
    
    
    (111
    )
    
    
    0
    
    
    
    3,699Net income
    
    
    5,869
    
    
    
    5,715
    
    
    
    (5,866
    )
    
    
    5,718Goodwill
    
    
    3,801
    
    
    
    0
    
    
    
    0
    
    
    
    3,801Total assets
    
    
    1,124,354
    
    
    
    95,369
    
    
    
    (92,297
    )
    
    
    1,127,426At or for the quarter ended June 30, 2008:Interest income  external customers
    
    $
    16,243
    
    
    
    10
    
    
    
    0
    
    
    
    16,253Non-interest income  external customers
    
    
    1,760
    
    
    
    0
    
    
    
    0
    
    
    
    1,760Earnings (loss) on limited partnerships
    
    
    (4
    )
    
    
    0
    
    
    
    0
    
    
    
    (4
    )Intersegment interest income
    
    
    0
    
    
    
    8
    
    
    
    (8
    )
    
    
    0Intersegment non-interest income
    
    
    43
    
    
    
    (1,928
    )
    
    
    1,885
    
    
    
    0Interest expense
    
    
    8,086
    
    
    
    0
    
    
    
    (8
    )
    
    
    8,078Amortization of mortgage servicing rights, net
    
    
    154
    
    
    
    0
    
    
    
    0
    
    
    
    154Other non-interest expense
    
    
    9,509
    
    
    
    180
    
    
    
    (43
    )
    
    
    9,646Goodwill impairment charge
    
    
    3,801
    
    
    
    0
    
    
    
    0
    
    
    
    3,801Income tax expense (benefit)
    
    
    1,090
    
    
    
    (64
    )
    
    
    0
    
    
    
    1,026Net loss
    
    
    (1,927
    )
    
    
    (2,026
    )
    
    
    1,928
    
    
    
    (2,025
    )Total assets
    
    
    1,075,128
    
    
    
    95,950
    
    
    
    (94,915
    )
    
    
    1,076,163At or for the quarter ended June 30, 2007:Interest income  external customers
    
    $
    19,611
    
    
    
    17
    
    
    
    0
    
    
    
    19,628Non-interest income  external customers
    
    
    1,296
    
    
    
    0
    
    
    
    0
    
    
    
    1,296Earnings (loss) on limited partnerships
    
    
    (4
    )
    
    
    0
    
    
    
    0
    
    
    
    (4
    )Intersegment interest income
    
    
    0
    
    
    
    17
    
    
    
    (17
    )
    
    
    0Intersegment non-interest income
    
    
    43
    
    
    
    2,541
    
    
    
    (2,584
    )
    
    
    0Interest expense
    
    
    9,790
    
    
    
    0
    
    
    
    (17
    )
    
    
    9,773Amortization of mortgage servicing rights, net
    
    
    189
    
    
    
    0
    
    
    
    0
    
    
    
    189Other non-interest expense
    
    
    5,815
    
    
    
    189
    
    
    
    (44
    )
    
    
    5,960Income tax expense (benefit)
    
    
    1,581
    
    
    
    (61
    )
    
    
    0
    
    
    
    1,520Net income
    
    
    2,542
    
    
    
    2,448
    
    
    
    (2,540
    )
    
    
    2,450Goodwill
    
    
    3,801
    
    
    
    0
    
    
    
    0
    
    
    
    3,801Total assets
    
    
    1,124,354
    
    
    
    95,369
    
    
    
    (92,297
    )
    
    
    1,127,426
 13




---



##### Table of Contents



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




---



##### Table of Contents



Allowance for Loan Losses and Related Provision
   Mortgage Servicing Rights
  Income Taxes
  15




---



##### Table of Contents



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




---



##### Table of Contents



For the six month period endingJune 30, 2008
    
    
    June 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
    
    $
    153,123
    
    
    
    3,853
    
    
    
    5.06
    %
    
    $
    180,616
    
    
    
    4,595
    
    
    
    5.13
    %Loans held for sale
    
    
    2,484
    
    
    
    73
    
    
    
    5.88
    
    
    
    2,316
    
    
    
    71
    
    
    
    6.21Mortgage loans, net
    
    
    161,743
    
    
    
    5,019
    
    
    
    6.22
    
    
    
    139,721
    
    
    
    4,309
    
    
    
    6.22Commercial loans, net
    
    
    632,565
    
    
    
    21,875
    
    
    
    6.95
    
    
    
    578,852
    
    
    
    24,304
    
    
    
    8.47Consumer loans, net
    
    
    83,324
    
    
    
    2,973
    
    
    
    7.17
    
    
    
    84,933
    
    
    
    3,690
    
    
    
    8.76Cash equivalents
    
    
    15,172
    
    
    
    118
    
    
    
    1.57
    
    
    
    27,867
    
    
    
    722
    
    
    
    5.23Federal Home Loan Bank stock
    
    
    6,462
    
    
    
    133
    
    
    
    4.14
    
    
    
    7,541
    
    
    
    216
    
    
    
    5.78Total interest-earning assets
    
    
    1,054,873
    
    
    
    34,044
    
    
    
    6.49
    
    
    
    1,021,846
    
    
    
    37,907
    
    
    
    7.48Interest-bearing liabilities:Noninterest checking
    
    
    53,603
    
    
    
    0
    
    
    
    0.00
    
    
    
    55,079
    
    
    
    0
    
    
    
    0.00NOW accounts
    
    
    124,305
    
    
    
    988
    
    
    
    1.59
    
    
    
    110,918
    
    
    
    1,723
    
    
    
    3.13Savings accounts
    
    
    41,287
    
    
    
    239
    
    
    
    1.16
    
    
    
    40,750
    
    
    
    273
    
    
    
    1.35Money market accounts
    
    
    142,134
    
    
    
    1,800
    
    
    
    2.54
    
    
    
    223,058
    
    
    
    4,226
    
    
    
    3.82Certificates
    
    
    245,068
    
    
    
    5,177
    
    
    
    4.25
    
    
    
    235,205
    
    
    
    5,092
    
    
    
    4.37Brokered deposits
    
    
    269,270
    
    
    
    6,505
    
    
    
    4.86
    
    
    
    162,837
    
    
    
    3,909
    
    
    
    4.84Federal Home Loan Bank advances
    
    
    106,364
    
    
    
    2,476
    
    
    
    4.68
    
    
    
    135,679
    
    
    
    3,045
    
    
    
    4.53Other
    
    
    1,103
    
    
    
    0
    
    
    
    0.00
    
    
    
    959
    
    
    
    0
    
    
    
    0.00Total interest-bearing liabilities
    
    
    983,134
    
    
    
    17,185
    
    
    
    3.52
    
    
    
    964,485
    
    
    
    18,268
    
    
    
    3.82Net interest income
    
    
    
    
    
    $
    16,859
    
    
    
    
    
    
    
    
    
    
    $
    19,639Net interest rate spread
    
    
    
    
    
    
    
    
    
    
    2.98
    %
    
    
    
    
    
    
    
    
    
    
    3.66
    %Net earning assets
    
    $
    71,739
    
    
    
    
    
    
    
    
    
    
    $
    57,361Net interest margin
    
    
    
    
    
    
    
    
    
    
    3.21
    %
    
    
    
    
    
    
    
    
    
    
    3.88
    %Average interest-earning assets to
average interest-bearing liabilities
    
    
    
    
    
    
    107.30
    %
    
    
    
    
    
    
    
    
    
    
    105.95
    %
 17




---



##### Table of Contents



Provision for Loan Losses
   (Dollars in thousands)
    
    2008
    
    
    2007Balance at January 1,
    
    $
    12,438
    
    
    $
    9,873Provision
    
    
    2,690
    
    
    
    1,483Charge offs:Commercial
    
    
    (24
    )
    
    
    (17
    )Commercial real estate
    
    
    (75
    )
    
    
    (70
    )Mortgage
    
    
    (60
    )
    
    
    0Consumer
    
    
    (69
    )
    
    
    (632
    )Recoveries
    
    
    24
    
    
    
    88Balance at June 30,
    
    $
    14,924
    
    
    $
    10,725
  Non-Interest Income
   Non-Interest Expense
  18




---



##### Table of Contents



Income Tax Expense
  19




---



##### Table of Contents



Non-Performing Assets
  June 30,
    
    
    March 31,
    
    
    December 31,(Dollars in thousands)
    
    2008
    
    
    2008
    
    
    2007Non-Accruing Loans:One-to-four family real estate
    
    $
    1,046
    
    
    $
    802
    
    
    $
    1,196Commercial real estate
    
    
    39,221
    
    
    
    17,983
    
    
    
    15,641Consumer
    
    
    1,439
    
    
    
    1,380
    
    
    
    1,094Commercial business
    
    
    2,500
    
    
    
    3,830
    
    
    
    1,723Total
    
    
    44,206
    
    
    
    23,995
    
    
    
    19,654Other assets
    
    
    25
    
    
    
    34
    
    
    
    34Foreclosed and Repossessed Assets:One-to-four family real estate
    
    
    2,731
    
    
    
    2,852
    
    
    
    901Consumer
    
    
    19
    
    
    
    19
    
    
    
    33Commercial real estate
    
    
    1,541
    
    
    
    1,332
    
    
    
    1,313Total non-performing assets
    
    $
    48,522
    
    
    $
    28,232
    
    
    $
    21,935Total as a percentage of total assets
    
    
    4.50
    %
    
    
    2.56
    %
    
    
    1.96
    %Total non-performing loans
    
    $
    44,206
    
    
    $
    23,995
    
    
    $
    19,654Total as a percentage of total loans
receivable, net
    
    
    4.94
    %
    
    
    2.73
    %
    
    
    2.27
    %Allowance for loan loss to non-performing loans
    
    
    33.76
    %
    
    
    57.98
    %
    
    
    63.28
    %Delinquency Data:Delinquencies (1)30+ days
    
    $
    2,491
    
    
    $
    8,203
    
    
    $
    6,41690+ days
    
    
    0
    
    
    
    55
    
    
    
    0Delinquencies as a percentage of
loan and lease portfolio (1)30+ days
    
    
    0.27
    %
    
    
    0.92
    %
    
    
    0.73
    %90+ days
    
    
    0.00
    %
    
    
    0.01
    %
    
    
    0.00
    %
 
 (1)
    
    Excludes non-accrual loans.  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
    %
 20




---



##### Table of Contents



Liquidity
     Market Risk
  Rate Shock Table
  21




---



##### Table of Contents



Basis point change in interest rates(Dollars in thousands)
    
    -100
    
    
    0
    
    
    +100
    
    
    +200Total market risk sensitive assets
    
    $
    1,069,313
    
    
    
    1,052,224
    
    
    
    1,033,969
    
    
    
    1,013,506Total market risk sensitive liabilities
    
    
    969,700
    
    
    
    958,279
    
    
    
    947,261
    
    
    
    936,240Off-balance sheet financial instruments
    
    
    (121
    )
    
    
    0
    
    
    
    151
    
    
    
    290Net market risk
    
    $
    99,734
    
    
    
    93,945
    
    
    
    86,557
    
    
    
    76,976Percentage change from current market value
    
    
    6.16
    %
    
    
    0.00
    %
    
    
    (7.86)
    %
    
    
    (18.06)
    %
   Asset/Liability Management
  ProjectedRate Shock
    
    
    Change inin Basis
    
    
    Net Interest
    
    
    Percentage(Dollars in thousands)
    
    Points
    
    
    Income
    
    
    Change+200
    
    
    
    (143
    )
    
    
    (0.46
    )%+100
    
    
    
    (246
    )
    
    
    (0.79
    )%0
    
    
    
    0
    
    
    
    0.00
    %-100
    
    
    
    (246
    )
    
    
    (0.79
    )%
 22




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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.
 23




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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)April 1 through April 30, 2008
    
    
    0
    
    
    
    N/A
    
    
    
    0
    
    
    
    106,000May 1 through May 31, 2008
    
    
    0
    
    
    
    N/A
    
    
    
    0
    
    
    
    106,000June 1 through June 30, 2008
    
    
    0
    
    
    
    N/A
    
    
    
    0
    
    
    
    106,000Total
    
    
    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.
    For
    
    WithholdAllan DeBoer
    
    
    2,659,501
    
    
    
    263,415Timothy Geisler
    
    
    2,688,998
    
    
    
    233,918Karen Himle
    
    
    2,706,496
    
    
    
    216,420
  24




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##### Table of Contents



Director
    
    Term of Office ExpiresMichael McNeil
    
    2009Duane Benson
    
    2009Mahlon Schneider
    
    2009Michael Fogarty
    
    2010Malcolm McDonald
    
    2010Susan Kolling
    
    2010
  NUMBER
    
    
    PERCENTAGE OFOF VOTES
    
    
    VOTES ACTUALLY CASTFOR
    
    



    2,810,940
    
    
    
    96.17
    %AGAINST
    
    
    61,539
    
    
    
    2.11
    %ABSTAIN
    
    
    50,437
    
    
    
    1.73
    %BROKER NON-VOTE
    
    
    0
    
    
    
    0.00
    %
  
 Item 5. Other Information.
  
 Item 6. Exhibits.
  25




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##### Table of Contents



SIGNATURES
  HMN FINANCIAL, INC.
RegistrantDate:  August 1, 2008
    By:
    /s/ Michael McNeilMichael McNeil,President and Chief Executive Officer
(Principal Executive Officer)
(Duly Authorized Representative)Date:  August 1, 2008
    By:
    /s/ Jon EberleJon Eberle,Chief Financial Officer
(Principal Financial Officer) 26




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##### Table of Contents



HMN FINANCIAL, INC.
 INDEX TO EXHIBITS
FOR FORM 10-Q
 Reference
    
    Sequentialto Prior
    
    Page NumberingFiling or
    
    Where AttachedExhibit
    
    Exhibits AreRegulation S-K
    
    
    
    
    Number
    
    Located in ThisExhibit Number
    
    
    Document Attached Hereto
    
    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 the same numbered exhibit to the Companys Quarterly Report on Form
10-Q for the period ended June 30, 2007 (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). 27