##### 



Exhibit 13 F I V E - Y E A
R   C O N S O L I D A T E D   F I N A N C I A
L   H I G H L I G H T S Selected Operations Data:
    
    Year Ended December 31,(Dollars in thousands, except per share data)
    
    2004
    
    

    2003
    
    
    2002
    
    
    2001
    
    
    2000Total interest income
    
    $
    51,617
    
    
    
    44,937
    
    
    
    42,868
    
    
    
    51,468
    
    
    
    52,917Total interest expense
    
    
    20,993
    
    
    
    20,289
    
    
    
    21,295
    
    
    
    30,444
    
    
    
    33,001Net interest income
    
    
    30,624
    
    
    
    24,648
    
    
    
    21,573
    
    
    
    21,024
    
    
    
    19,916Provision for loan losses
    
    
    2,755
    
    
    
    2,610
    
    
    
    2,376
    
    
    
    1,150
    
    
    
    180Net interest income after provision for loan losses
    
    
    27,869
    
    
    
    22,038
    
    
    
    19,197
    
    
    
    19,874
    
    
    
    19,736Fees and service charges
    
    
    2,776
    
    
    
    2,304
    
    
    
    1,723
    
    
    
    1,563
    
    
    
    1,297Mortgage servicing fees
    
    
    1,169
    
    
    
    998
    
    
    
    715
    
    
    
    470
    
    
    
    341Securities gains (losses), net
    
    
    (535
    )
    
    
    1,275
    
    
    
    422
    
    
    
    (671
    )
    
    
    (23
    )Gain on sales of loans
    
    
    1,703
    
    
    
    5,240
    
    
    
    3,077
    
    
    
    2,934
    
    
    
    1,216Losses in limited partnerships
    
    
    (26
    )
    
    
    (243
    )
    
    
    (659
    )
    
    
    (1,311
    )
    
    
    (121
    )Other non-interest income
    
    
    880
    
    
    
    681
    
    
    
    597
    
    
    
    599
    
    
    
    613Total non-interest income
    
    
    5,967
    
    
    
    10,255
    
    
    
    5,875
    
    
    
    3,584
    
    
    
    3,323Other non-interest expense
    
    
    20,162
    
    
    
    19,653
    
    
    
    17,849
    
    
    
    15,749
    
    
    
    12,559Total non-interest expense
    
    
    20,162
    
    
    
    19,653
    
    
    
    17,849
    
    
    
    15,749
    
    
    
    12,559Income tax expense
    
    
    4,387
    
    
    
    4,038
    
    
    
    2,099
    
    
    
    2,634
    
    
    
    3,798Income before minority interest
    
    
    9,287
    
    
    
    8,602
    
    
    
    5,124
    
    
    
    5,075
    
    
    
    6,702Minority interest
    
    
    (3
    )
    
    
    (3
    )
    
    
    (142
    )
    
    
    (383
    )
    
    
    0Net income
    
    $
    9,290
    
    
    
    8,605
    
    
    
    5,266
    
    
    
    5,458
    
    
    
    6,702Per common share and common share equivalents:Basic
    
    $
    2.40
    
    
    
    2.26
    
    
    
    1.40
    
    
    
    1.45
    
    
    
    1.75Diluted
    
    
    2.31
    
    
    
    2.16
    
    
    
    1.32
    
    
    
    1.37
    
    
    
    1.69
 Selected Financial Condition Data:
    
    December 31,(Dollars in thousands, except per share data)
    
    2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000Total assets
    
    $
    960,673
    
    
    
    866,726
    
    
    
    737,523
    
    
    
    721,114
    
    
    
    716,016Securities available for sale
    
    
    103,672
    
    
    
    104,664
    
    
    
    121,397
    
    
    
    119,895
    
    
    
    139,206Loans held for sale
    
    
    2,712
    
    
    
    6,543
    
    
    
    15,127
    
    
    
    68,018
    
    
    
    7,861Loans receivable, net
    
    
    783,213
    
    
    
    688,951
    
    
    
    533,906
    
    
    
    471,668
    
    
    
    518,765Deposits
    
    
    698,902
    
    
    
    551,688
    
    
    
    432,951
    
    
    
    421,843
    
    
    
    421,691Federal Home Loan Bank advances
    
    
    170,900
    
    
    
    203,900
    
    
    
    218,300
    
    
    
    217,800
    
    
    
    221,900Stockholders equity
    
    
    83,771
    
    
    
    80,931
    
    
    
    76,065
    
    
    
    72,161
    
    
    
    66,626Book value per share
    
    
    18.95
    
    
    
    17.93
    
    
    
    17.28
    
    
    
    16.41
    
    
    
    15.17Number of full service offices
    
    
    13
    
    
    
    12
    
    
    
    13
    
    
    
    12
    
    
    
    11Number of mortgage origination offices
    
    
    2
    
    
    
    6
    
    
    
    2
    
    
    
    1
    
    
    
    1Key Ratios(1)Stockholders equity to total assets at year end
    
    
    8.72
    %
    
    
    9.34
    %
    
    
    10.31
    %
    
    
    10.01
    %
    
    
    9.31
    %Average stockholders equity to average assets
    
    
    9.17
    
    
    
    10.15
    
    
    
    10.66
    
    
    
    9.91
    
    
    
    9.56Return on stockholders equity (ratio of net income to average equity)
    
    
    11.03
    
    
    
    10.85
    
    
    
    6.94
    
    
    
    7.57
    
    
    
    9.81Return on assets (ratio of net income to average assets)
    
    
    1.01
    
    
    
    1.10
    
    
    
    0.74
    
    
    
    0.75
    
    
    
    0.94Dividend payout ratio
    
    
    36.36
    
    
    
    39.58
    
    
    
    57.63
    
    
    
    39.71
    
    
    
    27.22
   (1)
    
    Average balances were calculated based upon amortized cost without the market
value impact of SFAS No. 115.  
 5




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##### 



M A N A G E M E N T  S  D I S C U S S I O N  A N D  A N A L Y S I S This Annual Report, other reports filed by the Company with the Securities and Exchange
Commission, and the Companys proxy statement may contain forward-looking statements that deal
with future results, plans or performance. In addition, the Companys management may make such
statements orally to the media, or to securities analysts, investors or others. Forward-looking
statements deal with matters that do not relate strictly to historical facts such as anticipated
liquidity information. The Companys future results may differ materially from historical
performance and forward-looking statements about the Companys expected financial results or
other plans are subject to a number of risks and uncertainties. These include but are not limited
to possible legislative changes and adverse economic, business and competitive developments such
as shrinking interest margins; deposit outflows; reduced demand for financial services and loan
products; changes in accounting policies and guidelines, or monetary and fiscal policies of the
federal government; changes in credit and other risks posed by the Companys loan and investment
portfolios; technological, computer-related or operational difficulties; adverse changes in
securities markets; results of litigation or other significant uncertainties. O V E R V I E W HMN Financial, Inc. (HMN or the Company) is the stock savings bank holding company for Home
Federal Savings Bank (the Bank) which operates community retail banking facilities and loan
production offices in southern Minnesota and Iowa. Eagle Crest Capital Bank, a division of Home
Federal Savings Bank, provides private banking services to a diverse group of high net worth
customers from offices in Edina and Rochester, Minnesota. The earnings of the Company are
 primarily dependent on the Banks net interest income, which is the difference between interest
earned on its loans and investments, and the interest paid on interest-bearing liabilities such as
deposits and Federal Home Loan Bank (FHLB) advances. The difference between the average rate of
interest earned on assets and the average rate paid on liabilities is the interest rate spread.
Net interest income is produced when interest-earning assets equal or exceed interest-bearing
liabilities and there is a positive interest rate spread. The Companys interest rate spread has
been enhanced by the increased level of commercial loans placed in portfolio and the increased
amount of lower rate deposit products such as checking and money market accounts. Net interest
income and net interest rate spread are affected by changes in interest rates, the volume and mix
of interest-earning assets and interest-bearing liabilities, and the level of non-performing
assets. The Companys net income is also affected by the generation of non-interest income, which
consists primarily of gains or losses from the sale of securities, gains from the sale of loans,
fees for servicing mortgage loans, and the generation of fees and service charges on deposit
accounts. The Bank incurs expenses in addition to interest expense in the form of salaries and
benefits, occupancy expenses, provisions for loan losses and amortization and valuation adjustments
on mortgage servicing assets. The earnings of financial institutions, such as the Bank, are significantly affected by
prevailing economic and competitive conditions, particularly changes in interest rates,
government monetary and fiscal policies, and regulations of various regulatory authorities.
Lending activities are influenced by the demand for and supply of single family and commercial
properties, competition among lenders, the level of interest rates and the availability of funds.
Deposit flows and costs of deposits are influenced by prevailing market rates of interest on
competing investments, account maturities and the levels of personal income and savings. C r i t i c a
l   A c c o u n t i n g   P o l i c i e s Critical accounting policies are those policies that the Companys management believes are
the most important to understanding the Companys financial condition and operating results. The
Company has identified the following three policies as being critical because they require
difficult, subjective, and/or complex judgments that are inherently uncertain. Therefore, actual
financial results could differ significantly depending upon the estimates used. Allowance for Loan Losses and Related Provision The allowance for loan losses is based on periodic analysis of the loan portfolio. In this
analysis, management considers factors including, but not limited to, specific occurrences of
loan impairment, changes in the size of the portfolios, national and regional economic conditions
such as unemployment data, loan portfolio composition, loan delinquencies, local construction
permits, development plans, local economic growth rates, historical experience and observations
made by the Companys ongoing internal audit and regulatory exam processes. Loans are charged off
to the extent they are deemed to be uncollectible. The Company has established separate processes
to determine the adequacy of the loan loss allowance for its homogeneous single-family and
consumer loan portfolios and its non-homogeneous portfolios. The determination of the allowance
for the non-homogeneous commercial, commercial real estate, and multi-family loan portfolios
involves assigning standardized risk ratings and loss factors that are periodically reviewed. The
loss factors are estimated using a combination of the Companys own loss experience and external
industry data and are assigned to all loans without identified credit weaknesses. The Company
also performs an individual analysis of impairment on each non-performing loan that is based on
the expected cash flows or the value of the assets collateralizing the loans. The determination
of the allowance on the homogeneous single-family and consumer loan portfolios is calculated on a
pooled basis with individual determination of the allowance of all non-performing loans. The adequacy of the allowance for loan losses is dependent upon managements estimates of
variables affecting valuation, appraisals of collateral, evaluations of performance and status, and
the amounts and timing of future cash flows expected to be received on impaired loans. Such
estimates, appraisals, evaluations and cash flows may be subject to frequent adjustments due to
changing economic prospects of borrowers or properties. The estimates are reviewed periodically and
adjustments, if any, are recorded in 6




---



##### 



the provision for loan losses in the periods in which the
adjustments become known. The allowance is allocated to individual loan categories based upon the
relative risk characteristics of the loan portfolios and the actual loss experience. The Company
increases its allowance for loan losses by charging the provision for loan losses against income.
The methodology for establishing the allowance for loan losses takes into consideration probable
losses that have been identified in connection with specific loans as well as losses in the loan
portfolio for which specific reserves are not required. Although management believes that the
allowance for loan losses is maintained at an adequate amount to provide for probable loan losses
inherent in the portfolio as of the balance sheet dates, future adjustments to the provision for
loan losses may be necessary if conditions differ substantially from those in the assumptions used
to determine the allowance for loan losses. Mortgage Servicing Rights The Company recognizes as an asset the rights to service mortgage loans for others, which
are referred to as mortgage servicing rights (MSRs). MSRs are capitalized at the relative fair
value of the servicing rights on the date the mortgage loan is sold and are carried at the lower
of the capitalized amount, net of accumulated amortization, or fair value. MSRs are capitalized
and amortized in proportion to, and over the period of, estimated net servicing income. Each
quarter the Company evaluates its MSRs for impairment in accordance with Statement of Financial
Accounting Standards (SFAS) No. 140. Loan type and interest rate are the predominant risk
characteristics of the underlying loans used to stratify the MSRs for purposes of measuring
impairment. If temporary impairment exists, a valuation allowance is established for any excess
of amortized cost over the current fair value through a charge to income. If the Company later
determines that all or a portion of the temporary impairment no longer exists, a reduction of
the valuation allowance is recorded as an increase to income. The valuation is based on various
assumptions including the estimated prepayment speeds and default rates of the stratified
portfolio. Changes in the mix of loans, interest rates, prepayment speeds, or default rates from
the estimates used in the valuation of the mortgage servicing rights may have a material effect
on the amortization and valuation of MSRs. Although management believes that the assumptions
used and the values determined are reasonable, future adjustments may be necessary if economic
conditions differ substantially from the economic conditions in the assumptions used to
determine the value of the MSRs. The Company does not formally hedge its MSRs because they are
hedged naturally by the Companys origination volume. Generally, as interest rates rise the
origination volume declines and the value of MSRs increases and as interest rates decline the
origination volume increases and the value of MSRs decreases. Income Taxes Deferred tax assets and liabilities are recognized for the future tax consequences
attributable to temporary differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax basis. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable income in the years
in which those temporary differences are expected to be recovered or settled. The effect on
deferred tax assets and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date. These calculations are based on many complex factors
including estimates of the timing of reversals of temporary differences, the interpretation of
federal and state income tax laws, and a determination of the differences between the tax and the
financial reporting basis of assets and liabilities. Actual results could differ significantly
from the estimates and interpretations used in determining the current and deferred income tax
liabilities. R e s u l t s  
o f   O p e r a t i o n s Net income was $9.3 million for the year ended December 31, 2004, compared to $8.6
million for the year ended December 31, 2003. Diluted earnings per common share for the year
ended December 31, 2004 were $2.31, compared to $2.16 for the year ended December 31, 2003.
Return on average assets was 1.01% and 1.10% and return on average equity was 11.03% and 10.85%
for the years ended December 31, 2004 and 2003, respectively. In comparing the year ended December 31, 2004 to the year ended December 31, 2003, net
interest income increased by $6.0 million primarily because of an increase in interest-earning
assets and because of a higher concentration of commercial and consumer loans and an increase in
checking and money market deposit accounts. Non-interest income decreased by $4.3 million
primarily due to decreases in the gains recognized on the sale of mortgage loans and securities.
Non-interest expense increased by $500,000 primarily because of the $1.5 million increase in
compensation and benefits costs due to increases in health insurance costs and the number of
employees. This increase was partially offset by a $1.1 million decrease in the amortization of
mortgage servicing rights that was primarily caused by a decrease in the prepayments of mortgage
loans in 2004. Net Interest Income Net interest income for the year ended December 31, 2004 was $30.6 million, an increase
of $6.0 million, compared to $24.6 million in 2003. Interest income was $51.6 million for the
year ended December 31, 2004, an increase of $6.7 million, from $44.9 million for the same
period in 2003. Interest income increased primarily because of an increase in average
interest-earning assets and because of a change in the mix of assets between the periods. The
increase in interest-earning assets was caused primarily by the $105 million increase in the
commercial and consumer loan portfolios between the periods. During 2004, the Companys
commercial and consumer loan portfolios continued to increase and these portfolios represented
77.9% of the Companys outstanding loans at December 31, 2004, 7




---



##### 



M A N A G E M E N T  S  D I S C U S S I O N  A N D  A N A L Y S I S compared to 61.7% at December 31, 2003. The increase in interest income as a result of the
increased interest-earning assets more than offset the decrease in the interest rates earned on
the assets between the periods. The yield earned on interest-earning assets was 5.90% for the
year ended December 31, 2004, a decrease of 14 basis points from the 6.04% yield for the same
period of 2003. Interest expense was $21.0 million for the year ended December 31, 2004, an
increase of $704,000, from the $20.3 million for the same period in 2003. Interest expense on
deposits and Federal Home Loan Bank advances increased by $2.1 million due to the $132 million in
growth in the average outstanding balance of deposits and advances between the periods. This
increase was partially offset by a $1.4 million decrease in interest expense due to a decline in
the interest rates paid. The decline in interest rates paid is due in part to the $90 million
increase in the outstanding average balance of checking and money market accounts between the
periods, which generally have lower interest rates than other deposit accounts. The average
interest rate paid on interest-bearing liabilities was 2.53% for the year ended December 31,
2004, a decrease of 38 basis points from the 2.91% in 2003. The following table presents the
total dollar amount of interest income from average interest-earning assets and the resultant
yields, as well as the interest expense on average interest-bearing liabilities, expressed both
in dollars and rates. Non-accruing loans have been included in the table as loans carrying a zero
yield. Year Ended December 31,2004
    
    
    2003
    
    
    2002Average
    
    
    Interest
    
    
    
    
    
    
    Average
    
    
    Interest
    
    
    
    
    
    
    Average
    
    
    InterestOutstanding
    
    
    Earned/
    
    
    Yield/
    
    
    Outstanding
    
    
    Earned/
    
    
    Yield/
    
    
    Outstanding
    
    
    Earned/
    
    
    Yield/(Dollars in thousands)
    
    Balance
    
    
    Paid
    
    
    Rate
    
    
    Balance
    
    
    Paid
    
    
    Rate
    
    
    Balance
    
    
    Paid
    
    
    RateInterest-earning assets:Securities available for sale:Mortgage-backed and
related securities
    
    $
    11,225
    
    
    
    385
    
    
    
    3.43
    %
    
    $
    21,885
    
    
    
    272
    
    
    
    1.24
    %
    
    $
    63,022
    
    
    
    1,704
    
    
    
    2.70
    %Other marketable securities
    
    
    97,508
    
    
    
    2,898
    
    
    
    2.97
    
    
    
    74,487
    
    
    
    2,387
    
    
    
    3.20
    
    
    
    60,973
    
    
    
    2,420
    
    
    
    3.97Loans held for sale
    
    
    4,349
    
    
    
    249
    
    
    
    5.73
    
    
    
    12,899
    
    
    
    748
    
    
    
    5.80
    
    
    
    22,485
    
    
    
    1,587
    
    
    
    7.06Loans receivable, net(1)(2)
    
    
    732,638
    
    
    
    47,714
    
    
    
    6.51
    
    
    
    602,653
    
    
    
    41,052
    
    
    
    6.81
    
    
    
    479,158
    
    
    
    36,426
    
    
    
    7.60Federal Home Loan Bank stock
    
    
    9,889
    
    
    
    207
    
    
    
    2.10
    
    
    
    11,464
    
    
    
    349
    
    
    
    3.04
    
    
    
    12,086
    
    
    
    349
    
    
    
    2.89Other, including
cash equivalents
    
    
    18,954
    
    
    
    164
    
    
    
    0.87
    
    
    
    20,503
    
    
    
    129
    
    
    
    0.63
    
    
    
    37,831
    
    
    
    382
    
    
    
    1.01Total interest-earning assets
    
    $
    874,563
    
    
    
    51,617
    
    
    
    5.90
    
    
    $
    743,891
    
    
    
    44,937
    
    
    
    6.04
    
    
    $
    675,555
    
    
    
    42,868
    
    
    
    6.35Interest-bearing liabilities:Noninterest checking
    
    $
    38,862
    
    
    
    0
    
    
    
    0.00
    %
    
    $
    28,964
    
    
    
    0
    
    
    
    0.00
    %
    
    $
    19,095
    
    
    
    0
    
    
    
    0.00
    %NOW accounts
    
    
    88,559
    
    
    
    638
    
    
    
    0.72
    
    
    
    46,277
    
    
    
    120
    
    
    
    0.26
    
    
    
    39,625
    
    
    
    226
    
    
    
    0.57Passbooks
    
    
    43,186
    
    
    
    77
    
    
    
    0.18
    
    
    
    38,201
    
    
    
    91
    
    
    
    0.24
    
    
    
    35,847
    
    
    
    241
    
    
    
    0.67Money market accounts
    
    
    106,943
    
    
    
    1,519
    
    
    
    1.42
    
    
    
    73,800
    
    
    
    878
    
    
    
    1.19
    
    
    
    47,593
    
    
    
    796
    
    
    
    1.67Certificate accounts
    
    
    354,811
    
    
    
    10,163
    
    
    
    2.86
    
    
    
    286,238
    
    
    
    9,185
    
    
    
    3.21
    
    
    
    270,482
    
    
    
    9,686
    
    
    
    3.58Federal Home Loan
Bank advances
    
    
    196,662
    
    
    
    8,595
    
    
    
    4.37
    
    
    
    221,503
    
    
    
    10,015
    
    
    
    4.52
    
    
    
    215,623
    
    
    
    10,346
    
    
    
    4.80Other interest-bearing liabilities
    
    
    905
    
    
    
    1
    
    
    
    0.00
    
    
    
    2,556
    
    
    
    0
    
    
    
    0.00
    
    
    
    1,544
    
    
    
    0
    
    
    
    0.00Total interest-bearing liabilities
    
    $
    829,928
    
    
    
    20,993
    
    
    
    2.53
    
    
    $
    697,539
    
    
    
    20,289
    
    
    
    2.91
    
    
    $
    629,809
    
    
    
    21,295
    
    
    
    3.39Net interest income
    
    
    
    
    
    
    30,624
    
    
    
    
    
    
    
    
    
    
    
    24,648
    
    
    
    
    
    
    
    
    
    
    
    21,573Net interest rate spread
    
    
    
    
    
    
    
    
    
    
    3.37
    %
    
    
    
    
    
    
    
    
    
    
    3.13
    %
    
    
    
    
    
    
    
    
    
    
    2.96
    %Net earning assets
    
    $
    44,635
    
    
    
    
    
    
    
    
    
    
    $
    46,352
    
    
    
    
    
    
    
    
    
    
    $
    45,746Net interest margin
    
    
    
    
    
    
    
    
    
    
    3.50
    %
    
    
    
    
    
    
    
    
    
    
    3.31
    %
    
    
    
    
    
    
    
    
    
    
    3.19
    %Average interest-earning assets to
average interest-bearing
liabilities
    
    
    
    
    
    
    105.38
    %
    
    
    
    
    
    
    
    
    
    
    106.65
    %
    
    
    
    
    
    
    
    
    
    
    107.26
    %
   (1)
    
    Tax exempt income was not significant; therefore, the yield was not presented on
a tax equivalent basis. The tax-exempt income was $1,000,300 for 2004, $837,343 for 2003 and
$315,093 for 2002.(2)
    
    Calculated net of deferred loan fees, loan discounts, loans in process and loss
reserve.  
 8




---



##### 



Net interest margin increased to 3.50% in 2004 compared to 3.31% for 2003 primarily
because of the growth in commercial and consumer loans and the increase in the outstanding average
balance of checking and money market accounts. Average net earning assets were $44.6 million in
2004 compared to $46.4 million for 2003. Net earning assets were reduced because of the repurchase
of HMN common stock, the payment of dividends, an increase in non-interest earning cash due to the
operation of more ATM machines in 2004, and an increase in non-interest bearing reserve accounts
required to be maintained because of the increase in transaction account deposits between the
periods. During 2004 and 2003 the Company paid $3.3 million and $1.4 million to purchase its common
stock in the open market and paid dividends to stockholders of $3.2 million and $2.9 million, respectively. Non-interest bearing cash amounts increased by $2.4
million and the required non-interest bearing reserve balance on transaction accounts grew by
$1.4 million. The following table presents the dollar amount of changes in interest income and interest
expense for major components of interest-earning assets and interest-bearing liabilities. It
quantifies the changes in interest income and interest expense related to changes in the average
outstanding balances (volume) and those changes caused by fluctuating interest rates. For each
category of interest-earning assets and interest-bearing liabilities, information is provided on
changes attributable to (i) changes in volume (i.e., changes in volume multiplied by old rate)
and (ii) changes in rate (i.e., changes in rate multiplied by old volume). Year Ended December 31,2004 vs. 2003
    
    
    
    
    
    
    2003 vs. 2002Increase (Decrease)
    
    
    
    
    
    
    Increase (Decrease)Due to
    
    
    Total
    
    
    Due to
    
    
    TotalIncrease
    
    
    
    
    
    
    
    
    
    
    Increase(Dollars in thousands)
    
    Volume(1)
    
    
    Rate(1)
    
    
    (Decrease)
    
    
    Volume(1)
    
    
    Rate(1)
    
    
    (Decrease)Interest-earning assets:Securities available for sale:Mortgage-backed and related securities
    
    $
    (184
    )
    
    
    297
    
    
    
    113
    
    
    $
    (784
    )
    
    
    (648
    )
    
    
    (1,432
    )Other marketable securities
    
    
    782
    
    
    
    (271
    )
    
    
    511
    
    
    
    591
    
    
    
    (620
    )
    
    
    (29
    )Loans held for sale, net
    
    
    (489
    )
    
    
    (10
    )
    
    
    (499
    )
    
    
    (592
    )
    
    
    (247
    )
    
    
    (839
    )Loans receivable, net
    
    
    8,947
    
    
    
    (2,286
    )
    
    
    6,661
    
    
    
    10,084
    
    
    
    (5,457
    )
    
    
    4,627Federal Home Loan Bank stock
    
    
    (43
    )
    
    
    (99
    )
    
    
    (142
    )
    
    
    (18
    )
    
    
    24
    
    
    
    6Other, including cash equivalents
    
    
    (11
    )
    
    
    46
    
    
    
    35
    
    
    
    (136
    )
    
    
    (128
    )
    
    
    (264
    )Total interest-earning assets
    
    $
    9,002
    
    
    
    (2,323
    )
    
    
    6,679
    
    
    $
    9,145
    
    
    
    (7,076
    )
    
    
    2,069Interest-bearing liabilities:NOW accounts
    
    $
    231
    
    
    
    286
    
    
    
    517
    
    
    $
    88
    
    
    
    (194
    )
    
    
    (106
    )Passbooks
    
    
    13
    
    
    
    (26
    )
    
    
    (13
    )
    
    
    17
    
    
    
    (168
    )
    
    
    (151
    )Money market accounts
    
    
    474
    
    
    
    168
    
    
    
    642
    
    
    
    702
    
    
    
    (622
    )
    
    
    80Certificates
    
    
    2,454
    
    
    
    (1,478
    )
    
    
    976
    
    
    
    585
    
    
    
    (1,084
    )
    
    
    (499
    )Federal Home Loan Bank advances
    
    
    (1,094
    )
    
    
    (326
    )
    
    
    (1,420
    )
    
    
    287
    
    
    
    (617
    )
    
    
    (330
    )Other interest bearing liabilities
    
    
    0
    
    
    
    1
    
    
    
    1
    
    
    
    0
    
    
    
    0
    
    
    
    0Total interest-bearing liabilities
    
    $
    2,078
    
    
    
    (1,375
    )
    
    
    703
    
    
    $
    1,679
    
    
    
    (2,685
    )
    
    
    (1,006
    )Net interest income
    
    
    
    
    
    
    
    
    
    $
    30,624
    
    
    
    
    
    
    
    
    
    
    $
    24,648
   (1)
    
    For purposes of this table, changes attributable to both rate and volume which
cannot be segregated have been allocated proportionately to the change due to volume and
the change due to rate.  
 9




---



##### 



M A N A G E M E N T 
S   D I S C U S S I O N   A N D   A N A L Y S I S The following table sets forth the weighted average yields on the Companys
interest-earning assets, the weighted average interest rates on interest-bearing liabilities and
the interest rate spread between the weighted average yields and rates as of the date indicated.
Non-accruing loans have been included in the table as loans carrying a zero yield. At December 31, 2004Weighted average yield on:Securities available for sale:Mortgage-backed and related securities
    
    
    3.71
    %Other marketable securities
    
    
    2.83Loans held for sale
    
    
    5.56Loans receivable, net
    
    
    6.68Federal Home Loan Bank stock
    
    
    2.73Other interest-earning assets
    
    
    1.13Combined weighted average yield on interest-earning assets
    
    
    6.12Weighted average rate on:NOW accounts
    
    
    1.01
    %Passbooks
    
    
    0.19Money market accounts
    
    
    1.72Certificates
    
    
    2.86Federal Home Loan Bank advances
    
    
    4.20Combined weighted average rate on interest-bearing liabilities
    
    
    2.46Interest rate spread
    
    
    3.66
 Provision For Loan Losses The provision for loan losses is recorded to maintain the allowance for loan losses at a
level deemed appropriate by management based on the factors disclosed in the critical accounting
policy previously discussed. The provision for loan losses was $2.8 million for 2004 compared to
$2.6 million for 2003. The provision for loan losses increased primarily because of an increase
in the reserves established on two commercial lending relationships with combined outstanding
balances of $10.4 million and loss reserves of $744,000 at December 31, 2004. The increased
reserves were due to downgrades in the risk ratings assigned to these loans. Both of these loans
were performing at December 31, 2004 and will continue to be monitored for changes in risk in
accordance with the Companys commercial credit policy. The increase in the provision because of
these downgrades was partially offset by the $43 million decrease in loan growth that was
experienced in the commercial and consumer loan portfolios during 2004 when compared to 2003.
Commercial and consumer loans generally require a larger provision due to the greater inherent
credit risk of these loans. Non-Interest Income Non-interest income was $6.0 million for the year ended December 31, 2004, a decrease of
$4.3 million, from $10.3 million for the same period in 2003. The following table presents the
components of non-interest income: PercentageYear Ended December 31,
    
    
    Increase (Decrease)(Dollars in thousands)
    
    2004
    
    
    2003
    
    
    2002
    
    
    2004/2003
    
    
    2003/2002Fees and service charges
    
    $
    2,776
    
    
    
    2,304
    
    
    
    1,723
    
    
    
    20.5
    %
    
    
    33.7
    %Mortgage servicing fees
    
    
    1,169
    
    
    
    998
    
    
    
    715
    
    
    
    17.1
    
    
    
    39.6Securities gains (losses), net
    
    
    (535
    )
    
    
    1,275
    
    
    
    422
    
    
    
    (142.0
    )
    
    
    202.1Gain on sales of loans
    
    
    1,703
    
    
    
    5,240
    
    
    
    3,077
    
    
    
    (67.5
    )
    
    
    70.3Losses in limited partnerships
    
    
    (26
    )
    
    
    (243
    )
    
    
    (659
    )
    
    
    89.3
    
    
    
    63.1Other non-interest income
    
    
    880
    
    
    
    681
    
    
    
    597
    
    
    
    29.2
    
    
    
    14.1Total non-interest income
    
    $
    5,967
    
    
    
    10,255
    
    
    
    5,875
    
    
    
    (41.8
    )
    
    
    74.6
 10




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##### 



Fees and service charges earned in 2004 increased by $472,000 from those earned in
2003, primarily due to the full year effect of increased fees generated from an overdraft
protection program that was implemented in the second quarter of 2003. The Company also increased
the charges for some services and developed more retail and commercial checking account
relationships during 2004, which created more fee income opportunities. The Company will continue
to focus on deposit growth in checking and money market accounts in order to increase fee income
opportunities and decrease its cost of funds. Mortgage servicing fees increased by $171,000 for the year ended December 31, 2004 due to
the increased number of single-family loans that were serviced for others. The lower mortgage
interest rates in 2003 resulted in increased loan originations and the majority of the loans were
sold on the secondary mortgage market with the servicing rights retained. Security gains decreased by $1.8 million for the year ended December 31, 2004 as fewer
investments were sold and because of the $539,000 write down of a Federal Home Loan Mortgage
Corporation (FHLMC) preferred stock investment whose decline in value due to changes in interest
rates was determined to be other than temporary. The ability to realize gains on the sale of
securities is dependent on the type of securities in the securities portfolio and on changes in
the general interest rate environment. The Company was able to recognize gains on both its debt
and equity security portfolios in the declining interest rate conditions that existed during
2003, but was not able to do this in the rising rate environment that existed in 2004. Gains on the sale of single-family loans decreased by $3.5 million for the year ended
December 31, 2004. Increases in interest rates from the historically low mortgage rates
experienced during 2003 resulted in a significant decrease in mortgage loan origination activity
in 2004 when compared to 2003. The majority of the fixed rate single-family loans that are
originated are sold in the secondary mortgage market in order to reduce interest rate risk, increase non-interest income, and provide
funding for the commercial and consumer loan growth. The Company expects mortgage interest rates
to trend slightly higher in 2005, which may result in lower single-family loan originations and
less gain on sales of loans than that experienced in 2004. Losses from limited partnerships decreased by $217,000 for the year ended December 31, 2004
primarily because the Companys investment in a limited partnership that invested in mortgage
servicing rights was dissolved in the second quarter of 2003. Generally, as interest rates rise
the value of fixed rate mortgage servicing rights increases and as interest rates fall the value
of mortgage servicing rights declines due to changes in the anticipated cash flows caused by
prepayments on the loans being serviced. During 2003, declines in interest rates on single-family
mortgages caused the Company to recognize losses on its investment in the mortgage servicing
limited partnership. This partnership was dissolved in the second quarter of 2003 in order to
eliminate future losses. For more information on investments in limited partnerships refer to
Notes 1 and 9 of the Notes to Consolidated Financial Statements. Other non-interest income consists primarily of
fees and commissions earned on the sale of financial
planning and insurance products and the gains and
losses from the sale of assets. For the year ended
December 31, 2004, other non-interest income was
$880,000 compared to $681,000 for 2003. The change in
other non-interest income is principally due to
increases in revenues from the sale of uninsured
investment products. Non-Interest Expense Non-interest expense for the year ended December
31, 2004 was $20.2 million, compared to $19.7 million
for the year ended in 2003. The following table
presents the components of non-interest expense: PercentageYear Ended December 31,
    
    
    Increase (Decrease)(Dollars in thousands)
    
    2004
    
    
    2003
    
    
    2002
    
    
    2004/2003
    
    
    2003/2002Compensation and benefits
    
    $
    10,187
    
    
    
    8,676
    
    
    
    8,013
    
    
    
    17.4
    %
    
    
    8.3
    %Occupancy
    
    
    3,630
    
    
    
    3,424
    
    
    
    3,110
    
    
    
    6.0
    
    
    
    10.1Deposit insurance premiums
    
    
    96
    
    
    
    72
    
    
    
    74
    
    
    
    33.3
    
    
    
    (2.7
    )Advertising
    
    
    430
    
    
    
    393
    
    
    
    522
    
    
    
    9.4
    
    
    
    (24.7
    )Data processing
    
    
    930
    
    
    
    1,109
    
    
    
    1,107
    
    
    
    (16.1
    )
    
    
    0.2Amortization of mortgage servicing rights,
net of valuation adjustments and servicing costs
    
    
    1,061
    
    
    
    1,982
    
    
    
    1,166
    
    
    
    (46.5
    )
    
    
    70.0Other
    
    
    3,828
    
    
    
    3,997
    
    
    
    3,857
    
    
    
    (4.2
    )
    
    
    3.6Total non-interest expense
    
    $
    20,162
    
    
    
    19,653
    
    
    
    17,849
    
    
    
    2.6
    
    
    
    10.1
 11




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##### 



M A N A G E M E N T  S  D I S C U S S I O N  A N D  A N A L Y S I S Non-interest expense increased by $509,000 in 2004 primarily because of a $1.5
million increase in compensation and benefits expense due to increases in health insurance and
payroll costs due to normal staffing growth during the year and annual salary increases.
Occupancy expense increased by $206,000 primarily because of real estate tax increases on
existing facilities and increased expenses related to the additional corporate facilities that
were put in place in the first quarter of 2004. Amortization expense on mortgage servicing
rights decreased by $921,000 between the periods because of a decrease in the prepayments on
the mortgage loans being serviced. It is anticipated that prepayments will remain about the
same in 2005 as they were in 2004 due to the reduced number of loans that are being refinanced
compared to those that were refinanced in 2003. Data processing costs decreased by $179,000
primarily because of the renegotiation of a third party service contract in the fourth quarter
of 2003. Income Taxes The Company considers the calculation of current and deferred income taxes to be a
critical accounting policy that is subject to significant estimates. Actual results could
differ significantly from the estimates and interpretations used in determining the current and
deferred income tax liabilities. During 2004 and 2003 the Company recorded income tax expense
of $4.4 million and $4.0 million, respectively. The change in income tax expense is primarily
the result of changes in taxable income. Refer to Note 15 of the Notes to Consolidated
Financial Statements for additional information relating to income taxes. C O M P A R I S O N  O F  2 0 0 3  W I T H  2 0 0 2 Net income was $8.6 million for the year ended
December 31, 2003, compared to $5.3 million for the
year ended December 31, 2002. Diluted earnings per
common share for the year ended December 31, 2003 were
$2.16, compared to $1.32 for the year ended December
31, 2002. Return on average assets was 1.10% and 0.74%
and return on average equity was 10.85% and 6.94% for
the years ended December 31, 2003 and 2002,
respectively. In comparing the year ended December 31, 2003 to the
year ended December 31, 2002, net interest income
increased by $3.1 million primarily because of an
increase in interest-earning assets and because of a
higher concentration of commercial and consumer loans
and an increase in checking and money market deposit
accounts. Non-interest income increased $4.4 million
primarily due to increases in the gains recognized on
the sale of mortgage loans and securities. Non-interest
expense increased by $1.8 million primarily because of an
increase in the amortization of mortgage servicing
rights that was caused by the large number of loan
prepayments during 2003. Non-interest expense also
increased because of increases in compensation and
benefits and occupancy expense primarily related to the
growth in employees and facilities between the periods. Net interest income for the year ended December
31, 2003 was $24.6 million, an increase of $3.1
million, from $21.5 million in 2002. Interest income
was $44.9 million for the year ended December 31, 2003,
an increase of $2.0 million, from $42.9 million for the
same period in 2002. Interest income increased
primarily because of an increase in interest-earning
assets and because of a higher concentration of
commercial and consumer loans in portfolio. The
commercial and consumer loan portfolios increased by
$148 million between the periods. During 2003, the
Companys commercial and consumer loan portfolios
continued to increase and the percentage of loans in
these portfolios represented 61.7% of the Companys
outstanding loans at December 31, 2003, compared to
58.2% at December 31, 2002. The increase in
interest-earning assets offsets the decrease in the
interest rates earned on the assets between the
periods. Interest expense was $20.3 million for the
year ended December 31, 2003, a decrease of $1.0
million, from the $21.3 million for the same period in
2002. Interest expense declined primarily because of a
decrease in the rates paid on deposits and Federal Home
Loan Bank advances and because of a $45 million
increase in the outstanding average balance of checking
and money market accounts between the periods, which
generally have lower interest rates than other deposit
accounts. Net interest margin increased to 3.31% in 2003
compared to 3.19% for 2002 primarily because of the
increased focus on commercial and consumer loans and
the 12




---



##### 



increase in the outstanding average balance of checking
and money market accounts. Average net earning assets
were $46.4 million in 2003 compared to $45.7 million
for 2002. The Company has actively purchased its common
stock in the open market and has paid quarterly
dividends to its stockholders, both of which reduce net
interest earning assets. During 2003 and 2002 HMN paid
$1.4 million and $1.5 million to purchase its common
stock in the open market and paid dividends to
stockholders of $2.9 million and $2.6 million,
respectively. The increase in net interest earning
assets in 2003 is primarily the result of net income
exceeding stock repurchases, dividends on common stock,
and fixed asset additions. The provision for loan losses for 2003 was $2.6
million compared to $2.4 million for 2002. The
provision increased primarily because of the additional
$33 million in growth experienced in the commercial and
consumer loan portfolios in 2003. Commercial and
consumer loans generally require a larger provision due
to the greater inherent credit risk of these loans. The
provision also increased because of increases in
specific consumer loan reserves and increased instances
of personal bankruptcies that resulted in an increase
in non-accruing loans of $1.2 million between the
periods. The Company incurred $494,000 of net loan
charge-offs in 2003 compared to $1.3 million of net
loan charge-offs in 2002. Non-interest income was $10.3 million for 2003,
compared to $5.9 million for 2002. Fees and service
charges earned for the year ended December 31, 2003
increased by $581,000 from those earned in 2002,
primarily due to the increased fees generated from an
overdraft protection program that was implemented in
the second quarter of 2003. Mortgage servicing fees
increased by $283,000 in 2003 due to the increased
number of single-family loans that were serviced for
others. Gains on the sale of securities increased by
$853,000 in 2003 as investments were sold to fund a
portion of the consumer and commercial loan growth that
was experienced. Gains on the sale of single-family
loans increased by $2.2 million for the year ended
December 31, 2003. Low mortgage rates during 2003
resulted in higher single-family loan originations than
in 2002 as consumers took advantage of the low interest
rates to purchase a home or refinance their existing home mortgage. Losses from
limited partnerships decreased by $416,000 for the year
ended December 31, 2003 primarily because of lower
losses on an investment in a limited partnership that
invested in mortgage servicing rights. Generally, as
interest rates rise the value of fixed rate mortgage
servicing rights increases and as interest rates fall
the value of mortgage servicing rights declines due to
changes in the anticipated cash flows caused by
prepayments on the loans being serviced. During 2003
and 2002, declines in interest rates on single-family
mortgages caused the Company to recognize losses on its
investment in the mortgage servicing limited
partnership. This partnership was dissolved in the
second quarter of 2003. Other non-interest income
increased by $84,000 principally due to increases in
the gains recognized on the sale of assets as the
Company sold three former branch locations in 2003. Non-interest expense increased by $1.8 million in
2003 primarily because of an increase of $816,000 in
the amortization of mortgage servicing rights which was
caused by the large number of loan prepayments during
the year. Because of the low interest rates in 2003,
many loans that were being serviced by the Bank were
refinanced. When a serviced loan was paid off, the
remaining value of the right to service that loan was
recorded as additional amortization expense in the
month in which the loan was repaid. Compensation and
benefits expense increased by $663,000 primarily
because of an increase in the number of employees,
annual payroll cost increases, and costs related to a
separation agreement with a former executive officer.
Occupancy expense increased by $314,000 due to the
increased costs associated with operating and
maintaining additional facilities in 2003, including
loan production offices opened in Byron, Stewartville,
and St. Cloud, Minnesota, as well as West Des Moines,
Iowa. During 2003 and 2002 the Company recorded income
tax expense of $4.0 million and $2.1 million,
respectively. The change in income tax expense is the
result of changes in taxable income and an increase in the Companys effective
tax rate caused primarily by lower state tax deductions
as a percentage of income in 2003 when compared to
2002. 13




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##### 



M A N A G E M E N T  S  D I S C U S S I O N  A N D  A N A L Y S I S F i n a n c i a l  C o n d i t i o n Loans Receivable, Net The following table sets forth the information on the Companys loan portfolio in dollar
amounts and in percentages (before deductions for loans in process, deferred fees and discounts and
allowances for losses) as of the dates indicated. December 31,2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000(Dollars in thousands)
    
    Amount
    
    
    Percent
    
    
    Amount
    
    
    Percent
    
    
    Amount
    
    
    Percent
    
    
    Amount
    
    
    Percent
    
    
    Amount
    
    
    PercentReal Estate Loans:One-to-four family
    
    $
    139,008
    
    
    
    17.34
    %
    
    $
    144,315
    
    
    
    20.37
    %
    
    $
    151,566
    
    
    
    27.72
    %
    
    $
    215,448
    
    
    
    44.73
    %
    
    $
    312,888
    
    
    
    59.43
    %Multi-family
    
    
    41,922
    
    
    
    5.23
    
    
    
    31,540
    
    
    
    4.45
    
    
    
    15,766
    
    
    
    2.88
    
    
    
    14,369
    
    
    
    2.98
    
    
    
    12,090
    
    
    
    2.30Commercial
    
    
    224,945
    
    
    
    28.06
    
    
    
    199,124
    
    
    
    28.10
    
    
    
    130,417
    
    
    
    23.85
    
    
    
    70,768
    
    
    
    14.69
    
    
    
    61,654
    
    
    
    11.71Construction or
development
    
    
    98,397
    
    
    
    12.28
    
    
    
    95,346
    
    
    
    13.45
    
    
    
    61,336
    
    
    
    11.22
    
    
    
    46,977
    
    
    
    9.75
    
    
    
    20,211
    
    
    
    3.84Total real estate
    
    
    504,272
    
    
    
    62.91
    
    
    
    470,325
    
    
    
    66.37
    
    
    
    359,085
    
    
    
    65.67
    
    
    
    347,562
    
    
    
    72.15
    
    
    
    406,843
    
    
    
    77.28Other Loans:Consumer Loans:Automobile
    
    
    9,496
    
    
    
    1.18
    
    
    
    14,754
    
    
    
    2.08
    
    
    
    11,062
    
    
    
    2.02
    
    
    
    6,624
    
    
    
    1.38
    
    
    
    6,363
    
    
    
    1.21Home equity line
    
    
    67,140
    
    
    
    8.38
    
    
    
    54,193
    
    
    
    7.64
    
    
    
    52,106
    
    
    
    9.53
    
    
    
    35,714
    
    
    
    7.42
    
    
    
    26,907
    
    
    
    5.11Home equity
    
    
    20,033
    
    
    
    2.50
    
    
    
    18,974
    
    
    
    2.68
    
    
    
    21,075
    
    
    
    3.85
    
    
    
    26,356
    
    
    
    5.47
    
    
    
    27,812
    
    
    
    5.28Mobile home
    
    
    2,896
    
    
    
    0.36
    
    
    
    3,665
    
    
    
    0.52
    
    
    
    4,534
    
    
    
    0.83
    
    
    
    5,456
    
    
    
    1.13
    
    
    
    4,921
    
    
    
    0.93Land/lot loans
    
    
    11,572
    
    
    
    1.44
    
    
    
    10,486
    
    
    
    1.48
    
    
    
    3,590
    
    
    
    0.66
    
    
    
    850
    
    
    
    0.18
    
    
    
    1,038
    
    
    
    0.20Other
    
    
    3,836
    
    
    
    0.48
    
    
    
    3,833
    
    
    
    0.54
    
    
    
    4,054
    
    
    
    0.75
    
    
    
    4,131
    
    
    
    0.86
    
    
    
    3,855
    
    
    
    0.74Total consumer loans
    
    
    114,973
    
    
    
    14.34
    
    
    
    105,905
    
    
    
    14.94
    
    
    
    96,421
    
    
    
    17.64
    
    
    
    79,131
    
    
    
    16.44
    
    
    
    70,896
    
    
    
    13.47Commercial business
loans
    
    
    182,369
    
    
    
    22.75
    
    
    
    132,459
    
    
    
    18.69
    
    
    
    91,260
    
    
    
    16.69
    
    
    
    54,940
    
    
    
    11.41
    
    
    
    48,760
    
    
    
    9.25Total other loans
    
    
    297,342
    
    
    
    37.09
    
    
    
    238,364
    
    
    
    33.63
    
    
    
    187,681
    
    
    
    34.33
    
    
    
    134,071
    
    
    
    27.85
    
    
    
    119,656
    
    
    
    22.72Total loans
    
    
    801,614
    
    
    
    100.00
    %
    
    
    708,689
    
    
    
    100.00
    %
    
    
    546,766
    
    
    
    100.00
    %
    
    
    481,633
    
    
    
    100.00
    %
    
    
    526,499
    
    
    
    100.00
    %Less:Loans in process
    
    
    7,561
    
    
    
    
    
    
    
    11,298
    
    
    
    
    
    
    
    6,826
    
    
    
    
    
    
    
    4,692
    
    
    
    
    
    
    
    2,953Unamortized
discounts
    
    
    63
    
    
    
    
    
    
    
    166
    
    
    
    
    
    
    
    142
    
    
    
    
    
    
    
    278
    
    
    
    
    
    
    
    289Net deferred
loan fees
    
    
    1,781
    
    
    
    
    
    
    
    1,334
    
    
    
    
    
    
    
    1,068
    
    
    
    
    
    
    
    1,212
    
    
    
    
    
    
    
    1,348Allowance for losses
    
    
    8,996
    
    
    
    
    
    
    
    6,940
    
    
    
    
    
    
    
    4,824
    
    
    
    
    
    
    
    3,783
    
    
    
    
    
    
    
    3,144Total loans
receivable, net
    
    $
    783,213
    
    
    
    
    
    
    $
    688,951
    
    
    
    
    
    
    $
    533,906
    
    
    
    
    
    
    $
    471,668
    
    
    
    
    
    
    $
    518,765
 The Company continues to manage interest
rate risk and increase interest income by increasing
its investment in shorter term and generally higher
yielding commercial real estate and commercial business
loans and reducing its investment in longer term
one-to-four family real estate loans. The Company
intends to continue to increase the size of its
commercial real estate, commercial business and
consumer loan portfolios while maintaining the one-to-four family loans held in
portfolio. The one-to-four family real estate loans were
$139.0 million at December 31, 2004, a decrease of $5.3
million, compared to $144.3 million at December 31,
2003. During 2004 loan originations decreased and the
mortgage loans that were originated and placed in
portfolio were not enough to offset the principal
payments received on the loans already in the
portfolio. The decrease in the amount of mortgage loans
placed in portfolio was the primary reason for the
decline in the one-to-four family loan portfolio during
2004. 14




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##### 



Commercial real estate loans were $224.9 million at December 31, 2004, an increase of
$25.8 million, compared to $199.1 million at December 31, 2003. Commercial business loans were
$182.4 million at December 31, 2004, an increase of $49.9 million, compared to $132.5 million at
December 31, 2003. The Companys continued emphasis on commercial real estate and commercial
business loans resulted in the origination or purchase of commercial real estate loans totaling
$65.7 million in 2004 and $133.6 million in 2003. Commercial business loans originated or purchased
were $127.7 million in 2004, compared to $142.6 million in 2003. Production volume was the
principal reason for the increase in commercial real estate and commercial business loans in 2004. Home equity line loans were $67.1 million at December 31, 2004, compared to $54.2 million at
December 31, 2003. The open-end home equity lines are written with an adjustable rate with terms of
20 years, a 10 year draw period which requires interest only payments and a 10 year repayment
period which fully amortizes the outstanding balance. Closed-end home equity loans are written with
fixed or adjustable rates with terms up to 15 years. Home equity loans were $20.0 million at
December 31, 2004, compared to $19.0 million at December 31, 2003. Because many borrowers
refinanced their home mortgage during the record low interest rates in 2003, many turned to home
equity loans to finance their home improvement and other purchases as they did not want to
refinance their first mortgage at the higher rates in effect during 2004. Allowance for Loan Losses The determination of the allowance for loan losses and the related provision is a critical
accounting policy of the Company that is subject to significant estimates, as previously discussed.
The current level of the allowance for loan losses is a result of managements assessment of the
risks within the portfolio based on the information obtained through the credit evaluation process.
The Company utilizes a risk-rating system on non-homogenous commercial real estate and commercial
business loans that includes regular credit reviews to identify and quantify the risk in the
commercial portfolio. Management conducts quarterly reviews of the loan portfolio and evaluates the
need to establish general allowances on the basis of these reviews. Management continues to actively monitor asset quality and to charge off loans against the
allowance for loan losses when appropriate. Although management believes it uses the best
information available to make determinations with respect to the allowance for loan losses, future
adjustments may be necessary if economic conditions differ substantially from the economic
conditions in the assumptions used to determine the size of the allowance for losses. The allowance for loan losses was $9.0 million, or 1.12%, of gross loans at December 31, 2004,
compared to $6.9 million, or 0.98%, of gross loans at December 31, 2003. The following table
reflects the activity in the allowance for loan losses and selected statistics: December 31,(Dollars in thousands)
    
    2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000Balance at the beginning of year
    
    $
    6,940
    
    
    
    4,824
    
    
    
    3,783
    
    
    
    3,144
    
    
    
    3,273Provision for losses
    
    
    2,755
    
    
    
    2,610
    
    
    
    2,376
    
    
    
    1,150
    
    
    
    180Charge-offs:One-to-four family
    
    
    (331
    )
    
    
    (69
    )
    
    
    (44
    )
    
    
    0
    
    
    
    0Consumer
    
    
    (407
    )
    
    
    (226
    )
    
    
    (310
    )
    
    
    (170
    )
    
    
    (59
    )Commercial business and real estate
    
    
    0
    
    
    
    (255
    )
    
    
    (1,015
    )
    
    
    (347
    )
    
    
    (253
    )Recoveries
    
    
    39
    
    
    
    56
    
    
    
    34
    
    
    
    6
    
    
    
    3Net charge-offs
    
    
    (699
    )
    
    
    (494
    )
    
    
    (1,335
    )
    
    
    (511
    )
    
    
    (309
    )Balance at end of year
    
    $
    8,996
    
    
    
    6,940
    
    
    
    4,824
    
    
    
    3,783
    
    
    
    3,144Year end allowance for loan losses as a percent of year end
gross loan balance
    
    
    1.12
    %
    
    
    0.98
    %
    
    
    0.88
    %
    
    
    0.79
    %
    
    
    0.60
    %Ratio of net loan charge-offs to average loans outstanding
    
    
    0.09
    
    
    
    0.08
    
    
    
    0.26
    
    
    
    0.10
    
    
    
    0.06
 15




---



##### 



M A N A G E M E N T  S  D I S C U S S I O N  A N D  A N A L Y S I S The following table reflects the allocation of the allowance for loan losses: December 31,2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000Percent
    
    
    
    
    
    
    Percent
    
    
    
    
    
    
    Percent
    
    
    
    
    
    
    Percent
    
    
    
    
    
    
    PercentAllocated
    
    
    of loans
    
    
    Allocated
    
    
    of loans
    
    
    Allocated
    
    
    of loans
    
    
    Allocated
    
    
    of loans
    
    
    Allocated
    
    
    of loansallowance
    
    
    in each
    
    
    allowance
    
    
    in each
    
    
    allowance
    
    
    in each
    
    
    allowance
    
    
    in each
    
    
    allowance
    
    
    in eachas a %
    
    
    category
    
    
    as a %
    
    
    category
    
    
    as a %
    
    
    category
    
    
    as a %
    
    
    category
    
    
    as a %
    
    
    categoryof loan
    
    
    to total
    
    
    of loan
    
    
    to total
    
    
    of loan
    
    
    to total
    
    
    of loan
    
    
    to total
    
    
    of loan
    
    
    to total(Dollars in thousands)
    
    category
    
    
    loans
    
    
    category
    
    
    loans
    
    
    category
    
    
    loans
    
    
    category
    
    
    loans
    
    
    category
    
    
    loansReal estate loans:One-to-four family
    
    
    0.17
    %
    
    
    17.34
    %
    
    
    0.12
    %
    
    
    20.36
    %
    
    
    0.06
    %
    
    
    27.72
    %
    
    
    0.10
    %
    
    
    44.73
    %
    
    
    0.10
    %
    
    
    59.43
    %Multi-family
    
    
    1.67
    
    
    
    5.23
    
    
    
    1.34
    
    
    
    4.45
    
    
    
    1.30
    
    
    
    2.88
    
    
    
    1.41
    
    
    
    2.98
    
    
    
    0.92
    
    
    
    2.30Commercial real estate
    
    
    1.60
    
    
    
    28.06
    
    
    
    1.42
    
    
    
    28.10
    
    
    
    1.55
    
    
    
    23.88
    
    
    
    1.28
    
    
    
    14.69
    
    
    
    1.30
    
    
    
    11.71Construction or
development
    
    
    1.07
    
    
    
    12.28
    
    
    
    0.92
    
    
    
    13.45
    
    
    
    0.97
    
    
    
    11.22
    
    
    
    1.19
    
    
    
    9.75
    
    
    
    2.02
    
    
    
    3.84Consumer
    
    
    0.81
    
    
    
    14.34
    
    
    
    0.98
    
    
    
    14.95
    
    
    
    0.56
    
    
    
    17.63
    
    
    
    0.71
    
    
    
    16.44
    
    
    
    0.58
    
    
    
    13.47Commercial business
    
    
    1.36
    
    
    
    22.75
    
    
    
    1.20
    
    
    
    18.69
    
    
    
    1.48
    
    
    
    16.67
    
    
    
    2.44
    
    
    
    11.41
    
    
    
    2.72
    
    
    
    9.25Total
    
    
    1.12
    %
    
    
    100.00
    %
    
    
    0.98
    %
    
    
    100.00
    %
    
    
    0.88
    %
    
    
    100.00
    %
    
    
    0.79
    %
    
    
    100.00
    %
    
    
    0.60
    %
    
    
    100.00
    %
 The allocation of the allowance for loan losses increased in 2004 for one-to-four
family, multi-family, commercial, construction or development, and commercial business loans
primarily because managements overall assessment of the risk of the individual loans in these
categories increased between the years. The allocated percentage for the consumer loans decreased
in 2004 primarily because of an increased percentage of home equity loans in the consumer loan mix
in 2004. Allowance for Real Estate Losses Real estate properties acquired or expected to be acquired through loan foreclosures are
initially recorded at the lower of the related loan balance, less any specific allowance for loss,
or fair value less estimated selling costs. Management periodically performs valuations and an
allowance for losses is established if the carrying value of a property exceeds its fair value less
estimated selling costs. There was limited activity in the allowance for real estate losses and the
balance was zero at December 31, 2004 and December 31, 2003. Non-performing Assets Loans are reviewed at least quarterly and any loan whose collectibility is doubtful is
placed on non-accrual status. Loans are placed on non-accrual status when either principal or
interest is 90 days or more past due, unless, in the judgment of management, the loan is well
collateralized and in the process of collection. Interest accrued and unpaid at the time a loan is
placed on non-accrual status is charged against interest income. Subsequent payments are either
applied to the outstanding principal balance or recorded as interest income, depending on the
assessment of the ultimate collectibility of the loan. Restructured loans include the Banks
troubled debt restructurings that involved forgiving a portion of interest or principal on any
loans or making loans at a rate materially less than the market rate. Foreclosed and repossessed
assets include assets acquired in settlement of loans. Non-performing assets is comprised of non-accrual loans, restructured loans, impaired
securities, delinquent accounts receivable, real estate acquired through foreclosure, and
repossessed assets and totaled $4.9 million at December 31, 2004, compared to $5.0 million at
December 31, 2003. The $153,000 decrease in non-performing assets in 2004 relates primarily to a
$350,000 decrease in non-performing loans and a $9,000 decrease in non-performing other assets that
are partially offset by an increase of $206,000 in foreclosed and repossessed assets. The increase
in this category is primarily related to an increase in the number of repossessed mobile homes at
December 31, 2004. The following table sets forth the amounts and categories of non-performing assets in the
Companys portfolio: 16




---



##### 



December 31,(Dollars in thousands)
    
    2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000Non-accruing loans:Real estate:One-to-four family
    
    $
    1,864
    
    
    
    1,177
    
    
    
    695
    
    
    
    771
    
    
    
    775Commercial real estate
    
    
    1,114
    
    
    
    2,162
    
    
    
    1,719
    
    
    
    187
    
    
    
    0Consumer
    
    
    472
    
    
    
    1,050
    
    
    
    495
    
    
    
    311
    
    
    
    142Commercial business
    
    
    261
    
    
    
    186
    
    
    
    427
    
    
    
    890
    
    
    
    95Total
    
    
    3,711
    
    
    
    4,575
    
    
    
    3,336
    
    
    
    2,159
    
    
    
    1,012Accruing loans delinquent 90 days or more:One-to-four family
    
    
    628
    
    
    
    114
    
    
    
    171
    
    
    
    24
    
    
    
    405Other assets
    
    
    201
    
    
    
    211
    
    
    
    866
    
    
    
    1,390
    
    
    
    0Foreclosed and repossessed assets:Real estate:One-to-four family
    
    
    141
    
    
    
    73
    
    
    
    300
    
    
    
    0
    
    
    
    195Commercial real estate
    
    
    0
    
    
    
    0
    
    
    
    127
    
    
    
    0
    
    
    
    0Consumer
    
    
    201
    
    
    
    62
    
    
    
    107
    
    
    
    155
    
    
    
    0Commercial business
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    33
    
    
    
    0Total
    
    
    342
    
    
    
    135
    
    
    
    534
    
    
    
    188
    
    
    
    195Total non-performing assets
    
    $
    4,882
    
    
    
    5,035
    
    
    
    4,907
    
    
    
    3,761
    
    
    
    1,612Total as a percentage of total assets
    
    
    0.51
    %
    
    
    0.58
    %
    
    
    0.67
    %
    
    
    0.52
    %
    
    
    0.23
    %Total non-performing loans
    
    $
    4,339
    
    
    
    4,689
    
    
    
    3,507
    
    
    
    2,183
    
    
    
    1,417Total as a percentage of total loans receivable, net
    
    
    0.55
    %
    
    
    0.68
    %
    
    
    0.66
    %
    
    
    0.46
    %
    
    
    0.27
    %Allowance for loan losses to non-performing loans
    
    
    207.30
    %
    
    
    147.99
    %
    
    
    134.60
    %
    
    
    173.29
    %
    
    
    221.87
    %
 For the year ended December 31, 2004, gross interest income which would have been
recorded had the non-accruing loans been current in accordance with their original terms amounted
to $271,071. The amounts that were included in interest income on a cash basis for such loans
during 2004 were $158,767. For the year ended December 31, 2003, gross interest income which would have been recorded had
the non-accruing loans been current in accordance with their original terms amounted to $458,473.
The amounts that were included in interest income on a cash basis for such loans during 2003 were
$163,044. In addition to the non-performing assets set forth in the table above, as of December 31, 2004
there were no loans with known information about the possible credit problems of the borrowers or
the cash flows of the secured properties that have caused management to have concerns as to the
ability of the borrowers to comply with present loan repayment terms which may result in the future
inclusion of such items in the non-performing asset categories. Management has considered the
Banks non-performing and of concern assets in establishing its allowance for loan losses. Liquidity and Capital Resources The Company manages its liquidity position to ensure that the funding needs of borrowers and
depositors are met timely and in the most cost effective manner. Asset liquidity is the ability to
convert assets to cash through the maturity or sale of the asset. Liability liquidity is the
ability of the Bank to attract retail or brokered deposits or to borrow funds from third parties
such as the FHLB. The primary investing activities are the origination of loans and the purchase of securities.
Principal and interest payments on loans and securities along with the proceeds from the sale of
loans held for sale are the primary sources of cash for the Company. Additional cash can be
obtained by selling securities from the available for sale portfolio or by selling loans or
mortgage servicing rights. Loans could also be securitized and used as collateral for additional
borrowings with the FHLB to generate additional cash. The primary financing activity is the attraction of retail and brokered deposits. The Bank has
the ability to borrow additional funds from the FHLB by pledging additional securities or loans.
Refer to Note 13 of the Notes to Consolidated Financial Statements for more information on
additional advances that could be drawn upon based on existing collateral levels with the FHLB.
Information on outstanding advance maturities and related early call features is also included in
Note 13. The Companys most liquid assets are cash and cash equivalents, which consist of short-term
highly liquid investments with original maturities of less than three 17




---



##### 



M A N A G E M E N T  S  D I S C U S S I O N  A N D  A N A L Y S I S months that are readily convertible to known amounts of cash and interest-bearing deposits.
The level of these assets is dependent on the operating, financing, and investing activities during
any given period. Cash and cash equivalents at December 31, 2004 were $34.3 million, an increase of $3.8
million, compared to $30.5 million at December 31, 2003. Net cash provided by operating activities
during 2004 was $15.4 million. The Company conducted the following major investing activities
during 2004: proceeds from the sale of securities available for sale were $15.1 million, principal
received on payments and maturities of securities available for sale was $19.4 million, purchases
of securities available for sale were $34.9 million, and net loans receivable increased by $96.8
million. The Company spent $2.2 million for the purchase of equipment and updating its premises,
and received $267,000 from the sale of real estate and old branch facilities. Net cash used by
investing activities during 2004 was $98.0 million. The Company conducted the following major
financing activities during 2004: purchase of treasury stock of $3.3 million, paid out $21.7
million in customer escrows, paid $3.2 million in dividends to HMN stockholders, proceeds from FHLB
advances totaled $54.9 million, repayments of FHLB advances totaled $87.9 million, and increases in
deposits were $147.6 million. Net cash provided by financing activities was $86.4 million. The Company has certificates of deposit with outstanding balances of $197.6 million that
mature during 2005. Based upon past experience management anticipates that the majority of the
deposits will renew for another term. The Company believes that deposits that do not renew will be
replaced with deposits from a combination of other customers or brokers. FHLB advances or the sale
of securities could also be used to replace unanticipated outflows of deposits. Management does not
anticipate that it will have a liquidity problem in 2005 due to maturing deposits. The Company has $10 million of FHLB advances that mature in 2005 and it has $110.9 million of
FHLB advances with maturities beyond 2005 that have call features that may be exercised by the FHLB
during 2005. If the call features are exercised, the Company has the option of requesting any
advance otherwise available to it pursuant to the credit policy of the FHLB. Since the Company has
the ability to request another advance to replace the advance that is being called, management does
not anticipate that it will have a liquidity problem due to advances being called by the FHLB
during 2005. The credit policy of the FHLB may change such that the current collateral pledged to secure
the advances is no longer acceptable or the formulas for determining the excess pledged collateral
may change. If this were to happen the Bank may not have additional collateral to pledge to secure
the existing advances which could cause the FHLB advances to become a liquidity problem during
2005. The Company anticipates that its liquidity requirements for 2005 will be similar to the cash
flows it experienced in 2004 with the following exceptions: net increase in loans receivable is
anticipated to be $27 million; net increase in customer escrows is anticipated to be $200,000; the
funds provided from deposits and/or FHLB advances are anticipated to be $56 million; and the funds
provided by security sales and/or principal collections on securities are anticipated to be $25
million. On February 24, 2004, the Companys Board of Directors authorized the extension of the stock
repurchase program to August 26, 2005. The plan authorized HMN to repurchase up to 350,000 shares
of its common stock in the open market and as of December 31, 2004, there remained 227,000 shares
authorized for repurchase. Contractual Obligations and Commercial Commitments The Company has certain obligations and commitments to make future payments under
existing contracts. At December 31, 2004, the aggregate contractual obligations (excluding bank
deposits) and commercial commitments are as follows: Payments Due by PeriodLess than 1
    
    
    
    
    
    
    
    
    
    
    After 5(Dollars in thousands)
    
    Total
    
    
    Year
    
    
    1-3 Years
    
    
    4-5 Years
    
    
    YearsContractual Obligations:Total borrowings
    
    $
    170,900
    
    
    
    10,000
    
    
    
    60,000
    
    
    
    10,000
    
    
    
    90,900Annual rental commitments under
non-cancelable operating leases
    
    
    969
    
    
    
    517
    
    
    
    452
    
    
    
    0
    
    
    
    0$
    171,869
    
    
    
    10,517
    
    
    
    60,452
    
    
    
    10,000
    
    
    
    90,900
 Amount of Commitment-Expiration by PeriodOther Commercial Commitments:Commercial lines of credit
    
    $
    22,066
    
    
    
    16,711
    
    
    
    4,670
    
    
    
    0
    
    
    
    685Commitments to lend
    
    
    93,211
    
    
    
    39,183
    
    
    
    13,527
    
    
    
    46
    
    
    
    40,455Standby letters of credit
    
    
    7,025
    
    
    
    6,581
    
    
    
    444
    
    
    
    0
    
    
    
    0$
    122,302
    
    
    
    62,475
    
    
    
    18,641
    
    
    
    46
    
    
    
    41,140
 18




---



##### 



Regulatory Capital Requirements As a result of the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA),
banking and thrift regulators are required to take prompt regulatory action against institutions
which are undercapitalized. FDICIA requires banking and thrift regulators to categorize
institutions as well capitalized, adequately capitalized, undercapitalized, significantly
undercapitalized, or critically undercapitalized. A savings institution will be deemed to be
well capitalized if it: (i) has a total risk-based capital ratio of 10% or greater, (ii) has a Tier
1 (core) risk-based capital ratio of 6% or greater, (iii) has a leverage ratio of 5% or greater,
and (iv) is not subject to any order or written directive by the Office of Thrift Supervision (OTS)
to meet and maintain a specific capital level for any capital measure. Management believes that, as
of December 31, 2004, the Bank met all of the capital requirements to which it was subject and is
well capitalized based on the regulatory definition described above. Refer to Note 19 of the Notes
to Consolidated Financial Statements for a table which reflects the Banks capital compared to its
capital requirements. Dividends The declaration of dividends is subject to, among other things, the Companys financial
condition and results of operations, the Banks compliance with its regulatory capital
requirements, tax considerations, industry standards, economic conditions, regulatory restrictions,
general business practices and other factors. Refer to Note 19 of the Notes to Consolidated
Financial Statements for information on regulatory limitations on dividends from the Bank to the
Company and additional information on dividends. The payment of dividends is dependent upon the
Company having adequate cash or other assets that can be converted to cash to pay dividends to its
stockholders. The Company does not anticipate a liquidity problem in 2005 relating to the payment
of dividends. Impact of Inflation and Changing Prices The impact of inflation is reflected in the increased cost of operations. Unlike most
industrial companies, nearly all of the assets and liabilities of the Company are monetary in
nature. As a result, interest rates have a greater impact on the Companys performance than do the
effects of general levels of inflation. Interest rates do not necessarily move in the same
direction or to the same extent as the prices of goods and services. New Accounting Pronouncements In December 2004, the Financial Accounting Standards Board (FASB) issued a revised SFAS No.
123, Share-Based Payment.This Statement is a revision of FASB Statement No.
123, Accounting for Stock Based Compensationand requires that the cost resulting from all
share-based payment transactions be recognized in the financial statements. This Statement is
effective for public entities that do not file as small business issuers as of the beginning of the
first interim or annual reporting period that begins after June 15, 2005. It requires a public
entity to measure the cost of employee services received in exchange for an award of equity
instruments based on the grant-date fair value of the award. That cost will be recognized over the
period during which an employee is required to provide service in exchange for the award. The
Statement also requires that the notes to financial statements disclose information to assist users
of financial information to understand the nature of share-based payment transactions and the
effects of those transactions on the financial statements. The impact of adopting the revised SFAS
No. 123 in the third quarter of 2005 on the Companys financial condition and results of operations
will not be material. At its March 2004 meeting, the Emerging Issues Task Force revisited EITF Issue No. 03-1, The
Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments(EITF No.
03-1). Effective with reporting periods beginning after June 15, 2004, companies carrying certain
types of debt and equity securities at amounts higher than the securities fair values would have
to use more detailed criteria to evaluate whether to record a loss and would have to disclose
additional information about unrealized losses. The FASB has since issued a statement of financial
position deferring the effective date of the revised EITF No. 03-1 until further implementation
issues are resolved. The impact on the Companys financial position and results of operations
cannot be determined until the final statement is issued. Market Risk Market risk is the risk of loss from adverse changes in market prices and rates. The
Companys market risk arises primarily from interest rate risk inherent in its investing, lending
and deposit taking activities. Management actively monitors and manages its interest rate risk
exposure. The Companys profitability is affected by fluctuations in interest rates. A sudden and
substantial change in interest rates may adversely impact the Companys earnings to the extent that
the interest rates borne by assets and liabilities do not change at the same speed, to the same
extent, or on the same basis. The Company monitors the projected changes in net interest income
that occur if interest rates were to suddenly change up or down. The Rate Shock Table located in
the Asset/Liability Management section of this Managements Discussion and Analysis section
discloses the Companys projected changes in net interest income based upon immediate interest rate
changes called rate shocks. The Company utilizes a model that uses the discounted 19




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##### 



M A N A G E M E N T  S  D I S C U S S I O N  A N D  A N A L Y S I S cash flows from its interest-earning assets and its interest-bearing liabilities to
calculate the current market value of those assets and liabilities. The model also calculates the
changes in market value of the interest-earning assets and interest-bearing liabilities under
different interest rate changes. The management of the Company believes that over the next twelve months interest rates could
conceivably fluctuate in a range of 200 basis points up or 100 basis points down from where the
rates were at December 31, 2004. The following table discloses the projected changes in market
value to the Companys interest-earning assets and interest-bearing liabilities based upon
incremental 100 basis point changes in interest rates from interest rates in effect on December 31,
2004. (Dollars in thousands)
    
    Market ValueBasis point change in interest rates
    
    100
    
    
    0
    
    
    +100
    
    
    +200Total market risk sensitive assets
    
    $
    964,217
    
    
    
    956,346
    
    
    
    945,265
    
    
    
    932,907Total market risk sensitive liabilities
    
    
    864,064
    
    
    
    848,729
    
    
    
    833,726
    
    
    
    819,618Off-balance sheet financial instruments
    
    
    (43
    )
    
    
    0
    
    
    
    227
    
    
    
    263Net market risk
    
    $
    100,196
    
    
    
    107,617
    
    
    
    111,312
    
    
    
    113,026Percentage change from current market value
    
    
    (6.90
    )%
    
    
    0.00
    %
    
    
    33.43
    %
    
    
    5.03
    %
 The preceding table was prepared utilizing the following assumptions (the Model
Assumptions) regarding prepayment and decay ratios that were determined by management based upon
their review of historical prepayment speeds and future prepayment projections. Fixed rate loans
were assumed to prepay at annual rates of between 5% and 75%, depending on the note rate and the
period to maturity. Adjustable rate mortgages (ARMs) were assumed to prepay at annual rates of
between 10% and 33%, depending on the note rate and the period to maturity. Growing Equity Mortgage
(GEM) loans were assumed to prepay at annual rates of between 5% and 53% depending on the note rate
and the period to maturity. Mortgage-backed securities and Collateralized Mortgage Obligations
(CMOs) were projected to have prepayments based upon the underlying collateral securing the
instrument and the related cash flow priority of the CMO tranche owned. Certificate accounts were
assumed not to be withdrawn until maturity. Passbook and money market accounts were assumed to
decay at an annual rate of 30%. Non-interest checking and NOW accounts were assumed to decay at an
annual rate of 16%. Commercial NOW and MMDA accounts were assumed to decay at an annual rate of
30%. FHLB advances were projected to be called at the first call date where the projected interest
rate on similar remaining term advances exceeded the interest rate on the callable advance. Refer
to Note 13 of the Notes to Consolidated Financial Statements for more information on call
provisions of the FHLB advances. Certain shortcomings are inherent in the method of analysis presented in the foregoing table.
The interest rates on certain types of assets and liabilities may fluctuate in advance of changes
in market interest rates, while interest rates on other types of assets and liabilities may lag
behind changes in market interest rates. The model assumes that the difference between the current
interest rate being earned or paid compared to a treasury instrument or other interest index with a
similar term to maturity (the Interest Spread) will remain constant over the interest changes
disclosed in the table. Changes in Interest Spread could impact projected market value changes.
Certain assets, such as ARMs, have features that restrict changes in interest rates on a short-term
basis and over the life of the assets. The market value of the interest-bearing assets that are
approaching their lifetime interest rate caps could be different from the values calculated in the
table. In the event of a change in interest rates, prepayment and early withdrawal levels may
deviate significantly from those assumed in calculating the foregoing table. The ability of many
borrowers to service their debt may decrease in the event of a substantial sustained interest rate
increase. 20




---



##### 



Asset/Liability Management The Companys management reviews the impact that changing interest rates will have on
its net interest income projected for the twelve months following December 31, 2004 to determine if
its current level of interest rate risk is acceptable. The following table projects the estimated
impact on net interest income of immediate interest rate changes called rate shocks. Rate Shock
    
    Net Interest
    
    Percentagein Basis Points
    
    Income
    
    Change+200
    
    
    $
    36,434,000
    
    
    
    7.25
    %+100
    
    
    $
    35,344,000
    
    
    
    4.04
    %0
    
    
    $
    33,971,000
    
    
    
    0.00
    %-100
    
    
    $
    32,986,000
    
    
    
    (2.90
    )%
 The preceding table was prepared utilizing the Model Assumptions. Certain shortcomings
are inherent in the method of analysis presented in the foregoing table. In the event of a change
in interest rates, prepayment and early withdrawal levels would likely deviate significantly from
those assumed in calculating the foregoing table. The ability of many borrowers to service their
debt may decrease in the event of a substantial increase in interest rates and could impact net
interest income. In an attempt to manage its exposure to changes in interest rates, management closely monitors
interest rate risk. The Company has an Asset/Liability Committee that meets frequently to discuss
changes made to the interest rate risk position and projected profitability. The Committee makes
adjustments to the asset-liability position of the Bank that are reviewed by the Board of Directors
of the Bank. This Committee also reviews the Banks portfolio, formulates investment strategies and
oversees the timing and implementation of transactions to assure attainment of the Banks
objectives in the most effective manner. In addition, the Board reviews on a quarterly basis the
Banks asset/liability position, including simulations of the effect on the Banks capital of
various interest rate scenarios. In managing its asset/liability mix, the Bank, at times, depending on the relationship between
long and short-term interest rates, market conditions and consumer preference, may place more
emphasis on managing net interest margin than on better matching the interest rate sensitivity of
its assets and liabilities in an effort to enhance net interest income. Management believes that
the increased net interest income resulting from a mismatch in the maturity of its asset and
liability portfolios can, during periods of declining or stable interest rates, provide high enough
returns to justify the increased exposure to sudden and unexpected increases in interest rates. To the extent consistent with its interest rate spread objectives, the Bank attempts to reduce
its interest rate risk and has taken a number of steps to restructure its balance sheet in order to
better match the maturities of its assets and liabilities. The Bank has primarily focused its fixed
rate one-to-four family residential lending program on loans that are saleable to third parties and
only places fixed rate loans that meet certain risk characteristics into its loan portfolio. The
Bank does place into portfolio adjustable rate single-family loans that reprice over a one-year,
three-year or five-year period. The Banks commercial loan production has primarily been in
adjustable rate loans and the fixed rate commercial loans placed in portfolio have been
shorter-term loans, usually with maturities of five years or less, in order to lower the Companys
interest rate risk exposure. 21




---



##### 



C O N S O L I D A T E D  B A L A N C E  S H E E T S December 31, 2004 and 2003
    
    2004
    
    
    2003A S S E T SCash and cash equivalents
    
    $
    34,298,394
    
    
    
    30,496,823Securities available for sale:Mortgage-backed and related securities
(amortized cost $9,509,377 and $13,707,005)
    
    
    9,150,871
    
    
    
    13,048,718Other marketable securities
(amortized cost $95,097,051 and $91,035,285)
    
    
    94,521,512
    
    
    
    91,615,047103,672,383
    
    
    
    104,663,765Loans held for sale
    
    
    2,711,760
    
    
    
    6,542,824Loans receivable, net
    
    
    783,213,262
    
    
    
    688,951,119Accrued interest receivable
    
    
    3,694,133
    
    
    
    3,462,221Real estate, net
    
    
    140,608
    
    
    
    73,271Federal Home Loan Bank stock, at cost
    
    
    9,292,800
    
    
    
    10,004,400Mortgage servicing rights, net
    
    
    3,231,242
    
    
    
    3,447,843Premises and equipment, net
    
    
    12,464,265
    
    
    
    12,110,151Investment in limited partnerships
    
    
    168,258
    
    
    
    617,042Goodwill
    
    
    3,800,938
    
    
    
    3,800,938Core deposit intangible, net
    
    
    333,617
    
    
    
    447,474Prepaid expenses and other assets
    
    
    2,638,681
    
    
    
    2,108,575Deferred tax assets
    
    
    1,012,700
    
    
    
    0Total assets
    
    $
    960,673,041
    
    
    
    866,726,446L I A B I L I T I E S  A N D  S T O C K H O L D E R S   E
Q U I T YDeposits
    
    $
    698,902,185
    
    
    
    551,687,995Federal Home Loan Bank advances
    
    
    170,900,000
    
    
    
    203,900,000Accrued interest payable
    
    
    1,314,356
    
    
    
    766,837Customer escrows
    
    
    762,737
    
    
    
    22,457,671Accrued expenses and other liabilities
    
    
    5,022,927
    
    
    
    6,952,600Deferred tax liabilities
    
    
    0
    
    
    
    26,300Total liabilities
    
    
    876,902,205
    
    
    
    785,791,403Commitments and contingencies
Minority interest
    
    
    0
    
    
    
    3,986Stockholders 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 shares; issued 9,128,662
    
    
    91,287
    
    
    
    91,287Additional paid-in capital
    
    
    57,875,595
    
    
    
    57,863,726Retained earnings, subject to certain restrictions
    
    
    91,408,028
    
    
    
    85,364,657Accumulated other comprehensive loss
    
    
    (604,446
    )
    
    
    (50,725
    )Unearned employee stock ownership plan shares
    
    
    (4,544,300
    )
    
    
    (4,738,084
    )Treasury stock, at cost 4,708,798 and 4,616,010 shares
    
    
    (60,455,328
    )
    
    
    (57,599,804
    )Total stockholders equity
    
    
    83,770,836
    
    
    
    80,931,057Total liabilities and stockholders equity
    
    $
    960,673,041
    
    
    
    866,726,446
 See accompanying notes to consolidated financial statements. 22




---



##### 



C O N S O L I D A T E D  S T A T E M E N T S  O F  I N C O M E Years ended December 31, 2004, 2003 and 2002
    
    2004
    
    
    2003
    
    
    2002Interest income:Loans receivable
    
    $
    47,962,485
    
    
    
    41,800,039
    
    
    
    38,011,750Securities available for sale:Mortgage-backed and related
    
    
    385,067
    
    
    
    272,253
    
    
    
    1,704,248Other marketable
    
    
    2,897,834
    
    
    
    2,386,590
    
    
    
    2,420,317Federal Home Loan Bank stock
    
    
    207,240
    
    
    
    349,150
    
    
    
    349,214Other, including cash equivalents
    
    
    164,061
    
    
    
    128,948
    
    
    
    382,021Total interest income
    
    
    51,616,687
    
    
    
    44,936,980
    
    
    
    42,867,550Interest expense:Deposits
    
    
    12,398,505
    
    
    
    10,274,188
    
    
    
    10,949,802Federal Home Loan Bank advances
    
    
    8,594,790
    
    
    
    10,014,865
    
    
    
    10,345,102Total interest expense
    
    
    20,993,295
    
    
    
    20,289,053
    
    
    
    21,294,904Net interest income
    
    
    30,623,392
    
    
    
    24,647,927
    
    
    
    21,572,646Provision for loan losses
    
    
    2,755,000
    
    
    
    2,610,000
    
    
    
    2,376,000Net interest income after provision for loan losses
    
    
    27,868,392
    
    
    
    22,037,927
    
    
    
    19,196,646Non-interest income:Fees and service charges
    
    
    2,776,553
    
    
    
    2,304,090
    
    
    
    1,723,117Mortgage servicing fees
    
    
    1,168,760
    
    
    
    998,200
    
    
    
    715,074Securities gains (losses), net
    
    
    (535,188
    )
    
    
    1,274,537
    
    
    
    422,346Gain on sales of loans
    
    
    1,702,979
    
    
    
    5,240,442
    
    
    
    3,077,294Losses in limited partnerships
    
    
    (26,118
    )
    
    
    (243,305
    )
    
    
    (659,378
    )Other
    
    
    880,233
    
    
    
    681,518
    
    
    
    596,117Total non-interest income
    
    
    5,967,219
    
    
    
    10,255,482
    
    
    
    5,874,570Non-interest expense:Compensation and benefits
    
    
    10,186,538
    
    
    
    8,675,596
    
    
    
    8,012,953Occupancy
    
    
    3,629,766
    
    
    
    3,423,745
    
    
    
    3,109,548Deposit insurance premiums
    
    
    95,465
    
    
    
    72,524
    
    
    
    74,108Advertising
    
    
    430,417
    
    
    
    392,833
    
    
    
    521,898Data processing
    
    
    930,144
    
    
    
    1,109,098
    
    
    
    1,107,248Amortization of mortgage servicing rights,
net of valuation adjustments and servicing costs
    
    
    1,061,407
    
    
    
    1,982,337
    
    
    
    1,165,762Other
    
    
    3,828,086
    
    
    
    3,997,243
    
    
    
    3,857,117Total noninterest expense
    
    
    20,161,823
    
    
    
    19,653,376
    
    
    
    17,848,634Income before income tax expense
    
    
    13,673,788
    
    
    
    12,640,033
    
    
    
    7,222,582Income tax expense
    
    
    4,387,100
    
    
    
    4,037,800
    
    
    
    2,099,200Income before minority interest
    
    
    9,286,688
    
    
    
    8,602,233
    
    
    
    5,123,382Minority interest
    
    
    (3,109
    )
    
    
    (3,014
    )
    
    
    (142,274
    )Net income
    

    $
    9,289,797
    
    
    
    8,605,247
    
    
    
    5,265,656Basic earnings per share
    
    $
    2.40
    
    
    
    2.26
    
    
    
    1.40Diluted earnings per share
    
    $
    2.31
    
    
    
    2.16
    
    
    
    1.32
 C O N S O L I D A T E D  S T A T E M E N T S  O F  C O M P R E H E N S I V E  I N C O M E Net income
    
    $
    9,289,797
    
    
    
    8,605,247
    
    
    
    5,265,656Other comprehensive income (loss), net of tax:Unrealized losses on hedging valuation
    
    
    0
    
    
    
    0
    
    
    
    (35,795
    )Less: minority interest in hedging valuation
    
    
    0
    
    
    
    0
    
    
    
    (21,950
    )Net unrealized losses on hedging valuation
    
    
    0
    
    
    
    0
    
    
    
    (13,845
    )Unrealized gains (losses) on securities:Unrealized holding gains (losses) arising during the year
    
    
    (899,909
    )
    
    
    (801,965
    )
    
    
    1,494,824Less: reclassification adjustment
for gains (losses) included in net income
    
    
    (346,188
    )
    
    
    824,337
    
    
    
    273,146Net unrealized gains (losses) on securities
    
    
    (553,721
    )
    
    
    (1,626,302
    )
    
    
    1,221,678Other comprehensive income (loss)
    
    
    (553,721
    )
    
    
    (1,626,302
    )
    
    
    1,207,833Comprehensive income
    
    $
    8,736,076
    
    
    
    6,978,945
    
    
    
    6,473,489
 See accompanying notes to consolidated financial statements. 23




---



##### 



C O N S O L I D A T E D  S T A T E M E N T S  O F  S T O C K H O L D E R S   E Q U I T Y UnearnedEmployeeAccumulated
    
    
    Stock
    
    
    UnearnedAdditional
    
    
    
    
    
    
    Other
    
    
    Ownership
    
    
    Compensation
    
    
    
    
    
    
    TotalCommon
    
    
    Paid-In
    
    
    Retained
    
    
    Comprehensive
    
    
    Plan
    
    
    Restricted
    
    
    Treasury
    
    
    StockholdersStock
    
    
    Capital
    
    
    Earnings
    
    
    Income (Loss)
    
    
    Shares
    
    
    Stock Awards
    
    
    Stock
    
    
    EquityBalance,
December 31, 2001
    
    $
    91,287
    
    
    
    59,168,782
    
    
    
    76,956,978
    
    
    
    367,744
    
    
    
    (5,124,746
    )
    
    
    (7,350
    )
    
    
    (59,291,344
    )
    
    
    72,161,351Net income
    
    
    
    
    
    
    
    
    
    
    5,265,656
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,265,656Other comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,207,833
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,207,833Treasury stock purchases
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,496,111
    )
    
    
    (1,496,111
    )Employee stock options exercised
    
    
    
    
    
    
    (699,641
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,570,772
    
    
    
    871,131Tax benefits of exercised stock options
    
    
    
    
    
    
    272,534
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    272,534Amortization of restricted stock awards
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,350
    
    
    
    
    
    
    
    7,350Earned employee stock ownership plan shares
    
    
    
    
    
    
    143,604
    
    
    
    
    
    
    
    
    
    
    
    193,361
    
    
    
    
    
    
    
    
    
    
    
    336,965Dividends paid
    
    
    
    
    
    
    
    
    
    
    (2,562,153
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    ( 2,562,153
    )Balance,
December 31, 2002
    
    $
    91,287
    
    
    
    58,885,279
    
    
    
    79,660,481
    
    
    
    1,575,577
    
    
    
    (4,931,385
    )
    
    
    0
    
    
    
    (59,216,683
    )
    
    
    76,064,556Net income
    
    
    
    
    
    
    
    
    
    
    8,605,247
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    8,605,247Other comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,626,302
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,626,302
    )Treasury stock purchases
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,384,560
    )
    
    
    (1,384,560
    )Employee stock options exercised
    
    
    
    
    
    
    (1,578,979
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,001,439
    
    
    
    1,422,460Tax benefits of exercised stock options
    
    
    
    
    
    
    376,969
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    376,969Earned employee stock ownership plan shares
    
    
    
    
    
    
    180,457
    
    
    
    
    
    
    
    
    
    
    
    193,301
    
    
    
    
    
    
    
    
    
    
    
    373,758Dividends paid
    
    
    
    
    
    
    
    
    
    
    (2,901,071
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    ( 2,901,071
    )Balance,
December 31, 2003
    
    $
    91,287
    
    
    
    57,863,726
    
    
    
    85,364,657
    
    
    
    (50,725
    )
    
    
    (4,738,084
    )
    
    
    0
    
    
    
    (57,599,804
    )
    
    
    80,931,057Net income
    
    
    
    
    
    
    
    
    
    
    9,289,797
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    9,289,797Other comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (553,721
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (553,721
    )Treasury stock purchases
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3,316,550
    )
    
    
    (3,316,550
    )Employee stock options exercised
    
    
    
    
    
    
    (394,392
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    461,026
    
    
    
    66,634Tax benefits of exercised stock options
    
    
    
    
    
    
    98,096
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    98,096Earned employee stock ownership plan shares
    
    
    
    
    
    
    308,165
    
    
    
    
    
    
    
    
    
    
    
    193,784
    
    
    
    
    
    
    
    
    
    
    
    501,949Dividends paid
    
    
    
    
    
    
    
    
    
    
    (3,246,426
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3,246,426
    )Balance,
December 31, 2004
    
    $
    91,287
    
    
    
    57,875,595
    
    
    
    91,408,028
    
    
    
    (604,446
    )
    
    
    (4,544,300
    )
    
    
    0
    
    
    
    (60,455,328
    )
    
    
    83,770,836
 See accompanying notes to consolidated financial statements. 24




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##### 



C O N S O L I D A T E D  S T A T E M E N T S  O F  C A S H  F L O W S Years ended December 31, 2004, 2003 and 2002
    
    2004
    
    
    2003
    
    
    2002Cash flows from operating activities:Net income
    
    $
    9,289,797
    
    
    
    8,605,247
    
    
    
    5,265,656Adjustments to reconcile net income to cash provided by operating activities:Provision for loan losses
    
    
    2,755,000
    
    
    
    2,610,000
    
    
    
    2,376,000Depreciation
    
    
    1,596,252
    
    
    
    1,549,997
    
    
    
    1,460,636Amortization of (discounts) premiums, net
    
    
    (353,598
    )
    
    
    652,344
    
    
    
    501,945Amortization of deferred loan fees
    
    
    (1,166,855
    )
    
    
    (690,176
    )
    
    
    (672,993
    )Amortization of core deposit intangible
    
    
    113,857
    
    
    
    113,857
    
    
    
    124,178Amortization of mortgage servicing rights,
net of valuation adjustments and servicing costs
    
    
    1,061,407
    
    
    
    1,982,337
    
    
    
    1,165,762Capitalized mortgage servicing rights
    
    
    (844,806
    )
    
    
    (2,522,231
    )
    
    
    (1,956,845
    )Deferred income tax benefit
    
    
    (737,200
    )
    
    
    (540,900
    )
    
    
    (158,700
    )Securities (gains) losses, net
    
    
    535,188
    
    
    
    (1,274,537
    )
    
    
    (422,346
    )Loss (gain) on sale of premises
    
    
    43,440
    
    
    
    (185,630
    )
    
    
    85,434Loss (gain) on sales of real estate
    
    
    21,775
    
    
    
    115,710
    
    
    
    (1,254
    )Proceeds from sales of real estate
    
    
    825,461
    
    
    
    740,194
    
    
    
    151,453Gain on sales of loans
    
    
    (1,702,979
    )
    
    
    (5,240,442
    )
    
    
    (3,077,294
    )Proceeds from sales of loans held for sale
    
    
    90,118,839
    
    
    
    297,862,680
    
    
    
    283,485,340Disbursements on loans held for sale
    
    
    (84,592,187
    )
    
    
    (280,633,930
    )
    
    
    (221,645,865
    )Principal collected on loans held for sale
    
    
    0
    
    
    
    11,521
    
    
    
    120,621Amortization of restricted stock awards
    
    
    0
    
    
    
    0
    
    
    
    7,350Amortization of unearned ESOP Shares
    
    
    193,784
    
    
    
    193,301
    
    
    
    193,361Earned employee stock ownership shares priced above original cost
    
    
    308,165
    
    
    
    180,457
    
    
    
    143,604Decrease (increase) in accrued interest receivable
    
    
    (231,912
    )
    
    
    (411,585
    )
    
    
    458,192Increase (decrease) in accrued interest payable
    
    
    547,519
    
    
    
    (82,590
    )
    
    
    (168,029
    )Equity losses of limited partnerships
    
    
    26,118
    
    
    
    243,305
    
    
    
    659,378Equity losses of minority interest
    
    
    (3,109
    )
    
    
    (3,014
    )
    
    
    (142,274
    )Decrease (increase) in other assets
    
    
    (533,660
    )
    
    
    680,227
    
    
    
    126,663Increase (decrease) in other liabilities
    
    
    (1,820,633
    )
    
    
    663,785
    
    
    
    629,031Other, net
    
    
    (62,873
    )
    
    
    178,627
    
    
    
    366,903Net cash provided by operating activities
    
    
    15,386,790
    
    
    
    24,798,554
    
    
    
    69,075,907Cash flows from investing activities:Proceeds from sales of securities available for sale
    
    
    15,129,325
    
    
    
    50,372,919
    
    
    
    18,036,553Principal collected on securities available for sale
    
    
    4,354,497
    
    
    
    30,938,152
    
    
    
    25,481,396Proceeds collected on maturity of securities available for sale
    
    
    15,000,000
    
    
    
    10,000,000
    
    
    
    19,900,000Purchases of securities available for sale
    
    
    (34,877,137
    )
    
    
    (76,410,791
    )
    
    
    (63,173,006
    )Redemption of interest in limited partnership
    
    
    422,474
    
    
    
    0
    
    
    
    0Purchase of Federal Home Loan Bank stock
    
    
    (1,793,200
    )
    
    
    (768,900
    )
    
    
    0Redemption of Federal Home Loan Bank stock
    
    
    2,504,800
    
    
    
    2,645,000
    
    
    
    364,500Net increase in loans receivable
    
    
    (96,761,454
    )
    
    
    (161,455,973
    )
    
    
    (69,313,264
    )Proceeds from sale of mortgage servicing rights
    
    
    0
    
    
    
    0
    
    
    
    33,032Proceeds from sale of premises
    
    
    266,972
    
    
    
    416,354
    
    
    
    655,465Purchases of premises and equipment
    
    
    (2,220,610
    )
    
    
    (1,046,235
    )
    
    
    (4,281,615
    )Net cash used by investing activities
    
    
    (97,974,333
    )
    
    
    (145,309,474
    )
    
    
    (72,296,939
    )Cash flows from financing activities:Increase in deposits
    
    
    147,580,390
    
    
    
    118,784,449
    
    
    
    10,925,976Purchase of treasury stock
    
    
    (3,316,550
    )
    
    
    (1,384,560
    )
    
    
    (1,496,111
    )Stock options exercised
    
    
    66,634
    
    
    
    1,422,460
    
    
    
    871,131Dividends to stockholders
    
    
    (3,246,426
    )
    
    
    (2,901,071
    )
    
    
    (2,562,153
    )Proceeds from Federal Home Loan Bank advances
    
    
    54,900,000
    
    
    
    161,000,000
    
    
    
    10,000,000Repayment of Federal Home Loan Bank advances
    
    
    (87,900,000
    )
    
    
    (175,400,000
    )
    
    
    (9,500,000
    )Minority interest in limited partnership
    
    
    0
    
    
    
    7,000
    
    
    
    0Increase (decrease) in customer escrows
    
    
    (21,694,934
    )
    
    
    21,750,458
    
    
    
    (308,357
    )Net cash provided by financing activities
    
    
    86,389,114
    
    
    
    123,278,736
    
    
    
    7,930,486Increase in cash and cash equivalents
    
    
    3,801,571
    
    
    
    2,767,816
    
    
    
    4,709,454Cash and cash equivalents, beginning of year
    
    
    30,496,823
    
    
    
    27,729,007
    
    
    
    23,019,553Cash and cash equivalents, end of year
    
    $
    34,298,394
    
    
    
    30,496,823
    
    
    
    27,729,007Supplemental cash flow disclosures:Cash paid for interest
    
    $
    20,445,776
    
    
    
    20,371,643
    
    
    
    21,462,933Cash paid for income taxes
    
    
    6,548,500
    
    
    
    2,141,000
    
    
    
    1,952,500Supplemental noncash flow disclosures:Loans transferred to loans held for sale
    
    
    0
    
    
    
    3,741,477
    
    
    
    4,669,139Transfer of loans to real estate
    
    
    892,802
    
    
    
    769,584
    
    
    
    628,233Transfer of real estate to loans
    
    
    0
    
    
    
    47,802
    
    
    
    0
 See accompanying notes to consolidated financial statements. 25




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##### 



N O T E S  T O  C O N S O L I D A T E D  F I N A N C I A L  S T A T E M E N T S December 31, 2004, 2003 and 2002 NOTE 1 Description of the Business and
Summary of Significant Accounting Policies
HMN Financial, Inc. (HMN or the Company) is a
stock savings bank holding company that owns 100
percent of Home Federal Savings Bank (the Bank). The
Bank has a community banking philosophy and operates
retail banking facilities in Minnesota and Iowa. The
Bank has two wholly owned subsidiaries, Osterud
Insurance Agency, Inc. (OAI) which offers financial
planning products and services and Home Federal
Holding, Inc. (HFH) which is the holding company for
Home Federal REIT, Inc. (HFREIT) which invests in real
estate loans acquired from the Bank. HMN has another
wholly owned subsidiary, Security Finance Corporation
(SFC) which acts as an intermediary for the Bank in
transacting like kind property exchanges for Bank
customers. The Bank had an 80% owned subsidiary,
Federal Title Services, LLC (FTS), which performed
mortgage title services for Bank customers. FTS stopped
accepting title orders in the third quarter of 2004 and
was dissolved. The Bank had a 51% owned subsidiary,
Home Federal Mortgage Services, LLC (HFMS), that was a
mortgage banking and mortgage brokerage business until
its assets were liquidated in 2003 and it was
dissolved. The consolidated financial statements included
herein are for HMN, SFC, the Bank and the Banks
consolidated entities as described above. All
significant intercompany accounts and transactions have
been eliminated in consolidation. Use of EstimatesIn preparing the
consolidated financial statements, management is
required to make estimates and assumptions that affect
the reported amounts of assets and liabilities as of
the date of the balance sheet and revenues and expenses
for the period. Actual results could differ from those
estimates. Estimates that are particularly susceptible
to change relate to the determination of the allowance
for loan losses and the valuation of mortgage servicing
rights. Management believes that the allowance for loan
losses is adequate to cover probable losses inherent in
the portfolio at the date of the balance sheet. While
management uses available information to recognize
losses on loans, future additions to the allowance may
be necessary based on changes in economic conditions.
In addition, various regulatory agencies, as an
integral part of their examination process,
periodically review the allowance for loan losses. Such
agencies may require additions to the allowance based
on their judgment about information available to them
at the time of their examination. Mortgage servicing rights are stratified by loan
type and note rate and are valued quarterly using
prepayment and default rate assumptions. While
management believes that the assumptions used and the
values determined are reasonable, future adjustments
may be necessary if economic conditions differ
substantially from the economic
conditions in the assumptions used to determine
the value of the mortgage servicing rights. Cash and Cash EquivalentsThe Company
considers highly liquid investments with original
maturities of three months or less to be cash
equivalents. SecuritiesSecurities are accounted for
according to their purpose and holding period. The
Company classifies its debt and equity securities in
one of three categories: Trading SecuritiesSecurities
held principally for resale in the near term are
classified as trading securities and are recorded at
their fair values. Unrealized gains and losses on
trading securities are included in other income. Securities Held to MaturitySecurities that the
Company has the positive intent and ability to hold to
maturity are reported at cost and adjusted for premiums
and discounts that are recognized in interest income
using the interest method over the period to maturity.
Unrealized losses on securities held to maturity
reflecting a decline in value judged to be other than
temporary are charged to income. Securities Available for SaleSecurities
available for sale consist of securities not classified
as trading securities or as securities held to
maturity. They include securities that management
intends to use as part of its asset/liability strategy
or that may be sold in response to changes in interest
rate, changes in prepayment risk, or similar factors.
Unrealized gains and losses, net of income taxes, are
reported as a separate component of stockholders
equity until realized. Gains and losses on the sale of
securities available for sale are determined using the
specific identification method and recognized on the
trade date. Premiums and discounts are recognized in
interest income using the interest method over the
period to maturity. Unrealized losses on securities
available for sale reflecting a decline in value judged
to be other than temporary are charged to income, and a
new cost basis is established. Loans Held for SaleMortgage loans
originated or purchased which are intended for sale in
the secondary market are carried at the lower of cost
or estimated market value in the aggregate. Net fees
and costs associated with acquiring and/or originating
loans held for sale are deferred and included in the
basis of the loan in determining the gain or loss on
the sale of the loans. Gains are recognized on the
settlement date. Net unrealized losses are recognized
through a valuation allowance by charges to income. Loans Receivable, NetLoans receivable, net
are considered long-term investments and, accordingly,
are carried at amortized cost. Loan origination fees
received, net of certain loan origination costs, are
deferred as an adjustment to the carrying value of the
related loans, and are amortized into income using the
interest method over the estimated life of the loans. Premiums and discounts on loans are amortized into
interest income using the interest method over the
period to contractual maturity, adjusted for estimated
prepayments. The allowance for loan losses is maintained at an
amount considered adequate by management to provide for
probable losses inherent in the loan portfolio as of
the balance sheet dates. The allowance for loan losses
is based on a quarterly analysis of the loan portfolio
by management. In this analysis, management considers
factors including, but not limited to, specific
occurrences which include loan impairment, changes in
the size of the portfolios, general economic
conditions, loan portfolio composition and historical
experience. In connection with the determination of the
allowance for loan losses, management obtains
independent 26




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##### 



appraisals for significant properties. The allowance
for loan losses is established for known problem loans,
as well as for loans which are not currently known to
require specific allowances. Loans are charged off to
the extent they are deemed to be uncollectible. The
adequacy of the allowance for loan losses is dependent
upon managements estimates of variables affecting
valuation, appraisals of collateral, evaluations of
performance and status, and the amounts and timing of
future cash flows expected to be received on impaired
loans. Such estimates, appraisals, evaluations and cash
flows may be subject to frequent adjustments due to
changing economic prospects of borrowers or properties.
The estimates are reviewed periodically and
adjustments, if any, are recorded in the provision for
loan losses in the periods in which the adjustments
become known. Interest income is recognized on an
accrual basis except when collectibility is in doubt.
When loans are placed on a non-accrual basis, generally
when the loan is 90 days past due, previously accrued
but unpaid interest is reversed from income. Interest
is subsequently recognized as income to the extent cash
is received when, in managements judgment, principal
is collectible. All impaired loans are valued at the present value
of expected future cash flows discounted at the loans
initial effective interest rate. The fair value of the
collateral of an impaired collateral-dependent loan or
an observable market price, if one exists, may be used
as an alternative to discounting. If the value of the
impaired loan is less than the recorded investment in
the loan, impairment will be recognized through the
allowance for loan losses. A loan is considered
impaired when, based on current information and events,
it is probable that the Company will be unable to
collect all amounts due according to the contractual
terms of the loan agreement. Impaired loans include all
loans which are delinquent as to principal and interest
for 90 days or greater and all loans that are
restructured in a troubled debt restructuring involving
a modification of terms. All portfolio loans are
reviewed for impairment on an individual basis. Mortgage Servicing RightsMortgage servicing
rights are capitalized and amortized in proportion to,
and over the period of, estimated net servicing income.
The Company evaluates its capitalized mortgage
servicing rights for impairment each quarter. Loan type
and note rate are the predominant risk characteristics
of the underlying loans used to stratify capitalized
mortgage servicing rights for purposes of measuring
impairment. Any impairment is recognized through a
valuation allowance. Real Estate, NetReal estate acquired
through loan foreclosures are initially recorded at the
lower of the related loan balance, less any specific
allowance for loss, or fair value less estimated
selling costs. Valuations are reviewed quarterly by
management and an allowance for losses is established
if the carrying value of a property exceeds its fair
value less estimated selling costs. Premises and EquipmentLand is carried at
cost. Office buildings, improvements, furniture and
equipment are carried at cost less accumulated
depreciation. Depreciation is computed on a straight-line basis
over estimated useful lives of 5 to 40 years for office
buildings and improvements and 3 to 10 years for
furniture and equipment. Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed OfThe Company
reviews long-lived assets and certain identifiable
intangibles for impairment whenever events or changes
in circumstances indicate that the carrying amount of
an asset may not be recoverable. Investment in Limited PartnershipsThe
Company has investments in limited partnerships that
invest in low to moderate income housing projects that
generate tax credits for the Company. The Company
accounts for the earnings or losses from the limited
partnerships on the equity method. Intangible AssetsGoodwill resulting from
acquisitions is not amortized but is tested for
impairment annually in accordance with the requirements
of Statement of Financial Accounting Standards (SFAS)
No. 142, Goodwill and Other Intangible Assets.Deposit
base intangibles are amortized on an accelerated basis
as the deposits run off. The Company reviews the
recoverability of the carrying value of these assets
annually or whenever an event occurs indicating that
they may be impaired. Stock Based CompensationThe Company
accounts for stock based compensation in accordance
with Accounting Principles Board (APB) Opinion No. 25
and related interpretations which measure compensation
cost using the intrinsic value method. See Note 16 for
additional information relating to stock based
compensation. Had compensation cost for the Companys
stock based plan been determined in accordance with the
fair value method recommended by SFAS No. 123, the
Companys net income
and earnings per share would have been adjusted to the
pro forma amounts indicated below: 2004
    
    
    2003
    
    
    2002Net income:As reported
    
    $
    9,289,797
    
    
    
    8,605,247
    
    
    
    5,265,656Deduct: Total stock-based
employee compensation
expense (benefit) determined
under fair value based
method for all awards, net
of related tax effects
    
    
    37,822
    
    
    
    44,935
    
    
    
    42,960Pro forma
    
    $
    9,251,975
    
    
    
    8,560,312
    
    
    
    5,222,696Earnings per common share:As reported:Basic
    
    $
    2.40
    
    
    
    2.26
    
    
    
    1.40Diluted
    
    
    2.31
    
    
    
    2.16
    
    
    
    1.32Pro forma:Basic
    
    
    2.39
    
    
    
    2.25
    
    
    
    1.39Diluted
    
    
    2.30
    
    
    
    2.15
    
    
    
    1.31
 Income TaxesDeferred tax assets and
liabilities are recognized for the future tax
consequences attributable to temporary differences
between the financial statement carrying amounts of
existing assets and liabilities and their respective
tax basis. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to
taxable income in the years in which those temporary
differences are expected to be recovered or settled.
The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the
period that includes the enactment date. 27




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##### 



N O T E S  T O   C O N S O L I D A T E D  F I N A N C I A L   S T A T E M E N T S Earnings per ShareBasic earnings per share (EPS)
excludes dilution and is computed by dividing income
available to common stockholders by the
weighted-average number of common shares outstanding
for the period. Diluted EPS reflects the potential
dilution that could occur if securities or other
contracts to issue common stock were exercised or
converted into common stock or resulted in the issuance
of common stock that shared in the earnings of the
entity. See Note 17 for disclosure of EPS calculations. Comprehensive IncomeComprehensive income is
defined as the change in equity during a period from
transactions and other events from nonowner sources.
Comprehensive income is the total of net income and
other comprehensive income, which for the Company is
comprised of unrealized gains and losses on securities
available for sale and unrealized gains and losses on
hedging valuations qualifying for cash flow hedge
accounting treatment pursuant to SFAS No. 133. Segment InformationThe amount of each
segment item reported is the measure reported to the
chief operating
decision maker for purposes of making decisions about
allocating resources to the segment and assessing its
performance. Adjustments and eliminations made in
preparing an enterprises general-purpose financial
statements and allocations of revenues, expenses and
gains or losses are included in determining reported
segment profit or loss if they are included in the
measure of the segments profit or loss that is used by
the chief operating decision maker. Similarly, only
those assets that are included in the measure of the
segments assets that are used by the chief operating
decision maker are reported for that segment. New Accounting StandardsIn December 2004,
the Financial Accounting Standards Board (FASB) issued
a revised SFAS No. 123, Share-Based Payment.This
Statement is a revision of FASB Statement No. 123,
Accounting for Stock Based Compensationand requires
that the cost resulting from all share-based payment
transactions be recognized in the financial statements.
This Statement is effective for public entities that do
not file as small business issuers as of the beginning
of the first interim or annual reporting period that
begins after June 15, 2005. It requires a public entity
to measure the cost of employee services received in
exchange for an award of equity instruments based on
the grant-date fair value of the award. That cost will
be recognized over the period during which an employee
is required to provide service in exchange for the
award. The Statement also requires that the notes to
financial statements disclose information to assist
users of financial information to understand the nature
of share-based payment transactions and the effects of
those transactions on the
financial statements. The impact of adopting the
revised SFAS No. 123 in the third quarter of 2005 on
the Companys financial condition and results of
operations will not be material. At its March 2004
meeting, the Emerging Issues Task Force revisited EITF
Issue No. 03-1, The Meaning of Other-Than-Temporary
Impairment and its Application to Certain Investments
(EITF No. 03-1). Effective with reporting periods
beginning after June 15, 2004, companies carrying
certain types of debt and equity securities at amounts
higher than the securities fair values would have to
use more detailed criteria to evaluate whether to
record a loss and would have to disclose additional
information about unrealized losses. The FASB has since
issued a statement of financial position deferring the
effective date of the revised EITF No. 03-1 until
further implementation issues may be resolved. The
impact on the Companys financial position and results
of operations cannot be determined until the final
statement is issued. Derivative Financial InstrumentsThe Company
uses derivative financial instruments in order to
manage the interest rate risk on residential loans held
for sale and its commitments to extend credit for
residential loans. The Company may also use interest
rate swaps to manage
interest rate risk. Derivative financial instruments
include commitments to extend credit and forward
mortgage loan sales commitments. See Note 21 for
additional information concerning these derivative
financial instruments. ReclassificationsCertain amounts in the
consolidated financial statements for prior years have
been reclassified to conform with the current year
presentation. NOTE 2 Other Comprehensive Income
The gross unrealized holding losses on securities
for the year ended December 31, 2004 was $1,391,000,
the income tax benefit would have been $491,000 and
therefore, the net unrealized holding loss was
$900,000. The gross reclassification adjustment for the
year ended December 31, 2004 was $535,000, the income
tax benefit would have been $189,000 and therefore, the
net reclassification adjustment was $346,000. The gross
unrealized holding losses on securities for the year
ended December 31, 2003 was $1,241,000, the income tax
benefit would have been $439,000 and therefore, the net
unrealized holding loss was $802,000. The gross
reclassification adjustment for the year ended December
31, 2003 was $1,274,000, the income tax expense would
have been $450,000 and therefore, the net
reclassification adjustment was $824,000. 28




---



##### 



NOTE 3 Securities Available for Sale
A summary of securities available for sale at December 31, 2004 and 2003 is as follows: Gross
    
    
    GrossAmortized
    
    
    unrealized
    
    
    unrealized
    
    
    Faircost
    
    
    gains
    
    
    losses
    
    
    valueDecember 31, 2004:Mortgage-backed securities:FHLMC
    
    $
    242,841
    
    
    
    12,798
    
    
    
    0
    
    
    
    255,639GNMA
    
    
    21,644
    
    
    
    1,157
    
    
    
    0
    
    
    
    22,801Collateralized mortgage obligations:FHLMC
    
    
    3,661,962
    
    
    
    0
    
    
    
    219,947
    
    
    
    3,442,015FNMA
    
    
    5,582,930
    
    
    
    18,589
    
    
    
    171,103
    
    
    
    5,430,4169,509,377
    
    
    
    32,544
    
    
    
    391,050
    
    
    
    9,150,871Other marketable securities:U.S. Government and agency obligations
    
    
    91,371,119
    
    
    
    7,500
    
    
    
    583,335
    
    
    
    90,795,284Corporate debt
    
    
    64,932
    
    
    
    296
    
    
    
    0
    
    
    
    65,228Corporate and agency preferred stock
    
    
    3,661,000
    
    
    
    0
    
    
    
    0
    
    
    
    3,661,00095,097,051
    
    
    
    7,796
    
    
    
    583,335
    
    
    
    94,521,512$
    104,606,428
    
    
    
    40,340
    
    
    
    974,385
    
    
    
    103,672,383December 31, 2003:Mortgage-backed securities:FHLMC
    
    $
    421,818
    
    
    
    19,938
    
    
    
    0
    
    
    
    441,756GNMA
    
    
    31,715
    
    
    
    1,621
    
    
    
    3
    
    
    
    33,333Collateralized mortgage obligations:FHLMC
    
    
    4,697,157
    
    
    
    1,618
    
    
    
    266,403
    
    
    
    4,432,372FNMA
    
    
    8,556,315
    
    
    
    14,262
    
    
    
    429,320
    
    
    
    8,141,25713,707,005
    
    
    
    37,439
    
    
    
    695,726
    
    
    
    13,048,718Other marketable securities:U.S. Government and agency obligations
    
    
    86,658,130
    
    
    
    929,527
    
    
    
    0
    
    
    
    87,587,657Corporate debt
    
    
    177,155
    
    
    
    0
    
    
    
    6,765
    
    
    
    170,390Corporate and agency preferred stock
    
    
    4,200,000
    
    
    
    0
    
    
    
    343,000
    
    
    
    3,857,00091,035,285
    
    
    
    929,527
    
    
    
    349,765
    
    
    
    91,615,047$
    104,742,290
    
    
    
    966,966
    
    
    
    1,045,491
    
    
    
    104,663,765
 Proceeds from securities available for sale
which were sold during 2004 were $15,129,325, resulting
in gross gains of $8,029 and gross losses of $4,217.
The Company also recognized a loss of $539,000
resulting from an other than temporary impairment on a
FHLMC preferred stock investment in 2004. The fair
market value of the FHLMC preferred stock was
$2,961,000 at December 31, 2004. Proceeds from
securities available for sale which were sold during
2003 were $50,372,919, resulting in gross gains of
$1,353,885 and gross losses of $79,348. Proceeds from
securities available for sale which were sold during
2002 were $18,036,553, resulting in gross gains of
$456,946 and gross losses of $34,600. The following
table indicates amortized cost and estimated fair value
of securities available for sale at December 31, 2004
based upon contractual maturity adjusted for scheduled
repayments of principal and projected prepayments of
principal based upon current economic conditions and
interest rates. Actual maturities may differ from the
maturities in the following table because obligors may
have the right to call or prepay obligations with or
without call or prepayment penalties: Amortized
    
    
    Faircost
    
    
    valueDue less than one year
    
    $
    23,420,260
    
    
    
    23,333,181Due after one year through five years
    
    
    74,659,254
    
    
    
    73,944,940Due after five years through ten years
    
    
    2,167,971
    
    
    
    2,072,310Due after ten years
    
    
    697,943
    
    
    
    660,952No stated maturity
    
    
    3,661,000
    
    
    
    3,661,000Total
    
    $
    104,606,428
    
    
    
    103,672,383
 The allocation of mortgage-backed securities
and collateralized mortgage obligations in the table
above is based upon the anticipated future cash flow of
the securities using estimated mortgage prepayment
speeds. The following table shows the gross unrealized
losses and fair values for the securities available for
sale portfolio aggregated by investment category and
length of time that individual securities have been in a
continuous unrealized loss position at December 31,
2004: 29




---



##### 



N O T E S   T
O   C O N S O L I D A T E D   F I N A N C I A L
  S T A T E M E N T S Less than twelve months
    
    
    Twelve months or more
    
    
    Total# of
    
    
    Fair
    
    
    Unrealized
    
    
    # of
    
    
    Fair
    
    
    Unrealized
    
    
    Fair
    
    
    Unrealized(Dollars in thousands)
    
    Investments
    
    
    Value
    
    
    Losses
    
    
    Investments
    
    
    Value
    
    
    Losses
    
    
    Value
    
    
    LossesMortgage backed securities:FHLMC
    
    
    1
    
    
    $
    28
    
    
    
    0
    
    
    
    1
    
    
    $
    3,413
    
    
    
    (220
    )
    
    $
    3,441
    
    
    
    (220
    )FNMA
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    1
    
    
    
    4,142
    
    
    
    (171
    )
    
    
    4,142
    
    
    
    (171
    )Other marketable securities:FNMA Debt
    
    
    3
    
    
    
    14,875
    
    
    
    (74
    )
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    14,875
    
    
    
    (74
    )FHLMC Debt
    
    
    2
    
    
    
    9,907
    
    
    
    (41
    )
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    9,907
    
    
    
    (41
    )FHLB Debt
    
    
    11
    
    
    
    58,006
    
    
    
    (468
    )
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    58,006
    
    
    
    (468
    )Total temporarily impaired
securities
    
    
    17
    
    
    $
    82,816
    
    
    
    (583
    )
    
    
    2
    
    
    $
    7,555
    
    
    
    (391
    )
    
    $
    90,371
    
    
    
    (974
    )
 All of these fixed rate investments are temporarily impaired due to changes in interest rates.
Mortgage backed securities have an average life of less than six years and the other marketable
securities have an average life of less than two years. NOTE 4 Loans Receivable, Net A summary of loans receivable at December 31 is as follows: 2004
    
    
    2003Residential real estate loans:1-4 family conventional
    
    $
    137,953,340
    
    
    
    143,239,9621-4 family conventional  construction
    
    
    37,841,355
    
    
    
    44,581,1961-4 family FHA
    
    
    647,006
    
    
    
    692,6901-4 family VA
    
    
    408,074
    
    
    
    382,107176,849,775
    
    
    
    188,895,9555 or more family
    
    
    41,921,601
    
    
    
    31,540,8045 or more family  construction
    
    
    19,153,847
    
    
    
    23,337,195237,925,223
    
    
    
    243,773,954Commercial real estate:Lodging
    
    
    49,799,669
    
    
    
    39,464,818Retail/office
    
    
    56,183,453
    
    
    
    54,770,096Nursing home/health care
    
    
    7,719,285
    
    
    
    5,545,180Land developments
    
    
    67,506,276
    
    
    
    53,374,516Golf courses
    
    
    29,363,624
    
    
    
    26,938,649Restaurant/bar/café
    
    
    4,013,659
    
    
    
    3,400,084Ethanol plants
    
    
    9,431,878
    
    
    
    0Warehouse
    
    
    8,793,067
    
    
    
    7,577,813Manufacturing
    
    
    5,698,911
    
    
    
    5,950,639Other
    
    
    27,837,119
    
    
    
    29,529,814266,346,941
    
    
    
    226,551,609Other loans:Autos
    
    
    9,496,044
    
    
    
    14,754,042Home equity line
    
    
    67,140,395
    
    
    
    54,192,801Home equity
    
    
    20,032,508
    
    
    
    18,973,890Consumer  secured
    
    
    1,522,682
    
    
    
    1,544,456Commercial business
    
    
    182,368,675
    
    
    
    132,459,066Land/lot loans
    
    
    11,572,361
    
    
    
    10,486,039Savings
    
    
    453,522
    
    
    
    494,227Mobile home
    
    
    2,896,209
    
    
    
    3,665,206Consumer  unsecured
    
    
    1,859,611
    
    
    
    1,794,226Total other loans
    
    
    297,342,007
    
    
    
    238,363,953Total loans
    
    
    801,614,171
    
    
    
    708,689,516Less:Unamortized discounts
    
    
    63,377
    
    
    
    166,364Net deferred loan fees
    
    
    1,781,018
    
    
    
    1,334,284Allowance for losses
    
    
    8,995,892
    
    
    
    6,939,602Loans in process
    
    
    7,560,622
    
    
    
    11,298,147$
    783,213,262
    
    
    
    688,951,119Commitments to originate
or purchase loans
    
    $
    68,751,130
    
    
    
    69,547,706Commitments to deliver loans
to secondary market
    
    $
    6,433,115
    
    
    
    7,077,725Weighted average contractual
interest rate
    
    
    6.26
    %
    
    
    6.20
    %Loans serviced for others
    
    $
    523,635,219
    
    
    
    483,620,394
 Included in total commitments to originate or
purchase loans are fixed rate loans aggregating
$28,140,130 and $20,037,650 as of
December 31, 2004 and 2003, respectively. The interest
rates on these commitments ranged from 4.625% to 7.00%
at December 31, 2004 and from 4.75% to 8.50% at
December 31, 2003. At December 31, 2004, 2003 and 2002, loans on
nonaccrual status totaled $3,710,807, $4,574,950 and
$3,336,046, respectively. Had the loans performed in
accordance with their original terms throughout 2004,
the Company would have recorded gross interest income
of $271,071 for these loans. For the years ended
December 31, 2004, 2003 and 2002, the Company
recognized interest income of $158,767, $163,044 and
$551,542, respectively. At December 31, 2004 and 2003 there were no loans
included in loans receivable, net, with terms that had
been modified in a troubled debt restructuring. There were no material commitments to lend
additional funds to customers whose loans were
classified as restructured or nonaccrual at December
31, 2004. At December 31, 2004, 2003 and 2002, the recorded
investment in loans that are considered to be impaired
was $4,339,450, $4,689,162, and $3,507,418 for which
the related allowance for credit losses was $523,312,
$1,045,495, and $904,840, respectively. The average
investment in impaired loans during 2004, 2003 and 2002
was $3,646,340, $4,801,109 and $3,005,743,
respectively. For the years ended December 31, 2004,
2003 and 2002, the
Company recognized interest income on impaired
loans of $158,767, $163,044 and $551,542, respectively.
All of the interest income that was recognized for
impaired loans was recognized using the cash basis
method of income recognition. The aggregate amounts of loans to executive
officers and directors of the Company was $706,869,
$1,038,119 and $8,861,210 at December 31, 2004, 2003
and 2002, respectively. During 2004 repayments on loans
to executive officers and directors were $579,699, new
loans to executive officers and directors totaled
$517,570, sales of executive officer and director loans
were $240,000, and net loans removed from the executive
officer listing due to change in status of the officer
were $29,121. During 2003 repayments on loans to
executive officers and directors were $7,891,091 and
loans originated aggregated $490,500, and sales
executive officer and director loans totaled $422.500.
All loans were made in the ordinary course of business
on normal credit terms, including interest rates and
collateral, as those prevailing at the time for
comparable transactions with unrelated parties. 30




---



##### 



At December 31, 2004, 2003 and 2002, the Company
was servicing real estate loans for others with
aggregate unpaid principal balances of approximately
$523,635,219, $483,620,394 and $337,490,407,
respectively. The Company originates residential, commercial
real estate and other loans primarily in southern
Minnesota and Iowa. Prior to
2003, the Company also purchased loans from a third
party broker located in the southeastern United States.
At December 31, 2004 and 2003, the Company had in its
portfolio single family and multi-family residential
loans located in the following states: 2004
    
    
    2003Percent
    
    
    
    
    
    
    PercentAmount
    
    
    of Total
    
    
    Amount
    
    
    of TotalAlabama
    
    $
    1,544,742
    
    
    
    0.6
    %
    
    $
    2,084,425
    
    
    
    0.9
    %Arizona
    
    
    2,031,585
    
    
    
    0.9
    
    
    
    1,559,579
    
    
    
    0.6Colorado
    
    
    172,988
    
    
    
    0.1
    
    
    
    1,794,321
    
    
    
    0.7Florida
    
    
    2,204,299
    
    
    
    0.9
    
    
    
    5,206,942
    
    
    
    2.2Georgia
    
    
    5,236,234
    
    
    
    2.2
    
    
    
    7,338,911
    
    
    
    3.0Illinois
    
    
    1,683,487
    
    
    
    0.7
    
    
    
    3,914,175
    
    
    
    1.6Iowa
    
    
    16,944,040
    
    
    
    7.1
    
    
    
    16,106,426
    
    
    
    6.6Massachusetts
    
    
    1,252,635
    
    
    
    0.5
    
    
    
    2,647,058
    
    
    
    1.1Minnesota
    
    
    189,770,503
    
    
    
    79.8
    
    
    
    178,051,169
    
    
    
    73.0North Carolina
    
    
    2,450,469
    
    
    
    1.0
    
    
    
    3,243,818
    
    
    
    1.3South Carolina
    
    
    0
    
    
    
    0.0
    
    
    
    4,335,467
    
    
    
    1.8Texas
    
    
    6,612,676
    
    
    
    2.8
    
    
    
    5,826,905
    
    
    
    2.4Wisconsin
    
    
    4,548,029
    
    
    
    1.9
    
    
    
    4,977,308
    
    
    
    2.0Other states
    
    
    3,473,536
    
    
    
    1.5
    
    
    
    6,687,450
    
    
    
    2.8Total
    
    $
    237,925,223
    
    
    
    100.0
    %
    
    $
    243,773,954
    
    
    
    100.0
    %
 Amounts under one million dollars are included in Other states.  At December 31, 2004 and 2003, the Company had in its portfolio
commercial real estate loans located in the following states: 2004
    
    
    2003Percent
    
    
    
    
    
    
    PercentAmount
    
    
    of Total
    
    
    Amount
    
    
    of TotalArizona
    
    $
    3,346,259
    
    
    
    1.3
    %
    
    $
    12,967,520
    
    
    
    5.7
    %California
    
    
    1,000,000
    
    
    
    0.3
    
    
    
    0
    
    
    
    0.0Colorado
    
    
    1,674,433
    
    
    
    0.6
    
    
    
    3,255,512
    
    
    
    1.4Connecticut
    
    
    0
    
    
    
    0.0
    
    
    
    2,481,462
    
    
    
    1.1Illinois
    
    
    658,800
    
    
    
    0.3
    
    
    
    0
    
    
    
    0.0Indiana
    
    
    660,435
    
    
    
    0.3
    
    
    
    0
    
    
    
    0.0Iowa
    
    
    25,144,085
    
    
    
    9.4
    
    
    
    14,390,247
    
    
    
    6.4Minnesota
    
    
    219,937,723
    
    
    
    82.6
    
    
    
    168,828,643
    
    
    
    74.5Missouri
    
    
    4,376,886
    
    
    
    1.6
    
    
    
    4,447,653
    
    
    
    2.0Montana
    
    
    2,114,048
    
    
    
    0.8
    
    
    
    2,186,326
    
    
    
    1.0Nebraska
    
    
    947,905
    
    
    
    0.4
    
    
    
    947,905
    
    
    
    0.4South Dakota
    
    
    1,603,132
    
    
    
    0.6
    
    
    
    8,499,929
    
    
    
    3.8Texas
    
    
    0
    
    
    
    0.0
    
    
    
    3,459,878
    
    
    
    1.5Utah
    
    
    1,892,340
    
    
    
    0.7
    
    
    
    1,848,385
    
    
    
    0.8Wisconsin
    
    
    2,990,895
    
    
    
    1.1
    
    
    
    3,238,149
    
    
    
    1.4Total
    
    $
    266,346,941
    
    
    
    100.0
    %
    
    $
    226,551,609
    
    
    
    100.0
    %
 NOTE 5 Allowance for Loan Losses The allowance for loan losses is summarized as follows: Balance, December 31, 2001
    
    $
    3,783,112Provision for losses
    
    
    2,376,000Charge-offs
    
    
    (1,369,241
    )Recoveries
    
    
    34,346Balance, December 31, 2002
    
    
    4,824,217Provision for losses
    
    
    2,610,000Charge-offs
    
    
    (550,580
    )Recoveries
    
    
    55,965Balance, December 31, 2003
    
    
    6,939,602Provision for losses
    
    
    2,755,000Charge-offs
    
    
    (737,917
    )Recoveries
    
    
    39,207Balance, December 31, 2004
    
    $
    8,995,892
 NOTE 6 Accrued Interest Receivable Accrued interest receivable at December 31 is summarized as follows: 2004
    
    
    2003Securities available for sale
    
    $
    626,367
    
    
    
    609,913Loans receivable
    
    
    3,067,766
    
    
    
    2,852,308$
    3,694,133
    
    
    
    3,462,221
 NOTE 7 Investment in Mortgage Servicing Rights A summary of mortgage servicing activity is as follows:  2004
    
    
    2003Mortgage servicing rightsBalance, beginning of year
    
    $
    3,447,843
    
    
    
    2,701,031Originations
    
    
    844,806
    
    
    
    2,522,231Amortization
    
    
    (1,061,407
    )
    
    
    (1,775,419
    )Balance, end of year
    
    
    3,231,242
    
    
    
    3,447,843Valuation reserve
Balance, beginning of year
    
    
    0
    
    
    
    (10,000
    )Additions
    
    
    0
    
    
    
    (800,000
    )Reductions
    
    
    0
    
    
    
    810,000Balance, end of year
    
    
    0
    
    
    
    0Mortgage servicing rights, net
    
    $
    3,231,242
    
    
    
    3,447,843
 Mortgage servicing costs, which include guarantee fees on
securitized mortgage loans, were $0 and $216,918,
respectively, in 2004 and 2003. All of the loans being serviced were single family
loans serviced for FNMA under the mortgage-backed
security program or the individual loan sale program.
The following is a summary of the risk characteristics
of the loans being serviced at December 31, 2004: Weighted
    
    
    WeightedLoan
    
    
    Average
    
    
    Average
    
    
    NumberPrincipal
    
    
    Interest
    
    
    Remaining
    
    
    ofBalance
    
    
    Rate
    
    
    Term
    
    
    LoansOriginal term 30 year
fixed rate
    
    $
    213,054,886
    
    
    
    5.92
    %
    
    
    341
    
    
    
    1,876Original term 15 year
fixed rate
    
    
    235,580,973
    
    
    
    5.29
    
    
    
    160
    
    
    
    2,859Adjustable rate
    
    
    8,748,528
    
    
    
    4.97
    
    
    
    337
    
    
    
    77
 31




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##### 



N O T E S   T O
  C O N S O L I D A T E D   F I N A N C I A L
  S T A T E M E N T S NOTE 8 Real Estate A summary of real estate at December 31 is as follows: 2004
    
    
    2003In-substance foreclosures
    
    $
    0
    
    
    
    73,271Real estate in judgment
subject to redemption
    
    
    116,000
    
    
    
    0Real estate acquired through foreclosure
    
    
    24,608
    
    
    
    0140,608
    
    
    
    73,271Allowance for losses
    
    
    0
    
    
    
    0$
    140,608
    
    
    
    73,271
 NOTE 9 Investment in Limited Partnerships Investments in limited partnerships at December 31 were as follows: Primary partnership activity
    
    2004
    
    
    2003Common stock of
financial institutions
    
    $
    0
    
    
    
    421,671Low to moderate
income housing
    
    
    168,258
    
    
    
    195,371$
    168,258
    
    
    
    617,042
 During 2004 the Companys proportionate share
of gains from the common stock investments in financial
institutions was $803 and its proportionate loss on low
income housing was $26,920. During 2004 the Company
received low income housing credits totaling $84,000
which were credited to current income tax benefits. During 2003 the Companys proportionate loss from
the mortgage servicing partnership was $349,577, its
proportionate share of gains from the common stock
investments in financial institutions was $132,273 and
its proportionate loss on low income housing was
$26,000. During 2003 the Company received low income
housing credits totaling $84,000 which were credited to
current income tax benefits. During 2003 the limited partnership that invested
in mortgage servicing rights was dissolved and in 2004
the limited partnership that invested in the common
stock of financial institutions was liquidated. NOTE 10 Intangible Assets The gross carrying amount of intangible assets and the associated accumulated amortization at
December 31, 2004 and 2003 are presented in the following table. Amortization expense for
intangible assets was $1,175,264 and $1,889,276 for the years ended December 31, 2004 and 2003,
respectively. Gross
    
    
    
    
    
    
    UnamortizedCarrying
    
    
    Accumulated
    
    
    IntangibleAmount
    
    
    Amortization
    
    
    AssetsDecember 31, 2004Amortized intangible assets:Mortgage servicing rights
    
    $
    4,555,552
    
    
    
    (1,324,311
    )
    
    
    3,231,242Core deposit intangible
    
    
    1,567,000
    
    
    
    (1,233,383
    )
    
    
    333,617Total
    
    $
    6,122,552
    
    
    
    (2,557,694
    )
    
    
    3,564,859December 31, 2003Amortized intangible assets:Mortgage servicing rights
    
    $
    4,308,468
    
    
    
    (860,625
    )
    
    
    3,447,843Core deposit intangible
    
    
    1,567,000
    
    
    
    (1,119,526
    )
    
    
    447,474Total
    
    $
    5,875,468
    
    
    
    (1,980,151
    )
    
    
    3,895,317
 The following table indicates the estimated future
amortization expense for amortized intangible assets: Mortgage
    
    
    CoreServicing
    
    
    DepositRights
    
    
    Intangible
    
    
    TotalYear ended December 31,2005
    
    $
    421,474
    
    
    
    113,857
    
    
    
    535,3312006
    
    
    353,091
    
    
    
    113,857
    
    
    
    466,9482007
    
    
    305,119
    
    
    
    105,903
    
    
    
    411,0222008
    
    
    260,401
    
    
    
    0
    
    
    
    260,4012009
    
    
    242,354
    
    
    
    0
    
    
    
    242,354
 Projections of amortization are based on existing asset balances and the existing interest
rate environment as of December 31, 2004. The Companys actual experiences may be significantly
different depending upon changes in mortgage interest rates and other market conditions. 32




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##### 



NOTE 11 Premises and Equipment A summary of premises and equipment at December 31 is as follows: 2004
    
    
    2003Land
    
    $
    1,309,519
    
    
    
    1,338,943Office buildings and improvements
    
    
    9,309,207
    
    
    
    9,376,782Furniture and equipment
    
    
    9,904,474
    
    
    
    9,875,74320,523,200
    
    
    
    20,591,468Less accumulated depreciation
    
    
    8,058,935
    
    
    
    8,481,317$
    12,464,265
    
    
    
    12,110,151
 NOTE 12 Deposits Deposits and their weighted average interest rates at December 31 are summarized as follows: 2004
    
    
    2003Weighted
    
    
    
    
    
    
    Percent of
    
    
    Weighted
    
    
    
    
    
    
    Percent ofaverage rate
    
    
    Amount
    
    
    total
    
    
    average rate
    
    
    Amount
    
    
    totalNoninterest checking
    
    
    0.00
    %
    
    $
    42,776,699
    
    
    
    6.1
    %
    
    
    0.00
    %
    
    $
    37,629,054
    
    
    
    6.8
    %NOW accounts
    
    
    1.01
    
    
    
    95,294,144
    
    
    
    13.6
    
    
    
    0.39
    
    
    
    61,270,853
    
    
    
    11.1Savings accounts
    
    
    0.19
    
    
    
    47,415,778
    
    
    
    6.8
    
    
    
    0.20
    
    
    
    35,882,917
    
    
    
    6.5Money market accounts
    
    
    1.72
    
    
    
    129,098,425
    
    
    
    18.5
    
    
    
    1.23
    
    
    
    91,314,858
    
    
    
    16.6314,585,046
    
    
    
    45.0
    
    
    
    
    
    
    
    226,097,682
    
    
    
    41.0Certificates:1-1.99%
    
    
    
    
    
    
    63,716,056
    
    
    
    9.1
    
    
    
    
    
    
    
    57,153,099
    
    
    
    10.42-2.99%
    
    
    
    
    
    
    160,829,030
    
    
    
    23.0
    
    
    
    
    
    
    
    103,449,915
    
    
    
    18.83-3.99%
    
    
    
    
    
    
    108,937,895
    
    
    
    15.6
    
    
    
    
    
    
    
    71,691,188
    
    
    
    13.04-4.99%
    
    
    
    
    
    
    49,449,374
    
    
    
    7.1
    
    
    
    
    
    
    
    76,315,958
    
    
    
    13.85-5.99%
    
    
    
    
    
    
    1,266,218
    
    
    
    0.2
    
    
    
    
    
    
    
    16,621,295
    
    
    
    3.06-6.99%
    
    
    
    
    
    
    4,818
    
    
    
    0.0
    
    
    
    
    
    
    
    246,042
    
    
    
    0.07-7.99%
    
    
    
    
    
    
    113,748
    
    
    
    0.0
    
    
    
    
    
    
    
    112,816
    
    
    
    0.0Total certificates
    
    
    2.86
    
    
    
    384,317,139
    
    
    
    55.0
    
    
    
    3.11
    
    
    
    325,590,313
    
    
    
    59.0Total deposits
    
    
    2.01
    
    
    $
    698,902,185
    
    
    
    100.0
    %
    
    
    2.09
    
    
    $
    551,687,995
    
    
    
    100.0
    %
 At December 31, 2004 and 2003, the Company had $207,354,351 and $117,733,801,
respectively, of deposit accounts with balances at $100,000 or more. At December 31, 2004 and 2003,
the Company had
$128,722,313 and $66,003,390 of certificate accounts, respectively, that were acquired through
a broker. Certificates had the following maturities at December 31: 2004
    
    
    2003Weighted
    
    
    
    
    
    
    WeightedAmount
    
    
    average
    
    
    Amount
    
    
    averageRemaining term to maturity
    
    (in thousands)
    
    
    rate
    
    
    (in thousands)
    
    
    rate1-6 months
    
    $
    110,550
    
    
    
    2.54
    %
    
    $
    97,354
    
    
    
    2.81
    %7-12 months
    
    
    87,099
    
    
    
    2.60
    
    
    
    69,890
    
    
    
    2.7313-36 months
    
    
    150,222
    
    
    
    3.10
    
    
    
    112,265
    
    
    
    3.19Over 36 months
    
    
    36,446
    
    
    
    3.51
    
    
    
    46,081
    
    
    
    3.61$
    384,317
    
    
    
    2.86
    
    
    $
    325,590
    
    
    
    3.11
 At December 31, 2004 mortgage loans and mortgage-backed and related securities with an
amortized cost of approximately $51,156,000 were pledged as collateral for certain deposits and
$4,260,000 of letters of credit from the Federal Home Loan Bank (FHLB) were pledged
as additional collateral on Bank deposits. Interest expense on deposits is summarized as follows for the years ended December 31: 2004
    
    
    2003
    
    
    2002NOW
    
    $
    702,102
    
    
    
    211,736
    
    
    
    181,073Savings Accounts
    
    
    77,293
    
    
    
    90,421
    
    
    
    241,397Money Market
    
    
    645,153
    
    
    
    437,645
    
    
    
    589,406Certificates
    
    
    10,973,957
    
    
    
    9,534,386
    
    
    
    9,937,926$
    12,398,505
    
    
    
    10,274,188
    
    
    
    10,949,802
 33




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##### 



N O T E S   T O
  C O N S O L I D A T E D   F I N A N C I A L
  S T A T E M E N T S NOTE 13 Federal Home Loan Bank Advances Fixed rate Federal Home Loan Bank advances consisted of the following at December 31, 2004 and
2003: 2004
    
    
    2003Year of Maturity
    
    Amount
    
    
    Rate
    
    
    Amount
    
    
    Rate2004
    
    
    
    
    
    
    

    
    
    $
    33,000,000
    
    
    
    5.01
    %2005
    
    $
    10,000,000
    
    
    
    2.69
    %
    
    
    10,000,000
    
    
    
    2.692007
    
    
    40,000,000
    
    
    
    2.91
    
    
    
    40,000,000
    
    
    
    2.912008
    
    
    20,000,000
    
    
    
    3.83
    
    
    
    20,000,000
    
    
    
    3.832010
    
    
    10,000,000
    
    
    
    6.48
    
    
    
    10,000,000
    
    
    
    6.482011
    
    
    10,900,000
    
    
    
    4.81
    
    
    
    10,900,000
    
    
    
    4.812013
    
    
    80,000,000
    
    
    
    4.75
    
    
    
    80,000,000
    
    
    
    4.75170,900,000
    
    
    
    4.20
    
    
    
    203,900,000
    
    
    
    4.33Lines of Credit
    
    
    0
    
    
    
    
    
    
    
    0$
    170,900,000
    
    
    
    4.20
    
    
    $
    203,900,000
    
    
    
    4.33
 Many of the advances listed above have call provisions which
allow the FHLB to request that the advance be paid back or
refinanced at the rates then being offered by the FHLB. As of
December 31, 2004, the Company had advances from the FHLB
with the following call features: Callable QuarterlyYear of Maturity
    
    in Year 20052008
    
    $
    10,000,0002010
    
    
    10,000,0002011
    
    
    10,900,0002013
    
    
    80,000,000$
    110,900,000
 At December 31, 2004 the advances from the FHLB were
collateralized by the Banks FHLB stock and mortgage loans with
unamortized principal balances of $208,195,000. The Bank has the
ability to draw additional borrowings of $33,035,000 based upon
the mortgage loans that are currently pledged subject to a
requirement to purchase FHLB stock. NOTE 14 Other Borrowed Money The Company had a $2,500,000 revolving line of credit established
with a bank that was not drawn at December 31, 2004 or 2003. The
line of credit expires on November 29, 2005. NOTE 15 Income Taxes Income tax expense (benefit) for the years ended December 31 is as follows: 2004
    
    
    2003
    
    
    2002Current:Federal
    
    $
    4,688,700
    
    
    
    4,080,500
    
    
    
    2,223,300State
    
    
    435,600
    
    
    
    498,200
    
    
    
    34,600Total current
    
    
    5,124,300
    
    
    
    4,578,700
    
    
    
    2,257,900Deferred:Federal
    
    
    (683,200
    )
    
    
    (506,200
    )
    
    
    1,400State
    
    
    (54,000
    )
    
    
    (34,700
    )
    
    
    (160,100
    )Total deferred
    
    
    (737,200
    )
    
    
    (540,900
    )
    
    
    (158,700
    )$
    4,387,100
    
    
    
    4,037,800
    
    
    
    2,099,200
 34




---



##### 



The reasons for the difference between expected income tax expense utilizing the
federal corporate tax rate of 34% and the actual income tax expense are as follows: 2004
    
    
    2003
    
    
    2002Federal expected income tax expense
    
    $
    4,651,300
    
    
    
    4,297,600
    
    
    
    2,455,700Items affecting federal income tax:Dividend received deduction
    
    
    (16,200
    )
    
    
    (26,100
    )
    
    
    (145,200
    )Non deductible portion of minority interest loss
    
    
    0
    
    
    
    0
    
    
    
    72,800State income taxes, net of federal income tax benefit
    
    
    247,900
    
    
    
    249,700
    
    
    
    21,700Reduction of tax rate due to employee stock ownership plan dividends
    
    
    (170,200
    )
    
    
    (160,500
    )
    
    
    (149,100
    )Low income housing credits
    
    
    (84,000
    )
    
    
    (84,000
    )
    
    
    (84,000
    )Tax exempt interest
    
    
    (340,300
    )
    
    
    (284,600
    )
    
    
    (107,000
    )Other, net
    
    
    98,600
    
    
    
    45,700
    
    
    
    34,300$
    4,387,100
    
    
    
    4,037,800
    
    
    
    2,099,200
 The tax effects of temporary differences that give rise to the deferred tax assets and deferred tax liabilities are as follows at December 31: 2004
    
    
    2003Deferred tax assets:Allowances for loan and real estate losses
    
    $
    3,144,400
    
    
    
    2,453,000Discounts on assets and liabilities acquired from Marshalltown
Financial Corporation
    
    
    200
    
    
    
    400Deferred compensation and pension costs
    
    
    162,400
    
    
    
    181,500Impairment losses on securities available for sale
    

    
    188,400
    
    
    
    0Net unrealized loss on market value adjustments to securities
available for sale
    
    
    329,600
    
    
    
    27,800Total gross deferred tax assets
    
    
    3,825,000
    
    
    
    2,662,700Valuation allowance
    
    
    0
    
    
    
    0Net deferred tax assets
    
    
    3,825,000
    
    
    
    2,662,700Deferred tax liabilities:Premium on assets acquired from Marshalltown Financial Corporation
    
    
    117,000
    
    
    
    158,100Deferred loan fees and costs
    
    
    452,600
    
    
    
    458,600Premises and equipment basis difference
    
    
    1,078,100
    
    
    
    852,800Originated mortgage servicing rights
    
    
    1,161,100
    
    
    
    1,218,700Other
    
    
    3,500
    
    
    
    800Total gross deferred tax liabilities
    
    
    2,812,300
    
    
    
    2,689,000Net deferred tax assets (liabilities)
    
    $
    1,012,700
    
    
    
    (26,300
    )
 Retained earnings at December 31, 2004 included approximately $8,800,000 for which no
provision for income taxes was made. This amount represents allocations of income to bad deductions
for tax purposes. Reduction of amounts so allocated for purposes other than absorbing losses will
create income for tax purposes, which will be subject to the then-current corporate income tax
rate. The Company has, in its judgement, made reasonable assumptions relating to the realization of
deferred tax assets. Based upon these assumptions, the Company has determined that no valuation
allowance is required with respect to the deferred tax assets. 35




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##### 



N O T E S    T O    C O N S O L I D A T E D    F I N A N C I A L    S T A T E M E N T S NOTE 16 Employee Benefits Prior to 2002, all eligible full-time employees of the Bank were included in a noncontributory
retirement plan sponsored by the
Financial Institutions Retirement Fund (FIRF). Effective September
1, 2002 the Bank froze the accrual of benefits for existing participants and no new enrollments are
permitted into the plan. The actuarial present value of accumulated plan benefits and net assets
available for benefits relating to the Banks employees is not available at December
31, 2004 because such information is not accumulated for each participating institution. As of June
30, 2004, the FIRF valuation report reflected that the Bank was obligated to make a contribution
for the plan year ending June 30, 2004 totaling $83,355. The contribution was $36,014 in 2003 and
$20,575 in 2002. The Company has a qualified, tax-exempt savings plan with a deferred feature qualifying under
Section 401(k) of the Internal
Revenue Code (the 401(k) Plan). All employees who have attained 18 years of age are eligible to
participate in the Plan. Participants are permitted to make contributions to the 401(k) Plan equal
to the lesser of 50% of the participants annual salary or the maximum allowed by law, which was
$13,000 for 2004. The Company matches 25% of each participants contributions up to a maximum of 8%
of the participants annual salary. Employee contributions above 8% are not matched by the Company.
Participant contributions and earnings are fully and immediately vested. The Companys
contributions made prior to January 1, 2002 are vested on a five year cliff basis and contributions
made after December 31, 2001 are vested on a three year cliff basis. The Companys matching
contributions to the 401(k) plan are expensed when made and they totaled $118,665, $113,843, and
$76,005 in 2004, 2003 and 2002, respectively. The Company has adopted an Employee Stock Ownership Plan (the ESOP) that meets the
requirements of Section (e)(7) of the Internal Revenue Code and Section 407(d)(6) of the Employee
Retirement Income Security Act of 1974, as amended (ERISA) and, as such the ESOP is empowered to
borrow in order to finance purchases of the common stock of HMN. The ESOP borrowed $6,085,770 from
the Company to purchase 912,866 shares of common stock in the initial public offering of HMN. As a
result of a merger with Marshalltown Financial Corporation (MFC), the ESOP borrowed $1,476,000 to
purchase 76,933 shares of HMN common stock to provide the employees from MFC with an ESOP benefit.
The ESOP debt requires quarterly payments of principal plus interest at 7.52%. The Company has
committed to make quarterly contributions to the ESOP necessary to repay the loan including
interest. The Company contributed $526,552 in 2004 and $525,224 for both of the years 2003 and
2002. As the debt is repaid, ESOP shares that were pledged as collateral for the debt are committed
to be released from collateral and allocated to active employees, based on the proportion of debt
service paid in the year. The Company accounts for its ESOP in accordance with Statement of
Position 93-6, Employers Accounting for Employee Stock Ownership Plans.Accordingly, the shares
pledged as collateral are reported as unearned ESOP shares in stockholders equity. As shares are
determined to be ratably released from collateral, the Company reports compensation expense equal
to the current market price of the shares, and the shares become outstanding for earnings per share
computations. ESOP compensation benefit expense was $670,112, $472,108 and $418,700 respectively,
for 2004, 2003 and 2002. All employees of the Bank are eligible to participate in the ESOP after they attain age 21 and
complete one year of service during which they worked at least 1,000 hours. A summary of the ESOP
share allocation is as follows for the years ended: 2004
    
    
    2003
    
    
    2002Shares allocated to participants
beginning of the year
    
    
    275,588
    
    
    
    245,031
    
    
    
    233,697Shares allocated to participants
    
    
    24,380
    
    
    
    24,317
    
    
    
    24,317Shares purchased with dividends
from allocated shares
    
    
    7,368
    
    
    
    10,638
    
    
    
    8,485Shares distributed to participants
    
    
    (36,452
    )
    
    
    (4,398
    )
    
    
    (21,468
    )Shares allocated to participants
end of year
    
    
    270,884
    
    
    
    275,588
    
    
    
    245,031Unreleased shares beginning
of the year
    
    
    596,113
    
    
    
    620,430
    
    
    
    644,747Shares released during year
    
    
    (24,380
    )
    
    
    (24,317
    )
    
    
    (24,317
    )Unreleased shares end of year
    
    
    571,733
    
    
    
    596,113
    
    
    
    620,430Total ESOP shares end of year
    
    
    842,617
    
    
    
    871,701
    
    
    
    865,461Fair value of unreleased
shares at December 31
    
    $
    18,861,472
    
    
    
    14,479,585
    
    
    
    10,435,633
 In June 1995, the Company adopted the 1995 Stock Option and Incentive Plan (1995 Plan).
In April of 2002, options for 15,000 shares were granted to a director at an exercise price of
$16.25. All options issued under this plan vest over a five year period and expire 10 years from
the grant date. The 1995 Plan terminates on April 25, 2005, and no more options may be granted from
the plan after that date. Outstanding options granted prior to the termination date may be
exercised for ten years after their date of grant. In March 2001, the Company adopted the HMN Financial, Inc. 2001 Omnibus Stock Plan (2001
Plan). The purpose of the 2001 Plan is to promote the interests of the Company and its stockholders
by providing key personnel with an opportunity to acquire a proprietary interest in the Company and
reward them for achieving a high level of corporate performance and thereby develop a stronger
incentive to put forth maximum effort for the success and growth of the Company. The total number
of shares of HMN common stock available for distribution under the 2001 Plan in either restricted
stock or stock options was 400,000 subject to adjustment for future stock splits, stock dividends
and similar changes to the capitalization of the Company. In April 2002, the Company awarded
212,410 options at $16.13 per share which vest beginning in April of 2008 through April of 2012. In
February of 2004, options for 5,000 shares of common stock were granted to an officer at an
exercise price of $27.64. These options vest beginning in February of 2005 through February of
2008. In March of 2004, options for 20,000 shares of common stock were issued to certain officers
at an exercise price of $27.66. These options vest beginning in March of 2005 through March of
2007. In July of 2004 options for 15,000 shares of common stock were issued to a director at an
exercise price of $26.98. These options vest beginning in July of 2005 through July of 2009. 36




---



##### 



The fair value of the options granted under the 1995 Plan were $1.85 for 2002. The fair value
of options granted under the 2001
Plan were $2.62, $2.10, $2.10, and $1.43 for July 2004, March
2004, February 2004, and 2002, respectively. A summary of activities under both plans for the past
three years are as follows: Options
    
    
    
    
    
    
    Weightedavailable for
    
    
    Options
    
    
    averagegrant
    
    
    outstanding
    
    
    exercise price1995 Stock Option and Incentive PlanDecember 31, 2001
    
    
    24,397
    
    
    
    502,119
    
    
    
    9.765Exercised
    
    
    
    
    
    
    (109,871
    )
    
    
    9.211Granted April 23, 2002
    
    
    (15,000
    )
    
    
    15,000
    
    
    
    16.250December 31, 2002
    
    
    9,397
    
    
    
    407,248
    
    
    
    10.154Exercised
    
    
    
    
    
    
    (228,493
    )
    
    
    9.211December 31, 2003
    
    
    9,397
    
    
    
    178,755
    
    
    
    11.358Exercised
    
    
    
    
    
    
    (43,814
    )
    
    
    9.471December 31, 2004
    
    
    9,397
    
    
    
    134,941
    
    
    
    11.9712001 Omnibus Stock PlanDecember 31, 2001
    

    
    400,000Granted April 16, 2002
    
    
    (212,410
    )
    
    
    212,410
    
    
    
    16.130December 31, 2002
    
    
    187,590
    
    
    
    212,410
    
    
    
    16.130Forfeited
    
    
    16,447
    
    
    
    (16,447
    )
    
    
    16.130December 31, 2003
    
    
    204,037
    
    
    
    195,963
    
    
    
    16.130Granted February 13, 2004
    
    
    (5,000
    )
    
    
    5,000
    
    
    
    27.640Granted March 3, 2004
    
    
    (20,000
    )
    
    
    20,000
    
    
    
    27.660Granted July 27, 2004
    
    
    (15,000
    )
    
    
    15,000
    
    
    
    26.980Forfeited
    
    
    17,618
    
    
    
    (17,618
    )
    
    
    19.049December 31, 2004
    
    
    181,655
    
    
    
    218,345
    
    
    
    17.960Total both plans
    
    
    191,052
    
    
    
    353,286
    
    
    
    15.672
 The following table summarizes information
about stock options outstanding at December 31, 2004: Options Outstanding
    
    
    Options ExercisableWeighted averageExercise
    
    
    Number
    
    remaining contractualprice
    
    
    outstanding
    
    life in years
    
    Number
    
    Price$
    9.211
    
    
    
    9,941
    
    
    
    0.4
    
    
    
    9,941
    
    
    $
    9.21113.007
    
    
    
    15,000
    
    
    
    2.3
    
    
    
    15,000
    
    
    
    13.00711.500
    
    
    
    65,000
    
    
    
    4.3
    
    
    
    65,000
    
    
    
    11.50011.250
    
    
    
    30,000
    
    
    
    5.4
    
    
    
    24,000
    
    
    
    11.25016.250
    
    
    
    15,000
    
    
    
    7.4
    
    
    
    6,000
    
    
    
    16.25016.130
    
    
    
    182,805
    
    
    
    7.3
    
    
    
    0
    
    
    
    16.13027.640
    
    
    
    5,000
    
    
    
    9.2
    
    
    
    0
    
    
    
    27.64027.660
    
    
    
    15,540
    
    
    
    9.2
    
    
    
    0
    
    
    
    27.66026.980
    
    
    
    15,000
    
    
    
    9.6
    
    
    
    0
    
    
    
    26.980353,286
    
    
    
    
    
    
    
    119,941
 The Company uses the intrinsic value method as described in
APB Opinion No. 25 and related interpretations to
account for its stock incentive plans. Accordingly, no
compensation cost has been recognized for the option
plans. Proceeds from stock options exercised are
credited to common stock and additional paid-in
capital. There are no charges or credits to expense
with respect to the granting or exercise of options
since the options were issued at fair value on the
respective grant dates. Had compensation cost for the
Companys stock-based plan been determined in
accordance with the fair value method recommended by
SFAS No. 123, the
Companys net income and earnings per share would have
been adjusted to the pro forma amounts indicated below: 2004
    
    
    2003
    
    
    2002Net income:As reported
    
    $
    9,289,797
    
    
    
    8,605,247
    
    
    
    5,265,656Deduct: total stock-based
employee compensation
expense determined
under fair value based
method for all awards, net
of related tax effects
    
    
    37,822
    
    
    
    44,935
    
    
    
    42,960Pro forma
    
    $
    9,251,975
    
    
    
    8,560,312
    
    
    
    5,222,696Earnings per common share:As reported:Basic
    
    $
    2.40
    
    
    
    2.26
    
    
    
    1.40Diluted
    
    
    2.31
    
    
    
    2.16
    
    
    
    1.32Pro forma:Basic
    
    
    2.39
    
    
    
    2.25
    
    
    
    1.39Diluted
    
    
    2.30
    
    
    
    2.15
    
    
    
    1.31
 The preceding disclosed pro forma effects of
applying SFAS No. 123 to compensation costs may not be
representative of the effects on reported pro forma net
income for future years. The fair value for each option grant is estimated on the date of
the grant using the Option Designer Model. The model
incorporated the following assumptions for each year of grant: 2004
    
    
    2002Risk-free interest rate
    
    
    4.13
    %
    
    
    5.20
    %Expected life
    
    9 years
    
    9 yearsExpected volatility
    
    
    10.63
    %
    
    
    13.00
    %Expected dividends
    
    
    3.9
    %
    
    
    4.5
    %
 37




---



##### 



N O T E S    T O    C O N S O L I D A T E D    F I N A N C I A L    S T A T E M E N T S NOTE 17 Earnings per Share The following table reconciles the weighted
average shares outstanding and the income available to
common shareholders used for basic and diluted EPS: Year Ended December 31,2004
    
    
    2003
    
    
    2002Weighted average number of
common shares outstanding
used in basic earnings per
common share calculation
    
    
    3,868,223
    
    
    
    3,812,213
    
    
    
    3,767,216Net dilutive effect of:Options
    
    
    159,442
    
    
    
    169,171
    
    
    
    217,576Restricted stock awards
    
    
    0
    
    
    
    0
    
    
    
    36Weighted average number of
shares outstanding adjusted for
effect of dilutive securities
    
    
    4,027,665
    
    
    
    3,981,384
    
    
    
    3,984,828Income available to common
shareholders
    
    $
    9,289,797
    
    
    
    8,605,247
    
    
    
    5,265,656Basic earnings per
common share
    
    $
    2.40
    
    
    
    2.26
    
    
    
    1.40Diluted earnings per
common share
    
    $
    2.31
    
    
    
    2.16
    
    
    
    1.32
 NOTE 18 Stockholders Equity The Company repurchased 123,000 shares of its
common stock in the open market during 2004, 86,600
during 2003, and 92,300 shares during 2002 for
$3,316,550, $1,384,560 and $1,496,111, respectively.
The shares were placed in treasury stock. HMN declared and paid dividends as follows: Dividend
    
    
    DividendRecord date
    
    Payable date
    
    per share
    
    
    Payout RatioFebruary 21, 2002
    
    March 7, 2002
    
    $
    0.14
    
    
    
    100.00
    %May 23, 2002
    
    June 10, 2002
    
    $
    0.18
    
    
    
    36.00
    %August 27, 2002
    
    September 10, 2002
    
    $
    0.18
    
    
    
    56.25
    %November 22, 2002
    
    December 11, 2002
    
    $
    0.18
    
    
    
    81.82
    %February 21, 2003
    
    March 7, 2003
    
    $
    0.18
    
    
    
    64.29
    %May 22, 2003
    
    June 9, 2003
    
    $
    0.18
    
    
    
    50.00
    %August 28, 2003
    
    September 11, 2003
    
    $
    0.20
    
    
    
    38.46
    %November 28, 2003
    
    December 17, 2003
    
    $
    0.20
    
    
    
    26.32
    %February 20, 2004
    
    March 8, 2004
    
    $
    0.20
    
    
    
    37.74
    %May 21, 2004
    
    June 8, 2004
    
    $
    0.20
    
    
    
    38.46
    %August 27, 2004
    
    September 10, 2004
    
    $
    0.22
    
    
    
    35.48
    %November 26, 2004
    
    December 15, 2004
    
    $
    0.22
    
    
    
    34.38
    %
 On January 25, 2005 the Company declared a
cash dividend of $0.22 per share payable on March 7,
2005, to stockholders of record on February 18, 2005.
The annualized dividend payout ratios for 2004, 2003,
and 2002 were 36.36%, 39.58%, and 57.63%, respectively. The Companys certificate of incorporation
authorizes the issuance of up to 500,000 shares of
preferred stock, but to date no shares have been
issued. In order to grant a priority to eligible
accountholders in the event of future liquidation, the
Bank, at the time of conversion established a
liquidation account equal to its regulatory capital as
of
September 30, 1993. In the event of future liquidation
of the Bank, an eligible accountholder who continues to
maintain their deposit account shall be entitled to
receive a distribution from the liquidation account.
The total amount of the liquidation account will be
decreased as the balance of eligible accountholders are
reduced subsequent to the conversion, based on an
annual determination of such balance. The Bank may not declare or pay a cash dividend to the
Company without filing a capital distribution application with the
OTS if the total amount of the dividends for the year exceeds the
Banks net income for the year plus the Banks retained
net income for the preceding two years. Additional
limitations on dividends declared or paid on, or
repurchases of, the Banks capital stock are tied to
the Banks level of compliance with its regulatory
capital requirements. NOTE 19 Federal Home Loan Bank Investment and
Regulatory Capital Requirements The Bank, as a member of the Federal Home Loan
Bank System, is required to hold a specified number of
shares of capital stock, which is carried at cost, in
the Federal Home Loan Bank of Des Moines. The Bank has
met the requirements as of December 31, 2004. The Bank is subject to various regulatory capital
requirements administered by the federal banking
agencies. Failure to meet minimum capital requirements
can initiate certain mandatory and possibly additional
discretionary actions by regulators that, if
undertaken, could have a direct material effect on the
Companys financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt
corrective action, the Bank must meet specific capital
guidelines that involve quantitative measures of the
Banks assets, liabilities, and certain off-balance
sheet items as calculated under regulatory accounting
practices. The Banks capital amounts and
classification are also subject to qualitative
judgments by the regulators about components, risk
weightings, and other factors. Quantitative measures established by regulations
to ensure capital adequacy require the Bank to maintain
minimum amounts and ratios (set forth in the following
table) of Tier I or Core capital, and Risk-based
capital (as defined in the regulations) to total assets
(as defined). Management believes, as of December 31,
2004 and 2003, that the Bank meets all capital adequacy
requirements to which it is subject. Management believes that based upon the Banks
capital calculations at December 31, 2004 and 2003 and
other conditions consistent with the Prompt Corrective
Actions Provisions of the OTS regulations, the Bank
would be categorized as well capitalized. 38




---



##### 



At December 31, 2004 and 2003 the Banks capital amounts and ratios are also presented for
actual capital, required capital, and excess capital including amounts and ratios in order to
qualify as being well capitalized under the Prompt Corrective Actions regulations: To Be Well CapitalizedRequired to
    
    
    
    
    
    
    
    
    
    
    Under Promptbe Adequately
    
    
    
    
    
    
    
    
    
    
    Corrective ActionsActual
    
    
    Capitalized
    
    
    Excess Capital
    
    
    ProvisionsPercent of
    
    
    
    
    
    
    Percent of
    
    
    
    
    
    
    Percent of
    
    
    
    
    
    
    Percent of(in thousands)
    
    Amount
    
    
    Assets(1)
    
    
    Amount
    
    
    Assets(1)
    
    
    Amount
    
    
    Assets(1)
    
    
    Amount
    
    
    Assets(1)December 31, 2004Tier I or core capital
    
    $
    74,131
    
    
    
    7.77
    %
    
    $
    38,150
    
    
    
    4.00
    %
    
    $
    35,981
    
    
    
    3.77
    %
    
    $
    47,687
    
    
    
    5.00
    %Tier I risk based capital
    
    $
    74,131
    
    
    
    9.45
    %
    
    $
    31,373
    
    
    
    4.00
    %
    
    $
    42,758
    
    
    
    5.45
    %
    
    $
    47,059
    
    
    
    6.00
    %Risk-based capital to
risk-weighted assets
    
    $
    82,274
    
    
    
    10.49
    %
    
    $
    62,746
    
    
    
    8.00
    %
    
    $
    19,528
    
    
    
    2.49
    %
    
    $
    78,432
    
    
    
    10.00
    %December 31, 2003Tier I or core capital
    
    $
    69,030
    
    
    
    8.03
    %
    
    $
    34,366
    
    
    
    4.00
    %
    
    $
    34,664
    
    
    
    4.03
    %
    
    $
    42,957
    
    
    
    5.00
    %Tier I risk based capital
    
    $
    69,030
    
    
    
    10.19
    %
    
    $
    27,088
    
    
    
    4.00
    %
    
    $
    41,942
    
    
    
    6.19
    %
    
    $
    40,633
    
    
    
    6.00
    %Risk-based capital to
risk-weighted assets
    
    $
    74,931
    
    
    
    11.06
    %
    
    $
    54,177
    
    
    
    8.00
    %
    
    $
    20,754
    
    
    
    3.06
    %
    
    $
    67,721
    
    
    
    10.00
    %
   (1)
    
    Based upon the Banks adjusted total assets for the purpose of the Tier I or core
capital ratios and risk-weighted assets for the purpose of the risk-based capital ratio. NOTE 20 Financial Instruments with Off-Balance Sheet Risk The Company is a party to financial instruments
with off-balance sheet risk in the normal course of
business to meet the financing needs of its customers.
These financial instruments include commitments to
extend credit. These instruments involve, to varying
degrees, elements of credit and interest rate risk in
excess of the amounts recognized in the balance sheet.
The contract amounts of these instruments reflect the
extent of involvement by the Company. The Companys exposure to credit loss in the event
of nonperformance by the other party to the financial
instrument for commitments to extend credit is
represented by the contract amount of these
commitments. The Company uses the same credit policies
in making commitments as it does for on-balance sheet
instruments. December 31,Contract amount(in thousands)
    
    2004
    
    
    
    2003Financial instruments whose contract amount
represents credit risk:Commitments to originate, fund or purchase loans:1-4 family mortgages
    
    $
    3,723
    
    
    
    3,753Multi-family mortgages
    
    
    12,000
    
    
    
    3,225Commercial real estate mortgages
    
    
    26,593
    
    
    
    6,220Non-mortgage loans
    
    
    26,435
    
    
    
    56,350Undisbursed balance of loans closed
    
    
    100,772
    
    
    
    99,108Unused lines of credit
    
    
    78,930
    
    
    
    69,635Letters of credit
    

    
    7,025
    
    
    
    2,027Total commitments to extend credit
    
    $
    255,478
    
    
    
    240,318Commitment of counter party to
purchase loans
    
    $
    6,433
    
    
    
    7,078
 Commitments to extend credit are agreements
to lend to a customer as long as there is no violation
of any condition established in the contract.
Commitments generally have fixed expiration dates or
other termination clauses and may require payment of a
fee. Since a portion of the commitments are expected to
expire without being drawn upon, the total commitment
amounts do not necessarily represent future cash
requirements. The Bank evaluates each customers
creditworthiness on a case-by-case basis. The amount of
collateral obtained, if deemed necessary by the Bank
upon extension of credit, is based on the loan type and
on managements credit evaluation of the borrower.
Collateral consists primarily of residential and
commercial real estate and personal property. Commitments of a counter party to purchase loans
represents commitments to sell loans to FNMA and are
entered into in the normal course of business by the
Bank. The Bank entered into two guaranty agreements with
third parties in order for Home Federal Mortgage
Services, LLC (HFMS) to secure loan purchase
agreements. Under the agreements, the Bank guaranteed
to satisfy and discharge all obligations of HFMS
arising from transactions entered into between HFMS and
the third parties if HFMS failed to fulfill its
obligations. The agreements are in effect until the
obligations of HFMS are fully satisfied and the Banks
guaranty is limited to a combined maximum of $3
million. No liability has been recorded in the
consolidated financial statements of the Company for
these guarantees and the Company is not aware of any
outstanding obligations of HFMS to either of the third
parties with whom a guarantee exists. HFMS ceased doing
business with both third parties in 2002. There is the
possibility that the Bank would be required to purchase
loans that were previously sold to the third parties by
HFMS prior to 2002 if the loans did not meet the
requirements in the loan purchase 39




---



##### 



N O T E S  T O  C O N S O L I D A T E D  F I N A N C I A L  S T A T E M E N T S agreements. If this were to occur, the proceeds
from the subsequent sale of these loans would enable
the Bank to recover a portion of the amounts paid under
the guaranty. The Bank issued standby letters of credit which
guarantee the performance of customers to third
parties. The standby letters of credit outstanding at
December 31, 2004 expire over the next 30 months and
totaled $1.6 million at December 31, 2004 and $2.5
million at December 31, 2003. The letters of credit
were collateralized primarily with commercial real
estate mortgages.
Since the conditions under which the Bank is required
to fund the standby letters of credit may not
materialize, the cash requirements are expected to be
less than the total outstanding commitments. NOTE 21 Derivative Instruments and Hedging Activities The Company originates and purchases single family
residential loans for sale into the secondary market
and enters into commitments to sell or securitize those
loans in order to mitigate the interest rate risk
associated with holding the loans until they are sold.
The Company adopted SFAS No. 133, Accounting for
Derivative Instruments and Hedging Activities, in the
first quarter of 2001. At the beginning of the second
quarter of 2001, certain commitments to sell loans held
for sale were designated as a cash flow hedge of a
forecasted transaction and were accounted for in
accordance with SFAS No. 133 with no ineffectiveness
recognized in the income statement. In the second
quarter of 2002 cash flow hedge accounting was
discontinued because the Company ceased delivering
loans under a mortgage backed security program. The
mortgage banking operations in the Brooklyn Park
location were eliminated in 2002 and some of the
activity was moved to other branches within the
Company. The Company has commitments outstanding to extend
credit to future borrowers that had not closed prior to
the end of the quarter, which is referred to as its
mortgage pipeline. As commitments to originate loans
enter the mortgage pipeline, the Company generally
enters into commitments to sell the loans into the
secondary market. The commitments to originate and sell
loans are derivatives that are recorded at market
value. As a result of marking these derivatives to
market for the period ended December 31, 2004 the
Company recorded a decrease in other assets of $13,435,
a decrease in other liabilities of $12,244, and a net
gain on the sale of loans of $1,191. As of December 31, 2004 the commitments to sell
loans held for sale are derivatives that do not qualify
for hedge accounting. As a result, these derivatives
are marked to market. The loans held for sale that are
not hedged are recorded at the lower of cost or market.
As a result of marking these loans, the Company
recorded a decrease in loans held for sale of $8,582,
an increase in other assets of $9,882, and a net
increase in other liabilities of $1,300 NOTE 22 Fair Value of Financial Instruments SFAS No. 107, Disclosures about Fair Values of
Financial Instruments,requires disclosure of estimated
fair values of the Companys financial instruments,
including assets, liabilities and off-balance sheet
items for which it is practicable to estimate fair
value. The fair value estimates are made as of December
31, 2004 and 2003 based upon relevant market
information, if available, and upon the characteristics
of the financial instruments themselves. Because no
market exists for a significant portion of the
Companys financial instruments, fair value estimates
are based upon judgments regarding future expected loss
experience, current economic conditions, risk
characteristics of various financial instruments, and
other factors. The estimates are subjective in nature
and involve uncertainties and matters of significant
judgment and therefore cannot be determined with
precision. Changes in assumptions could significantly
affect the estimates. Fair value estimates are based only on existing
financial instruments without attempting to estimate
the value of anticipated future business or the value
of assets and liabilities that are not considered
financial instruments. In addition, the tax
ramifications related to the realization of the
unrealized gains and losses can have a significant
effect on the fair value estimates and have not been
considered in any of the estimates. The estimated fair value of the Companys
financial instruments are shown below. Following the
table, there is an explanation of the methods and
assumptions used to estimate the fair value of each
class of financial instruments. 40




---



##### 



December 31,2004
    
    
    2003Carrying
    
    
    Estimated
    
    
    Contract
    
    
    Carrying
    
    
    Estimated
    
    
    Contract(in thousands)
    
    amount
    
    
    fair value
    
    
    amount
    
    
    amount
    
    
    fair value
    
    
    amountFinancial assets:Cash and cash equivalents .
    
    $
    34,298
    
    
    
    34,298
    
    
    
    
    
    
    
    30,497
    
    
    
    30,497Securities available for
sale
    
    
    103,672
    
    
    
    103,672
    
    
    
    
    
    
    
    104,664
    
    
    
    104,664Loans held for sale
    
    
    2,712
    
    
    
    2,712
    
    
    
    
    
    
    
    6,543
    
    
    
    6,560Loans receivable, net
    
    
    783,213
    
    
    
    785,533
    
    
    
    
    
    
    
    688,951
    
    
    
    695,454Federal Home Loan Bank stock
    
    
    9,293
    
    
    
    9,293
    
    
    
    
    
    
    
    10,004
    
    
    
    10,004Accrued interest
receivable
    
    
    3,694
    
    
    
    3,694
    
    
    
    
    
    
    
    3,462
    
    
    
    3,462Financial liabilities:Deposits
    
    
    698,902
    
    
    
    672,757
    
    
    
    
    
    
    
    551,688
    
    
    
    554,936Federal Home Loan Bank advances
    
    
    170,900
    
    
    
    175,973
    
    
    
    
    
    
    
    203,900
    
    
    
    213,256Accrued interest payable
    
    
    1,314
    
    
    
    1,314
    
    
    
    
    
    
    
    767
    
    
    
    767Off-balance sheet financial instruments:Commitments to extend credit
    
    
    13
    
    
    
    13
    
    
    
    213,846
    
    
    
    16
    
    
    
    16
    
    
    
    238,291Commitments to sell loans
    
    
    (3
    )
    
    
    (3
    )
    
    
    6,433
    
    
    
    (14
    )
    
    
    (14
    )
    
    
    7,078
 Cash and Cash EquivalentsThe carrying
amount of cash and cash equivalents approximates their
fair value. Securities Available for SaleThe fair
values of securities were based upon quoted market
prices. Loans Held for SaleThe fair values of loans
held for sale were based upon quoted market prices for
loans with similar interest rates and terms to
maturity. Loans ReceivableThe fair values of loans
receivable were estimated for groups of loans with
similar characteristics. The fair value of the loan
portfolio, with the exception of the adjustable rate
portfolio, was calculated by discounting the scheduled
cash flows through the estimated maturity using
anticipated prepayment speeds and using discount rates
that reflect the credit and interest rate risk inherent
in each loan portfolio. The fair value of the
adjustable loan portfolio was estimated by grouping the
loans with similar characteristics and comparing the
characteristics of each group to the prices quoted for
similar types of loans in the secondary market. Federal Home Loan Bank StockThe carrying
amount of FHLB stock approximates its fair value. Accrued Interest ReceivableThe carrying
amount of accrued interest receivable approximates its
fair value since it is short-term in nature and does
not present unanticipated credit concerns. DepositsUnder SFAS No. 107, the fair value
of deposits with no stated maturity such as checking,
savings and money market accounts, is equal to the
amount payable on demand. The fair value
of certificates of deposit is based on the discounted value of
contractual cash flows using as discount rates the rates that were
offered by the Company as of December 31, 2004 and 2003 for
deposits with maturities similar to the remaining maturities of the
existing certificates of deposit. The fair value estimate for deposits does not include the benefit
that results from the low cost funding provided by the Companys
existing deposits and long-term customer relationships compared to
the cost of obtaining different sources of funding. This benefit is
commonly referred to as the core deposit intangible. Federal Home Loan Bank AdvancesThe fair values of advances with
fixed maturities are estimated based on discounted cash flow analysis
using as discount rates the interest rates charged by the FHLB at
December 31, 2004 and 2003 for borrowings of similar remaining
maturities. Accrued Interest PayableThe carrying amount of accrued interest payable approximates its fair value since it is short-term in nature. Commitments to Extend CreditThe fair values of commitments to
extend credit for 2004 and 2003 are estimated using the fees
normally charged to enter into similar agreements, taking into
account the remaining terms of the agreements and the present
creditworthiness of the counter parties. Commitments to Sell LoansThe fair values of commitments to sell
loans for 2004 and 2003 are estimated using the quoted market
prices for loans with similar interest rates and terms to maturity. 41




---



##### 



N O T E S  T O  C O N S O L I D A T E D  F I N A N C I A L  S T A T E M E N T S NOTE 23 HMN Financial, Inc. Financial Information (Parent Company Only) The following are the condensed financial statements for the parent company only as of
December 31, 2004 and 2003 and for the years ended
December 31, 2004, 2003 and 2002. 2004
    
    
    2003
    
    
    2002Condensed Balance SheetsAssets:Cash and cash equivalents
    
    $
    5,608,727
    
    
    
    5,929,858Loans receivable, net
    
    
    0
    
    
    
    110,000Investment in subsidiaries
    
    
    78,236,806
    
    
    
    73,337,245Investment in limited partnerships
    
    
    0
    
    
    
    421,671Accrued interest receivable
    
    
    8,462
    
    
    
    5,620Prepaid expenses and other assets
    
    
    320,787
    
    
    
    1,318,313Deferred tax asset
    
    
    162,000
    
    
    
    33,600Total assets
    
    $
    84,336,782
    
    
    
    81,156,307Liabilities and Stockholders EquityAccrued expenses and other liabilities
    
    $
    565,946
    
    
    
    225,250Total liabilities
    
    
    565,946
    
    
    
    225,250Serial preferred stock
    
    
    0
    
    
    
    0Common stock
    
    
    91,287
    
    
    
    91,287Additional paid-in capital
    
    
    57,875,595
    
    
    
    57,863,726Retained earnings
    
    
    91,408,028
    
    
    
    85,364,657Net unrealized loss on securities available for sale
    
    
    (604,446
    )
    
    
    (50,725
    )Unearned employee stock option plan shares
    
    
    (4,544,300
    )
    
    
    (4,738,084
    )Treasury stock, at cost, 4,708,798 and 4,616,010 shares
    
    
    (60,455,328
    )
    
    
    (57,599,804
    )Total stockholders equity
    
    
    83,770,836
    
    
    
    80,931,057Total liabilities and stockholders equity
    
    $
    84,336,782
    
    
    
    81,156,307Condensed Statements of IncomeInterest income
    
    $
    69,936
    
    
    
    193,334
    
    
    
    365,202Securities gains, net
    
    
    0
    
    
    
    301,006
    
    
    
    118,238Equity earnings of subsidiaries
    
    
    9,453,280
    
    
    
    8,361,418
    
    
    
    5,095,784Equity earnings of limited partnerships
    
    
    803
    
    
    
    132,273
    
    
    
    23,441Other income
    
    
    0
    
    
    
    0
    
    
    
    15,514Compensation and benefits
    
    
    (207,300
    )
    
    
    (42,100
    )
    
    
    (44,250
    )Occupancy
    
    
    (14,400
    )
    
    
    (6,005
    )
    
    
    (6,000
    )Advertising
    
    
    0
    
    
    
    (2,500
    )
    
    
    0Data processing
    
    
    (2,600
    )
    
    
    (1,200
    )
    
    
    (1,200
    )Mortgage servicing
    
    
    (145
    )
    
    
    (8,009
    )
    
    
    (1,459
    )Other
    
    
    (409,377
    )
    
    
    (481,770
    )
    
    
    (523,314
    )Income before income tax expense
    
    
    8,890,197
    
    
    
    8,446,447
    
    
    
    5,041,956Income tax benefit
    
    
    (399,600
    )
    
    
    (158,800
    )
    
    
    (223,700
    )Net income
    
    $
    9,289,797
    
    
    
    8,605,247
    
    
    
    5,265,656
 42




---



##### 



2004
    
    
    2003
    
    
    2002Condensed Statements of Cash FlowsCash flows from operating activities:Net income
    
    $
    9,289,797
    
    
    
    8,605,247
    
    
    
    5,265,656Adjustments to reconcile net income to cash provided
by operating activities:Equity earnings of subsidiaries
    
    
    (9,453,280
    )
    
    
    (8,361,418
    )
    
    
    (5,095,784
    )Equity earnings in limited partnership
    
    
    (803
    )
    
    
    (132,273
    )
    
    
    (23,441
    )Amortization of premiums, net
    
    
    0
    
    
    
    0
    
    
    
    31,028Securities gains, net
    
    
    0
    
    
    
    (301,006
    )
    
    
    (118,238
    )Deferred income taxes
    
    
    (128,400
    )
    
    
    (3,200
    )
    
    
    257,600Earned employee stock ownership shares priced above original cost
    
    
    308,165
    
    
    
    180,457
    
    
    
    143,604Decrease in restricted stock awards
    
    
    0
    
    
    
    0
    
    
    
    7,350Decrease in unearned ESOP shares
    
    
    193,784
    
    
    
    193,301
    
    
    
    193,361(Increase) decrease in accrued interest receivable
    
    
    (2,842
    )
    
    
    15,548
    
    
    
    98,659Increase in accrued expenses and other liabilities
    
    
    340,696
    
    
    
    26,526
    
    
    
    199,219Decrease (increase) in other assets
    
    
    1,095,622
    
    
    
    330,037
    
    
    
    (944,817
    )Other, net
    
    
    (2
    )
    
    
    0
    
    
    
    1Net cash provided by operating activities
    
    
    1,642,737
    
    
    
    553,219
    
    
    
    14,198Cash flows from investing activities:Proceeds from sales of securities available for sale
    
    
    0
    
    
    
    1,601,007
    
    
    
    6,296,788Decrease (increase) in loans receivable, net
    
    
    110,000
    
    
    
    1,491,383
    
    
    
    (1,601,383
    )Redemption of investment in limited partnership
    
    
    422,474
    
    
    
    0
    
    
    
    0Net decrease (increase) in loans receivable from subsidiaries
    
    
    0
    
    
    
    4,700,000
    
    
    
    (3,985,118
    )Net cash provided by investing activities
    
    
    532,474
    
    
    
    7,792,390
    
    
    
    710,287Cash flows from financing activities:Purchase of treasury stock
    
    
    (3,316,550
    )
    
    
    (1,384,560
    )
    
    
    (1,496,111
    )Stock options exercised
    
    
    66,634
    
    
    
    1,422,460
    
    
    
    871,131Dividends to stockholders
    
    
    (3,246,426
    )
    
    
    (2,901,071
    )
    
    
    (2,562,153
    )Proceeds from dividends on Bank stock
    
    
    4,000,000
    
    
    
    0
    
    
    
    0Net cash used by financing activities
    
    
    (2,496,342
    )
    
    
    (2,863,171
    )
    
    
    (3,187,133
    )Increase (decrease) in cash and cash equivalents
    
    
    (321,131
    )
    
    
    5,482,438
    
    
    
    (2,462,648
    )Cash and cash equivalents, beginning of year
    
    
    5,929,858
    
    
    
    447,420
    
    
    
    2,910,068Cash and cash equivalents, end of year
    
    $
    5,608,727
    
    
    
    5,929,858
    
    
    
    447,420
 43




---



##### 



N O T E S   T
O   C O N S O L I D A T E D   F I N A N C I A L
   S T A T E M E N T S NOTE 24 Business
Segments

The Bank has been identified as a reportable
operating segment in accordance with the provisions of
SFAS No. 131. SFC and HMN, the holding company, did not
meet the quantitative thresholds for a reportable
segment and therefore are included in the Other
category.
Prior to 2003, Home Federal Mortgage Services, (HFMS)
was reported as a separate business segment. HFMS
discontinued operations in 2002 and has been dissolved.
Its segmented information has been included in the
Home Federal Savings Bank category to conform with
the current year presentation. The Company evaluates performance and allocates
resources based on the segments net income, return on
average assets and return on average equity. Each
corporation is managed separately with its own officers
and board of directors. The following table sets forth certain information
about the reconciliations of reported net income and
assets for each of the
Companys reportable segments. Home Federal
    
    
    
    
    
    
    
    
    
    
    Consolidated(Dollars in thousands)
    
    Savings Bank
    
    
    Other
    
    
    Eliminations
    
    
    TotalAt or for the year ended December 31, 2004:Interest income  external customers
    
    $
    51,568
    
    
    
    49
    
    
    
    0
    
    
    
    51,617Non-interest income  external customers
    
    
    5,993
    
    
    
    0
    
    
    
    0
    
    
    
    5,993Earnings (losses) on limited partnerships
    
    
    (27
    )
    
    
    1
    
    
    
    0
    
    
    
    (26
    )Intersegment interest income
    
    
    0
    
    
    
    21
    
    
    
    (21
    )
    
    
    0Intersegment non-interest income
    
    
    174
    
    
    
    9,453
    
    
    
    (9,627
    )
    
    
    0Interest expense
    
    
    21,014
    
    
    
    0
    
    
    
    (21
    )
    
    
    20,993Amortization of mortgage servicing rights and
net valuation adjustments and servicing costs
    
    
    1,061
    
    
    
    0
    
    
    
    0
    
    
    
    1,061Other non-interest expense
    
    
    18,633
    
    
    
    642
    
    
    
    (174
    )
    
    
    19,101Income tax expense (benefit)
    
    
    4,790
    
    
    
    (403
    )
    
    
    0
    
    
    
    4,387Minority interest
    
    
    (3
    )
    
    
    0
    
    
    
    0
    
    
    
    (3
    )Net income
    
    
    9,458
    
    
    
    9,285
    
    
    
    (9,453
    )
    
    
    9,290Goodwill
    
    
    3,801
    
    
    
    0
    
    
    
    0
    
    
    
    3,801Total assets
    
    
    954,779
    
    
    
    84,391
    
    
    
    (78,497
    )
    
    
    960,673Net interest margin
    
    
    3.51
    %
    
    NM
    
    
    NM
    
    
    
    3.50
    %Return on average assets
    
    
    1.04
    
    
    NM
    
    
    NM
    
    
    
    1.01Return on average realized common equity
    
    
    12.49
    
    
    NM
    
    
    NM
    
    
    
    11.03At or for the year ended December 31, 2003:Interest income  external customers
    
    $
    44,775
    
    
    
    162
    
    
    
    0
    
    
    
    44,937Non-interest income  external customers
    
    
    10,198
    
    
    
    301
    
    
    
    0
    
    
    
    10,499Earnings (losses) on limited partnerships
    
    
    (376
    )
    
    
    132
    
    
    
    0
    
    
    
    (244
    )Intersegment interest income
    
    
    28
    
    
    
    31
    
    
    
    (59
    )
    
    
    0Intersegment non-interest income
    
    
    868
    
    
    
    8,361
    
    
    
    (9,229
    )
    
    
    0Interest expense
    
    
    20,348
    
    
    
    0
    
    
    
    (59
    )
    
    
    20,289Amortization of mortgage servicing rights and
net valuation adjustments and servicing costs
    
    
    2,298
    
    
    
    8
    
    
    
    (324
    )
    
    
    1,982Other non-interest expense
    
    
    17,456
    
    
    
    542
    
    
    
    (327
    )
    
    
    17,671Income tax expense (benefit)
    
    
    4,200
    
    
    
    (162
    )
    
    
    0
    
    
    
    4,038Minority interest
    
    
    (3
    )
    
    
    0
    
    
    
    0
    
    
    
    (3
    )Net income
    
    
    8,584
    
    
    
    8,599
    
    
    
    (8,578
    )
    
    
    8,605Goodwill
    
    
    3,801
    
    
    
    0
    
    
    
    0
    
    
    
    3,801Total assets
    
    
    860,510
    
    
    
    81,182
    
    
    
    (74,966
    )
    
    
    866,726Net interest margin
    
    
    3.30
    %
    
    NM
    
    
    NM
    
    
    
    3.31
    %Return on average assets
    
    
    1.08
    
    
    NM
    
    
    NM
    
    
    
    1.10Return on average realized common equity
    
    
    11.88
    
    
    NM
    
    
    NM
    
    
    
    10.85At or for the year ended December 31, 2002:Interest income  external customers
    
    $
    42,550
    
    
    
    318
    
    
    
    0
    
    
    
    42,868Non-interest income  external customers
    
    
    6,401
    
    
    
    134
    
    
    
    0
    
    
    
    6,535Earnings (losses) on limited partnerships
    
    
    (683
    )
    
    
    23
    
    
    
    0
    
    
    
    (660
    )Intersegment interest income
    
    
    517
    
    
    
    47
    
    
    
    (564
    )
    
    
    0Intersegment non-interest income
    
    
    305
    
    
    
    5,168
    
    
    
    (5,473
    )
    
    
    0Interest expense
    
    
    21,859
    
    
    
    0
    
    
    
    (564
    )
    
    
    21,295Amortization of mortgage servicing rights and
net valuation adjustments and servicing costs
    
    
    1,364
    
    
    
    1
    
    
    
    (199
    )
    
    
    1,166Other non-interest expense
    
    
    16,643
    
    
    
    583
    
    
    
    (543
    )
    
    
    16,683Income tax expense (benefit)
    
    
    2,368
    
    
    
    (269
    )
    
    
    0
    
    
    
    2,099Minority interest
    
    
    (142
    )
    
    
    0
    
    
    
    0
    
    
    
    (142
    )Net income
    
    
    4,728

    
    
    
    5,269
    
    
    
    (4,731
    )
    
    
    5,266Goodwill
    
    
    3,801
    
    
    
    0
    
    
    
    0
    
    
    
    3,801Total assets
    
    
    732,769
    
    
    
    76,436
    
    
    
    (71,682
    )
    
    
    737,523Net interest margin
    
    
    3.13
    %
    
    NM
    
    
    NM
    
    
    
    3.19
    %Return on average assets
    
    
    0.75
    
    
    NM
    
    
    NM
    
    
    
    0.74Return on average realized common equity
    
    
    8.33
    
    
    NM
    
    
    NM
    
    
    
    6.94NM  Not meaningful
 44




---



##### 



R E P O R T   O F   I N D E P E N D E N T   R E G I S T E R E D   P U B L I C   A C C O U N T I N G   F I R M (KPMG LOGO) The Board of Directors
HMN Financial, Inc.: We have audited the accompanying consolidated balance sheets of HMN Financial, Inc. and
subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of income,
comprehensive income, stockholders equity, and cash flows for each of the years in the three-year
period ended December 31, 2004. These consolidated financial statements are the responsibility of
the Companys management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all
material respects, the financial position of HMN Financial, Inc. and subsidiaries as of December
31, 2004 and 2003, and the results of their operations and their cash flows for each of the years
in the three-year period ended December 31, 2004, in conformity with U.S. generally accepted
accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the effectiveness of HMN Financial Inc.s internal control over
financial reporting as of December 31, 2004, based on Internal Control  Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our
report dated March 8, 2005 expressed an unqualified opinion on managements assessment of, and the
effective operation of, internal control over financial reporting. KPMG LLP (KPMG LLP) Minneapolis, Minnesota
March 8, 2005 45




---



##### 



S E L E C T E D   Q U A R T E R L Y   F I N A N C I A L   D A T A December 31,
    
    
    September 30,
    
    
    June 30,(Dollars in thousands, except per share data)
    
    2004
    
    
    2004
    
    
    2004Selected Operations Data (3 months ended):Interest income
    
    $
    13,678
    
    
    
    13,156
    
    
    
    12,427Interest expense
    
    
    5,428
    
    
    
    5,387
    
    
    
    5,060Net interest income
    
    
    8,250
    
    
    
    7,769
    
    
    
    7,367Provision for loan losses
    
    
    714
    
    
    
    775
    
    
    
    447Net interest income after provision
for loan losses
    
    
    7,536
    
    
    
    6,994
    
    
    
    6,920Noninterest income:Fees and service charges
    
    
    762
    
    
    
    742
    
    
    
    705Mortgage servicing fees
    
    
    299
    
    
    
    292
    
    
    
    291Securities gains (losses), net
    
    
    (539
    )
    
    
    3
    
    
    
    1Gain on sales of loans
    
    
    435
    
    
    
    349
    
    
    
    507Earnings (losses) in limited partnerships
    
    
    (7
    )
    
    
    (7
    )
    
    
    (7
    )Other noninterest income
    
    
    212
    
    
    
    210
    
    
    
    183Total noninterest income
    
    
    1,162
    
    
    
    1,589
    
    
    
    1,680Noninterest expense:Compensation and benefits
    
    
    2,646
    
    
    
    2,430
    
    
    
    2,582Occupancy
    
    
    960
    
    
    
    914
    
    
    
    871Deposit insurance premiums
    
    
    25
    
    
    
    24
    
    
    
    28Advertising
    
    
    139
    
    
    
    116
    
    
    
    88Data processing
    

    
    278
    
    
    
    233
    
    
    
    228Amortization of mortgage servicing rights and
net valuation adjustments
    
    
    266
    
    
    
    240
    
    
    
    302Other noninterest expense
    
    
    1,045
    
    
    
    923
    
    
    
    898Total noninterest expense
    
    
    5,359
    
    
    
    4,880
    
    
    
    4,997Income before income tax expense
    
    
    3,339
    
    
    
    3,703
    
    
    
    3,603Income tax expense
    
    
    1,218
    
    
    
    1,153
    
    
    
    1,106Income before minority interest
    
    
    2,121
    
    
    
    2,550
    
    
    
    2,497Minority interest
    
    
    (1
    )
    
    
    0
    
    
    
    0Net income
    
    $
    2,122
    
    
    
    2,550
    
    
    
    2,497Basic earnings per share
    
    $
    0.55
    
    
    
    0.66
    
    
    
    0.65Diluted earnings per share
    
    $
    0.53
    
    
    
    0.64
    
    
    
    0.62Financial Ratios:Return on
average
assets(1)
    
    
    0.88
    %
    
    
    1.09
    
    
    
    1.12Return on
average
equity(1)
    
    
    9.85
    
    
    
    12.02
    
    
    
    12.06Average equity to average assets
    
    
    9.17
    
    
    
    9.23
    
    
    
    9.34Dividend payout ratio
    
    
    34.38
    
    
    
    35.48
    
    
    
    38.46Net interest
margin(1)(2)
    
    
    3.62
    
    
    
    3.47
    
    
    
    3.45
 (Dollars in thousands)Selected Financial Condition Data:Total assets
    
    $
    960,673
    
    
    
    955,335
    
    
    
    914,098Securities available for sale:Mortgage-backed and related securities
    
    
    9,151
    
    
    
    9,393
    
    
    
    9,882Other marketable securities
    
    
    94,522
    
    
    
    95,404
    
    
    
    99,947Loans held for sale
    
    
    2,712
    
    
    
    3,652
    
    
    
    3,767Loans receivable, net
    
    
    783,213
    
    
    
    766,063
    
    
    
    722,800Deposits
    
    
    698,902
    
    
    
    666,752
    
    
    
    627,305Federal Home Loan Bank advances
    
    
    170,900
    
    
    
    198,900
    
    
    
    198,900Stockholders equity
    
    
    83,771
    
    
    
    82,791
    
    
    
    81,127
   (1)
    
    Annualized(2)
    
    Net interest income divided by average interest-earning assets. 46




---



##### 



March 31,
    
    December 31,
    
    
    September 30,
    
    
    June 30,
    
    
    March 31,2004
    
    2003
    
    
    2003
    
    
    2003
    
    
    200312,355
    
    
    11,922
    
    
    
    11,507
    
    
    
    11,036
    
    
    
    10,4725,118
    
    
    5,165
    
    
    
    5,065
    
    
    
    5,108
    
    
    
    4,9517,237
    
    
    6,757
    
    
    
    6,442
    
    
    
    5,928
    
    
    
    5,521819
    
    
    710
    
    
    
    545
    
    
    
    490
    
    
    
    8656,418
    
    
    6,047
    
    
    
    5,897
    
    
    
    5,438
    
    
    
    4,656568
    
    
    691
    
    
    
    626
    
    
    
    555
    
    
    
    432287
    
    
    282
    
    
    
    261
    
    
    
    239
    
    
    
    2160
    
    
    41
    
    
    
    417
    
    
    
    225
    
    
    
    592412
    
    
    648
    
    
    
    1,601
    
    
    
    1,526
    
    
    
    1,465(6
    )
    
    70
    
    
    
    10
    
    
    
    31
    
    
    
    (354
    )275
    
    
    167
    
    
    
    179
    
    
    
    115
    
    
    
    2201,536
    
    
    1,899
    
    
    
    3,094
    
    
    
    2,691
    
    
    
    2,5712,528
    
    
    2,283
    
    
    
    2,085
    
    
    
    2,028
    
    
    
    2,278885
    
    
    1,025
    
    
    
    806
    
    
    
    769
    
    
    
    82419
    
    
    18
    
    
    
    18
    
    
    
    18
    
    
    
    1987
    
    
    115
    
    
    
    92
    
    
    
    101
    
    
    
    85191
    
    
    238
    
    
    
    311
    
    
    
    290
    
    
    
    271253
    
    
    277
    
    
    
    (193
    )
    
    
    1,108
    
    
    
    791962
    
    
    974
    
    
    
    1,211
    
    
    
    867
    
    
    
    9444,925
    
    
    4,930
    
    
    
    4,330
    
    
    
    5,181
    
    
    
    5,2123,029
    
    
    3,016
    
    
    
    4,661
    
    
    
    2,948
    
    
    
    2,015910
    
    
    874
    
    
    
    1,621
    
    
    
    918
    
    
    
    6252,119
    
    
    2,142
    
    
    
    3,040
    
    
    
    2,030
    
    
    
    1,390(2
    )
    
    (3
    )
    
    
    0
    
    
    
    0
    
    
    
    0aaaaaaaaa2,121
    
    
    2,145
    
    
    
    3,040
    
    
    
    2,030
    
    
    
    1,3900.54
    
    
    0.55
    
    
    
    0.79
    
    
    
    0.54
    
    
    
    0.370.52
    
    
    0.53
    
    
    
    0.76
    
    
    
    0.52
    
    
    
    0.360.96
    
    
    1.03
    
    
    
    1.53
    
    
    
    1.06
    
    
    
    0.7610.21
    
    
    10.45
    
    
    
    15.12
    
    
    
    10.45
    
    
    
    7.219.42
    
    
    10.15
    
    
    
    10.27
    
    
    
    10.34
    
    
    
    10.5937.74
    
    
    26.32
    
    
    
    38.46
    
    
    
    50.00
    
    
    
    64.293.46
    
    
    3.39
    
    
    
    3.41
    
    
    
    3.24
    
    
    
    3.20899,725
    
    
    866,726
    
    
    
    807,043
    
    
    
    785,910
    
    
    
    761,39911,937
    
    
    13,049
    
    
    
    16,327
    
    
    
    21,121
    
    
    
    15,04997,066
    
    
    91,615
    
    
    
    72,201
    
    
    
    84,510
    
    
    
    83,9824,955
    
    
    6,543
    
    
    
    17,634
    
    
    
    13,855
    
    
    
    12,999717,021
    
    
    688,951
    
    
    
    645,715
    
    
    
    606,931
    
    
    
    577,542611,656
    
    
    551,688
    
    
    
    490,088
    
    
    
    463,185
    
    
    
    448,083198,900
    
    
    203,900
    
    
    
    229,300
    
    
    
    235,300
    
    
    
    219,30082,148
    
    
    80,931
    
    
    
    79,467
    
    
    
    77,522
    
    
    
    74,894
 47




---



##### 



O T H E R  
F I N A N C I A L   D A T A Year Ended December 31,(Dollars in thousands)
    
    2004
    
    
    2003
    
    
    2002Maximum Balance:Federal Home Loan Bank advances
    
    $
    214,800
    
    
    
    241,800
    
    
    
    218,300Federal Home Loan Bank short-term borrowings
    
    
    43,900
    
    
    
    69,400
    
    
    
    64,400Average Balance:Federal Home Loan Bank advances
    
    
    196,008
    
    
    
    221,510
    
    
    
    215,673Federal Home Loan Bank short-term borrowings
    
    
    29,918
    
    
    
    41,169
    
    
    
    36,290
 The following table sets forth certain information as to the Banks Federal Home Loan Bank (FHLB) advances. December 31,2004
    
    
    2003
    
    
    2002Weighted
    
    
    
    
    
    
    Weighted
    
    
    
    
    
    WeightedAverage
    
    
    
    
    
    
    Average
    
    
    
    
    
    Average(Dollars in thousands)
    
    Amount
    
    
    Rate
    
    
    Amount
    
    
    Rate
    
    
    Amount
    
    
    RateFHLB short-term borrowings
    
    $
    10,000
    
    
    
    2.69
    
    
    
    33,000
    
    
    
    5.01
    %
    
    
    64,400
    
    
    
    3.20
    %FHLB long-term advances
    
    
    160,900
    
    
    
    4.29
    
    
    
    170,900
    
    
    
    4.20
    
    
    
    153,900
    
    
    
    5.17Total
    
    $
    170,900
    
    
    
    4.20
    
    
    
    203,900
    
    
    
    4.33
    
    
    
    218,300
    
    
    
    4.59
 Refer to Note 13 of the Notes to Consolidated Financial Statements for more information on
the Banks FHLB advances. C O M M O N   S T O C K   I N F O R M A T I O N The common stock of HMN Financial, Inc. is listed on the Nasdaq Stock Market under the
symbol: HMNF. The common stock outstanding is 9,128,662 shares of which 4,708,798 shares are in
treasury stock at December 31, 2004. As of December 31, 2004 there were 704 stockholders of record
and 1,087 estimated beneficial stockholders. The following table represents the stock price
information for HMN Financial, Inc. as furnished by Nasdaq for each quarter starting in December
31, 2004 and regressing back to March 31, 1999. Dec. 31,
    
    
    Sept. 30,
    
    
    June 30,
    
    
    March 31,
    
    
    Dec. 31,
    
    
    Sept. 30,
    
    
    June 30,
    
    
    March 31,2004
    
    2004
    
    2004
    
    2004
    
    2003
    
    2003
    
    2003
    
    2003HIGH
    
    $
    33.50
    
    
    
    27.99
    
    
    
    27.65
    
    
    
    28.19
    
    
    
    24.70
    
    
    
    21.63
    
    
    
    20.04
    
    
    
    16.82LOW
    
    
    27.35
    
    
    
    25.10
    
    
    
    24.51
    
    
    
    23.25
    
    
    
    20.00
    
    
    
    19.36
    
    
    
    15.85
    
    
    
    15.55CLOSE
    
    
    32.99
    
    
    
    27.75
    
    
    
    27.09
    
    
    
    27.48
    
    
    
    24.29
    
    
    
    21.50
    
    
    
    19.40
    
    
    
    16.05
 Dec. 31,
    
    Sept. 30,
    
    June 28,
    
    March 29,
    
    Dec. 31,
    
    Sept. 28,
    
    

    June 29,

    
    
    March 30,2002
    
    2002
    
    2002
    
    2002
    
    2001
    
    2001
    
    2001
    
    2001HIGH
    
    $
    18.14
    
    
    
    19.31
    
    
    
    20.25
    
    
    
    16.17
    
    
    
    15.85
    
    
    
    17.10
    
    
    
    17.15
    
    
    
    15.06LOW
    
    
    15.78
    
    
    
    16.50
    
    
    
    15.90
    
    
    
    15.24
    
    
    
    13.27
    
    
    
    14.35
    
    
    
    13.50
    
    
    
    13.00CLOSE
    
    
    16.82
    
    
    
    17.46
    
    
    
    19.06
    
    
    
    16.05
    
    
    
    15.49
    
    
    
    15.10
    
    
    
    17.10
    
    
    
    14.75
 Dec. 29,
    
    
    Sept. 29,
    
    
    June 30,
    
    
    March 31,
    
    
    Dec. 31,
    
    
    Sept. 30,
    
    
    June 30,
    
    
    March 31,2000
    
    2000
    
    2000
    
    2000
    
    1999
    
    1999
    
    1999
    
    1999HIGH
    
    $
    13.25
    
    
    
    13.88
    
    
    
    11.75
    
    
    
    12.13
    
    
    
    12.75
    
    
    
    13.50
    
    
    
    13.13
    
    
    
    13.50LOW
    
    
    12.31
    
    
    
    10.88
    
    
    
    10.13
    
    
    
    9.63
    
    
    
    10.88
    
    
    
    11.88
    
    
    
    10.50
    
    
    
    11.38CLOSE
    
    
    13.06
    
    
    
    12.44
    
    
    
    11.00
    
    
    
    10.13
    
    
    
    11.25
    
    
    
    12.25
    
    
    
    11.63
    
    
    
    11.38
 48