**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**Form 10-K**

 
| **ý**                          | **ANNUAL REPORT PURSUANT TO SECTION  13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [ No Fee Required]**                                           |
|-------------------------------------|--------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                |                                                                                                                                                   |
|                                | **For the fiscal year ended December  31, 2002**                                                                                                       |
|                                | **OR**                                                                                                                                                 |
|                                |                                                                                                                                                   |
| **o**                               | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934 [No Fee Required]**                                        |
|                                |                                                                                                                                                   |
|                                | **For the transition period from            to           .** |
|                                |                                                                                                                                                   |
| **Commission file number 0-24100.** |

 

| **HMN  FINANCIAL, INC.**                                             |
|----------------------------------------------------------------------|
| (Exact Name of  Registrant as Specified in its Charter)              |
|                                                                 |   |   |
| **Delaware**                                                         |   | **41-1777397** |
| (State or other  jurisdiction of incorporation or organization)      |   | (I.R.S. Employer  Identification No.) |
|                                                                 |   |   |
| **1016 Civic Center Drive NorthwestPO Box 6057Rochester, Minnesota** |   | **55903-6057** |
| (Address of  principal executive offices)                            |   | (Zip Code) |
|                                                                 |   |   |
| Registrant’s  telephone number, including area code:            |   | **(507) 535-1200** |

 

Securities RegisteredPursuant to Section 12(b) of the Act:    None

 

Securities RegisteredPursuant to Section 12(g) of the Act:   Common Stock, par value$.01 per share  (Title of Class)

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the precedingtwelve months (or for such shorter period that the Registrant was required tofile such reports), and (2) has been subject to such requirements for the past90 days.   YES ý NO  o

 

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, tothe best or registrant’s knowledge, in definitive proxy or informationstatements incorporated by reference in Part III of this Form 10-K or anyamendment to this Form 10-K. ý

 

Indicate by checkmarkwhether the registrant is an accelerated filer (as defined in Rule 12b-2 of theAct.   YES o NO ý

 

The aggregate marketvalue of the voting stock held by non-affiliates of the registrant as of June28, 2002 (the last business day of the registrant’s most recently completedsecond fiscal quarter), was approximately $63.9 million computed by referenceto the average high and low prices of $19.01 on such date as reported on NasdaqNational Market.   (The exclusion fromsuch amount of the market value of the shares owned by any person shall not bedeemed an admission by the Registrant that such person is an affiliate of theRegistrant.)

 

As of February 25, 2003,the Registrant had issued and outstanding 4,343,206 shares of the Registrant’sCommon Stock.

 

Our Internet website ishttp://www.hmnf.com and you may access, free of charge, our annual reports onForm 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, andamendments to such reports filed or furnished pursuant to Section 13(a) or 15(d)of the Securities Exchange Act of 1934, as amended, as soon as reasonablypracticable after we electronically file such material with, or furnish it to,the Securities and Exchange Commission.

 

**DOCUMENTSINCORPORATED BY REFERENCE**

Parts of the Registrant’sAnnual Report for the year ended December 31, 2002, are incorporated byreference in Parts I, II and IV of this Form 10-K. Parts of the Registrant’sProxy Statement dated March 21, 2003, are incorporated by reference in Part IIIof this Form 10-K.

 

 

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**TABLE OF CONTENTS**

 
| PART I             |
|--------------------|
|               |   |
| Item 1.            | Business |
|               |   | General |
|               |   | Market Area |
|               |   | Lending  Activities |
|               |   | Origination,  Purchases and Sales of Mortgage-Backed and Related Securities |
|               |   | Classified Assets  and Delinquencies |
|               |   | Investment  Activities |
|               |   | Sources of  Funds |
|               |   | Other Information |
|               |   |   | Service Corporations  of the Bank |
|               |   |   | Competition |
|               |   |   | Other Corporations  Owned by HMN |
|               |   |   | Employees |
|               |   | Regulation and Supervision |
|               |   | Forward-looking Information |
| Item 2.            | Properties |
| Item 3.            | Legal Proceedings |
| Item  4.           | Submission  of Matters to a Vote of Security Holders |
|               |   |
| PART II            |
|               |   |
| Item  5.           | Market  for the Registrant’s Common Equity and Related Stockholder Matters |
| Item 6.            | Selected Financial  Data |
| Item  7.           | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |
| Item  7A.          | Quantitative  and Qualitative Disclosure About Market Risk |
| Item  8.           | Financial  Statements and Supplementary Data |
| Item  9.           | Changes  in and Disagreements with Accountants on Accounting and Financial Disclosure |
|               |   |
| PART III           |
|               |   |
| Item  10.          | Directors  and Executive Officers of the Registrant |
| Item 11.           | Executive  Compensation |
| Item  12.          | Security  Ownership of Certain Beneficial Owners and Management |
| Item  13.          | Certain  Relationships and Related Transactions |
| Item 14.           | Controls and  Procedures |
|               |   |
| PART IV            |
|               |   |
| Item 15.           | Exhibits, Financial Statement Schedules and  Reports on Form 8-K |
| Signatures         |
| Certifications     |
| Index to  Exhibits |
|                    |  |  |  |  |

 

2

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**PARTI**

 

**ITEM 1.  BUSINESS**

 

**General**

 

HMN Financial, Inc. (HMN or the Corporation), is theholding company of Home Federal Savings Bank (Home Federal or the Bank), whichis a federally chartered stock savings bank that has a community bankingphilosophy and operates twelve full service retail banking facilities inMinnesota and Iowa. The Bank also provides highly personalized financial servicesto a select group of individuals and businesses from Eagle Crest Capital Bank,a division of Home Federal Savings Bank, in Edina, Minnesota.  HMN was incorporated under the laws of theState of Delaware in 1994 for the purpose of becoming a savings and loanholding company of the Bank.  The Bankhas two wholly owned subsidiaries, Osterud Insurance Agency, Inc. (OAI) whichoffers financial planning products and services and Home Federal Holding, Inc.(HFH) which is the holding company for Home Federal REIT, Inc. (HFREIT) whichinvests in real estate loans acquired from the Bank.  HMN has another wholly owned subsidiary, Security FinanceCorporation (SFC) which acts as an intermediary for the Bank in transacting likekind property exchanges for Bank customers.  The Bank has a 51% owned subsidiary, Home Federal Mortgage Services, LLC(HFMS), which was a mortgage banking and mortgage brokerage business located inBrooklyn Park, Minnesota.  HFMS’sbrokerage and production activity stopped during the third quarter of 2002 andthe Bank assumed responsibility for certain components of HFMS.  The remaining assets of HFMS, consistingprimarily of single family mortgage loans, are in the process of beingliquidated.

 

The Company’s financial statements identify the Bankand HFMS as reportable operating segments. In addition, HFMS has been segmentedfurther into mortgage servicing rights and mortgage banking activities. Theinformation on pages 47 - 48 of the Company’s annual report is incorporatedherein by reference.

 

As a community-oriented financial institution, HMNseeks to serve the financial needs of communities in its market area.  HMN’s business involves attracting depositsfrom the general public and businesses and using such deposits to originate orpurchase one-to-four family residential, commercial real estate, andmulti-family mortgage loans in addition to consumer, construction, andcommercial business loans.  HMN alsoprovides highly personalized services to a diverse high net worth customer basethrough Eagle Crest Capital Bank, a division of Home Federal Savings Bank.  HMN also invests in mortgage-backed andrelated securities, investment securities (consisting primarily of U.S.government and government agency obligations) and other permissible investments.  The executive offices of HMN are located at1016 Civic Center Drive Northwest, PO Box 6057, Rochester, Minnesota55903-6057.  Its telephone number atthat address is (507) 535-1200.

 

**MarketArea**

 

HMN serves the southern Minnesota counties of Fillmore,Freeborn, Houston, Mower, Olmsted and Winona and portions of Steele, Dodge,Goodhue and Wabasha through its corporate office located in Rochester,Minnesota and its ten branch offices located in Albert Lea, Austin, LaCrescent,Rochester, Spring Valley and Winona, Minnesota. The portion of HMN’s southernMinnesota market area consisting of Rochester and the contiguous communities iscomposed of primarily urban and suburban communities, while the balance ofHMN’s southern Minnesota market area consists primarily of rural areas andsmall towns.  Primary industries inHMN’s southern Minnesota market area include manufacturing, agriculture, healthcare, wholesale and retail trade, service industries and education. Major employersinclude IBM, Mayo Clinic, Hormel, a food processing company, and various smallindustrial and other companies. HMN’s market area is also the home of WinonaState University, Rochester Community and Technical College, University ofMinnesota - Rochester Center, Winona State University - Rochester Center andAustin’s Riverland Community College.

 

HMN serves the Iowa counties of Marshall and Tamathrough its branch offices located in Marshalltown and Toledo. Major industriesin the area are Swift & Company - pork processors, Fisher ControlsInternational - valve and regulator manufacturing, Lennox Industries - furnaceand air conditioner manufacturing, Iowa Veterans Home - hospital care, MarshallCommunity School District - education, Marshall Medical & Surgical Center -hospital care and Meskwaki Casino - gaming operations.

 

3

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Based upon information obtained from the U.S. CensusBureau for 2001, the population of the six primary counties in the Bank’ssouthern Minnesota market area was as follows: Fillmore - 21,296; Freeborn - 32,300; Houston - 19,940; Mower - 38,631;Olmsted - 126,275; and Winona - 49,588. The median household income for thesesix counties ranged from approximately $36,651 to $51,316.

 

Based upon information obtained from the U.S. CensusBureau for 2001, the population of Marshall County was 39,438 and thepopulation of Tama County was 18,045. The median household income of these twocounties ranged from approximately $37,419 to $38,268.

 

HMN also serves a diversehigh net worth customer base primarily in the seven county metropolitan area ofMinneapolis and St. Paul from Eagle Crest Capital Bank, a division of HomeFederal Savings Bank, located in Edina, Minnesota.

 

**LendingActivities**

 

***General.* **Historically, HMN originated 30-year, fixed-rate mortgage loanssecured by one-to-four family residences. Over the past twenty years, in order to reduce its vulnerability tochanges in interest rates, HMN has emphasized the origination or purchase ofloans for the loan portfolio which have shorter terms to maturity such as 15year, fixed rate residential loans and Graduated Equity Mortgages (GEMs) whichfully amortize in 15 to 20 years. HMN has also emphasized the origination orpurchase of Adjustable Rate Mortgage loans (ARMs) for portfolios which haveinterest rates that are fixed for an initial period of one, three or five yearsand then generally adjust annually, thereafter, based upon a treasury interestrate index plus a certain margin, subject to annual and lifetime rate adjustmentlimits.  During 2002 and 2001 HMN soldthe majority of the fixed rate one-to-four family mortgage loan originations inorder to reduce its interest rate risk. Over the past five years, HMN hasactively pursued commercial real estate and other commercial business loans tosmall and medium sized businesses.  HMNalso offers a competitive array of consumer loan products which include bothopen lines and closed ended home equity loans as well as other consumer loans. Thehome equity line of credit has an adjustable interest rate based upon the WallStreet Journal prime rate plus a margin. Refer to Notes 1 and 4 of the Notes toConsolidated Financial Statements in the Annual Report for more information onthe loan portfolio.

 

4

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The following table showsthe composition of HMN’s loan portfolio by fixed and adjustable-rate loans asof December 31:

 
|                                    |   | **2002**   |    | **2001**    |   | **2000**   |   | **1999**    |   | **1998**   |   |
|-----------------------------------------|--------|------------|---------|-------------|--------|------------|--------|-------------|--------|------------|--------|
| **(Dollars in thousands)**              |   | **Amount** |    | **Percent** |   | **Amount** |   | **Percent** |   | **Amount** |   | **Percent** |   | **Amount** |   | **Percent** |   | **Amount** |   | **Percent** |   |
| Fixed-Rate Loans                        |   |       |    |        |   |       |   |        |   |       |   |   |   |   |   |   |   |   |   |   |   |
| Real Estate:                            |   |       |    |        |   |       |   |        |   |       |   |   |   |   |   |   |   |   |   |   |   |
| One-to-four family                      |   |       |    |        |   |       |   |        |   |       |   |   |   |   |   |   |   |   |   |   |   |
| GEM                                     |   | $          | 17,394  |        | 3.18   | %          | $      | 30,727      |   | 6.38       | %      | $ | 47,811 |   | 9.08 | % | $ | 51,309 |   | 10.56 | % | $ | 56,211 |   | 12.20 | % |
| Other                                   |   | 74,510     |    | 13.63       |   | 110,619    |   | 22.97       |   | 158,083    |   | 30.03 |   | 187,796 |   | 38.66 |   | 227,790 |   | 49.43 |   |
| Total one-to-four family                |   | 91,904     |    | 16.81       |   | 141,346    |   | 29.35       |   | 205,894    |   | 39.11 |   | 239,105 |   | 49.22 |   | 284,001 |   | 61.63 |   |
| Multi-family                            |   | 6,588      |    | 1.20        |   | 7,644      |   | 1.59        |   | 7,099      |   | 1.35 |   | 7,475 |   | 1.54 |   | 3,432 |   | 0.74 |   |
| GEM                                     |   | 65         |    | 0.01        |   | 68         |   | 0.01        |   | 71         |   | 0.01 |   | 74 |   | 0.02 |   | 77 |   | 0.02 |   |
| Commercial                              |   | 51,674     |    | 9.45        |   | 29,756     |   | 6.18        |   | 27,743     |   | 5.27 |   | 27,801 |   | 5.72 |   | 17,768 |   | 3.86 |   |
| Construction or development             |   | 17,733     |    | 3.24        |   | 15,542     |   | 3.22        |   | 2,126      |   | 0.40 |   | 5,011 |   | 1.03 |   | 9,366 |   | 2.03 |   |
| Total fixed-rate real estate loans      |   | 167,964    |    | 30.71       |   | 194,356    |   | 40.35       |   | 242,933    |   | 46.14 |   | 279,466 |   | 57.53 |   | 314,644 |   | 68.28 |   |
| Consumer loans:                         |   |       |    |        |   |       |   |        |   |       |   |   |   |   |   |   |   |   |   |   |   |
| Savings                                 |   | 534        |    | 0.10        |   | 594        |   | 0.12        |   | 695        |   | 0.13 |   | 733 |   | 0.15 |   | 994 |   | 0.22 |   |
| Automobile                              |   | 11,062     |    | 2.02        |   | 6,624      |   | 1.38        |   | 6,363      |   | 1.21 |   | 4,532 |   | 0.93 |   | 2,897 |   | 0.63 |   |
| Home equity                             |   | 21,049     |    | 3.85        |   | 26,300     |   | 5.46        |   | 27,832     |   | 5.29 |   | 16,962 |   | 3.49 |   | 9,384 |   | 2.04 |   |
| Mobile home                             |   | 4,534      |    | 0.83        |   | 5,456      |   | 1.13        |   | 4,921      |   | 0.94 |   | 791 |   | 0.16 |   | 58 |   | 0.01 |   |
| Other                                   |   | 4,080      |    | 0.75        |   | 4,093      |   | 0.85        |   | 3,650      |   | 0.69 |   | 2,311 |   | 0.48 |   | 1,553 |   | 0.33 |   |
| Total consumer loans                    |   | 41,259     |    | 7.55        |   | 43,067     |   | 8.94        |   | 43,461     |   | 8.26 |   | 25,329 |   | 5.21 |   | 14,886 |   | 3.23 |   |
| Commercial business loans               |   | 47,383     |    | 8.67        |   | 37,123     |   | 7.71        |   | 27,821     |   | 5.28 |   | 18,936 |   | 3.90 |   | 10,157 |   | 2.20 |   |
| Total other loans                       |   | 88,642     |    | 16.22       |   | 80,190     |   | 16.65       |   | 71,282     |   | 13.54 |   | 44,265 |   | 9.11 |   | 25,043 |   | 5.43 |   |
| Total fixed-rate loans                  |   | 256,606    |    | 46.93       |   | 274,546    |   | 57.00       |   | 314,215    |   | 59.68 |   | 323,731 |   | 66.64 |   | 339,687 |   | 73.71 |   |
| Adjustable-Rate Loans                   |   |       |    |        |   |       |   |        |   |       |   |   |   |   |   |   |   |   |   |   |   |
| Real estate:                            |   |       |    |        |   |       |   |        |   |       |   |   |   |   |   |   |   |   |   |   |   |
| One-to-four family                      |   | 59,662     |    | 10.91       |   | 74,102     |   | 15.38       |   | 106,994    |   | 20.32 |   | 105,569 |   | 21.73 |   | 81,495 |   | 17.68 |   |
| Multi-family                            |   | 9,113      |    | 1.67        |   | 6,657      |   | 1.38        |   | 4,920      |   | 0.93 |   | 724 |   | 0.15 |   | 1,210 |   | 0.26 |   |
| Commercial                              |   | 78,885     |    | 14.43       |   | 41,012     |   | 8.52        |   | 33,911     |   | 6.44 |   | 16,309 |   | 3.36 |   | 11,222 |   | 2.44 |   |
| Construction or development             |   | 43,602     |    | 7.97        |   | 31,435     |   | 6.53        |   | 18,055     |   | 3.44 |   | 11,035 |   | 2.27 |   | 5,789 |   | 1.26 |   |
| Total adjustable-rate real estate loans |   | 191,262    |    | 34.98       |   | 153,206    |   | 31.81       |   | 163,910    |   | 31.13 |   | 133,637 |   | 27.51 |   | 99,716 |   | 21.64 |   |
| Consumer (home equity and other)        |   | 55,162     |    | 10.09       |   | 36,064     |   | 7.49        |   | 27,435     |   | 5.21 |   | 22,907 |   | 4.72 |   | 19,914 |   | 4.32 |   |
| Commercial business loans               |   | 43,736     |    | 8.00        |   | 17,817     |   | 3.70        |   | 20,939     |   | 3.98 |   | 5,499 |   | 1.13 |   | 1,538 |   | 0.33 |   |
| Total adjustable-rate loans             |   | 290,160    |    | 53.07       |   | 207,087    |   | 43.00       |   | 212,284    |   | 40.32 |   | 162,043 |   | 33.36 |   | 121,168 |   | 26.29 |   |
| Total loans                             |   | 546,766    |    | 100.00      |   | 481,633    |   | 100.00      |   | 526,499    |   | 100.00 |   | 485,774 |   | 100.00 |   | 460,855 |   | 100.00 |   |
| Less                                    |   |       |    |        |   |       |   |        |   |       |   |   |   |   |   |   |   |   |   |   |   |
| Loans in process                        |   | 6,826      |    |        |   | 4,692      |   |        |   | 2,953      |   |   |   | 2,771 |   |   |   | 7,997 |   |   |   |
| Unamortized discounts                   |   | 142        |    |        |   | 278        |   |        |   | 289        |   |   |   | 297 |   |   |   | 414 |   |   |   |
| Net deferred loan fees                  |   | 1,068      |    |        |   | 1,212      |   |        |   | 1,348      |   |   |   | 1,537 |   |   |   | 1,948 |   |   |   |
| Allowance for losses on loans           |   | 4,824      |    |        |   | 3,783      |   |        |   | 3,144      |   |   |   | 3,273 |   |   |   | 3,041 |   |   |   |
| Total loans receivable, net             |   | $          | 533,906 |        |   |       | $      | 471,668     |   |       |   | $ | 518,765 |   |   |   | $ | 477,896 |   |   |   | $ | 447,455 |   |   |   |

 

5

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The following tableillustrates the interest rate sensitivity of HMN’s loan portfolio at December31, 2002. Loans which have adjustable or renegotiable interest rates are shownas maturing in the period during which the contract is due. Scheduledrepayments of principal are reflected in the year in which they are scheduledto be paid.

 
|                                      |   | **Real  Estate**        |    |                              |   |             |   |                        |   |                     |   |                        |   |       |   |
|-------------------------------------------|--------|-------------------------|---------|-----------------------------------|--------|------------------|--------|-----------------------------|--------|--------------------------|--------|-----------------------------|--------|------------|--------|
|                                      |   | **One-to-four  family** |    | **Multi-family  and  Commercial** |   | **Construction** |   | **Consumer**                |   | **Commercial  Business** |   | **Total**                   |   |
| **Due During Years Ending  December 31,** |   | **Amount**              |    | **Weighted  Average  Rate**       |   | **Amount**       |   | **Weighted  Average  Rate** |   | **Amount**               |   | **Weighted  Average  Rate** |   | **Amount** |   | **Weighted  Average  Rate** |   | **Amount** |   | **Weighted  Average  Rate** |   | **Amount** |   | **Weighted  Average  Rate** |   |
|                                      |   |                    |    |                              |   |             |   |                        |   |                     |   |                        |   |       |   |   |   |   |   |   |   |   |   |   |   |
| 2003(1)                                   |   | $                       | 12,475  |                              | 7.21   | %                | $      | 17,029                      |   | 6.28                     | %      | $                           | 16,977 |       | 6.53   | % | $ | 16,428 |   | 8.25 | % | $ | 42,716 |   | 6.23 | % | $ | 105,625 |   | 6.71 | % |
| 2004                                      |   | 9,295                   |    | 7.04                              |   | 13,096           |   | 6.77                        |   | 3,976                    |   | 6.81                        |   | 10,950     |   | 7.68 |   | 11,295 |   | 6.83 |   | 48,613 |   | 7.04 |   |
| 2005                                      |   | 8,982                   |    | 6.98                              |   | 21,778           |   | 7.21                        |   | 7,261                    |   | 7.37                        |   | 14,196     |   | 7.53 |   | 14,782 |   | 6.70 |   | 66,999 |   | 7.15 |   |
| 2006 through 2007                         |   | 18,107                  |    | 6.95                              |   | 24,902           |   | 7.45                        |   | 3,345                    |   | 7.29                        |   | 21,849     |   | 7.70 |   | 10,144 |   | 7.18 |   | 78,347 |   | 7.36 |   |
| 2008 through 2012                         |   | 36,633                  |    | 6.79                              |   | 51,895           |   | 7.40                        |   | 10,052                   |   | 6.94                        |   | 31,144     |   | 7.18 |   | 9,481 |   | 6.84 |   | 139,204 |   | 7.12 |   |
| 2013 through 2027                         |   | 57,990                  |    | 6.70                              |   | 17,625           |   | 7.37                        |   | 18,336                   |   | 5.75                        |   | 1,854      |   | 10.45 |   | 2,701 |   | 6.22 |   | 98,506 |   | 6.70 |   |
| 2028 and following                        |   | 8,084                   |    | 6.70                              |   | 0                |   | 0.00                        |   | 1,388                    |   | 5.86                        |   | 0          |   | 0.00 |   | 0 |   | 0.00 |   | 9,472 |   | 6.58 |   |
|                                      |   | $                       | 151,566 |                              |   |             | $      | 146,325                     |   |                     |   | $                           | 61,335 |       |   |   | $ | 96,421 |   |   |   | $ | 91,119 |   |   |   | $ | 546,766 |   |   |   |

 

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(1)           Includesdemand loans, loans having no stated maturity and overdraft loans.

 

The total amount of loansdue after December 31, 2003 which have predetermined interest rates is $233.7million, while the total amount of loans due after such date which havefloating or adjustable interest rates is $207.4 million.

 

At December 31, 2002construction or development loans for one-to-four family dwellings totaled$23.1 million, multi-family totaled $14.1 million, and non-residential totaled$24.1 million.

 

6

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Under the Financial Institutions Reform, Recovery andEnforcement Act of 1989 (“FIRREA”), the aggregate amount of loans that the Bankis permitted to make to any one borrower is generally limited to 15% ofunimpaired capital and surplus (25% if the security for such loan has a “readilyascertainable” value or 30% for certain residential development loans).  At December 31, 2002, based upon the15% limitation, the Bank’s regulatory limit for loans-to-one borrower wasapproximately $9.5 million. At December 31, 2002, the dollar amount ofoutstanding loans to two borrowers or groups of related borrowers exceeded thisamount, but some of the loans included in these loan totals are exempt from thelending limit due to the “Direct Benefit and Common Enterprise Rules”.  The total loans outstanding to theseborrowers at December 31, 2002 were $16.3 million and $10.9 million,respectively.  The amounts outstanding,excluding those loans that were exempt from the loans to one borrower limitsbecause of the “Direct Benefit and Common Enterprise Rules”, were $9.2 millionand $6.9 million, respectively.  Thelargest borrowing relationship is secured by a theater complex and othercommercial real estate located in Rochester, Minnesota.  The borrowing relationship was performing inaccordance with its terms at December 31, 2002.

 

All of the Bank’s lending is subject to its writtenunderwriting standards and to loan origination procedures. Decisions on loanapplications are made on the basis of detailed applications and propertyvaluations (consistent with the Bank’s appraisal policy) by an independentappraiser. The loan applications are designed primarily to determine theborrower’s ability to repay. The more significant items on the application areverified through use of credit reports, financial statements, tax returnsand/or confirmations. The Bank also offers the Home Credit Plus Program whichrelies on the credit score of the loan applicant instead of income, asset andemployment verification procedures.  TheBank also offers low or alternative documentation underwriting procedures whichconform to FNMA underwriting guidelines.

 

The Bank’s Mortgage and Consumer Loan Committee isresponsible for review and approval of all loans over the FHLMC/FNMA conformingloan dollar limits (the Limit) originated by the Bank which are not sold in thesecondary loan market. The Limit was $300,700 for 2002 and $275,000 for2001.  Approval of one member of theLoan Committee was obtained on all loans above the Limit.

 

The Bank’s Commercial Loan Committee is responsiblefor reviewing and approving commercial loans which range from $500,000 to $4.0million. The Bank’s commercial loan officers have the authority to approveloans which meet the guidelines established by the commercial loan policy forloans less than $500,000.  Loans of $4.0million or more must be approved by the Board of Directors or its ExecutiveCommercial Loan Committee.

 

Generally, the Bank requires title insurance on itsmortgage loans as well as fire and extended coverage casualty insurance inamounts at least equal to the principal amount of the loan or the value ofimprovements on the property. The Bank also requires flood insurance to protectthe property securing its interest when the property is located in a floodplain.

 

***One-to-Four Family Residential Real Estate Lending*.**  At December 31, 2002 HMN’s one-to-fourfamily real estate loans, consisting of both fixed rate and adjustable rateloans, totaled $151.6 million, a decline of $63.8 million compared to $215.4million at December 31, 2001, compared to $312.9 million at December 31, 2000,compared to $344.7 million at December 31, 1999, compared to $365.5 million atDecember 31, 1998.   During 2002 and2001 loan prepayments increased as a result of the low interest rateenvironment and many loans that were in the loan portfolio were refinanced andsold to FNMA.  In order to reduce itsinterest rate risk the Bank sold 80% of all one-to-four family loans originatedduring 2000. The Bank converted $11.1 million of one-to-four family loans intomortgage-backed securities and transferred the securities into the securitiesavailable for sale portfolio.  The Bankalso sold another $5.1 million of one-to-four family loans from the loanportfolio.  The impact of the loansecuritization and sales when coupled with principal repayments caused theone-to-four family loan portfolio to decline by $31.8 million during 2000.  During 1999 the Bank sold 62% of allone-to-four family mortgage loans originated or refinanced. It converted $6.9million of one-to-four family loans into mortgage-backed securities(securitization) and transferred the securities into the securities availablefor sale portfolio.  The Bank also soldanother $10.2 million of one-to-four family loans from the loan portfolio. Theimpact of the loan securitization and sales when coupled with the principalrepayments caused the one-to-four family loan portfolio to decline by $20.8million during 1999.

 

7

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Fixed rate loans in HMN’s portfolio include both GEMloans and conventional fixed-rate loans. The GEM loans require payments which increase after the first year.Under the GEM loans, the monthly payments required for the first year areestablished based on a 30-year amortization schedule.  Depending upon the program selected, the payments may increase inthe succeeding years by amounts ranging from 0% to 6.2%. Most of the GEM loansoriginated by HMN provide for at least three annual payment increases over thefirst five years of the loan. The increased payments required under GEM loansare applied to principal and have the effect of shortening the term tomaturity; the GEM loans do not permit negative amortization. HMN currentlyoffers one GEM product with a contractual maturity of approximately 15 years.The GEMs are generally priced based upon loans with similar contractualmaturities. The GEMs are popular with consumers who anticipate future increasesin income and who desire an amortization schedule of less than 30 years.  At December 31, 2002, HMN had $17.4 millionof one-to-four family GEM loans, a decrease of $13.3 million from $30.7 millionat December 31, 2001, compared to $47.8 million at December 31, 2000, comparedto $51.3 million at December 31, 1999, and $56.2 million at December 31, 1998.

 

HMN offers conventional fixed-rate one-to-four familyloans that have maximum terms of up to 30 years. HMN generally sells themajority of new loan originations or refinances with fixed rates and terms tomaturity ranging from 15 years to 30 years that are eligible for sale in thesecondary market. The interest rates charged on the fixed-rate loan productsare generally set based on the FNMA delivery rates, as well as othercompetitive factors.  At December 31,2002, HMN had $74.5 million of fixed rate one-to-four family mortgage loans, adecrease of $36.1 million compared to $110.6 million at December 31, 2001,compared to $158.1 million at December 31, 2000, compared to $187.8 million atDecember 31, 1999, and $227.8 million at December 31, 1998.

 

HMN also offers one-year ARMs at a margin (generally275 to 375 basis points) over the yield on the Average Monthly One Year U.S.Treasury Constant Maturity Index for terms of up to 30 years. The ARM loanscurrently offered by HMN allow the borrower to select (subject to pricing) aninitial period of one year, three years, or five years between the loanorigination and the date the first interest rate change occurs.  Generally, the ARMs provide for up to a 200basis point annual interest rate change cap and a lifetime cap 600 basis pointsover or under the initial rate. Initial interest rates offered on the ARM loansduring 2002 ranged from 100 basis points below the fully indexed loan rate to100 basis points over the fully indexed loan rate. All borrowers are qualifiedfor the loan at the fully indexed rate. HMN’s originated ARMs do not permitnegative amortization of principal, generally do not contain prepaymentpenalties and generally are not convertible into fixed-rate loans.   In the past, the Bank offered one-year ARMswith a margin of 200 to 235 basis points over a specified index and an averageannual cap of 145 basis points. At December 31, 2002 the one-to-four familyARMs totaled $59.7 million a decrease of $14.4 million compared to $74.1million at December 31, 2001, compared to $107.0 million at December 31, 2000,compared to $105.6 million at December 31, 1999, and $81.5 million at December31, 1998.

 

HMN has also originated a limited number of fixed-rateloans with terms up to 30 years which are insured by the Federal HousingAuthority (FHA), Veterans Administration (VA) and Minnesota Home FinanceAdministration (MHFA).

 

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In underwriting one-to-four family residential realestate loans, HMN evaluates the borrower’s credit history, ability to makeprincipal, interest and escrow payments, and the value of the property thatwill secure the loan and debt to income ratios. Properties securing one-to-fourfamily residential real estate loans made by HMN are appraised by independentfee appraisers. HMN originates residential mortgage loans with loan-to-valueratios of up to 95% for owner-occupied homes and up to 70% for non-owneroccupied homes; however, private mortgage insurance is generally required toreduce HMN’s exposure to 80% or less on most loans.  HMN generally seeks to underwrite its loans in accordance withsecondary market standards.

 

HMN’s residential mortgage loans customarily includedue-on-sale clauses giving it the right to declare the loan immediately due andpayable in the event that, among other things, the borrower sells or otherwisedisposes of the property subject to the mortgage.

 

***Commercial Real Estate and Multi-Family Lending.*  **HMN originates permanent commercialreal estate and multi-family loans secured by properties located primarily inits market area. It also purchases commercial real estate and multi-familyloans originated by third parties on properties outside of its marketarea.  Commercial real estate loanstotaled $130.6 million at December 31, 2002, an increase of $59.8 million from$70.8 million at December 31, 2001, compared to $61.7 million at December 31,2000, compared to $43.9 million at December 31, 1999, and $29.0 million atDecember 31, 1998. Multi-family loans totaled $15.8 million at December 31,2002, an increase of $1.4 million from $14.4 million at December 31, 2001,compared to $12.1 million at December 31, 2000, compared to $8.5 million atDecember 31, 1999 and $4.7 million at December 31, 1998.

 

The commercial real estate and multi-family loanportfolio includes loans secured by motels, hotels, apartment buildings,churches, small office buildings, small business facilities, shopping malls,nursing homes, golf courses, warehouses and other non-residential building propertiesprimarily located in the upper midwestern United States.

 

Permanent commercial real estate and multi-familyloans are generally originated for a maximum term of 10-15 years and may havelonger amortization periods with balloon maturity features. The interest ratesmay be fixed for the term of the loan or have adjustable features which aretied to prime or a published index. Commercial real estate and multi-family loans are generally written inamounts of up to 75% to 80% of the lesser of the appraised value of theproperty or the purchase price and generally have a debt service coverage ratioof at least 120%. The debt service coverage is the ratio of net cash fromoperations before payment of debt to debt service. HMN may originateconstruction loans secured by commercial or multi-family real estate, or maypurchase participation interests in third party originated construction loanssecured by commercial or multi-family real estate.

 

Appraisals on commercial real estate and multi-familyreal estate properties are performed by independent appraisers prior to thetime the loan is made.  For transactionsless than $250,000, HMN may use an internal valuation.  All appraisals on commercial andmulti-family real estate are reviewed and approved by a commercial loanofficer, credit manager or commercial department manager, or a qualified thirdparty.  The Bank’s underwritingprocedures require verification of the borrower’s credit history, income andfinancial statements, banking relationships and income projections for theproperty. All commercial real estate and multi-family loans over $500,000 mustbe approved by a majority of the commercial loan committee prior toclosing.  For commercial real estate andmulti-family loans under $500,000, two authorized loan officers are required toapprove the loan.  The commercial loanpolicy generally requires personal guarantees from the proposed borrowers.  An initial on-site inspection is generallyrequired for all collateral properties for loans with balances in excess of$250,000.  Independent annual reviewsare performed for aggregate commercial lending relationships that exceed$500,000.  The reviews cover financialperformance, documentation completeness and accuracy of loan risk ratings.

 

At December 31, 2002, HMN’s two largestcommercial real estate loans totaled $7.4 million and $6.6 million.  The first loan is secured by a theatercomplex in Rochester, Minnesota and the second loan is secured by a shoppingmall in Winona, Minnesota. Both of these loans were performing atDecember 31, 2002.

 

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Multi-family and commercial real estate loansgenerally present a higher level of risk than loans secured by one-to-fourfamily residences. This greater risk is due to several factors, including theconcentration of principal in a limited number of loans and borrowers, theeffects of general economic conditions on income producing properties and theincreased difficulty of evaluating and monitoring these types of loans.  Furthermore, the repayment of loans securedby multi-family and commercial real estate is typically dependent upon thesuccessful operation of the related real estate project. If the cash flow fromthe project is reduced (for example, if leases are not obtained or renewed),the borrower’s ability to repay the loan may be impaired. At December 31,2002, $1.9 million of loans in the commercial real estate portfolio werenonperforming. There can be no assurance that delinquencies will not increasein the future.

 

***Construction Lending.***  HMN makes construction loans to individualsfor the construction of their residences and to builders for the constructionof one-to-four family residences. It also makes a limited number of loans tobuilders for houses built on speculation. Construction loans also include commercial real estate loans.  HMN had $61.3 million of construction loansoutstanding at December 31, 2002, an increase of $14.3 million from $47.0million at December 31, 2001, compared to $20.2 million at December 31, 2000,$16.0 million at December 31, 1999 and $15.2 million at December 31, 1998.

 

Almost all loans to individuals for the constructionof their residences are structured as permanent loans.  Such loans are made on the same terms asresidential loans, except that during the construction phase, which typicallylasts up to seven months, the borrower pays interest only. Generally, theborrower also pays a construction fee at the time of origination equal to theorigination fee plus other costs associated with processing the loans.Residential construction loans are underwritten pursuant to the same guidelinesused for originating residential loans on existing properties.

 

Construction loans to builders or developers ofone-to-four family residences generally carry terms of 1 year. Such loans maypermit the payment of interest from loan proceeds.

 

Construction loans to owner occupants are generallymade in amounts of up to 95% of the lesser of cost or appraised value, but nomore than 85% of the loan proceeds can be disbursed until the building iscompleted. The loan-to-value ratios on loans to builders are generally limitedto 80%. Prior to making a commitment to fund a construction loan, HMN requiresa valuation of the property and financial data and verification of theborrower’s income. HMN obtains personal guarantees for substantially all of itsconstruction loans to builders. Personal financial statements of guarantors are also obtained as part ofthe loan underwriting process. Generally construction loans have been locatedin HMN’s market area.

 

Construction loans are obtained principally throughcontinued business from builders and developers who have previously borrowedfrom the Bank, as well as referrals from existing customers and walk-in customers.The application process includes a submission to the Bank of accurate plans,specifications and costs of the project to be constructed. These items are usedas a basis to determine the appraised value of the subject property to bebuilt.

 

At December 31, 2002 construction real estate loanstotaled $61.3 million of which one-to-four family residential loans totaled$23.1 million, multi-family residential totaled $14.1 million and constructionon commercial real estate totaled $24.1 million.

 

The nature of construction loans is such that they aremore difficult to evaluate and monitor. The risk of loss on a construction loan is dependent largely upon theaccuracy of the initial estimate of the property’s value upon completion of theproject and the estimated cost (including interest) of the project. If theestimate of value proves to be inaccurate, HMN may be confronted, at or priorto the maturity of the loan, with a project having a value which isinsufficient to assure full repayment and/or the possibility of having to makesubstantial investments to complete and sell the project.  Because defaults in repayment may not occurduring the construction period it may be difficult to identify problem loans atan early stage.  In such cases, HMN maybe required to modify the terms of the loan.

 

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***Consumer Lending.**** *HMN originates a variety of consumer loans, including homeequity loans (open-end and closed-end), automobile, home improvement, mobilehome, deposit account and other loans for household and personal purposes. AtDecember 31, 2002, consumer loans totaled $96.4 million, an increase of $17.3million from $79.1 million at December 31, 2001, compared to $70.9 million atDecember 31, 2000, compared to $48.2 million at December 31, 1999, and $34.8million at December 31, 1998.

 

Consumer loan terms vary according to the type andvalue of collateral, length of contract and creditworthiness of the borrower.HMN’s consumer loans are made at fixed and adjustable interest rates, withterms of up to 20 years for secured loans and up to three years for unsecuredloans.

 

HMN’s home equity loans are written so that the totalcommitment amount, when combined with the balance of any other outstandingmortgage liens, may not exceed 100% of the appraised value of theproperty.  The closed-end home equityloans are written with fixed- or adjustable-rates with terms of up to 15years.  The open-end home equity linesare written with an adjustable rate with terms of up to 20 years, a 10 yeardraw period which requires “interest only” payments and a 10 year repaymentperiod which fully amortizes the outstanding balance.  The consumer may access the open-end home equity line either bymaking a withdrawal at the Bank or writing a check on the home equity line ofcredit account. HMN’s closed-end home equity loans totaled $23.8 million atDecember 31, 2002, a decrease of $2.6 million from $26.4 million at December31, 2001, compared to  $28.1 million atDecember 31, 2000, compared to $17.3 million at December 31, 1999, and $9.6million at December 31, 1998.   HMN’sopen-end home equity lines totaled $52.1 million at December 31, 2002, anincrease of $16.4 million from $35.7 million at December 31, 2001, compared to$26.9 million at December 31, 2000, compared to $22.4 million at December 31,1999, and $19.5 million at December 31, 1998.

 

The underwriting standards employed by the Bank forconsumer loans include a determination of the applicant’s payment history onother debts and ability to meet existing obligations and payments on theproposed loan. Although creditworthiness of the applicant is of primaryconsideration, the underwriting process also includes a comparison of the valueof the security, if any, in relation to the proposed loan amount. Consumerloans may entail greater credit risk than do residential mortgage loans,particularly in the case of consumer loans which are unsecured or are securedby rapidly depreciable assets, such as automobiles or mobile homes. In such cases,any repossessed collateral for a defaulted consumer loan may not provide anadequate source of repayment of the outstanding loan balance as a result of thegreater likelihood of damage, loss or depreciation. In addition, consumer loancollections are dependent on the borrower’s continuing financial stability, andthus are more likely to be affected by adverse personal circumstances.Furthermore, the application of various federal and state laws, includingbankruptcy and insolvency laws, may limit the amount which can be recovered onsuch loans. At December 31, 2002, $495,000 of the consumer loan portfoliowas non-performing. There can be no assurance that delinquencies will notincrease in the future.

 

***Commercial Business Lending.* **In order to satisfy the demand forfinancial services to individuals and businesses in its market area, HMNmaintains a portfolio of commercial business loans primarily to small retailoperations, small manufacturing concerns and professional firms.  HMN’s commercial business loans generallyhave terms ranging from six months to five years and may have either fixed orvariable interest rates.  HMN’scommercial business loans generally include personal guarantees and areusually, but not always, secured by business assets such as inventory,equipment, leasehold interests in equipment fixtures, real estate and accountsreceivables. The underwriting process for commercial business loans includesconsideration of the borrower’s financial statements, tax returns, projectionsof future business operations and inspection of the subject collateral, if any.HMN has also purchased participation interests in commercial business loansfrom third party originators. The underlying collateral for the loans aregenerally inventory or equipment and generally have repayment periods of lessthan ten years. Commercial business loans totaled $91.1 million at December 31,2002, an increase of $36.2 million from $54.9 million at December 31, 2001,compared to $48.8 million at December 31, 2000, compared to $24.4 million atDecember 31, 1999, and $11.7 million at December 31, 1998.

 

Unlike residential mortgage loans, which generally aremade on the basis of the borrower’s ability to make repayment from his or herincome, and which are secured by real property whose value tends to be moreeasily ascertainable, commercial business loans are of higher risk andtypically are made on the basis of the

 

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borrower’s ability to make repayment from the cash flow of theborrower’s business.  As a result, theavailability of funds for the repayment of commercial business loans may besubstantially dependent on the success of the business itself. Furthermore, thecollateral securing the loans may depreciate over time, may be difficult toappraise and may fluctuate in value based on the success of the business. AtDecember 31, 2002, $619,000 of loans in the commercial business loanportfolio were non-performing. There can be no assurance that delinquencieswill not increase in the future.

 

**Originations, Purchases and Sales of Loans and Mortgage-Backed andRelated Securities**

 

Real estate loans are generally originated by HMN’sstaff of salaried and commissioned loan officers.  Loan applications are taken in all branch offices.

 

While HMN originates both fixed and adjustable-rateloans, its ability to originate loans is dependent upon the relative customerdemand for loans in its market. Demand for adjustable-rate loans is affected bythe interest rate environment. HMN originated for portfolio $8.6 million ofone-to-four family adjustable rate loans during 2002, the same amount as in2001, compared to $12.5 million for 2000. HMN also originated for portfolio$19.8 million of fixed rate one-to-four family loans during 2002, an increaseof $6.4 million from $13.4 million for 2001, compared to $2.7 million for 2000.

 

During the past several years HMN has focused itsportfolio loan origination efforts on commercial real estate, commercialbusiness and consumer loans because these loans generally have terms tomaturity and adjustable interest rate characteristics which are generally morebeneficial to HMN than single family fixed-rate conventional loans.  HMN originated $201.2 million of multi-familyand commercial real estate, commercial business and consumer loans (whichexcludes commercial real estate loans in construction or development) duringthe year ended December 31, 2002, an increase of $91.6 million fromoriginations of $109.6 million for 2001, compared to $112.9 million for 2000.

 

In order to supplement loan demand in HMN’s marketarea and geographically diversify its loan portfolio, HMN purchases real estateloans from selected sellers, with yields based upon current market rates.  HMN carefully reviews and underwrites all loansto be purchased to ensure that they meet HMN’s underwriting standards. Theseller generally continues to service the purchased loans. HMN purchased $71.3million of loans during 2002, an increase of $58.9 million from $12.4 millionduring 2001, compared to $20.6 million during 2000.  The majority of the purchased one-to-four family loans haveinterest rates that are fixed for a one, three or five year period and thenadjust annually thereafter or were 15 year fixed-rate loans. The commercialreal estate and commercial business loans purchased have terms and interestrates that are similar in nature to HMN’s originated commercial and businessportfolio.  All purchased loans arereviewed to determine that each loan meets certain underwriting requirements.Refer to Note 4 of the Notes to Consolidated Financial Statements in the AnnualReport for more information on purchased loans.

 

HMN has substantial holdings of mortgage-backed andrelated securities which are held, depending on the investment intent, in the“available for sale” portfolio. HMN purchased $10.1 million of mortgage-backedsecurities during 2002, an increase of $10.1 million from in 2001, compared to$2.1 million for 2000.  HMN sold nomortgage-backed securities during 2002, a decrease of $2.1 million from the$2.1 million sold during 2001, compared to sales of $30.0 million for 2000. See– “Investment Activities.”

 

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The following table showsthe loan and mortgage-backed and related securities origination, purchase,acquisition, sale and repayment activities of HMN for the periods indicated.

 

**LOANS HELD FOR INVESTMENT**

 
|                                             |   | **Year Ended  December 31,** |   |
|--------------------------------------------------|--------|------------------------------|--------|
| **(Dollars in thousands)**                       |   | **2002**                     |   | **2001** |   | **2000** |   |
| Originations  by type:                           |   |                         |   |   |   |   |   |
| Adjustable-rate:                                 |   |                         |   |   |   |   |   |
| Real-estate  – one-to-four family           |   | $                            | 8,583  |   | 8,581 |   | 12,479 |   |
| -multi-family                                    |   | 866                          |   | 1,765 |   | 160 |   |
| -commercial                                      |   | 25,768                       |   | 8,947 |   | 7,953 |   |
| -construction  or development                    |   | 63,145                       |   | 49,314 |   | 28,727 |   |
| Non-real  estate – consumer                 |   | 36,498                       |   | 21,199 |   | 20,374 |   |
| -commercial  business                            |   | 48,866                       |   | 13,262 |   | 20,681 |   |
| Total  adjustable-rate                           |   | 183,726                      |   | 103,068 |   | 90,374 |   |
| Fixed-rate:                                      |   |                         |   |   |   |   |   |
| Real  estate-one-to-four family                  |   | 19,798                       |   | 13,350 |   | 2,698 |   |
| -multi-family                                    |   | 0                            |   | 56 |   | 738 |   |
| -commercial                                      |   | 21,666                       |   | 7,003 |   | 8,194 |   |
| -construction  or development                    |   | 16,335                       |   | 16,731 |   | 4,502 |   |
| Non-real  estate –consumer                  |   | 26,589                       |   | 30,756 |   | 36,706 |   |
| -commercial  business                            |   | 40,981                       |   | 26,571 |   | 18,062 |   |
| Total  fixed-rate                                |   | 125,369                      |   | 94,467 |   | 70,900 |   |
| Total  loans originated                          |   | 309,095                      |   | 197,535 |   | 161,274 |   |
| Purchases:                                       |   |                         |   |   |   |   |   |
| Real  estate-one-to-four family                  |   | 11,819                       |   | 0 |   | 10,133 |   |
| -  commercial                                    |   | 23,305                       |   | 2,371 |   | 2,045 |   |
| -construction  or development                    |   | 25,049                       |   | 1,715 |   | 4,750 |   |
| Non-real  estate – commercial business      |   | 11,105                       |   | 8,360 |   | 3,671 |   |
| Total  loans purchased                           |   | 71,278                       |   | 12,446 |   | 20,599 |   |
| Sales  and repayments:                           |   |                         |   |   |   |   |   |
| Real  estate – commercial                   |   | 162                          |   | 2,398 |   | 2,240 |   |
| Construction  or development                     |   | 6,381                        |   | 99 |   | 0 |   |
| Non-real  estate – consumer                 |   | 0                            |   | 0 |   | 207 |   |
| -  commercial business                           |   | 162                          |   | 439 |   | 0 |   |
| Total  sales                                     |   | 6,705                        |   | 2,936 |   | 2,447 |   |
| Loans  securitized and transferred to securities |   | 0                            |   | 0 |   | 11,129 |   |
| Transfers  to (from) loans held for sale         |   | 9,502                        |   | 2,214 |   | (5,081 | ) |
| Principal  repayments                            |   | 243,828                      |   | 221,495 |   | 134,347 |   |
| Total  reductions                                |   | 260,035                      |   | 226,645 |   | 142,842 |   |
| Increase  (decrease) in other items, net         |   | (55,205                      | )      | (28,202 | ) | 1,694 |   |
| Net  increase (decrease)                         |   | $                            | 65,133 |   | (44,866 | ) | 40,725 |   |

 

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**LOANS HELD FOR SALE**

 
|                                           |   | **Year Ended  December 31,** |    |
|------------------------------------------------|--------|------------------------------|---------|
| **(Dollars in thousands)**                     |   | **2002**                     |    | **2001** |   | **2000** |   |
| Originations  by type:                         |   |                         |    |   |   |   |   |
| Adjustable-rate:                               |   |                         |    |   |   |   |   |
| Real-estate  – one-to-four family         |   | $                            | 7,477   |   | 664 |   | 1,724 |   |
| -  construction or development                 |   | 268                          |    | 0 |   | 0 |   |
| Total  adjustable-rate                         |   | 7,745                        |    | 664 |   | 1,724 |   |
| Fixed-rate:                                    |   |                         |    |   |   |   |   |
| Real  estate-one-to-four family                |   | 167,884                      |    | 235,614 |   | 58,928 |   |
| -  construction or development                 |   | 3,667                        |    | 2,559 |   | 1,240 |   |
| Total  fixed-rate                              |   | 171,551                      |    | 238,173 |   | 60,168 |   |
| Total  loans originated                        |   | 179,296                      |    | 238,837 |   | 61,892 |   |
| Purchases:                                     |   |                         |    |   |   |   |   |
| Real  estate-one-to-four family                |   | 32,203                       |    | 544,053 |   | 51,826 |   |
| Total  loans purchased                         |   | 32,203                       |    | 544,053 |   | 51,826 |   |
| Sales  and repayments:                         |   |                         |    |   |   |   |   |
| Real  estate – one-to-four family         |   | 274,602                      |    | 724,219 |   | 104,815 |   |
| Total  sales                                   |   | 274,602                      |    | 724,219 |   | 104,815 |   |
| Transfers  to (from) loans held for investment |   | (9,502                       | )       | (2,214 | ) | 5,081 |   |
| Total  reductions                              |   | 265,100                      |    | 722,005 |   | 109,896 |   |
| Net  increase (decrease)                       |   | $                            | (53,601 | ) | 60,885 |   | 3,822 |   |

 

**MORTGAGE-BACKED AND RELATEDSECURITIES**

 
|                                             |   | **Year Ended  December 31,** |    |
|--------------------------------------------------|--------|------------------------------|---------|
| **(Dollars in thousands)**                       |   | **2002**                     |    | **2001** |   | **2000** |   |
| Loans  securitized and transferred to securities |   | $                            | 0       |   | 0 |   | 11,129 |   |
| Purchases:                                       |   |                         |    |   |   |   |   |
| Mortgage-backed  securities:                     |   |                         |    |   |   |   |   |
| CMOs  and REMICs(1)                              |   | 10,063                       |    | 0 |   | 2,112 |   |
| Total  securitizations and purchases             |   | 10,063                       |    | 0 |   | 13,241 |   |
| Sales:                                           |   |                         |    |   |   |   |   |
| Mortgage-backed  securites:                      |   |                         |    |   |   |   |   |
| Adjustable-rate(2)                               |   | 0                            |    | 0 |   | 3,776 |   |
| Fixed-rate(2)                                    |   | 0                            |    | 0 |   | 1,674 |   |
| CMOs  and REMICs                                 |   | 0                            |    | 2,069 |   | 24,574 |   |
| Total  sales                                     |   | 0                            |    | 2,069 |   | 30,024 |   |
| Principal  repayments                            |   | (24,397                      | )       | (7,081 | ) | (8,615 | ) |
| Net  decrease                                    |   | $                            | (14,334 | ) | (9,150 | ) | (25,398 | ) |

 

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(1) CollateralizedMortgage Obligations and Real Estate Mortgage Investment Conduits

(2) Consists ofpass-through securities.

 

**ClassifiedAssets and Delinquencies**

 

***Classification of Assets*. **Federal regulations require that eachsavings institution classify its own assets on a regular basis. In addition, inconnection with examinations of savings institutions, the Office of ThriftSupervision (OTS) and Federal Deposit Insurance Corporation (FDIC) examiners haveauthority to identify problem assets and, if appropriate, require them to beclassified.  There are threeclassifications for problem assets: Substandard, Doubtful and Loss. Assets classified as Substandard have one or more defined weaknesses andare characterized by the distinct possibility that the Bank will sustain someloss if the deficiencies are not corrected. Assets classified as Doubtful have the weaknesses of those classified asSubstandard, with the additional characteristics that make collection orliquidation in full on the basis of currently existing facts, conditions andvalues questionable, and there is a high possibility of loss. An assetclassified as Loss is considered uncollectible and of such little value thatcontinuance as an asset on the balance sheet of the institution is notwarranted.  Assets classified asSubstandard or Doubtful require the institution to establish prudent generalallowances for loan losses. If an asset or portion thereof is classified asLoss, the institution must either establish specific allowances for loan lossesin the amount of 100% of the portion of the asset classified as Loss, or charge

 

14

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off such amount. If an institution does not agree with an examiner’sclassification of an asset, it may appeal this determination to the DistrictDirector of the OTS.  On the basis ofmanagement’s review of its assets, at December 31, 2002, the Bank hadclassified a total of $5.2 million of its loans and other assets in thesecategories as follows:

 
| **(Dollars in thousands)** |   | **One-to-Four  Family** |   | **Construction  or  Development** |   | **Commercial  and  Multi-family** |   | **Consumer** |   | **Commercial  Business** |   | **Other  Assets** |   | **Total** |   |
|----------------------------|--------|-------------------------|--------|-----------------------------------|--------|-----------------------------------|--------|--------------|--------|--------------------------|--------|-------------------|--------|-----------|--------|
| Substandard                |   | $                       | 866    |                              | 0      |                              | 143    |         | 389    |                     | 227    |              | 1,400  |      | 3,025  |   |
| Doubtful                   |   | 0                       |   | 0                                 |   | 0                                 |   | 54           |   | 0                        |   | 0                 |   | 54        |   |
| Loss                       |   | 0                       |   | 0                                 |   | 1,719                             |   | 52           |   | 392                      |   | 0                 |   | 2,163     |   |
| Total                      |   | $                       | 866    |                              | 0      |                              | 1,862  |         | 495    |                     | 619    |              | 1,400  |      | 5,242  |   |

 

The Bank’s classified assets consist of non-performingloans and loans and other assets of concern discussed herein.  As of the date hereof, these assetclassifications are materially consistent with those of the OTS and FDIC.

 

***Delinquency Procedures.*** When aborrower fails to make a required payment on a loan, HMN attempts to cure thedelinquency by contacting the borrower. A late notice is sent on all loans over16 days delinquent. Additional written and verbal contacts may be made with theborrower between 30 and 60 days after the due date. If the loan iscontractually delinquent 90 days, HMN usually sends a 30-day demand letter tothe borrower and after the loan is contractually delinquent 120 days,institutes appropriate action to foreclose on the property. If foreclosed, theproperty is sold at a sheriff’s sale and may be purchased by HMN. Delinquentconsumer loans are generally handled in a similar manner. HMN’s procedures forrepossession and sale of consumer collateral are subject to variousrequirements under state consumer protection laws.

 

Real estate acquired byHMN as a result of foreclosure or by deed in lieu of foreclosure is classifiedas real estate in judgment for six months to one year and thereafter as realestate owned until it is sold. When property is acquired or expected to beacquired by foreclosure or deed in lieu of foreclosure, it is recorded at the lowerof cost or estimated fair value, less the estimated cost of disposition. Afteracquisition, all costs incurred in maintaining the property are expensed. Costsrelating to the development and improvement of the property, however, arecapitalized to the extent of fair value less disposition cost.

 

The following table setsforth HMN’s loan delinquencies by type, by amount and by percentage of type atDecember 31, 2002.

 
|                            |   | **Loans  Delinquent For:** |   | **Total  Delinquent  Loans** |   |
|---------------------------------|--------|----------------------------|--------|------------------------------|--------|
| **60-89 Days**                  |   | **90 Days  and Over**      |
| **(Dollars in thousands)**      |   | **Number**                 |   | **Amount**                   |   | **Percent  of Loan  Category** |   | **Number** |   | **Amount** |   | **Percent  of Loan  Category** |   | **Number** |   | **Amount** |   | **Percent  of Loan  Category** |   |
| One-to-four  family real estate |   | 14                         |   | $                            | 1,078  |   | 0.71 | % | 9 |   | $ | 866 |   | 0.57 | % | 23 |   | $ | 1,944 |   | 1.28 | % |
| Consumer                        |   | 29                         |   | 430                          |   | 0.45 |   | 23 |   | 495 |   | 0.51 |   | 52 |   | 925 |   | 0.96 |   |
| Commercial  business            |   | 0                          |   | 0                            |   | 0.00 |   | 2 |   | 35 |   | 0.04 |   | 2 |   | 35 |   | 0.04 |   |
| Total                           |   | 43                         |   | $                            | 1,508  |   | 0.28 | % | 34 |   | $ | 1,396 |   | 0.26 | % | 77 |   | $ | 2,904 |   | 0.53 | % |

 

15

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# **Investment Activities**

 

HMN and the Bank utilizethe available for sale securities portfolio in virtually all aspects ofasset/liability management strategy. In making investment decisions, theInvestment-Asset/Liability Committee considers, among other things, the yieldand interest rate objectives, the credit risk position and the projected cashflow requirements.

 

***Securities.* **Federally chartered savings institutions have the authorityto invest in various types of liquid assets, including United States Treasuryobligations, securities of various federal agencies, certain certificates ofdeposit of insured banks and savings institutions, certain bankers’acceptances, repurchase agreements and federal funds. Subject to variousrestrictions, the holding company of a federally chartered savings institutionmay also invest their assets in commercial paper, investment grade corporatedebt securities and mutual funds whose assets conform to the investments that afederally chartered savings institution is otherwise authorized to makedirectly.

 

The investment strategyof HMN and the Bank has been directed toward a mix of high-quality assets(primarily government and agency obligations) with short and intermediate termsto maturity.  At December 31, 2002,HMN did not own any investment securities of a single issuer which exceeded 10%of HMN’s stockholder’s equity other than U.S. government or federal agencyobligations.

 

The Bank invests aportion of its liquid assets in interest-earning overnight deposits of theFederal Home Loan Bank of Des Moines (“FHLB”) and various money market mutualfunds.  Other investments include highgrade medium-term (up to three years) corporate debt securities, medium-termfederal agency notes, and a variety of other types of mutual funds which investin adjustable-rate, mortgage-backed securities, asset-backed securities,repurchase agreements and U.S. Treasury and agency obligations.  This investment has been classified asnon-performing since the third quarter of 2001. HMN invests in the same type ofinvestment securities as the Bank and also invests in taxable and tax exemptmunicipal obligations and corporate equities such as preferred and commonstock.  Refer to Note 3 of the Notes toConsolidated Financial Statements in the Annual Report for additionalinformation regarding HMN’s securities portfolio.

 

16

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The following table setforth the composition of HMN’s securities portfolio, excluding mortgage-backedand related securities, at the dates indicated.

 
|                                                                                                                                             |   | **2002**        |    | **2001**         |   | **2000**          |    |
|--------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------|---------|------------------|--------|-------------------|---------|
|                                                                                                                                             |   | **Amort  Cost** |    | **Adjusted  To** |   | **Market  Value** |    | **% 0f  Total** |   | **Amort  Cost** |   | **Adjusted  To** |   | **Market  Value** |   | **% 0f  Total** |   | **Amort  Cost** |   | **Adjusted  To** |   | **Market  Value** |   | **% 0f  Total** |   |
| Securities available for sale:                                                                                                                   |   |            |    |             |   |              |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| U.S. Government and agency obligations                                                                                                           |   | $               | 61,098  |             | 2,154  |              | 63,252  |   | 59.05 | % | $ | 34,576 |   | 210 |   | 34,786 |   | 41.04 | % | $ | 35,216 |   | (1,206 | ) | 34,010 |   | 37.59 | % |
| U.S. Treasury obligations                                                                                                                        |   | 0               |    | 0                |   | 0                 |    | 0.00 |   | 0 |   | 0 |   | 0 |   | 0.00 |   | 1,482 |   | (2 | ) | 1,480 |   | 1.64 |   |
| Municipal obligations                                                                                                                            |   | 319             |    | (11              | )      | 308               |    | 0.29 |   | 728 |   | (9 | ) | 719 |   | 0.85 |   | 1,104 |   | (6 | ) | 1,098 |   | 1.21 |   |
| Corporate debt                                                                                                                                   |   | 1,061           |    | 16               |   | 1,077             |    | 1.01 |   | 9,546 |   | 96 |   | 9,642 |   | 11.37 |   | 16,235 |   | (501 | ) | 15,734 |   | 17.39 |   |
| Corporate equity                                                                                                                                 | (1)    | 1,300           |    | 191              |   | 1,491             |    | 1.39 |   | 4,821 |   | (91 | ) | 4,730 |   | 5.58 |   | 8,587 |   | (768 | ) | 7,819 |   | 8.64 |   |
| Stock of federal agencies                                                                                                                        | (1)    | 3,504           |    | (131             | )      | 3,373             |    | 3.15 |   | 3,768 |   | 21 |   | 3,789 |   | 4.47 |   | 3,768 |   | (82 | ) | 3,686 |   | 4.07 |   |
| Subtotal                                                                                                                                         |   | 67,282          |    |             |   | 69,501            |    | 64.89 |   | 53,439 |   |   |   | 53,666 |   | 63.31 |   | 66,392 |   |   |   | 63,827 |   | 70.54 |   |
| Federal Home Loan Bank stock                                                                                                                     |   | 11,881          |    |             |   | 11,881            |    | 11.09 |   | 12,245 |   |   |   | 12,245 |   | 14.44 |   | 12,245 |   |   |   | 12,245 |   | 13.53 |   |
| Total investment securities and Federal Home Loan  Bank stock                                                                                    |   | 79,163          |    |             |   | 81,382            |    | 75.98 |   | 65,684 |   |   |   | 65,911 |   | 77.75 |   | 78,637 |   |   |   | 76,072 |   | 84.07 |   |
|                                                                                                                                             |   |            |    |             |   |              |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Average remaining life of investment securities  excluding Federal Home Loan Bank stock                                                          |   | 2.3 years       |    |             |   |              |    |   |   | 2.8 years |   |   |   |   |   |   |   | 4.3 years |   |   |   |   |   |   |   |
|                                                                                                                                             |   |            |    |             |   |              |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Other interest earning assets:                                                                                                                   |   |            |    |             |   |              |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash equivalents                                                                                                                                 |   | 25,729          |    |             |   | 25,729            |    | 24.02 |   | 18,864 |   |   |   | 18,864 |   | 22.25 |   | 14,417 |   |   |   | 14,417 |   | 15.93 |   |
| Total                                                                                                                                            |   | $               | 104,892 |             |   |              | 107,111 |   | 100.00 | % | $ | 84,548 |   |   |   | 84,775 |   | 100.00 | % | $ | 93,054 |   |   |   | 90,489 |   | 100.00 | % |
| Average remaining life or term to repricing of  investment securities and other interest earning assets, excluding Federal  Home Loan Bank stock |   | 1.7 years       |    |             |   |              |    |   |   | 2.1 years |   |   |   |   |   |   |   | 3.7 years |   |   |   |   |   |   |   |

 

----

(1)Average life assignedto corporate equity holdings and stock of federal agencies is five years.

 

17

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The composition andmaturities of the investment securities portfolio, excluding Federal Home LoanBank stock, mortgage-backed securities and other related securities, areindicated in the following table.

 
|                            |   | **December 31,  2002** |   |
|---------------------------------|--------|-----------------------------|--------|
|                            |   | **1 Year  or Less**         |   | **After 1  through 5  Years** |   | **After 5  through 10  Years** |   | **Over  10  Years** |   | **No Stated  Maturity** |   | **Total  Securities** |   |   |   |
| **(Dollars in thousands)**      |   | **Amortized  Cost**         |   | **Amortized  Cost** |   | **Amortized  Cost** |   | **Amortized  Cost** |   | **Amortized  Cost** |   | **Amortized  Cost** |   | **Adjusted  To** |   | **Market  Value** |   |
| Securities  available for sale: |   |                        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| U.S.  government securities     |   | $                           | 0      |   | 60,990 |   | 0 |   | 108 |   | 0 |   | 61,098 |   | 2,154 |   | 63,252 |   |
| Municipal  obligations          |   | 0                           |   | 0 |   | 319 |   | 0 |   | 0 |   | 319 |   | (11 | ) | 308 |   |
| Corporate  debt                 |   | 883                         |   | 178 |   | 0 |   | 0 |   | 0 |   | 1,061 |   | 16 |   | 1,077 |   |
| Corporate  equity               |   | 0                           |   | 0 |   | 0 |   | 0 |   | 1,300 |   | 1,300 |   | 191 |   | 1,491 |   |
| Stock  of federal agencies      |   | 0                           |   | 0 |   | 0 |   | 0 |   | 3,504 |   | 3,504 |   | (131 | ) | 3,373 |   |
| Total  stock                    |   | $                           | 883    |   | 61,168 |   | 319 |   | 108 |   | 4,804 |   | 67,282 |   |   |   | 69,501 |   |
|                            |   |                        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Weighted  average yield(1)      |   | 2.76                        | %      | 3.44 | % | 7.55 | % | 8.50 | % | 6.03 | % | 3.64 | % |   |   |   |   |

 

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(1)  Yields are computed on a tax equivalentbasis.

 

***Mortgage-Backed and Related Securities*. **In order to supplement loan productionand achieve its asset/liability management goals, HMN invests inmortgage-backed and related securities. All of the mortgage-backed and relatedsecurities owned by HMN are issued, insured or guaranteed either directly orindirectly by a federal agency or are rated “AA” or higher.  HMN had $51.9 million of mortgage-backed andrelated securities classified as “available for sale” at December 31, 2002,compared to $66.2 at December 31, 2001 and $75.4 at December 31, 2000.

 

The contractual maturities of the mortgage-backed andrelated securities portfolio without any prepayment assumptions at December 31,2002 is as follows:

 
| **(Dollars in thousands)**                |   | **5 Years  or Less** |   | **5 to 10  Years** |   | **10 to 20  Years** |   | **Over 20  Years** |   | **December 31,  2002  Balance  Outstanding** |   |
|-------------------------------------------|--------|----------------------|--------|--------------------|--------|---------------------|--------|--------------------|--------|---------------------------------------------------|--------|
| Securities  available for sale:           |   |                 |   |               |   |                |   |               |   |                                              |   |
| Federal  Home Loan Mortgage Corporation   |   | $                    | 0      |               | 229    |                | 1,161  |               | 203    |                                              | 1,593  |   |
| Federal  National Mortgage Association    |   | 0                    |   | 0                  |   | 144                 |   | 0                  |   | 144                                               |   |
| Government  National Mortgage Association |   | 2                    |   | 0                  |   | 54                  |   | 0                  |   | 56                                                |   |
| Collateralized  Mortgage Obligations      |   | 0                    |   | 267                |   | 6,477               |   | 43,359             |   | 50,103                                            |   |
| Total                                     |   | $                    | 2      |               | 496    |                | 7,836  |               | 43,562 |                                              | 51,896 |   |
|                                      |   |                 |   |               |   |                |   |               |   |                                              |   |
| Weighted  average yield                   |   | 9.00                 | %      | 6.59               | %      | 5.96                | %      | 2.85               | %      | 3.35                                              | %      |

 

At December 31,2002, HMN did not have any non-agency mortgage-backed or related securities inexcess of 10% of its stockholders’ equity.

 

CMOs are securitiesderived by reallocating the cash flows from mortgage-backed securities or poolsof mortgage loans in order to create multiple classes, or tranches, ofsecurities with coupon rates and average lives that differ from the underlyingcollateral as a whole.  The terms tomaturity of any particular tranche is dependent upon the prepayment speed ofthe underlying collateral as well as the structure of the particular CMO.  Although a significant proportion of HMN’sCMOs are in tranches which have been structured (through the use of cash flowpriority and “support” tranches) to give somewhat more predictable cash flows,the cash flow and hence the value of CMOs is subject to change.

 

18

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At December 31, 2002, HMNhad $43.6 million invested in CMOs which have floating interest rates thatchange either monthly or quarterly, compared to $54.6 million at December 31,2001, and $58.2 million at December 31, 2000.

 

Refer to Management’sDiscussion and Analysis - Market Risk Table on page 22 in the Annual Report forinformation on changes in market value of the mortgage-backed or relatedsecurities under different rate shock environments.

 

Mortgage-backed andrelated securities can serve as collateral for borrowings and, through salesand repayments, as a source of liquidity. In addition, mortgage-backed and related securities available for salecan be sold to respond to changes in economic conditions.

 

**Sourcesof Funds**

 

***General.* **The Bank’s primary sources of funds are deposits, payments of loanprincipal, interest earned on loans and securities, repayments of securities,borrowings and other funds provided from operations.

 

***Deposits.* **The Bank offers a variety of deposit accounts having a wide range ofinterest rates and terms.  The Bank’sdeposits consist of passbook, negotiable order of withdrawal (NOW), moneymarket, non-interest bearing checking and certificate accounts (includingindividual retirement accounts) to retail consumers and commercial businessaccounts.  The Bank relies primarily oncompetitive pricing policies and customer service to attract and retain thesedeposits. The Bank also obtains brokered deposits.

 

The variety of depositaccounts offered by the Bank has allowed it to be competitive in obtainingfunds and to respond with flexibility to changes in consumer demand.  As customers have become more interest rateconscious, the Bank has become more susceptible to short-term fluctuations indeposit flows.  The Bank manages thepricing of its deposits in keeping with its asset/liability management,profitability and growth objectives. Based on its experience, the Bank believes that its passbook and NOWaccounts are relatively stable sources of deposits.  However, the ability of the Bank to attract and maintaincertificate deposits, and the rates paid on these deposits, has been and willcontinue to be significantly affected by market conditions.

 

The following table setsforth the savings flows at the Bank during the periods indicated.

 

 
|                       |   | **Year Ended  December 31,** |    |
|----------------------------|--------|-----------------------------------|---------|
| **(Dollars in thousands)** |   | **2002**                          |    | **2001** |   | **2000** |   |
| Opening  balance           |   | $                                 | 421,843 |   | 421,691 |   | 400,382 |   |
| Deposits                   |   | 1,444,532                         |    | 1,075,211 |   | 785,319 |   |
| Withdrawals                |   | (1,442,495                        | )       | (1,091,668 | ) | (780,460 | ) |
| Interest  credited         |   | 9,071                             |    | 16,609 |   | 16,450 |   |
| Ending  balance            |   | 432,951                           |    | 421,843 |   | 421,691 |   |
|                       |   |                              |    |   |   |   |   |
| Net  increase              |   | $                                 | 11,108  |   | 152 |   | 21,309 |   |
|                       |   |                              |    |   |   |   |   |
| Percent  increase          |   | 2.63                              | %       | 0.04 | % | 5.32 | % |

 

19

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The following table setsforth the dollar amount of savings deposits in the various types of depositprograms offered by the Bank as of December 31:

 
|                                   |   | **2002**   |    | **2001**               |   | **2000**   |   |
|----------------------------------------|--------|------------|---------|------------------------|--------|------------|--------|
| **(Dollars in thousands)**             |   | **Amount** |    | **Percent   of Total** |   | **Amount** |   | **Percent  of Total** |   | **Amount** |   | **Percent  of Total** |   |
| Transactions  and Savings Deposits(1): |   |       |    |                   |   |       |   |   |   |   |   |   |   |
|                                   |   |       |    |                   |   |       |   |   |   |   |   |   |   |
| Non-interest  checking                 |   | $          | 28,173  |                   | 6.51   | %          | $      | 18,148 |   | 4.30 | % | $ | 12,923 |   | 3.07 | % |
| NOW  Accounts – 0.30%(2)          |   | 43,509     |    | 10.03                  |   | 40,225     |   | 9.54 |   | 33,068 |   | 7.84 |   |
| Passbook  Accounts – 0.35%(3)     |   | 41,033     |    | 9.48                   |   | 32,738     |   | 7.76 |   | 32,742 |   | 7.76 |   |
| Money  Market Accounts – 1.16%(4) |   | 49,510     |    | 11.44                  |   | 45,002     |   | 10.67 |   | 34,427 |   | 8.16 |   |
| Total Non-Certificates                 |   | $          | 162,225 |                   | 37.46  | %          | $      | 136,113 |   | 32.27 | % | $ | 113,160 |   | 26.83 | % |
|                                   |   |       |    |                   |   |       |   |   |   |   |   |   |   |
| Certificates:                          |   |       |    |                   |   |       |   |   |   |   |   |   |   |
| 1.00  -  1.99%                    |   | $          | 23,003  |                   | 5.31   | %          | $      | 2,785 |   | 0.66 | % | $ | 0 |   | 0.00 | % |
| 2.00  -  2.99%                    |   | 72,161     |    | 16.67                  |   | 34,924     |   | 8.28 |   | 244 |   | 0.06 |   |
| 3.00  -  3.99%                    |   | 75,445     |    | 17.43                  |   | 64,330     |   | 15.25 |   | 15,884 |   | 3.77 |   |
| 4.00  -  4.99%                    |   | 74,818     |    | 17.28                  |   | 64,097     |   | 15.19 |   | 38,420 |   | 9.11 |   |
| 5.00  -  5.99%                    |   | 23,719     |    | 5.48                   |   | 35,909     |   | 8.51 |   | 52,714 |   | 12.50 |   |
| 6.00  -  6.99%                    |   | 1,468      |    | 0.35                   |   | 70,282     |   | 16.66 |   | 159,765 |   | 37.89 |   |
| 7.00  -  7.99%                    |   | 112        |    | 0.02                   |   | 13,403     |   | 3.18 |   | 41,504 |   | 9.84 |   |
| Total  Certificates                    |   | 270,726    |    | 62.54                  |   | 285,730    |   | 67.73 |   | 308,531 |   | 73.17 |   |
| Total  Deposits                        |   | $          | 432,951 |                   | 100.00 | %          | $      | 421,843 |   | 100.00 | % | $ | 421,691 |   | 100.00 | % |

 

----

(1)          Reflects rates paid ontransaction and savings deposits at December 31, 2002.

(2)          The rate on NOW accountsfor 2001 was 0.64% and 2000 was 1.0%.

(3)          The rate on PassbookAccounts for 2001 was 0.75% and 2000 was 2.0%.

(4)   The rate on Money Market Accounts for 2001was 1.89% and 2000 was 3.96%.

 

20

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The following table showsrate and maturity information for the Bank’s certificates of deposit as ofDecember 31, 2002.

 
| **(Dollars in thousands)**                           |   |             |   |             |   |             |   |             |   |             |   |             |   |             |   |            |   |      |    |                  |   |
|------------------------------------------------------|--------|------------------|--------|------------------|--------|------------------|--------|------------------|--------|------------------|--------|------------------|--------|------------------|--------|-----------------|--------|-----------|---------|-----------------------|--------|
| **Certificate accounts maturing in quarter ending:** |   | **0.00-  0.99%** |   | **1.00-  1.99%** |   | **2.00-  2.99%** |   | **3.00-  3.99%** |   | **4.00-  4.99%** |   | **5.00-  5.99%** |   | **6.00-  6.99%** |   | **7.00  7.99%** |   | **Total** |    | **Percent  of Total** |   |
|                                                 |   |             |   |             |   |             |   |             |   |             |   |             |   |             |   |            |   |      |    |                  |   |
| March  31, 2003                                      |   | 70               |   | 7,944            |   | 20,572           |   | 13,666           |   | 996              |   | 1,539            |   | 923              |   | 0               |   | 45,710    |    | 16.88                 |   |
| June  30, 2003                                       |   | 74               |   | 6,028            |   | 20,286           |   | 12,990           |   | 814              |   | 1,135            |   | 33               |   | 0               |   | 41,360    |    | 15.28                 |   |
| September  30, 2003                                  |   | 78               |   | 1,488            |   | 8,480            |   | 1,367            |   | 1,079            |   | 1,773            |   | 108              |   | 0               |   | 14,373    |    | 5.31                  |   |
| December 31,  2003                              |   | 88               |   | 6,105            |   | 2,043            |   | 378              |   | 1,042            |   | 3,101            |   | 180              |   | 0               |   | 12,937    |    | 4.78                  |   |
| March  31, 2004                                      |   | 8                |   | 171              |   | 16,664           |   | 245              |   | 6,504            |   | 3,914            |   | 176              |   | 0               |   | 27,682    |    | 10.23                 |   |
| June  30, 2004                                       |   | 34               |   | 116              |   | 998              |   | 305              |   | 8,940            |   | 9,819            |   | 39               |   | 0               |   | 20,251    |    | 7.48                  |   |
| September  30, 2004                                  |   | 17               |   | 20               |   | 1,157            |   | 10,140           |   | 10,733           |   | 917              |   | 0                |   | 0               |   | 22,984    |    | 8.49                  |   |
| December  31, 2004                                   |   | 37               |   | 537              |   | 891              |   | 8,822            |   | 674              |   | 227              |   | 5                |   | 0               |   | 11,193    |    | 4.13                  |   |
| March  31, 2005                                      |   | 21               |   | 5                |   | 185              |   | 3,091            |   | 10,609           |   | 282              |   | 0                |   | 0               |   | 14,193    |    | 5.24                  |   |
| June  30, 2005                                       |   | 10               |   | 73               |   | 401              |   | 2,582            |   | 16,529           |   | 161              |   | 0                |   | 12              |   | 19,768    |    | 7.30                  |   |
| September  30, 2005                                  |   | 5                |   | 3                |   | 238              |   | 18,459           |   | 541              |   | 129              |   | 0                |   | 100             |   | 19,475    |    | 7.20                  |   |
| December  31, 2005                                   |   | 7                |   | 0                |   | 246              |   | 187              |   | 328              |   | 68               |   | 0                |   | 0               |   | 836       |    | 0.31                  |   |
| Thereafter                                           |   | 32               |   | 31               |   | 1                |   | 3,213            |   | 16,029           |   | 654              |   | 4                |   | 0               |   | 19,964    |    | 7.37                  |   |
| Total                                                |   | $                | 481    |             | 22,521 |             | 72,162 |             | 75,445 |             | 74,818 |             | 23,719 |             | 1,468  |            | 112    |      | 270,726 |                  | 100.00 | % |
|                                                 |   |             |   |             |   |             |   |             |   |             |   |             |   |             |   |            |   |      |    |                  |   |
| Percent  of total                                    |   | 0.18             | %      | 8.32             | %      | 26.65            | %      | 27.87            | %      | 27.64            | %      | 8.76             | %      | 0.54             | %      | 0.04            | %      | 100.00    | %       |                  |   |
|                                                      |        |                  |        |                  |        |                  |        |                  |        |                  |        |                  |        |                  |        |                 |        |           |         |                       |        |  |

 

21

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The following tableindicates the amount of the Bank’s certificates of deposit and other depositsby time remaining until maturity as of December 31, 2002.

 
|                                         |   | **Maturity**          |   |                     |   |
|----------------------------------------------|--------|-----------------------|--------|--------------------------|--------|
| **(Dollars  in thousands)**                  |   | **3 Months  or Less** |   | **Over  3 to 6  Months** |   | **Over  6 to 12  Months** |   | **Over  12  months** |   | **Total** |   |
| Certificates  of deposit less than $100,000  |   | $                     | 36,499 |                     | 32,374 |   | 24,976 |   | 124,889 |   | 218,738 |   |
| Certificates  of deposit of $100,000 or more |   | 7,809                 |   | 7,985                    |   | 2,335 |   | 30,799 |   | 48,928 |   |
| Public  funds of $100,000 or more(1)         |   | 1,402                 |   | 1,000                    |   | 0 |   | 658 |   | 3,060 |   |
| Total  certificates of deposit               |   | $                     | 45,710 |                     | 41,359 |   | 27,311 |   | 156,346 |   | 270,726 |   |
| Passbook  of $100,000 or more                |   | $                     | 9,250  |                     | 0      |   | 0 |   | 0 |   | 9,250 |   |
| Accounts  of $100,000 or more                |   | $                     | 18,461 |                     | 8,985  |   | 2,335 |   | 31,457 |   | 61,238 |   |
|                                              |        |                       |        |                          |        |  |  |  |  |  |  |  |  |

 

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(1) Deposits fromgovernmental and other public entities.

 

 

For additionalinformation regarding the composition of the Bank’s deposits, see Note 13 ofthe Notes to  Consolidated FinancialStatements in the Annual Report.  Foradditional information on certificate maturities and the impact on HMN’sliquidity see Liquidity starting on page 20 of the Annual Report.

 

***Borrowings.***  The Bank’s other available sources of funds include advances fromthe FHLB and other borrowings.  As amember of the FHLB, the Bank is required to own capital stock in the FHLB andis authorized to apply for advances from the FHLB.  Each FHLB credit program has its own interest rate, which may befixed or variable, and range of maturities. The FHLB may prescribe the acceptable uses for these advances, as wellas limitations on the size of the advances and repayment provisions.  Consistent with its asset/liabilitymanagement strategy, the Bank has utilized FHLB advances from time to time toextend the term to maturity of its liabilities.  Also, the Bank has used FHLB borrowings to fund loan demand andother investment opportunities and to offset deposit outflows.  At December 31, 2002, the Bank had$218.3 million of FHLB advances outstanding. On such date, the Bank had a collateral pledge arrangement with the FHLBof Des Moines pursuant to which the Bank may borrow up to an additional $13.0million for liquidity purposes.  Referto Note 14 of the Notes to Consolidated Financial Statements in the AnnualReport for more information on FHLB advances.

 

At December 31, 2002, HMNhad an undrawn $2.5 million revolving line of credit with a bank.  The credit line matures November 15, 2003and has the flexibility of electing a rate based on prime minus 75 basis pointsor London Interbank Offering Rate (“LIBOR”). Refer to Other Financial Data on page 52 and Note 15 of the Notes toConsolidated Financial Statements in the Annual Report for more informationconcerning the Bank’s borrowing ability.

 

# **ServiceCorporations of the Bank**

 

As a federally charteredsavings bank, the Bank is permitted by OTS regulations to invest up to 2% ofits assets in the stock of, or loans to, service corporation subsidiaries, andmay invest an additional 1% of its assets in service corporations where suchadditional funds are used for inner-city or community developmentpurposes.  In addition to investments inservice corporations, federal institutions are permitted to invest an unlimitedamount in operating subsidiaries engaged solely in activities in which afederal savings bank may engage directly.

 

OAI is a Minnesotacorporation that was organized in 1983. OAI operated as an insurance agency until 1986 when its assets weresold.  OAI remained inactive until 1993when it began offering credit life insurance, annuity products and mutual fundproducts to the Bank’s customers and others. OAI recorded a net loss of $13,200for the year ended December 31, 2002.

 

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HFMS is a Delaware Limited Liability Corporation thatwas formed in 2001. HFMS was a 51% owned mortgage banking and mortgagebrokerage business located in Brooklyn Park, Minnesota.  HFMS’s brokerage and production activitystopped during the third quarter of 2002 and the Bank assumed responsibilityfor certain components of HFMS.  Theremaining assets of HFMS, consisting primarily of single family mortgage loans,are in the process of being liquidated. HFMS recorded a net loss of $437,000 for the year ended December 31,2002.

 

HFH is a Delaware corporation that was formed in 2002,with it principal office in Grand Caymen Islands.  HFH is the holding company for HFREIT which invests in realestate loans acquired from the Bank.  

 

# **Competition**

 

The Bank faces strongcompetition both in originating real estate, commercial and consumer loans andin attracting deposits.  Competition inoriginating loans comes primarily from mortgage bankers, commercial banks,credit unions and other savings institutions, which also make loans secured byreal estate located in the Bank’s market area and through Internet bankingoperations throughout the continental United States.  The Bank competes for loans principally on the basis of theinterest rates and loan fees it charges, the types of loans it originates andthe quality of services it provides to borrowers.

 

Competition for deposits is principally from moneymarket and mutual funds, securities firms, commercial banks and other savingsinstitutions located in the same communities and through Internet bankingoperations which are throughout the continental United States.  The ability of the Bank to attract andretain deposits depends on its ability to provide an investment opportunitythat satisfies the requirements of investors as to rate of return, liquidity,risk, convenient locations and other factors. The Bank competes for these deposits by offering a variety of depositaccounts at competitive rates, convenient business hours and a customeroriented staff.

 

 

# **Other CorporationsOwned by HMN**

 

HMN has one other wholly owned subsidiary, SecurityFinance Corporation (SFC).  During 2002,SFC began acting as an intermediary for the Bank in transacting like kindproperty exchanges for customers.  Priorto 2002, SFC invested in commercial loans and commercial real estate loanslocated throughout the United States which were originated by third parties.

 

 

# **Employees**

 

At December 31,2002, HMN had a total of 195 full-time equivalent employees.  None of the employees of HMN or itssubsidiaries are represented by any collective bargaining unit.  Management considers its employee relationsto be good.

 

 

**Regulation and Supervision**

 

The banking industry is highly regulated, and as asavings and loan holding company HMN is subject to regulation by OTS.  The Bank, a federally-chartered savingsassociation, is subject to extensive regulation and examination by the OTS,which is the Bank’s primary federal regulator. The FDIC also has some authority to regulate the Bank.  Subsidiaries of HMN and the Bank may also besubject to state regulation and/or licensing in connection with certaininsurance or mortgage banking activities. HMN and the Bank are subject to numerous laws and regulations.  These laws and regulations imposerestrictions on activities, set minimum capital

 

23

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requirements, impose lending and deposit restrictions and establishother restrictions.  References in thissection to applicable statutes and regulations are brief and incompletesummaries only.  You should consult thestatutes and regulations for a full understanding of the details of theiroperation.

 

**Holding Company Regulation**

 

An entity that owns a savings association is a savingsand loan holding company (“SLHC”).  If aholding company owns more than one savings association, it is a multiple SLHC;if it owns only one savings association, it is a unitary SLHC.  HMN is a unitary SLHC.  The Home Owners Loan Act (“HOLA”)historically limited multiple SLHCs and their non-association subsidiaries tofinancial activities and services and to activities authorized for bank holdingcompanies, but unitary SLHCs, in the past, were not subject to restrictions onthe activities that could be conducted by holding companies or theiraffiliates.

 

In November of 1999 the Gramm-Leach-Biley Act (“GLBAct”) was signed into law.  The GLB Actmade significant changes to laws regulating the financial servicesindustry.  Changes included:  (1) a new framework under in which bankholding companies can own securities firms, insurance companies and otherfinancial companies; (2) prohibitions on new unitary SLHCs from engaging innon-financial activities or affiliating with non-financial entities; (3) newconsumer protections associated with the transfer and use of non-publicpersonal information by financial institutions; and (4) modifications to theFederal Home Loan Bank System.  UnitarySLHCs, such as HMN, that were in existence or had an application filed with theOTS on or before May 4, 1999, are not subject to the new restrictions onunitary SLHCs.  As a result, the GLB Actdid not affect HMN’s ability to control non-financial firms or engage innon-financial activities.

 

Acquisitions by Savingsand Loan Holding Companies. Acquisition of a savings association or a savings and loan holdingcompany is generally subject to OTS approval and the public must have anopportunity to comment on the proposed acquisition.  Without prior approval from the OTS, HMN may not acquire morethan 5% of the voting stock of a savings association.

 

Examination and Reporting.  Under HOLA and OTS regulations HMN, as aSLHC, must file periodic reports with the OTS. In addition, HMN must comply with OTS recordkeeping requirements.  HMN is subject to holding company examinationby the OTS.  The OTS may takeenforcement action if the activities of a SLHC constitute a serious risk to thefinancial safety, soundness or stability of a subsidiary savings association.

 

Affiliate Transactions.  The Bank, as a holding company subsidiarythat is a depository institution, is subject to both qualitative and quantitativelimitations on transactions with HMN and HMN’s other subsidiaries.  *See* “Transactions with Affiliates andInsiders” below.

 

Capital Adequacy.  HMN is not currently subject to regulatorycapital requirements, the Bank is subject to various capital requirements.  See “Capital Requirements” below.

 

**Bank Regulation**

 

As a federally-chartered savings association, the Bankis subject to regulation and supervision by the OTS.  Federal law authorizes the Bank as a federal savings association,to conduct, subject to various conditions and limitations, business activitiesthat include:  accepting deposits andpaying interest on them; making and buying loans secured by residential andother real estate; making a limited amount of consumer loans; making a limitedamount of commercial loans; investing in corporate obligations, government debtsecurities, and other securities; and offering various banking, trust,securities and insurance agency services to its customers.

 

OTS regulations place limits on the Bank’s lending andinvestment powers.  Savings associationsare expected to conduct lending activities in a prudent, safe and soundmanner.  OTS regulations set aggregatelimits on certain types of loans including commercial loans and consumerloans.  OTS regulations also establishlimits on loans to a single borrower. As of December 31, 2002, the Bank’s loan limit to one borrower wasapproximately $9.5 million.  A federalsavings association generally may not invest in noninvestment-grade debt 

 

24

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securities.  A federal savingsassociation may establish subsidiaries to conduct any activity the associationis authorized to conduct and may establish service corporation subsidiaries forlimited preapproved activities.

 

Qualified Thrift LenderTest.  Savingsassociations, including the Bank, must be qualified thrift lenders(“QTL”).  A savings associationgenerally satisfies the QTL requirement if at least 65% of a specified assetbase consists of things such as loans to small businesses and loans to purchaseor improve domestic residential real estate. Savings associations may qualify as QTLs in other ways.  Savings associations that do not qualify asQTLs are subject to significant restrictions on their operations.  If the Bank fails to meet QLT requirementsthe Bank and HMN would face certain limitations, including limits on HMN’sability to control non-financial firms. As of December 31, 2002, the Bank met the QTL test.

 

OTS Assessments.  HOLA authorizes the OTS to chargeassessments to recover the costs of examining savings associations and theiraffiliates.  The assessment is donesemi-annually.  The OTS bases theassessment on three factors: 1) asset size; 2) condition; and 3) complexity of theinstitution.  The Bank’s OTS assessmentfor the year ended December 31, 2002, was approximately $145,000.

 

Transactions withAffiliates and Insiders. Banks and savings associations are subject to affiliate and insidertransaction restrictions.  Therestrictions prohibit or limit a savings association from extending credit to,or entering into certain transactions with affiliates, principal stockholders,directors and executive officers of the savings association and itsaffiliates.  The term “affiliate”generally includes a holding company, such as HMN, and any company under commoncontrol with the savings association. Federal law limits transactions between the Bank and any one affiliateto 10% of the Bank’s capital and surplus and with all affiliates in theaggregate to 20%.** **In addition, thefederal law governing unitary savings and loan holding companies prohibits theBank from making any loan to any affiliate whose activity is not permitted fora subsidiary of a bank holding company. This law also prohibits the Bank from making any equity investment inany affiliate that is not its subsidiary. The Bank is currently in materialcompliance with these requirements.

 

Dividend Restrictions.  Federal law limits the ability of adepository institution, such as the Bank, to pay dividends or make othercapital distributions.  The Bank, as asubsidiary of a savings and loan holding company, must file a notice with theOTS before the proposed declaration of a dividend or approval of a proposedcapital distribution by its board of directors and must obtain prior approvalfrom the OTS if it fails to meet certain regulatory conditions. No dividendswere declared or distributed by the Bank in 2002.

 

**Deposit Insurance**

 

The FDIC insures the deposits of the Bank.  The FDIC administers two separate depositinsurance funds, the Bank Insurance Fund (“BIF”) and the Savings AssociationInsurance Fund (“SAIF”).  The BIF is adeposit insurance fund for commercial banks and some state-chartered savings associations.  The SAIF is a deposit insurance fund formost savings associations.  The Bank is a member of the SAIF.

 

The FDIC has established a risk-based system forsetting deposit insurance assessments. Under the risk-based assessment system, an institution’s insuranceassessments vary according to the level of capital the institution holds andthe degree to which it is the subject of supervisory concern.  In addition, regardless of the potentialrisk to the insurance fund, federal law requires the FDIC to establishassessment rates that will maintain each insurance fund’s ratio of reserves toinsured deposits at $1.25 per $100. Both funds currently exceed this reserve ratio.  During 2002, the assessment rate for bothSAIF and BIF deposits ranged from zero to 0.27% of covered deposits.  The Bank qualified for the lowest rate onSAIF deposits in 2002 and thus paid $0 in 2002.  It is possible that the reserve ratio will fall below 1.25% andaccordingly, it is possible the Bank will have to pay deposit insuranceassessment in 2003.

 

In addition to deposit insurance assessments, the FDICis authorized to collect assessments against insured deposits to be paid to theFinancing Corporation (“FICO”) to service FICO debt incurred in the 1980s.  The FICO assessment rate is adjustedquarterly. In 2002 the Bank paid an assessment of approximately $74,000.

 

25

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**Capital Requirements**

 

The federal bank regulatory agencies, including theOTS, have a risk-based capital framework in place.  The regulators use a combination of risk based guidelines andleverage ratios to evaluate capital adequacy.

 

The following table sets forth the current regulatoryrequirement for capital ratios for savings associations as compared with theBank’s capital ratios at December 31, 2002:

 
|                    |   | **Core or  Tier 1  Capital to Adjusted  Total Assets** |   | **Tangible  Capital to  Assets** |   | **Core or  Tier 1  Capital to Risk-  Weighted Assets** |   | **Total  Capital to  Risk-Weighted  Assets** |   |
|-------------------------|--------|-------------------------------------------------------------|--------|----------------------------------|--------|-------------------------------------------------------------|--------|----------------------------------------------|--------|
| Regulatory  Minimum     |   | 3.00                                                        | %(1)   | 1.50                             | %      | 4.00                                                        | %      | 8.00                                         | %      |
| The  Bank’s Actual |   | 8.29                                                        | %      | 8.29                             | %      | 11.42                                                       | %      | 12.17                                        | %      |

 

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(1)  Most savings associations are required tomaintain a leverage ratio of 4.00% or more.

 

**Capital Categories and Prompt Corrective Action**

 

The Federal Deposit Insurance Corporation ImprovementAct of 1991 (“FDICIA”) created a statutory framework that increased theimportance of meeting applicable capital requirements.  FDICIA established five capitalcategories:  (1) well-capitalized; (2)adequately capitalized; (3) undercapitalized; (4) significantlyundercapitalized; and (5) critically undercapitalized.  The activities in which a depositoryinstitution may engage and regulatory responsibilities of federal bankregulatory agencies vary depending upon whether an institution iswell-capitalized, adequately capitalized or under capitalized.  Under capitalized institutions are subjectto various restrictions such as limitations on dividends and growth.  A depository institution’s category dependsupon where its capital levels are in relation to relevant capital measures,which include a risk-based capital measure and certain other factors.  The federal banking agencies (including theOTS) adopted regulations that implement this statutory framework.  Under these regulations, an institution isgenerally treated as well-capitalized if its ratio of total capital torisk-weighted assets is 10.00% or more, its ratio of core capital torisk-weighted assets is 6.00% or more, its ratio of core capital to adjustedtotal assets (leverage ratio) is 5.00% or more, and it is not subject to anyfederal supervisory order or directive to meet a specific capital level.  In order to be adequately capitalized, aninstitution must have a total risk-based capital ratio of not less than 8.00%,a Tier 1 risk-based capital ratio of not less than 4.00%, and a leverage ratioof not less than 4.00%.  Any institutionthat is neither well capitalized nor adequately capitalized will be consideredundercapitalized.  The Bank currently isconsidered well capitalized.

 

**Other Regulations and Examination Authority**

 

The FDIC has adopted regulations to protect thedeposit insurance funds and depositors, including regulations governing thedeposit insurance of various forms of accounts.  Federal regulation of depository institutions is intended for theprotection of depositors (and the BIF and the SAIF), and not for the protectionof stockholders or other creditors.  Inaddition, federal law requires that in any liquidation or other resolution ofany FDIC-insured depository institution, claims for administrative expenses ofthe receiver and for deposits in U.S. branches (including claims of the FDIC assubrogee of the insured institution) shall have priority over the claims ofgeneral unsecured creditors.

 

The OTS may sanction any OTS-regulated bank that doesnot operate in accordance with OTS regulations, policies and directives.  The FDIC has additional authority toterminate insurance of accounts, after notice and hearing, upon a finding thatthe insured institution is or has engaged in any unsafe or unsound practicethat has not been corrected, is operating in an unsafe or unsound condition, orhas violated any applicable law, regulation, rule, or order of or conditionimposed by the FDIC.

 

26

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**Federal Home Loan Bank (“FHLB”) System**

 

The Bank is a member of the FHLB of Des Moines(“FHLB”), which is one of the 12 regional Federal Home Loan Banks (“FHB”), thatadministers the home financing credit function of savings associations.  Each FHB serves as a reserve or central bankfor its members within its assigned region. It is funded primarily from proceeds derived from the sale ofconsolidated obligations of the FHB System. It makes loans or advances to members in accordance with policies andprocedures established by the board of directors of the FHB.  These policies and procedures are subject tothe regulation and oversight of the Federal Housing Financing Board.  All advances from the FHLB are required to befully secured by sufficient collateral as determined by the FHB.  Long-term advances are required to be usedfor residential home financing and small business and agricultural loans.

 

As a member, the Bank is required to purchase andmaintain stock in the FHLB of Des Moines. As of December 31, 2002, the Bank had $11.9 million in FHLB stock,which was in compliance with this requirement. In past years, the Bank has received dividends on its FHLB stock.  Over the past five calendar years suchdividends have averaged approximately 5.3%.

 

**Federal Reserve Regulation**

 

Under Federal Reserve Board regulations, the Bank isrequired to maintain reserves against transaction accounts (primarilyinterest-bearing and noninterest-bearing checking accounts).  Because reserves must generally bemaintained in cash or in noninterest-bearing accounts, the effect of thereserve requirements is to increase an institution’s cost of funds.  These regulations generally require that theBank maintain reserves against net transaction accounts.  The reserve levels are subject to adjustmentby the Federal Reserve Board.  A savingsassociation, like other depository institutions maintaining reservableaccounts, may, under certain conditions, borrow from the Federal Reserve Bankdiscount window.

 

Numerous other regulations promulgated by the FederalReserve Board or the OTS affect the business operations of the Bank.  These include regulations relating toprivacy, equal credit access, electronic fund transfers, collection of checks,lending and savings disclosures, and availability of funds.

 

**Community Reinvestment Act**

 

The Community Reinvestment Act (“CRA”) requiresfinancial institutions regulated by the federal financial supervisory agenciesto ascertain and help meet the credit needs of their delineated communities,including low-to moderate-income neighborhoods within those communities, whilemaintaining safe and sound banking practices. The regulatory agency assigns one of four possible ratings to aninstitution’s CRA performance and is required to make public an institution’srating and written evaluation.  The fourpossible ratings of meeting community credit needs are outstanding,satisfactory, needs improvement and substantial noncompliance.  Under regulations that apply to all CRAperformance evaluations after July 1, 1997, many factors play a role in assessinga financial institution’s CRA performance. The institution’s regulator must consider its financial capacity andsize, legal impediments, local economic conditions and demographics, includingthe competitive environment in which it operates.  The evaluation does not rely on absolute standards, and theinstitutions are not required to perform specific activities or to providespecific amounts or types of credit. The Bank maintains a CRA statement for public viewing, as well as anannual CRA highlights document.  Thesedocuments describe the Bank’s credit programs and services, community outreachactivities, public comments and other efforts to meet community creditneeds.  The Bank’s last CRA exam wasNovember 11, 2001 and the Bank received a “Satisfactory” rating.

 

**BankSecrecy Act**

 

The Bank Secrecy Actrequires financial institutions to keep records and file reports that aredetermined to have a high degree of usefulness in criminal, tax and regulatorymatters, and to implement counter-money laundering programs and complianceprocedures.

 

27

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**USAPatriot Act of 2001**

 

Enacted in response tothe terrorist attacks in New York, Pennsylvania and Washington, D.C. onSeptember 11, 2001, the USA Patriot Act of 2001 (the “Patriot Act”) is intendedto strengthen U.S. law enforcement’s and the intelligence communities’ abilityto work cohesively to combat terrorism on a variety of fronts. The potentialimpact of the Patriot Act on financial institutions of all kinds is significantand wide ranging. The Patriot Act contains sweeping anti-money laundering andfinancial transparency laws and requires various regulation including: duediligence requirements for financial institutions that administer, maintain ormanage private bank accounts or correspondent accounts for non-U.S. persons;standards for verifying customer identification at the time of account opening;rules to promote cooperation among financial institutions, regulators, and lawenforcement entities in identifying parties that may be involved in terrorismor money laundering; reports by nonfinancial trades and business filed with theTreasury Department’s Financial Crimes Enforcement Network for transactionsexceeding $10,000 and; filing of suspicious activity reports by brokers anddealers if they believe a customer may be violating U.S. laws and regulations.The impact on bank operations from the Patriot Act will ultimately depend onthe types of customers served by the bank and the form that issued and pendingregulations ultimately take.

 

#### **Forward-looking Information**

 

This Form 10-K and otherreports issued by HMN, including other reports filed with the Securities andExchange Commission, may contain “forward-looking” statements that deal withfuture results, plans or performance. In addition, HMN’s management may makesuch statements orally to the media, or to securities analysts, investors orothers.  Forward-looking statements dealwith matters that do not relate strictly to historical facts. HMN’s futureresults may differ materially from historical performance and forward-lookingstatements about HMN’s expected financial results or other plans are subject toa number of risks and uncertainties. These include but are not limited topossible legislative changes and adverse economic, business and competitivedevelopments such as shrinking interest margins; deposit outflows; reduceddemand for financial services and loan and lease products; changes inaccounting policies and guidelines, or monetary and fiscal policies of thefederal government; changes in credit and other risks posed by HMN’s loan,lease and investment portfolios; technological, computer-related or operationaldifficulties; adverse changes in securities markets; results of litigation orother significant uncertainties.

 

 

**ITEM2.   PROPERTIES**

 

At December 31, 2002, HMN leased the corporate officeat 1016 Civic Center Drive NW, Rochester, Minnesota and owned the buildings andland for 9 of its 12 full service branches. The remaining three full servicebranches are leased, as are the mortgage banking/brokerage office at 7101Northland Circle, Suite 200 Brooklyn Park, Minnesota and the Eagle CrestCapital Bank location at 5201 Eden Avenue, Suite 170, Edina, Minnesota. TheBank uses all properties except for the mortgage banking/brokerage office,which is used by HFMS. All the properties are located in Minnesota, except forthe two full service branches located in Iowa.

 

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The property of two former full services brancheslocated at 4th and Center in Winona, Minnesota and 29 South CenterStreet, in Marshalltown, Iowa are currently for sale and a portion of thebuilding located at 3900 55th Street NW is available for lease. In addition,the property at 101 North Broadway, Spring Valley, Minnesota that waspreviously used for corporate offices is being used for storage.

 

At December 31, 2002, HMN’s premises had an aggregatenet book value of approximately $8.6 million. See Note 12 of Notes toConsolidated Financial Statements in the Annual Report for more information onpremises and equipment.

 

###### **ITEM3.  LEGAL PROCEEDINGS**

 

From time to time, the Bank and HMN are involved asplaintiff or defendant in various legal proceedings arising in the normalcourse of its business. While the ultimate outcome of these various legalproceedings cannot be predicted with certainty, it is the opinion of managementthat the resolution of these legal actions should not have a material effect onHMN’s consolidated financial condition or results of operations.

 

 

**ITEM4.   SUBMISSION OF MATTERS TO A VOTE OFSECURITY HOLDERS**

 

None.

 

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**PARTII**

 

**ITEM5.   MARKET FOR THE REGISTRANT’S COMMONEQUITY AND RELATED SECURITY HOLDER MATTERS**

 

The information on pages 19,41,52 and the back coverpage of the Annual Report to Security Holders for the year ended December 31,2002 is incorporated herein by reference.

 

**ITEM6.   SELECTED FINANCIAL DATA**

 

The information on page 7 of the Annual Report toSecurity Holders for the year ended December 31, 2002 is incorporated herein byreference.

 

**ITEM7.   MANAGEMENT’S DISCUSSION ANDANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

Theinformation on pages 8 through 23 of the Annual Report to Security Holders forthe year ended December 31, 2002 is incorporated herein by reference.

 

**ITEM7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK**

 

Theinformation on pages 21 through 23 of the Annual Report to Security Holders forthe year ended December 31, 2002 is incorporated herein by reference.

 

**ITEM8.   FINANCIAL STATEMENTS ANDSUPPLEMENTARY DATA**

 

Theinformation on pages 24 through 52 of the Annual Report to Security Holders forthe year ended December 31, 2002 is incorporated herein by reference.

 

**ITEM9.   CHANGES IN AND DISAGREEMENTS WITHACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE**

 

None.

 

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**PARTIII**

 

**ITEM10.   DIRECTORS AND EXECUTIVE OFFICERSOF THE REGISTRANT**

 

The information regarding directors on pages 1 through5 and the information regarding beneficial ownership reporting compliance onpage 16 and 17 of the Registrant’s definitive Proxy Statement dated March 21,2003 is incorporated herein by reference.

 

**Executive Officers of the Registrant Who Are Not Directors**

 

Officers are elected annually by the Board ofDirectors of HMN and the Bank.  Thebusiness experience of each executive officer of both HMN and the Bank who isnot also a director of HMN is set forth below.

 

***Dwain C. Jorgensen.***  Mr. Jorgensen, age 54, is Senior VicePresident Operations of HMN and the Bank. Mr. Jorgensen has held such positions since 1998.  From 1989 to 1998, he served as VicePresident, Controller and Chief Accounting Officer of HMN and the Bank. From1983 to 1989, Mr. Jorgensen was an Assistant Vice President and OperationsOfficer with the Bank.

 

***Jon J. Eberle.***  Mr.Eberle, age 37, is Vice President Controller of HMN and the Bank. Mr. Eberlehas been Vice President since 2000 and has been Controller since 1998.  From 1994 to 1998, he served as the Directorof Internal Audit for HMN and the Bank.

 

In addition to the abovenamed directors, Timothy P. Johnson served as the Chief Financial Officer forthe Company and the Bank since November 2000. Pursuant to the terms of a separation agreement, Mr. Johnson hasresigned as an officer of the Company and the Bank effective March 31, 2003.

 

**ITEM11.   EXECUTIVE COMPENSATION**

 

The information on pages 9 through 13 of theRegistrant’s definitive Proxy Statement dated March 21, 2003 is incorporatedherein by reference.

 

**ITEM12.  SECURITY OWNERSHIP OF CERTAINBENEFICIAL OWNERS AND MANAGEMENT**

 

The information on pages 1, 2, 3, and 4 of theRegistrant’s definitive Proxy Statement dated March 21, 2003 is incorporatedherein by reference.

 

The following tableprovides information as of December 31, 2002 for compensation plans under whichequity securities may be issued.

 
| **Plan Category**                                       |   | **(a)  Number of Securities to be   issued upon exercise of   outstanding options,  warrants and rights** |   | **(b)  Weighted-average  exercise price of  outstanding options,  warrants and rights** |   | **(c)  Number of securities remaining  available for future issuance under  equity compensation plans (excluding  securities reflected in column (a))(1)** |    |
|---------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------|---------|
| Equity  compensation plans approved by shareholders     |   | 619,658                                                                                                   |   | $                                                                                       | 12.20  |                                                                                                                                                       | 196,987 |   |
| Equity  compensation plans not approved by shareholders |   | 0                                                                                                         |   | 0                                                                                       |   | 0                                                                                                                                                          |    |
| Total                                                   |   | 619,658                                                                                                   |   | $                                                                                       | 12.20  |                                                                                                                                                       | 196,987 |   |

 

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(1)                                  Includessecurities available for future issuance under stockholder approvedcompensation plans other than upon the exercise of an option, warrant or right,as follows: 9,397 shares under the Company’s Amended and Restated Stock Optionand Incentive Plan dated July 29, 1998 and 187,590 shares under the Company’s2001 Omnibus Stock Plan.

 

31

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**ITEM13.   CERTAIN RELATIONSHIPS AND RELATEDTRANSACTIONS**

 

The information on page 15 of the Registrant’sdefinitive Proxy Statement dated March 21, 2003 is incorporated herein by reference.

 

**ITEM14.   CONTROLS AND PROCEDURES**

 

***Evaluation of disclosure controls and procedures.*** The Company’s principal executive officer andits principal financial officer, after evaluating the effectiveness of theCompany’s disclosure controls and procedures (as defined in Exchange Act Rules13a-14(c) and 15d-14(c)) within the 90 days prior to the filing of this Form10-K, have concluded that the Company’s disclosure controls and procedures wereadequate and effective to ensure that material information relating to theCompany and its consolidated subsidiaries would be made known to them by otherswithin those entities.

 

***Changes in internal controls.***  There were no significant changes in theCompany’s internal controls or in other factors that could significantly affectthese controls subsequent to the date of their evaluation, nor were there anysignificant deficiencies or material weaknesses in the Company’s internalcontrols. As a result, no corrective actions were required or undertaken.

 

**PARTIV**

 

**ITEM 15****.   EXHIBITS, FINANCIAL STATEMENT SCHEDULES ANDREPORTS ON FORM 8-K**

 

**(a)   FinancialStatements, Financial Statement Schedules and Exhibits**

 

**1. Financial Statements**

 

The following information appearing in theRegistrant’s Annual Report to Security Holders for the year ended December 31,2002, is incorporated by reference in this Form 10-K Annual Report as Exhibit13.

 
|                                                                                                                            |   | **Pages in  2002 Annual Report** |
|---------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------|
| **Annual Report Section**                                                                                                       |   |
| Five Year Consolidated  Financial Highlights                                                                                    |   | 7                                |
|                                                                                                                            |   |                             |
| Consolidated  Balance Sheets —  December 31, 2002 and 2001                                                                 |   | 24                               |
|                                                                                                                            |   |                             |
| Consolidated  Statements of Income —  Each of the Years in the Three-Year Period Ended December 31, 2002                   |   | 25                               |
|                                                                                                                            |   |                             |
| Consolidated  Statements of Comprehensive Income —  Each of the Years in the Three-Year Period Ended December 31, 2002     |   | 25                               |
|                                                                                                                            |   |                             |
| Consolidated  Statement of Stockholders’ Equity —  Each of the Years in the Three-Year Period Ended December 31, 2002 |   | 26                               |
|                                                                                                                            |   |                             |
| Consolidated  Statements of Cash Flows —  Each of the Years in the Three-Year Period Ended December 31, 2002               |   | 27                               |
|                                                                                                                            |   |                             |
| Notes to Consolidated  Financial Statements                                                                                     |   | 28 - 48                          |
|                                                                                                                            |   |                             |
| Independent Auditors’  Report                                                                                              |   | 49                               |
|                                                                                                                            |   |                             |
| Selected Quarterly  Financial Data                                                                                              |   | 50 - 51                          |
|                                                                                                                            |   |                             |
| Other Financial Data                                                                                                            |   | 52                               |
|                                                                                                                            |   |                             |
| Common Stock Price  Information                                                                                                 |   | 52                               |

 

32

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**2.  FinancialStatement Schedules**

 

All financial statementschedules have been omitted as information is not required under the relatedinstructions, is not applicable or has been included in the Notes toConsolidated Financial Statements.

 

33

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**3.  Exhibits**

 
| **Regulation S-K  Exhibit Number** |   | **Document**                                                                                  |   | **Reference  to Prior  Filing or  Exhibit  Number  Attached Hereto** |   | **Sequential Page  Numbering  Where Attached  Exhibits Are  Located in This  Form 10-K Report** |
|------------------------------------|--------|-----------------------------------------------------------------------------------------------|--------|----------------------------------------------------------------------|--------|-------------------------------------------------------------------------------------------------|
| 2                                  |   | Agreement and Plan of  Merger dated July 1, 1997                                              |   | (1)*                                                                 |   | Not applicable                                                                                  |
|                               |   |                                                                                          |   |                                                                 |   |                                                                                            |
| 3                                  |   | Amended and Restated  Certificate of Incorporation                                            |   | (2)*                                                                 |   | Not applicable                                                                                  |
|                               |   | Amended and Restated  By-laws                                                                 |   | (3)*                                                                 |   | Not applicable                                                                                  |
|                               |   |                                                                                          |   |                                                                 |   |                                                                                            |
| 4                                  |   | Form of Common Stock  Certificate                                                             |   | (4)*                                                                 |   | Not applicable                                                                                  |
|                               |   |                                                                                          |   |                                                                 |   |                                                                                            |
| 10.1†                         |   | Early Retirement  Agreement for Mr. Gardner dated October 24, 2000                            |   | (7)*                                                                 |   | Not applicable                                                                                  |
|                               |   |                                                                                          |   |                                                                 |   |                                                                                            |
| 10.2a†                        |   | Change in Control  Agreement for Mr. McNeil dated as of November 1, 2000                      |   | (7)*                                                                 |   | Not applicable                                                                                  |
|                               |   |                                                                                          |   |                                                                 |   |                                                                                            |
| 10.2b†                        |   | Employment Agreement  for Mr. McNeil dated as of November 1, 2000                             |   | (7)*                                                                 |   | Not applicable                                                                                  |
|                               |   |                                                                                          |   |                                                                 |   |                                                                                            |
| 10.3a†                        |   | Change in Control  Agreement for Mr. Johnson dated as of November 1, 2000                     |   | (7)*                                                                 |   | Not applicable                                                                                  |
|                               |   |                                                                                          |   |                                                                 |   |                                                                                            |
| 10.3b†                        |   | Employment Agreement  for Mr. Johnson dated as of November 1, 2000                            |   | (7)*                                                                 |   | Not applicable                                                                                  |
|                               |   |                                                                                          |   |                                                                 |   |                                                                                            |
| 10.3c†                        |   | Separation Agreement  for Mr. Johnson dated as of March 17, 2003                              |   | Exhibit 10.3c                                                        |   | Filed electronically                                                                            |
|                               |   |                                                                                          |   |                                                                 |   |                                                                                            |
| 10.4†                         |   | Directors Deferred  Compensation Plan                                                         |   | (5)*                                                                 |   | Not applicable                                                                                  |
|                               |   |                                                                                          |   |                                                                 |   |                                                                                            |
| 10.5†                         |   | Amended and Restated  HMN Financial, Inc. Recognition and Retention Plan dated July 29, 1998  |   | (6)*                                                                 |   | Not applicable                                                                                  |
|                               |   |                                                                                          |   |                                                                 |   |                                                                                            |
| 10.6†                         |   | Amended and Restated  HMN Financial, Inc. Stock Option and Incentive Plan dated July 29, 1998 |   | (6)*                                                                 |   | Not applicable                                                                                  |
|                               |   |                                                                                          |   |                                                                 |   |                                                                                            |
| 10.7†                         |   | HMN Financial, Inc.  2001 Omnibus Stock Plan                                                  |   | (8)*                                                                 |   | Not applicable                                                                                  |
|                               |   |                                                                                          |   |                                                                 |   |                                                                                            |
| 13                                 |   | Portions of Annual  Report to security holders incorporated by reference                      |   | Exhibit 13                                                           |   | Filed electronically                                                                            |
|                               |   |                                                                                          |   |                                                                 |   |                                                                                            |
| 21                                 |   | Subsidiaries of  Registrant                                                                   |   | Exhibit 21                                                           |   | Filed electronically                                                                            |
|                               |   |                                                                                          |   |                                                                 |   |                                                                                            |
| 23                                 |   | Consent of KPMG LLP  dated March 25, 2003                                                     |   | Exhibit 23                                                           |   | Filed electronically                                                                            |
|                               |   |                                                                                          |   |                                                                 |   |                                                                                            |
| 99                                 |   | Certification Under 906  of the Sarbanes-Oxley Act of 2002                                    |   | Exhibit 99                                                           |   | Filed Electronically                                                                            |

 

34

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† Management contract ofcompensatory arrangement.

 

(1)*    Incorporatedby reference to the same numbered exhibit to the Company’s Current Report onForm 8-K dated July 1, 1997, filed on July 10, 1997.

(2)*    Incorporatedby reference to the same numbered exhibit to the Company’s Quarterly Report onForm 10-Q for the period ended March 31, 1998 (File No. 0-24100).

(3)*    Incorporatedby reference to the same numbered exhibit to the Company’s Quarterly Report onForm 10-Q for the period ended September 30, 1997 (File No. 0-24100).

(4)*    Incorporatedby reference to the same numbered exhibit to the Company’s RegistrationStatement on Form S-1 dated April 1, 1994 (File No. 33-77212).

(5)*    Incorporatedby reference to the same numbered exhibit to the Company’s Annual Report onForm 10-K for the period ended December 31, 1994 (File No. 0-24100).

(6)*    Incorporatedby reference to the same numbered exhibit to the Company’s Quarterly Report onForm 10-Q for the period ended September 30, 1998 (File No. 0-24100).

(7)*    Incorporatedby reference to the same numbered exhibit to the Company’s Annual Report onForm 10-K for the period ended December 31, 2000 (File No. 0-24100).

(8)*    Incorporatedby reference to Exhibit B to the Company’s Proxy Statement for its AnnualMeeting of Stockholders held on April 24, 2001 (File no. 0-24100).

 

**(b)  Reports on Form8-K:**

 

None.

 

35

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**SIGNATURES**

 

Pursuant to the requirements of Section 13 or 15(d) ofthe Securities Exchange Act of 1934, the Registrant has duly caused this reportto be signed on its behalf by the undersigned, thereunto duly authorized.

 
|                 |   | HMN FINANCIAL, INC.               |
|----------------------|--------|-----------------------------------|
|                 |   |                              |
| Date: March 25, 2003 |   | By:                          | /s/  Michael McNeil |   |
|                 |   | Michael McNeil,  President        |
|                 |   | (Duly Authorized  Representative) |

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, this report has been signed below by the followingpersons on behalf of the Registrant and in the capacities and on the datesindicated.

 
| By:    |   | /s/  Timothy R. Geisler   |   |   |                                   |                           |
|--------|--------|--------------------------------|--------|--------|----------------------------------------|--------------------------------|
|   |   | Timothy R. Geisler, Chairman   |   |   |                                   |
| Date:  |   | March 25, 2003                 |   |   |                                   |
|   |   |                           |   |   |                                   |
| By:    |   | /s/  Michael McNeil       |   | By:    |                                   | /s/  Timothy P. Johnson   |   |
|   |   | Michael McNeil,  President     |   |   | Timothy P. Johnson,                    |
|   |   | (Principal Executive  Officer) |   |   | Executive Vice  President and Director |
|   |   |                           |   |   |                                   | (Principal Financial  Officer) |
| Date:  |   | March 25, 2003                 | Date:  |   | March 25, 2003                         |
|   |   |                           |   |   |                                   |
| By:    |   | /s/  Allan R. DeBoer      |   | By:    |                                   | /s/ Duane D. Benson            |   |
|   |   | Allan R. DeBoer,  Director     |   |   | Duane D. Benson,  Director             |
| Date:  |   | March 25, 2003                 | Date:  |   | March 25, 2003                         |
|   |   |                           |   |   |                                   |
| By:    |   | /s/  Timothy R. Geisler   |   | By:    |                                   | /s/  Susan K. Kolling     |   |
|   |   | Timothy R. Geisler,  Director  |   |   | Susan K. Kolling,  Director            |
| Date:  |   | March 25, 2003                 | Date:  |   | March 25, 2003                         |
|   |   |                           |   |   |                                   |
| By:    |   | /s/ Mahlon C. Schneider        |   | By:    |                                   | /s/  Michael Fogarty      |   |
|   |   | Mahlon C. Schneider,  Director |   |   | Michael Fogarty,  Director             |
| Date:  |   | March 25, 2003                 | Date:  |   | March 25, 2003                         |
|   |   |                           |   |   |                                   |
| By:    |   | /s/  Roger P. Weise       |   | By:    |                                   | /s/  Jon J. Eberle        |   |
|   |   | Roger P. Weise,  Director      |   |   | Jon J. Eberle,                         |
|   |   |                           |   |   |                                   | Vice President and  Controller |
| Date:  |   | March 25, 2003                 | Date:  |   | March 25, 2003                         |
|        |        |                                |        |        |                                        |                                |  |  |  |  |

 

36

----

 

**CERTIFICATIONS**

 

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

 

1.             I have reviewed this annual report on Form 10-K of HMNFinancial, Inc.

 

2.             Based on my knowledge, this annual report does notcontain any untrue statement of a material fact or omit to state a materialfact necessary to make the statements made, in light of the circumstances underwhich such statements were made, not misleading with respect to the periodcovered by this quarterly report;

 

3.             Based on my knowledge, the financial statements, andother financial information included in this annual report, fairly present inall material respects the financial condition, results of operations and cashflows of the registrant as of, and for, the periods presented in this annualreport;

 

4.             The registrant’s other certifying officer and I areresponsible for establishing and maintaining disclosure controls and procedures(as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and wehave:

 

a)             designed such disclosure controlsand procedures to ensure that material information relating to the registrant,including its consolidated subsidiaries, is made known to us by others withinthose entities, particularly during the period in which this annual report isbeing prepared;

 

b)            evaluated the effectiveness of theregistrant’s disclosure controls and procedures as of a date within 90 daysprior to the filing date of this annual report (the “Evaluation Date”); and

 

c)             presented in this annual report ourconclusions about the effectiveness of the disclosure controls and proceduresbased on our evaluation as of the Evaluation Date;

 

5.             The registrant’s other certifying officer and I havedisclosed, based on our most recent evaluation, to the registrant’s auditorsand the audit committee of registrant’s board of directors (or personsperforming the equivalent function):

 

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

 

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

 

6.             The registrant’s other certifying officer and I haveindicated in this annual report whether or not there were significant changesin internal controls or in other factors that could significantly affectinternal controls subsequent to the date of our most recent evaluation,including any corrective actions with regard to significant deficiencies andmaterial weaknesses.

 
| Date: March 25, 2003 | By                                 | /s/  Michael McNeil |   |
|----------------------|------------------------------------|--------------------------|--------|
|                 | President/Chief  Executive Officer |

 

37

----

 

**CERTIFICATIONS**

 

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

 

1.             I have reviewed this annual report on Form 10-K of HMNFinancial, Inc.

 

2.             Based on my knowledge, this annual report does notcontain any untrue statement of a material fact or omit to state a materialfact necessary to make the statements made, in light of the circumstances underwhich such statements were made, not misleading with respect to the periodcovered by this quarterly report;

 

3.             Based on my knowledge, the financial statements, andother financial information included in this annual report, fairly present inall material respects the financial condition, results of operations and cashflows of the registrant as of, and for, the periods presented in this annualreport;

 

4.             The registrant’s other certifying officer and I areresponsible for establishing and maintaining disclosure controls and procedures(as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and wehave:

 

a)             designed such disclosure controlsand procedures to ensure that material information relating to the registrant,including its consolidated subsidiaries, is made known to us by others withinthose entities, particularly during the period in which this annual report isbeing prepared;

 

b)            evaluated the effectiveness of theregistrant’s disclosure controls and procedures as of a date within 90 daysprior to the filing date of this annual report (the “Evaluation Date”); and

 

c)             presented in this annual report ourconclusions about the effectiveness of the disclosure controls and proceduresbased on our evaluation as of the Evaluation Date;

 

5.             The registrant’s other certifying officer and I havedisclosed, based on our most recent evaluation, to the registrant’s auditorsand the audit committee of registrant’s board of directors (or personsperforming the equivalent function):

 

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

 

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

 

6.             The registrant’s other certifying officer and I haveindicated in this annual report whether or not there were significant changesin internal controls or in other factors that could significantly affectinternal controls subsequent to the date of our most recent evaluation,including any corrective actions with regard to significant deficiencies andmaterial weaknesses.

 
| Date: March 25, 2003 | By     | /s/  Timothy P. Johnson           |   |
|----------------------|--------|----------------------------------------|--------|
|                 |   | Treasurer and Chief  Financial Officer |
|                      |        |                                        |        |  |

 

38

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**INDEX TO EXHIBITS**

 
| **Regulation S-K  Exhibit Number** |   | **Document**                                                             |   | **Sequential  Page Numbering  Where Attached  Exhibits Are  Located in This  Form 10-K Report** |
|------------------------------------|--------|--------------------------------------------------------------------------|--------|-------------------------------------------------------------------------------------------------|
|                               |   |                                                                     |   |                                                                                            |
| 10.3c                              |   | Separation Agreement  for Mr. Johnson dated March 17, 2003               |   | Filed  electronically                                                                           |
|                               |   |                                                                     |   |                                                                                            |
| 13                                 |   | Portions of Annual  Report to Security Holders incorporated by reference |   | Filed  electronically                                                                           |
|                               |   |                                                                     |   |                                                                                            |
| 21                                 |   | Subsidiaries of  Registrant                                              |   | Filed electronically                                                                            |
|                               |   |                                                                     |   |                                                                                            |
| 23                                 |   | Consent of KPMG LLP  dated March 25, 2003                                |   | Filed  electronically                                                                           |
|                               |   |                                                                     |   |                                                                                            |
| 99.1                               |   | Certification Under 906  of the Sarbanes-Oxley Act of 2002               |   | Filed  Electronically                                                                           |
|                               |   |                                                                     |   |                                                                                            |
| 99.2                               |   | Certification Under 906  of the Sarbanes-Oxley Act of 2002               |   | Filed  Electronically                                                                           |

 

39

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