2014 Annual Report
2015_AnnualReport_cover.indd 1
2/5/2015 1:50:52 PM
1
Financial Highlights ............................................................................................................................................................
2
Letter to Shareholders and Customers .................................................................................................................................
3
Board of Directors ...............................................................................................................................................................
4
Five-year Consolidated Financial Highlights ......................................................................................................................
Management Discussion and Analysis ................................................................................................................................
5
Consolidated Financial Statements ..................................................................................................................................... 27
Notes to Consolidated Financial Statements ....................................................................................................................... 31
Report of Independent Registered Public Accounting Firm ................................................................................................ 62
Other Financial Data ........................................................................................................................................................... 63
Common Stock Information ................................................................................................................................................ 64
Selected Quarterly Financial Data ....................................................................................................................................... 65
Inside Back Cover
Corporate and Shareholder Information ...................................................................................................
Inside Back Cover
Directors and Officers ..............................................................................................................................
HMN Financial, Inc. and Home Federal Savings Bank are headquartered in Rochester, Minnesota. Home Federal
Savings Bank operates eight full service offices in Minnesota located in Albert Lea, Austin, Eagan, La Crescent, Rochester
(2), Spring Valley and Winona; one full service office in Marshalltown, Iowa; two loan origination offices located in Sartell,
Minnesota and Wauwatosa, Wisconsin; and two Private Banking offices in Rochester, Minnesota.
At or For the Year Ended
December 31,
Percentage
2014
2013
Change
FINANCIAL HIGHLIGHTS
Operating Results:
(Dollars in thousands, except per share data)
Total interest income ............................................................................. $
Total interest expense ............................................................................
Net interest income ........................................................................
Provision for loan losses .......................................................................
Net interest income after provision for loan losses ........................
Fees and service charges .......................................................................
Loan servicing fees ...............................................................................
Gain on sales of loans ...........................................................................
Other non-interest income .....................................................................
Total non-interest income ..............................................................
Total non-interest expense .............................................................
Income before income tax expense .......................................................
Income tax expense (benefit) ................................................................
Net income .....................................................................................
Preferred stock dividends and discount .........................................
Net income available to common shareholders ............................. $
20,613
1,211
19,402
(6,998)
26,400
3,458
1,058
1,828
940
7,284
21,403
12,281
4,902
7,379
(1,710)
5,669
Per Common Share Information:
Earnings per common share and common share equivalents
Basic .............................................................................................. $
Diluted ...........................................................................................
1.40
1.23
Stock price (for the year)
High ............................................................................................... $
Low ................................................................................................
Close ..............................................................................................
Book value per common share ..............................................................
Closing price to book value ...................................................................
Financial Ratios:
Return on average assets .......................................................................
Return on average common equity ........................................................
Net interest margin ................................................................................
Operating expenses to average assets ....................................................
Average equity to average assets...........................................................
Equity to total assets at year end ...........................................................
Non-performing assets to total assets ....................................................
Efficiency ratio ......................................................................................
13.95
8.94
12.40
14.77
83.95%
1.21%
9.12
3.38
3.51
13.25
13.16
2.43
80.00
22,983
3,289
19,694
(7,881)
27,575
3,513
1,029
2,102
668
7,312
22,623
12,264
(14,406)
26,670
(2,068)
24,602
6.15
5.71
10.98
2.99
10.57
13.49
78.35%
4.55%
42.22
3.51
3.86
10.77
13.21
3.76
83.77
(10.3)%
(63.2)
(1.5)
11.2
(4.3)
(1.6)
2.8
(13.0)
40.7
(0.4)
(5.4)
0.1
134.0
(72.3)
17.3
(77.0)
(73.4)%
(78.4)
(3.7)
(9.1)
23.0
(0.4)
(35.4)
(4.5)
Balance Sheet Data:
(Dollars in thousands)
Total assets ............................................................................................ $
Securities available for sale ...................................................................
Loans held for sale ................................................................................
Loans receivable, net .............................................................................
Deposits .................................................................................................
Stockholders’ equity ..............................................................................
Home Federal Savings Bank regulatory capital ratios:
Tier I or core capital ......................................................................
Tier I capital to risk weighted assets ..............................................
Risk-based capital ..........................................................................
December 31,
Percentage
2014
2013
Change
577,426
137,834
2,076
365,113
496,750
76,013
11.76%
17.21
18.48
648,622
107,956
1,502
384,615
553,930
85,675
12.22%
19.51
20.78
(11.0)%
27.7
38.2
(5.1)
(10.3)
(11.3)
(3.8)%
(11.8)
(11.1)
1
LETTER TO SHAREHOLDERS AND CLIENTS
I am very proud to present to you HMN Financial, Inc.’s 2014 Annual Report. During the year, our
staff made significant progress in achieving our strategic objectives in the areas of financial
performance, capital management, asset quality, community branch leadership, and regulatory
relations. I would like to take a moment to highlight a number of these key accomplishments.
Financial Performance
December 31, 2014 marked the third consecutive fiscal year and twelfth consecutive quarter of
profitable operations. During the year, our balance sheet declined in size due to management’s
efforts to improve diversification of our commercial loan portfolio by reducing loan concentrations.
The continued low interest rate environment has resulted in fierce competition to attract and retain
good clients. Our strategy of working with cooperative clients during the recession paid off in terms
of client loyalty and reduced margin compression. During the year, the volume of residential mortgages refinanced slowed,
however our gain on sale margins remained strong and our sale of governmental guaranteed loans increased.
Capital Management
Our continuing improvement in financial performance, combined with the decline in the size of our balance sheet mentioned
above, resulted in a much stronger capital position for the bank. The improvement enabled our company to repurchase $16.0
million in Preferred Shares and pay all accrued dividends on the Preferred Shares without the need to raise additional common
equity. In December 2014, we announced that we secured funding to repurchase the remaining $10.0 million of outstanding
Preferred Shares and in February of this year all of the remaining outstanding Preferred Shares were redeemed. With this
redemption, HMN Financial, Inc. completed the repayment of 100% of the Preferred Stock issued through the U.S. Treasury
Capital Purchase Program.
Asset Quality
Non-performing assets declined from $24.4 million at the end of 2013 to $14.0 million at the end of 2014, a reduction of over
42%. Our work to rehabilitate and collect problem loans resulted in our ability to reverse the provisions to our reserve for
loan losses by $7.0 million during the year.
Community Branch Management
Our market research determined that the communities we serve value local leadership and decision-making. We are
responding by recruiting experienced bankers to manage the major markets we serve. We believe that, over time, this will
result in the improved financial performance of these branches by accelerating the organic growth of our loans and deposits
within these markets.
Regulatory Relations
Our efforts to improve asset quality and financial performance resulted in the Office of the Comptroller of the Currency
terminating its Supervisory Agreement with Home Federal in February 2014. The Board of Governors of the Federal Reserve
System followed suit and terminated its Supervisory Agreement with the Company in May 2014. The elimination of these
restrictive agreements allows management to focus valuable resources on rebuilding the bank.
Thank you for your loyalty and support.
Respectfully,
Brad Krehbiel
President/CEO
2
3
FIVE-YEAR CONSOLIDATED FINANCIAL HIGHLIGHTS
Selected Operations Data:
(Dollars in thousands, except per share data)
Total interest income ............................................ $
Total interest expense ...........................................
Net interest income .......................................
Provision for loan losses ......................................
Net interest income (loss) after provision for
loan losses ...................................................
Fees and service charges ......................................
Loan servicing fees ..............................................
Gain on sales of loans ..........................................
Gain on sale of branch office ...............................
Other non-interest income ....................................
Total non-interest income .............................
Total non-interest expense ............................
Income (loss) before income tax expense
(benefit) ......................................................
Income tax expense (benefit) ...............................
Net income (loss) .........................................
Preferred stock dividends and discount .........
Net income (loss) available to common
2014
20,613
1,211
19,402
(6,998)
26,400
3,458
1,058
1,828
0
940
7,284
21,403
12,281
4,902
7,379
(1,710)
Year Ended December 31,
2012
2013
2011
22,983
3,289
19,694
(7,881)
27,575
3,513
1,029
2,102
0
668
7,312
22,623
30,816
7,139
23,677
2,544
21,133
3,325
964
3,574
552
575
8,990
24,670
39,541
11,135
28,406
17,278
11,128
3,739
987
1,656
0
487
6,869
29,552
2010
48,270
17,259
31,011
33,381
(2,370)
3,741
1,067
1,987
0
476
7,271
27,556
12,264
(14,406)(1)
26,670
(2,068)
5,453
132
5,321
(1,861)
(11,555)
0
(11,555)
(1,821)
(22,655)
6,323
(28,978)
(1,784)
shareholders ................................................ $
5,669
24,602
3,460
(13,376)
(30,762)
Basic earnings (loss) per common share ....... $
Diluted earnings (loss) per common share ....
1.40
1.23
6.15
5.71
0.88
0.86
(3.47)
(3.47)
(8.17)
(8.17)
(1) Relates to the elimination of the deferred tax asset valuation reserve at December 31, 2013. See “Results of Operations - Income Taxes” in the
Management Discussion and Analysis for further information.
2014
Selected Financial Condition Data:
(Dollars in thousands, except per share data)
Total assets .......................................................... $ 577,426
Securities available for sale ..................................
137,834
Loans held for sale ...............................................
2,076
Loans receivable, net ............................................
365,113
Deposits ................................................................
496,750
FHLB advances ....................................................
0
Stockholders’ equity .............................................
76,013
Book value per common share .............................
14.77
Number of full service offices ..............................
Number of loan origination offices ......................
11
2
2013
648,622
107,956
1,502
384,615
553,930
0
85,675
13.49
11
1
2011
December 31,
2012
653,327 790,155
85,891 126,114
3,709
2,584
454,045 555,908
514,951 656,176
70,000
57,061
7.36
70,000
60,834
8.02
2010
880,618
151,564
2,728
664,241
683,230
122,500
69,547
10.51
12
1
13
1
14
1
Key Ratios (2)
Stockholders’ equity to total assets at year end ....
Average stockholders’ equity to average assets ...
Return (loss) on stockholders’ equity
(ratio of net income (loss) to average equity) ..
Return (loss) on assets
(ratio of net income (loss) to average assets) ...
13.16%
13.25
13.21%
10.77
9.31%
8.81
7.22%
8.19
7.90%
9.40
9.12
1.21
42.22
8.94
(16.94)
(31.73)
4.55
0.79
(1.39)
(2.98)
(2) Average balances were calculated based upon amortized cost without the market value impact of ASC 320.
4
MANAGEMENT DISCUSSION AND ANALYSIS
forward-looking
This Annual Report, other reports filed by the Company
with the Securities and Exchange Commission, and the
Company’s proxy statement may contain forward-looking
statements within the meaning of the Private Securities
Litigation Reform Act of 1995. These statements are often
identified by such
terminology as
“expect,” “intend,” “look,” “believe,” “anticipate,”
“estimate,” “project,” “seek,” “may,” “will,” “would,”
“could,” “should,” “trend,” “target,” and “goal” or
similar statements or variations of such terms and include,
but are not limited to, those relating to increasing our core
deposit relationships, improving credit quality, reducing
non-performing assets, reducing expense and generating
improved financial results; the adequacy and amount of
available liquidity and capital resources to the Bank; the
Company’s
liquidity and capital requirements; our
expectations for core capital and our strategies and
potential strategies for improvement thereof; improvements
in loan production; changes in the size of the Bank’s loan
portfolio; the amount of the Bank’s non-performing assets
and the appropriateness of the allowance therefor;
anticipated future levels of the provision for loan losses;
future losses on non-performing assets; the amount and mix
of interest-earning assets; the amount and mix of deposits;
the availability of alternate funding sources; the payment
of dividends by HMN, the future outlook for the Company;
the amount of deposits that will be withdrawn from
checking and money market accounts and how the
withdrawn deposits will be replaced; the projected changes
in net interest income based on rate shocks; the range that
interest rates may fluctuate over the next twelve months; the
net market risk of interest rate shocks; the future outlook
for the issuer of the trust preferred securities held by the
Bank; the ability of the Bank to pay dividends to HMN; the
ability of HMN to pay the principal and interest payments
on the third party note; the ability to remain well
capitalized under revised capital rules; the expected impact
of new Basel III and the Dodd Frank Act capital standards
on the Bank’s and the Company’s capital positions; and
compliance by the Company and the Bank with regulatory
standards generally (including the Bank’s status as “well-
capitalized”) and other
supervisory directives or
requirements to which the Company or the Bank are or may
become expressly subject, specifically, and possible
responses of the Office of the Comptroller of the Currency
(OCC), Board of Governors of the Federal Reserve System
(FRB), the Bank, and the Company to any failure to comply
with any
standard, directive or
requirement.
regulatory
such
from
A number of factors could cause actual results to differ
materially
the Company’s assumptions and
expectations. These include but are not limited to the
adequacy and marketability of real estate and other
collateral securing loans to borrowers; federal and state
regulation and enforcement; possible legislative and
5
regulatory changes, including changes to regulatory
capital rules; the ability of the Bank to comply with other
applicable regulatory capital requirements; enforcement
activity of the OCC and FRB in the event of our non-
compliance with any applicable regulatory standard or
requirement; adverse economic, business and competitive
developments such as shrinking interest margins, reduced
collateral values, deposit outflows, changes in credit or
other risks posed by the Company’s loan and investment
portfolios, changes in costs associated with alternate
funding sources, including changes in collateral advance
rates and policies of the Federal Home Loan Bank,
technological, computer-related or operational difficulties,
results of litigation, and reduced demand for financial
services and loan products; changes in accounting policies
and guidelines, or monetary and fiscal policies of the
federal government or tax laws; international economic
developments; the Company’s access to and adverse
changes in securities markets; the market for credit related
assets; the future operating results, financial condition,
cash flow requirements and capital spending priorities of
the Company and the Bank; the availability of internal and,
as required, external sources of funding; or other
significant uncertainties. Additional factors that may cause
actual results to differ from the Company’s assumptions
and expectations include those set forth in the Company’s
most recent filings on Forms 10-K and 10-Q with the
Securities and Exchange Commission. All forward-looking
statements are qualified by, and should be considered in
conjunction with, such cautionary statements. For
additional discussion of the risks and uncertainties
applicable to the Company, see the “Risk Factors” sections
of the Company’s Annual Report on Form 10-K for the year
ended December 31, 2014.
All statements in this Annual Report, including forward-
looking statements, speak only as of the date hereof, and we
undertake no duty to update any of the forward-looking
statements after the date of this Annual Report.
Overview
HMN Financial, Inc. (HMN or the Company) is the stock
savings bank holding company for Home Federal Savings
Bank (the Bank), which operates community retail, private
banking and loan production offices in Minnesota, Iowa
and Wisconsin. The earnings of the Company are primarily
dependent on the Bank's net interest income, which is the
difference between
loans and
investments, and the interest paid on interest-bearing
liabilities such as deposits and Federal Home Loan Bank
(FHLB) advances. The difference between the average rate
of interest earned on assets and the average rate paid on
liabilities is the "interest rate spread". Net interest income
is produced when interest-earning assets equal or exceed
interest-bearing liabilities and there is a positive interest
rate spread. Net interest income and net interest rate spread
interest earned on
MANAGEMENT DISCUSSION AND ANALYSIS
interest-earning assets and
are affected by changes in interest rates, the volume and
mix of
interest-bearing
liabilities, and the level of non-performing assets. The
Company's net earnings are also affected by the generation
of non-interest income, which consists primarily of gains
from the sale of loans and real estate owned, fees for
servicing loans, and the generation of fees and service
charges on deposit accounts. The Bank incurs expenses in
addition to interest expense in the form of salaries and
benefits, occupancy expenses, provisions for loan losses,
deposit insurance, amortization of mortgage servicing
assets, and income taxes. The earnings of financial
institutions, such as the Bank, are also significantly affected
by prevailing economic and competitive conditions,
particularly changes in interest rates, government monetary
and fiscal policies, and regulations of various regulatory
authorities. Lending activities are influenced by the demand
for and supply of business credit, single family and
commercial properties, competition among lenders, the
level of interest rates and the availability of funds. Deposit
flows and costs of deposits are influenced by prevailing
market rates of interest on competing investments, account
maturities and the levels of personal income and savings.
Between 2008 and 2011, the Company’s commercial
business and commercial real estate loan portfolios required
significant charge offs due primarily to decreases in the
estimated value of the underlying collateral supporting the
loans, as many of these loans were made to borrowers in or
associated with the real estate industry. The decrease in the
estimated collateral value was primarily the result of
reduced demand for real estate, particularly as it relates to
single-family and commercial land developments. More
stringent lending standards implemented by the mortgage
industry in those years made it more difficult for borrowers
with marginal credit to qualify for a mortgage. This
decrease in available credit and the overall weakness in the
economy further reduced the demand for single family
homes and
the values of existing properties and
developments where the Company’s commercial loan
portfolio had concentrations. Consequently, our level of
non-performing assets and the related provision for loan
losses and charge-offs increased significantly during these
years, relative to prior periods. The increased levels of non-
performing assets, related provisions for loan losses and
loan charge-offs, expenses associated with real estate
owned, and the valuation allowance established against
deferred tax assets arising from the adverse operating
results, were the primary reasons for the net losses incurred
by the Company in each of the years 2008 through 2011.
Beginning in 2012 and continuing into 2014, commercial
real estate values stabilized and fewer charge offs were
recorded than in the 2008-2011 period. In addition, non-
performing assets and expenses associated with real estate
owned have continued to decline in 2013 and 2014, which
had a positive effect on earnings.
The Company took a number of measures since 2008 to
address its elevated level of non-performing assets,
improve operating results, and establish adequate levels of
liquidity and capital resources. Those measures included,
among others, obtaining $26 million in additional capital
through the sale of preferred stock to the United States
Treasury, substantially all of which was contributed to the
capital of the Bank. The Bank’s asset size was also reduced
by decreasing the outstanding wholesale funding amounts
and selling or closing branches. These changes contributed
to net assets being reduced $568 million from December
31, 2008 to December 31, 2014, which improved the
Bank’s capital ratios. The Company also hired additional
experienced commercial credit review staff, implemented
new loan credit approval processes, updated credit policies
and procedures, and implemented additional commercial
loan review procedures in order to improve the credit
quality of commercial loans being added to the Bank’s
portfolio and reduce commercial loan concentrations and
non-performing assets. Additional resources were also
allocated to establishing and maintaining remediation plans
on all classified loans in order to improve the monitoring
and ultimate collection of these loans. Because of these
efforts, and the relative stabilization of commercial real
estate values, the level of non-performing assets and related
loan losses have continued to decline compared to the four
years prior to 2012. The Company’s financial results in
2012 and 2013 also improved, which resulted in the
reversal of the entire valuation reserve against its deferred
tax asset in 2013.
Because of the losses incurred and elevated levels of non-
performing assets, the Company and the Bank, effective
February 22, 2011, each entered into a supervisory
agreement (the “Company Supervisory Agreement” and the
respectively, and,
“Bank Supervisory Agreement”,
collectively, the “Supervisory Agreements”) with the
Office of Thrift Supervision (the “OTS”), their primary
federal regulator at the time. The Supervisory Agreements
superseded the memoranda of understanding between each
of the Company and the Bank that were entered into with
the OTS in December 2009. As required by the Company
Supervisory Agreement, the Company submitted an initial
consolidated capital plan in May of 2011 and updated two
year capital plans in January of 2012, 2013, and 2014 and
submitted periodic reports on its compliance with the plan.
In addition, the Company could not incur or issue any debt,
guarantee the debt of any entity, declare or pay any cash
dividends or repurchase any of the Company’s capital
stock, enter into any new contractual arrangement or renew
or extend any existing arrangement related to compensation
or benefits with any director or officer, or make any golden
parachute payments, without the consent of the FRB (as
successor to the OTS with respect to the Company).
Effective May 1, 2014, the FRB terminated the Supervisory
Agreement to which the Company was subject.
6
MANAGEMENT DISCUSSION AND ANALYSIS
The Bank entered into a written Supervisory Agreement
with the OTS, effective February 22, 2011, that primarily
related to the Bank’s financial performance and credit
quality issues. In addition, the OCC (as successor to the
OTS with respect to the Bank) established an Individual
Minimum Capital Requirement (IMCR) for the Bank,
effective December 31, 2011. An IMCR requires a bank to
establish and maintain levels of capital greater than those
generally required for a bank to be classified as “well-
capitalized.” Effective February 11, 2014, the OCC
terminated the Supervisory Agreement and the IMCR to
which the Bank was subject.
For further discussion and a complete description of the
Supervisory Agreements, IMCR, and termination by the
OCC of the Bank Supervisory Agreement and IMCR, see
“Note 16 Regulatory Matters/Supervisory Agreements and
IMCR” in the Notes to the Consolidated Financial
Statements and “Item 1 – Business – Regulation and
Supervision” in our Annual Report on Form 10-K for the
fiscal year ended December 31, 2014.
Critical Accounting Estimates
Critical accounting policies are those policies that the
Company's management believes are the most important to
understanding the Company’s financial condition and
operating results. These critical accounting policies often
involve estimates and assumptions that could have a
material impact on the Company’s financial statements.
The Company has
the following critical
accounting policies that management believes involve the
most difficult, subjective, and/or complex judgments that
are inherently uncertain. Therefore, actual financial results
could differ significantly depending upon the estimates,
assumptions and other factors used.
identified
Allowance for Loan Losses and Related Provision
The allowance for loan losses is based on periodic analysis
of the loan portfolio and is maintained at an amount
considered to be appropriate by management to provide for
probable losses inherent in the loan portfolio as of the
balance sheet dates. In this analysis, management considers
factors including, but not limited to, specific occurrences of
loan impairment, actual and anticipated changes in the size
of the portfolios, national and regional economic conditions
(such as unemployment data, loan delinquencies, local
economic conditions, demand for single-family homes,
demand for commercial real estate and building lots, loan
portfolio composition and historical loss experience) and
observations made by the Company's ongoing internal audit
and regulatory exam processes. Loans are charged off to the
extent they are deemed to be uncollectible. The Company
has established separate processes to determine the
appropriateness of
its
loan
homogeneous single-family and consumer loan portfolios
portfolios. The
and
loss allowance for
non-homogeneous
loan
the
its
for
the non-homogeneous
determination of the allowance on the homogeneous single-
family and consumer loan portfolios is calculated on a
pooled basis with individual determination of the allowance
for all non-performing loans. The determination of the
commercial,
allowance
commercial real estate and multi-family loan portfolios
involves assigning standardized risk ratings and loss factors
that are periodically reviewed. The loss factors are
estimated based on the Company's own loss experience and
are assigned
identified credit
weaknesses. For each non-performing loan, the Company
also performs an individual analysis of impairment that is
based on the expected cash flows or the value of the assets
collateralizing the loans and establishes any necessary
reserves or charges off all loans or portions thereof that are
deemed uncollectable.
loans without
to all
The appropriateness of the allowance for loan losses is
dependent upon management’s estimates of variables
affecting valuation, appraisals of collateral, evaluations of
performance and status, and the amounts and timing of
future cash flows expected to be received on impaired
loans. Such estimates, appraisals, evaluations and cash
flows may be subject to adjustments due to changing
economic prospects of borrowers or properties. The fair
market value of collateral dependent loans are typically
based on the appraised value of the property less estimated
selling costs. The estimates are reviewed periodically and
adjustments, if any, are recorded in the provision for loan
losses in the periods in which the adjustments become
known. Because of the size of some loans, changes in
estimates can have a significant impact on the loan loss
provision. The allowance is allocated to individual loan
categories based upon the relative risk characteristics of the
loan portfolios and the actual loss experience. The
Company increases its allowance for loan losses by
charging the provision for loan losses against income and
decreases its allowance by crediting the provision for loan
losses. A review of the allowance in 2013 and 2014 resulted
required allowance and a
in a reduction
corresponding credit to the loan loss provision. The
methodology for establishing the allowance for loan losses
takes into consideration probable losses that have been
identified in connection with specific loans as well as losses
in the loan portfolio that have not been specifically
identified. Although management believes that based on
current conditions the allowance for loan losses is
maintained at an appropriate amount to provide for
probable loan losses inherent in the portfolio as of the
balance sheet dates,
future conditions may differ
substantially from those anticipated in determining the
allowance for loan losses and adjustments may be required
in the future.
the
in
7
MANAGEMENT DISCUSSION AND ANALYSIS
to
tax consequences attributable
Income Taxes
Deferred tax assets and liabilities are recognized for the
future
temporary
differences between the financial statement carrying
amounts of existing assets and liabilities and their
respective tax basis. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to
taxable income in the years in which those temporary
differences are expected to be recovered or settled. The
effect on deferred tax assets and liabilities of a change in
tax rates is recognized in income in the period that includes
the enactment date. These calculations are based on many
complex factors including estimates of the timing of
reversals of temporary differences, the interpretation of
federal and state income tax laws, and a determination of
the differences between the tax and the financial reporting
basis of assets and liabilities. Actual results could differ
significantly from the estimates and interpretations used in
determining the current and deferred income tax assets and
liabilities.
The Company maintains significant net deferred tax assets
for deductible temporary differences, the largest of which
relates to the allowance for loan and real estate losses and
net operating loss carryforwards. For income tax purposes,
only net charge-offs are deductible, not the entire provision
for loan losses. Under generally accepted accounting
principles, a valuation allowance is required to be
recognized if it is “more likely than not” that the deferred
tax asset will not be realized. The determination of the
realizability of the deferred tax assets is highly subjective
and dependent upon management’s
judgment and
evaluation of both positive and negative evidence,
including the forecasts of future income, tax planning
strategies, and assessments of the current and future
economic and business conditions. The Company considers
both positive and negative evidence regarding the ultimate
realizability of deferred tax assets. Positive evidence
includes the Company’s cumulative net income in the prior
three year period, the ability to implement tax planning
strategies to accelerate taxable income recognition, and the
probability that taxable income will be generated in future
periods. Negative evidence includes the general business
and economic environment. In the second quarter of 2010,
the Company recorded a valuation allowance against the
entire deferred tax asset balance and the Company
continued to maintain a valuation reserve against the entire
deferred tax asset balance until December 31, 2013 when
reserve was eliminated. The
the entire valuation
determination to eliminate the valuation reserve was based
primarily upon the existence of a three-year cumulative net
income and expectations of future taxable income. It is
possible that future conditions may differ substantially from
those anticipated in eliminating the valuation allowance on
deferred tax assets and adjustments may be required in the
future.
8
Determining the ultimate settlement of any tax position
requires significant estimates and judgments in arriving at
the amount of tax benefits to be recognized in the financial
statements. It is possible that the tax benefits realized upon
the ultimate resolution of a tax position may result in tax
benefits
those
estimated.
that are significantly different from
Results of Operations
Comparison of 2014 with 2013
Net income was $7.4 million for 2014, a decrease of $19.3
million, from $26.7 million for 2013. Net income available
to common shareholders was $5.7 million for the year
ended December 31, 2014, a decrease of $18.9 million,
from net income available to common shareholders of
$24.6 million for 2013. Diluted earnings per common share
for the year ended December 31, 2014 was $1.23, a
decrease of $4.48 from $5.71 diluted earnings per common
share for the year ended December 31, 2013. The decrease
in net income in 2014 is due primarily to a $19.3 million
increase in income tax expense between the periods as a
result of eliminating the valuation reserve against the
Company’s deferred tax asset in the fourth quarter of 2013
and recording regular income tax expense in 2014.
Net Interest Income
Net interest income was $19.4 million for 2014, a decrease
of $0.3 million, or 1.5%, from $19.7 million for 2013.
Interest income was $20.6 million for 2014, a decrease of
$2.4 million, or 10.3%, from $23.0 million for 2013.
Interest income decreased between the periods primarily
because of a change in the mix of average interest-earning
assets held and also because of a decrease in the average
yields earned between the periods. While the average
interest-earning assets increased $13.1 million between the
periods, the average interest-earning assets held in lower
yielding cash and investments increased $52.3 million and
the amount of average interest-earning assets held in higher
yielding loans decreased $39.2 million between the periods.
The decrease in the average outstanding loans between the
periods was primarily the result of a decrease in the
commercial loan portfolio, which occurred primarily
because of loan prepayments and non-renewals as a result
of the Company’s continued focus on improving credit
quality, decreasing loan concentration, and managing net
interest margin. The average yield earned on interest-
earning assets was 3.59% for the year ended December 31,
2014, a decrease of 50 basis points from 4.09% for the same
period of 2013. The decrease in average yield is due to the
change in the mix of assets held and the continued low
interest rate environment that existed during 2014.
MANAGEMENT DISCUSSION AND ANALYSIS
Interest expense was $1.2 million for the year ended
December 31, 2014, a decrease of $2.1 million, or 63.2%,
from $3.3 million for 2013. Interest expense decreased
primarily because of the change in the mix of the average
interest-bearing liabilities held between the periods and also
because of a decrease in the average interest rate. While the
average interest-bearing liabilities increased $4.4 million
between the periods, the amount held in higher rate
certificates of deposit and Federal Home Loan Bank
Advances decreased $70.2 million and the amount of
interest-bearing liabilities held in other lower rate deposit
accounts increased $74.6 million between the periods. The
decrease in certificates of deposit between the periods was
the result of using the proceeds from loan principal
payments to fund maturing certificates of deposit. The
decreased average rates paid were the result of the change
in the mix of liabilities held and the low interest rate
environment that continued to exist during 2014. The
average interest rate paid on interest-bearing liabilities was
0.23% for the year ended December 31, 2014, a decrease of
41 basis points from the 0.64% average interest rate paid in
2013.
The following table presents the total dollar amount of
interest income from average interest-earning assets and the
resultant yields, as well as the interest expense on average
interest-bearing liabilities, expressed both in dollars and
rates. Non-accruing loans have been included in the average
outstanding loan balance in the table as loans carrying a
zero yield.
(Dollars in thousands)
Interest-earning assets:
Securities available for sale:
Mortgage-backed and related securities .... $
Other marketable securities .......................
Loans held for sale .........................................
Loans receivable, net(1) (2) ...............................
FHLB stock ....................................................
Other, including cash equivalents ..................
Total interest-earning assets ........................... $
Interest-bearing liabilities:
NOW accounts ............................................... $
Passbooks .......................................................
Money market accounts .................................
Certificate accounts ........................................
Brokered deposits ...........................................
FHLB advances and other borrowings ...........
Other interest-bearing liabilities .....................
Total interest-bearing liabilities ..................... $
Noninterest checking ......................................
Total interest-bearing liabilities and
noninterest-bearing deposits ........................ $
Net interest income .........................................
Net interest rate spread ...................................
Net earning assets ........................................... $
Net interest margin .........................................
Average interest-earning assets to average
interest-bearing liabilities and noninterest-
bearing deposits ...........................................
Year Ended December 31,
Average
Outstanding
Balance
2014
Interest
Earned/
Paid
Average
Yield/
Rate
Average
Outstanding
Balance
2013
Interest
Earned/
Paid
Average
Yield/
Rate
Average
Outstanding
Balance
2012
Interest
Earned/
Paid
Average
Yield/
Rate
1,557
3,726
164
119,484 1,269
58
369,571 18,929
4
778
189
79,373
574,489 20,613
14
32
414
739
12
0
0
71,666
47,200
162,207
110,256
830
0
924
393,083
125,767
518,850 1,211
19,402
55,639
4.40% $
1.06
3.73
5.12
0.51
0.24
3.59
$
0.02% $
0.07
0.26
0.67
1.45
0.00
0.00
$
0.23% $
3.35%
$
3.38%
6,968
85,947
1,964
299
614
72
408,383 21,816
53
2,191
129
55,909
561,362 22,983
69,675
15
44,113
34
372
120,782
140,254 1,236
10,647
147
30,427 1,485
0
963
416,861
97,613
14,275
73,329
3,257
4.30% $
604
0.71
737
3.67
103
503,668 29,154
5.34
2.42
117
0.23
101
4.09 $ 645,122 30,816
4,098
46,495
0.02% $
0.08
0.31
0.88
1.38
4.88
0.00
65,566
35
40,139
67
110,665
447
202,082 2,413
35,161
779
70,000 3,398
1,019
0
$ 524,632
85,525
514,474 3,289
19,694
0.64% $ 610,157 7,139
23,677
46,888
3.45%
$
3.51%
34,965
4.23%
1.01
3.16
5.79
2.85
0.22
4.78
0.05%
0.17
0.40
1.19
2.22
4.85
0.00
1.17%
3.61%
3.67%
110.72%
109.11%
105.73%
(1) Tax exempt income was not significant; therefore, the yield was not presented on a tax equivalent basis for any of the years presented. The tax-exempt income was $0.1
million for 2014, $0.2 million for 2013, and $0.3 million for 2012.
(2) Calculated net of deferred loan fees, loan discounts, loans in process and loss reserve.
9
MANAGEMENT DISCUSSION AND ANALYSIS
Net interest margin decreased to 3.38% in 2014 from 3.51%
in 2013 primarily because the yield on interest-earning
assets decreased at a faster rate than the cost of interest-
bearing liabilities. Net interest margin was also negatively
impacted by a change in the asset mix as a higher
percentage of interest-earning assets were in lower yielding
cash and investments in 2014 when compared to 2013.
Average net earning assets increased $8.7 million to $55.6
million in 2014 compared to $46.9 million for 2013
primarily because the net income realized in 2014 was
reinvested in interest-earning assets.
interest
income and
The following table presents the dollar amount of changes
in
interest expense for major
components of interest-earning assets and interest-bearing
liabilities. It quantifies the changes in interest income and
interest expense related to changes in the average
outstanding balances (volume) and those changes caused by
fluctuating interest rates. For each category of interest-
earning assets and interest-bearing liabilities, information is
provided on changes attributable to (i) changes in volume
(i.e., changes in volume multiplied by old rate) and (ii)
changes in rate (i.e., changes in rate multiplied by old
volume).
Year Ended December 31,
2014 vs. 2013
Increase
(Decrease)
Due to
2013 vs. 2012
Increase
(Decrease)
Due to
(Dollars in thousands)
Interest-earning assets:
Volume(1)
Rate(1)
Total
Increase
(Decrease) Volume(1)
Rate(1)
Total
Increase
(Decrease)
Securities available for sale:
Mortgage-backed and related
securities .............................. $
Other marketable securities ....
Loans held for sale .....................
Loans receivable, net ..................
Cash equivalents .........................
FHLB stock ................................
Total interest-earning assets ... $
Interest-bearing liabilities:
NOW accounts ........................... $
Passbooks ...................................
Money market accounts ..............
Certificates .................................
Brokered deposits .......................
FHLB advances ..........................
Total interest-bearing
(139)
240
(15)
(2,001)
54
(34)
(1,895)
0
2
89
(300)
(137)
(1,484)
liabilities ...............................
Decrease in net interest income ...... $
(1,830)
(65)
4
415
1
(886)
6
(15)
(475)
(1)
(4)
(48)
(197)
2
0
(248)
(227)
(135)
655
(14)
(2,887)
60
(49)
(2,370)
(1)
(2)
41
(497)
(135)
(1,484)
(2,078)
(292)
(309)
127
(41)
(5,556)
21
(55)
(5,813)
2
7
26
(727)
(543)
(1,923)
4
(250)
10
(1,782)
7
(9)
(2,020)
(22)
(40)
(101)
(450)
(89)
10
(3,158)
(2,655)
(692)
(1,328)
(305)
(123)
(31)
(7,338)
28
(64)
(7,833)
(20)
(33)
(75)
(1,177)
(632)
(1,913)
(3,850)
(3,983)
(1) For purposes of this table, changes attributable to both rate and volume which cannot be segregated, have been allocated
proportionately to the change due to volume and the change due to rate.
10
MANAGEMENT DISCUSSION AND ANALYSIS
The following table sets forth the weighted average yields
on the Company's interest-earning assets, the weighted
average interest rates on interest-bearing liabilities and the
interest rate spread between the weighted average yields
and rates as of the date indicated. Non-accruing loans have
been included in the average outstanding loan balances in
the table as loans carrying a zero yield.
Weighted average yield on:
Securities available for sale:
At December 31, 2014
Weighted average rate on:
Mortgage-backed and related securities ......
Other marketable securities .........................
Loans held for sale ..........................................
Loans receivable, net ......................................
Federal Home Loan Bank stock......................
Other interest-earnings assets .........................
Combined weighted average yield on
4.44% NOW accounts ................................................
1.26
Passbooks ........................................................
3.25 Money market accounts ..................................
4.85 Certificates of Deposits ...................................
Federal Home Loan Bank advances and other
0.50
0.24 Combined weighted average rate on
borrowings...................................................
interest-bearing liabilities ............................
Interest rate spread ..........................................
0.02%
0.07
0.25
0.61
0.00
0.21
3.38
December 31,
Foreclosed and repossessed assets:
2014 2013
(Dollars in thousands)
Balance at beginning of year ................... $ 6,898 10,595
876
Transferred from non-performing loans ..
Other foreclosures/repossessions ............
687
Real estate sold ....................................... (4,891) (5,827)
Net gain on sale of assets ........................ 1,449 1,587
Write downs ............................................
(495) (1,020)
Balance at end of year ............................. $ 3,103 6,898
114
28
The decrease in non-performing loans during 2014 relates
primarily to principal payments received. Of the $7.2
million in principal payments received during the period,
$2.5 million was received on a residential development loan
as settlement of the outstanding debt, $1.7 million related
to the payoff of non-performing single family construction
loans as a result of the houses being sold, $1.2 million
related to the payoff of two non-performing one-to-four
family loans that were refinanced with other financial
institutions, $0.6 million related to additional principal
payments received from various developers as a result of
land or lot sales, and $0.7 million related to the payoff of
non-performing commercial and commercial real estate
loans.
interest-earning assets .................................
3.59
Provision for Loan Losses
The provision for loan losses was ($7.0 million) for the year
ended December 31, 2014, a decrease in the credit
provision of $0.9 million, from ($7.9 million) for the year
ended December 31, 2013. The decrease in the size of the
commercial loan portfolio, the continued improvement in
the credit quality of the loan portfolio, and the recoveries
received on previously charged off loans in 2014 and 2013
resulted in lower reserves being required in the allowance
for loan losses. The reduction in the allowance for loan
losses was the primary reason for the large credits in the
provision for loan losses for 2014 and 2013. Future loan
loss provisions are anticipated to return to more normalized
levels due to the decrease in non-performing assets and the
recoveries already received on previously charged off
loans. Total non-performing assets were $14.0 million at
December 31, 2014, a decrease of $10.4 million, or 42.5%,
from $24.4 million at December 31, 2013. Non-performing
loans decreased $6.6 million and
foreclosed and
repossessed assets decreased $3.8 million during 2014. The
non-performing loan and foreclosed and repossessed asset
activity for 2014 was as follows:
2014
December 31,
2013
Non-performing loans:
(Dollars in thousands)
Balance at beginning of year .......... $ 17,496 29,975
6,295
Classified as non-performing .........
5,153
(1,215)
Charge offs .....................................
(5,002)
(7,211) (11,043)
Principal payments received ...........
(1,853)
(3,189)
Classified as performing .................
Transferred to real estate owned ....
(876)
(114)
Balance at end of year .................... $ 10,920 17,496
11
MANAGEMENT DISCUSSION AND ANALYSIS
A reconciliation of the allowance for loan losses for 2014 and 2013 is summarized as follows:
(Dollars in thousands)
Balance at January 1, ........................................................................................................ $
Provision ..........................................................................................................................
Charge offs:
Commercial ..................................................................................................................
Commercial real estate .................................................................................................
Consumer ......................................................................................................................
Single family mortgage ................................................................................................
Recoveries ........................................................................................................................
Balance at December 31, .................................................................................................. $
Specific allowance ........................................................................................................... $
General allowance ............................................................................................................
$
2014
2013
11,401 $
(6,998 )
(55 )
(936 )
(131 )
(92 )
5,143
8,332 $
1,074 $
7,258
8,332 $
21,608
(7,881)
(651)
(3,711)
(484)
(200)
2,720
11,401
3,778
7,623
11,401
The allowance for loan losses and charge offs decreased in
2014 when compared to 2013 because of two factors. The
first factor was there were less required specific reserves
because some non-performing loans were paid or charged
off during 2014. The second factor was that the loan
portfolio decreased $22 million between the periods which
reduced the amount of the required allowance. These
decreases in the allowance were partially offset by an
increase in the required reserve percentages for certain risk
rated loan categories as a result of the periodic internal
analysis of recent loan charge-off history that was
performed in 2014.
Non-Interest Income
Non-interest income was $7.3 million for the year ended
December 31, 2014, the same as for the year ended
December 31, 2013.
The following table presents the components of non-
interest income:
Year ended December 31,
2013
2012
2014
2014/2013
(Dollars in thousands)
Fees and service charges ...................................... $
Loan servicing fees ..............................................
Gain on sales of loans ..........................................
Gain on sale of branch office ...............................
Other non-interest income ....................................
Total non-interest income ................................. $
3,458
1,058
1,828
0
940
7,284
3,513
1,029
2,102
0
668
7,312
3,325
964
3,574
552
575
8,990
Percentage
Increase (Decrease)
2013/2012
5.7%
6.7
(41.2)
(100.0)
16.2
(18.7)
(1.6)%
2.8
(13.0)
0.0
40.7
(0.4)
Gain on sales of loans decreased $0.3 million, or 13.0%,
between 2014 and 2013 primarily because of a decrease in
single family loan originations and sales. Fees and service
charges decreased $0.1 million primarily because of a
decrease in retail overdraft fees and other charges between
2014 and 2013. Other non-interest income increased $0.3
million between the periods due to increases in the sale of
non-insured investment products and rental income. Loan
servicing fees increased $29,000 as a result of servicing
more commercial loans.
Non-Interest Expense
Non-interest expense was $21.4 million for the year ended
December 31, 2014, a decrease of $1.2 million, or 5.4%,
from $22.6 million for 2013. The following table presents
the components of non-interest expense:
12
MANAGEMENT DISCUSSION AND ANALYSIS
Year ended December 31,
2013
2012
2014
2014/2013
(Dollars in thousands)
Compensation and benefits .................................. $
(Gains) losses on real estate owned ......................
Occupancy ............................................................
Deposit insurance .................................................
Data processing ....................................................
Other.....................................................................
Total non-interest expense ................................... $
13,332
(1,194)
3,691
435
1,011
4,128
21,403
12,680
(830)
3,338
868
1,289
5,278
22,623
12,452
181
3,358
1,255
1,434
5,990
24,670
Percentage
Increase (Decrease)
2013/2012
1.8%
(558.6)
(0.6)
(30.8)
(10.1)
(11.9)
(8.3)
5.1%
(43.9)
10.6
(49.9)
(21.6)
(21.8)
(5.4)
Other non-interest expenses decreased $1.2 million
between 2014 and 2013 primarily because of a decrease in
legal and other costs associated with loans and real estate
owned. Deposit insurance expense decreased $0.4 million
because of a decrease in assets and insurance rates between
the periods. Gains on real estate owned increased $0.4
million between the periods primarily because of the
significant gain realized on a commercial real estate
property that was sold in 2014. Data processing expense
decreased $0.3 million due to a decrease in hardware and
software depreciation expense in 2014. These decreases in
non-interest expense were partially offset by a $0.7 million
increase in compensation expense in 2014 primarily
because of an increase in salaries and pension benefit costs.
Occupancy expense increased $0.4 million between 2014
and 2013 due to an increase in software amortization
expense and the purchase of more non-capitalized items in
2014.
Income Taxes
The Company considers the calculation of current and
deferred income taxes to be a critical accounting policy that
is subject to significant estimates. Actual results could
differ significantly from the estimates and interpretations
used in determining the current and deferred income tax
assets and liabilities. Income tax expense was $4.9 million
for the year ended December 31, 2014, an increase of $19.3
million from the $14.4 million income tax benefit for the
same period in 2013. In the second quarter of 2010, the
Company recorded a deferred tax asset valuation reserve
against its entire deferred tax asset balance and the
Company continued to maintain a valuation reserve against
the entire deferred tax asset balance until the fourth quarter
of 2013. In the fourth quarter of 2013, the valuation reserve
against the deferred tax asset was eliminated which resulted
in a $14.4 million income tax benefit for 2013. Regular
income tax expense was recorded in 2014.
Net Income Available to Common Shareholders
Net income available to common shareholders was $5.7
million for the year ended December 31, 2014, a decrease
of $18.9 million from $24.6 million in net income available
to common shareholders for the year ended December 31,
2013. Basic earnings per common share for the year ended
13
December 31, 2014 was $1.40, a decrease of $4.75 from the
basic earnings per common share of $6.15 for the year
ended December 31, 2013. Diluted earnings per common
share for the year ended December 31, 2014 was $1.23, a
decrease of $4.48 from diluted earnings per common share
of $5.71 for the year ended December 31, 2013. The net
income available to common shareholders and the basic and
diluted earnings per common share decreased primarily
because of the decrease in net income between the periods
as a result of the elimination of the deferred tax asset
valuation reserve in the fourth quarter of 2013. The
difference between basic and diluted earnings per common
share is related primarily to the dilutive effect of the
outstanding warrant held by the U.S. Treasury to purchase
833,333 shares of the Company’s common stock at an
exercise price of $4.68.
On December 23, 2008, the Company sold 26,000 shares of
Fixed Rate Cumulative Perpetual Preferred Stock, Series A
with a $1,000 liquidation preference (“Preferred Stock”)
and a related warrant to the United States Department of
Treasury (“Treasury”) for $26.0 million as part of the
Treasury’s Capital Purchase Program. On February 8,
2013, Treasury sold the Preferred Stock to unaffiliated third
party investors in a private transaction for $18.8 million.
The shares of Preferred Stock were entitled to a 5% annual
cumulative dividend for each of the first five years of the
investment, which increased to 9% on February 15, 2014.
The Company paid the following dividends on, and effected
the following redemptions of, its Preferred Stock during
2014:
Date
Dividend Redemption
May 15, 2014
$201.71
per share
10,000 shares of Preferred
Stock on a pro rata basis at
$1,000 per share
August 15, 2014
$22.50
per share
None
November 17, 2014 $22.50
per share
6,000 shares of Preferred
Stock on a pro rata basis at
$1,000 per share
MANAGEMENT DISCUSSION AND ANALYSIS
Following the redemption on November 17, 2014, 10,000
shares of Preferred Stock remained outstanding. The
Company did not pay any dividends on the Preferred Stock
or redeem any shares of Preferred Stock in 2013.
On February 17, 2015, the Company redeemed the
remaining 10,000 shares of outstanding Preferred Stock.
After giving effect to a dividend of $22.50 per share on the
Preferred Stock that was paid on the same date, the
redemption price per share was $1,000. The Preferred Stock
redemption was funded with a $10 million term loan to
HMN from an unrelated third party that was evidenced by
a promissory note. The principal balance of the note bears
interest at a rate of 6.5% and is payable in consecutive
annual installments of $1 million on each December 15,
beginning December 15, 2015, with the balance due on
December 15, 2021. The Preferred Stock dividend was
funded by HMN through internally available funds.
Under applicable federal banking laws and regulations,
neither the Company nor the Bank may declare or pay any
cash dividends, or purchase or redeem any capital stock,
without prior notice to, and non-objection from its
regulators.
Comparison of 2013 with 2012
Net income was $26.7 million for 2013, an improvement of
$21.4 million, from $5.3 million for 2012. Net income
available to common shareholders was $24.6 million for the
year ended December 31, 2013, an improvement of $21.1
million, from net income available to common shareholders
of $3.5 million for 2012. Diluted earnings per common
share for the year ended December 31, 2013 was $5.71, an
improvement of $4.85 from $0.86 diluted earnings per
common share for the year ended December 31, 2012. The
improvement in net income in 2013 was due primarily to a
$14.5 million increase in income tax benefit as a result of
eliminating the valuation reserve against the Company’s
deferred tax asset, a $10.4 million decrease in the provision
for loan losses, a $1.0 million increase in the gains
recognized on the sale of real estate owned, and a $0.7
million decrease in other non-interest expenses primarily
related
legal and professional services. These
improvements to net income were partially offset by a $4.0
million decrease in net interest income due primarily to a
decrease in interest earning assets between the periods and
a $1.5 million decrease in the gain on sale of loans due to a
decrease in mortgage loan originations and sales.
to
Net interest income was $19.7 million for 2013, a decrease
of $4.0 million, or 16.8%, from $23.7 million for 2012.
Interest income was $23.0 million for 2013, a decrease of
$7.8 million, or 25.4%, from $30.8 million for 2012.
Interest income decreased between the periods primarily
because of an $84 million decrease in the average interest-
earning assets and also because of a decrease in the average
yields between the periods. Average interest-earning assets
decreased between the periods primarily because of a $69
million decrease in the commercial loan portfolio, which
occurred because loan payoffs exceeded loan production as
a result of the Company’s focus on improving credit
quality, managing net interest margin, and improving
capital ratios. The average yield earned on interest-earning
assets was 4.09% for the year ended December 31, 2013, a
decrease of 69 basis points from the 4.78% average yield
for 2012. The decrease in the average yield is due to the
continued low interest rate environment that existed during
2013 and also because of the $15 million increase in the
average assets that were held in lower earning cash and
investments in 2013 when compared to 2012.
liabilities between
Interest expense was $3.3 million for the year ended
December 31, 2013, a decrease of $3.8 million, or 53.9%,
from $7.1 million for 2012. Interest expense decreased
primarily because of a $96 million decrease in the average
interest-bearing
the periods. The
decrease in the average interest-bearing liabilities was
primarily the result of a decrease in the average outstanding
retail and brokered certificates of deposits and Federal
Home Loan Bank advances between the periods. The
decrease in certificates of deposits and advances between
the periods was the result of using the proceeds from loan
principal payments to fund the maturing certificates of
deposits and advances. The $126 million decrease in the
average balances of certificates of deposits and advances
was partially offset by the $30 million increase in the
average balance of retail and commercial checking and
money market accounts between the periods. Interest
expense also decreased because of the lower interest rates
paid on deposits as a result of the low interest rate
environment that continued to exist during 2013. The
average interest rate paid on interest-bearing liabilities was
0.64% for the year ended December 31, 2013, a decrease of
53 basis points from the 1.17% average interest rate paid
for 2012.
Net interest margin decreased to 3.51% in 2013 from 3.67%
in 2012 primarily because the yield on interest-earning
assets decreased at a faster rate than the cost of interest-
bearing liabilities. Net interest margin was also negatively
impacted by a change in the asset mix as a higher
percentage of interest-earning assets were in lower yielding
cash and investments in 2013 when compared to 2012.
Average net earning assets increased $11.9 million to $46.9
million in 2013 compared to $35.0 million for 2012
primarily because the income realized in 2013 was
reinvested in interest-earning assets.
14
MANAGEMENT DISCUSSION AND ANALYSIS
The provision for loan losses was ($7.9 million) for the year
ended December 31, 2013, a decrease of $10.4 million,
from $2.5 million for the year ended December 31, 2012.
The provision decreased between the periods primarily
because of improving values of the underlying collateral
supporting commercial real estate loans in 2013 when
compared to 2012. The provision also decreased because of
a reduction in the outstanding loan portfolio balances, a
decrease in the reserve percentages on certain risk
classifications as a result of an internal analysis of recent
loan charge-off history, an
the
classifications of certain risk rated loans, and the recoveries
received during 2013 on previously charged off loans. Total
non-performing assets were $24.4 million at December 31,
2013, a decrease of $16.2 million, or 39.9%, from $40.6
million at December 31, 2012.
improvement
in
Loans classified as non-performing during 2013 decreased
$12.5 million, from $30.0 million at December 31, 2012 to
$17.5 million at December 31, 2013. The decrease in loans
classified as non-performing during 2013 reflects continued
stabilization of the value of the real estate collateral
securing the loan portfolio which resulted in fewer loans
being classified as non-performing. Principal payments
received on non-performing
the year
decreased $2.8 million, from $13.8 million in 2012 to $11.0
million in 2013 which was primarily the result of having
fewer non-performing loans in 2013 when compared to
2012. Foreclosed and repossessed assets decreased $3.7
million during 2013 primarily because of the $5.8 million
in real estate sales that occurred during the year.
loans during
The allowance for loan losses and charge offs decreased in
2013 when compared to 2012 because of three factors. The
first factor was that there were fewer decreases in the value
of the underlying collateral supporting commercial real
estate loans that required additional allowances or charge
offs in 2013 when compared to 2012. The second factor was
that the loan portfolio decreased $80 million between the
periods, which reduced the amount of the required
allowance. The third factor was that required reserve
percentages for certain risk rated loan categories decreased
as a result of the periodic internal analysis of recent loan
charge-off history that was performed in 2013.
Non-interest income was $7.3 million for the year ended
December 31, 2013, a decrease of $1.7 million, or 18.7%,
from $9.0 million for the year ended December 31, 2012.
Gain on sales of loans decreased $1.5 million, or 41.2%,
between 2013 and 2012 primarily because of a decrease in
single family loan originations and sales. Gain on sale of
branch office was $0 for 2013, compared to $0.6 million in
2012 as a result of the sale of the Toledo, Iowa branch in
15
the first quarter of 2012. Fees and service charges increased
$0.2 million primarily because of an increase in overdraft
charges related to a combination of an increase in the
number of overdrafts and an increase in the amount charged
per overdraft between 2013 and 2012. Other non-interest
income increased $0.1 million due to an increase in the sale
of non-insured investment products. Loan servicing fees
increased $0.1 million as a result of servicing more single
family loans.
Non-interest expense was $22.6 million for the year ended
December 31, 2013, a decrease of $2.1 million, or 8.3%,
from $24.7 million for the same period in 2012. Gains on
real estate owned increased $1.0 million between 2013 and
2012 primarily because there were more gains realized on
the sale of real estate and fewer write downs in the value of
the real estate owned in 2013 when compared to 2012.
Deposit insurance expense decreased $0.4 million because
of a decrease in total assets and insurance rates between the
periods. Data processing expense decreased $0.2 million
due to a decrease in hardware and software depreciation
expense. Other non-interest expenses decreased $0.7
million between 2013 and 2012 primarily because of a
decrease in legal and other professional services. These
decreases in noninterest expense were partially offset by a
$0.2 million increase in compensation expense between
2013 and 2012, primarily because of an increase in
employee incentives and pension benefit costs.
The Company considers the calculation of current and
deferred income taxes to be a critical accounting policy that
is subject to significant estimates. Actual results could
differ significantly from the estimates and interpretations
used in determining the current and deferred income tax
assets and liabilities. Income tax benefit was $14.4 million
in 2013, an increase of $14.5 million from $0.1 million in
income tax expense for 2012. In the second quarter of 2010,
the Company recorded a deferred tax asset valuation
reserve against its entire deferred tax asset balance and the
Company continued to maintain a valuation reserve against
the entire deferred tax asset balance at December 31, 2012.
Since the valuation reserve was established against the
entire deferred tax asset balance, no regular income tax
expense was recorded for 2012. The income tax expense
that was recorded in 2012 related to alternative minimum
tax amounts that were due since only a portion of the
outstanding net operating loss carry forwards can be used
to offset current income under the current alternative
minimum tax rules. Due to the Company’s improved
financial performance, the valuation reserve against the
deferred tax asset was eliminated in the fourth quarter of
2013, which resulted in a $14.4 million income tax benefit
for the year ended December 31, 2013.
MANAGEMENT DISCUSSION AND ANALYSIS
Net income available to common shareholders was $24.6
million for the year ended December 31, 2013, an
improvement of $21.1 million, from net income available
to common shareholders of $3.5 million for 2012. Net
income available to common shareholders increased
primarily because of the increase in net income between the
periods.
On December 23, 2008, the Company sold 26,000 shares of
Fixed Rate Cumulative Perpetual Preferred Stock, Series A
with a $1,000 liquidation preference (“Preferred Stock”)
and a related warrant to the United States Department of
Treasury (“Treasury”) for $26.0 million as part of the
Treasury’s Capital Purchase Program. The Company made
all required dividend payments on the outstanding Preferred
Stock in 2009 and 2010. Beginning with the February 15,
2011 dividend payment, the Company began to defer
dividend payments on its Preferred Stock and as of
December 31, 2013 had deferred the last thirteen quarterly
dividend payments. Under the terms of the certificate of
designations for the Preferred Stock, dividend payments
could be deferred but the dividend was cumulative and
compounded quarterly while unpaid. The deferred dividend
payments were accrued for payment in the future and were
being reported for the deferral period as a preferred
dividend requirement that was deducted from net income
for financial statement purposes to arrive at the net income
available to common shareholders. In addition, since the
Company failed to pay dividends for six quarters, the
holders of Preferred Stock had the right to appoint two
representatives to the Company’s board of directors. The
Company, however, had been advised that the then-current
holders of substantially all of the Preferred Stock had
entered into agreements with the FRB pursuant to which
they had each agreed not to take actions, without the
consent of the FRB, which might be construed as exercising
or attempting to exercise a controlling influence over the
management or policies of the Company or the Bank,
including exercise of any right to elect any representatives
to the Company’s board of directors.
Financial Condition
Loans Receivable, Net
The following table sets forth the information on the Company's loan portfolio in dollar amounts and percentages before
deductions for deferred fees and discounts and allowances for losses as of the dates indicated:
2014
2013
December 31,
2012
2011
2010
(Dollars in thousands) Amount
Real Estate Loans:
Percent
Amount
Percent
Amount
Percent
Amount
Percent
Amount
Percent
One-to-four family $
Multi-family .........
Commercial ..........
Construction or
development .........
Total real estate
loans ...............
Other Loans:
Consumer Loans:
Automobile ...........
Home equity line ..
Home equity .........
Mobile home ........
Land/lot loans .......
Other .....................
Total consumer
loans ...............
Commercial
business loans .........
Total other
loans ...............
Total loans .......
Less:
Unamortized
discounts ..............
Net deferred loan
fees .......................
Allowance for
losses ....................
Total loans
receivable, net $
69,841
15,700
163,365
18.70% $
4.20
43.73
76,467
8,113
178,486
19.31% $
2.05
45.06
97,037
11,756
220,721
20.40% $
2.47
46.39
119,066
35,517
243,475
20.52% $
6.12
41.95
128,535
48,266
292,874
18.14%
6.81
41.34
12,603
3.37
7,851
1.98
12,430
2.61
10,922
1.88
15,251
2.15
261,509
70.00
270,917
68.40
341,944
71.87
408,980
70.47
484,926
68.44
1,124
36,832
12,420
263
1,670
2,616
0.30
9.86
3.33
0.07
0.45
0.70
971
36,178
11,629
360
1,827
2,458
0.25
9.13
2.94
0.09
0.46
0.62
623
36,521
11,390
449
2,246
2,746
0.13
7.68
2.39
0.10
0.47
0.58
404
41,429
13,426
657
2,723
3,522
0.07
7.14
2.31
0.11
0.47
0.61
604
44,933
17,840
764
2,510
3,952
0.08
6.34
2.52
0.11
0.35
0.56
54,925
14.71
53,423
13.49
53,975
11.35
62,161
10.71
70,603
9.96
57,122
15.29
71,709
18.11
79,854
16.78
109,259
18.82
153,039
21.60
112,047
373,556
30.00
100.00%
125,132
396,049
31.60
100.00%
133,829
475,773
28.13
100.00%
171,420
580,400
29.53
100.00%
223,642
708,568
31.56
100.00%
14
97
8,332
33
0
33
87
11,401
21,608
93
511
23,888
413
1,086
42,828
365,113
$
384,615
$
454,045
$
555,908
$
664,241
In 2014, the Company continued to focus on improving
credit quality, decreasing
loan concentrations, and
managing net interest margin, which resulted in a decrease
in outstanding loan balances. As a result of the Company’s
improved credit quality, reduced loan concentrations, and
enhanced lending staff, it is anticipated that loan production
will improve and the size of our overall loan portfolio will
increase in 2015.
16
MANAGEMENT DISCUSSION AND ANALYSIS
The Company’s commercial business and commercial real
estate loan portfolios continue to be impacted by the
diminished demand for real estate, particularly as it relates
to single-family and commercial land developments. More
stringent lending standards implemented by the mortgage
industry in recent years have made it more difficult for
some borrowers with marginal credit to qualify for a
mortgage. This decrease in available credit and the overall
weakness in the economy over the past several years has
reduced the demand for single family homes and the values
of existing properties and developments and is reflected in
the $14.0 million of Company assets that were classified as
non-performing at December 31, 2014. We continue to
work to resolve the non-performing status of these assets in
a cost effective manner. Because cash flow is dependent, in
many cases, on the sale of the properties, it will take some
time to liquidate some of the non-performing assets due to
the limited demand for the properties.
One-to-four family real estate loans were $69.8 million at
December 31, 2014, a decrease of $6.7 million, compared
to $76.5 million at December 31, 2013. Mortgage loan
originations declined in 2014 as a result of an increase in
mortgage rates which decreased the refinance activity in
2014 when compared to 2013. A significant portion of the
loans that were originated during the year were sold into the
secondary market and were not placed in the loan portfolio
in order to manage the Company’s interest rate risk
position. The decrease in mortgage loans originated and
their subsequent sale was the primary reason for the
decrease in the one-to-four family loan portfolio during
2014.
Multi-family real estate loans were $15.7 million at
December 31, 2014, an increase of $7.6 million, compared
to $8.1 million at December 31, 2013. The increase in
multi-family real estate loans in 2014 is primarily the result
of several new multi-family loans originated during the
year.
Commercial real estate loans were $163.4 million at
December 31, 2014, a decrease of $15.1 million, compared
to $178.5 million at December 31, 2013. Commercial
business loans were $57.1 million at December 31, 2014, a
decrease of $14.6 million, compared to $71.7 million at
December 31, 2013. Limited commercial loan demand and
tighter underwriting and pricing guidelines resulted in an
increase in loan payoffs and a decrease in the commercial
business and commercial real estate loan balances in 2014.
Construction or development loans were $12.6 million at
December 31, 2014, an increase of $4.7 million, compared
to $7.9 million at December 31, 2013. The increase resulted
primarily from $12.0 million in new construction loans,
$3.1 million in paid-off loans, and $4.2 million of projects
that were completed and the related loans were moved to a
permanent classification.
Home equity line loans were $36.8 million at December 31,
2014, an increase of $0.6 million, compared to $36.2
million at December 31, 2013. The open-end home equity
lines are generally written with an adjustable rate and a 10
year draw period which requires interest only payments
followed by a 10 year repayment period which fully
amortizes the outstanding balance. Closed-end home equity
loans are written with fixed or adjustable rates with terms
up to 15 years. Home equity loans were $12.4 million at
December 31, 2014, an increase of $0.8 million, compared
to $11.6 million at December 31, 2013. The increase in the
open-end equity lines and closed-end equity loans is related
primarily to an increase in originations which exceeded
loan payoffs.
Allowance for Loan Losses
The determination of the allowance for loan losses and the
related provision is a critical accounting policy of the
Company that is subject to significant estimates, as
previously discussed. The current level of the allowance for
loan losses is a result of management’s assessment of the
risks within the portfolio based on the information obtained
through the credit evaluation process. The Company
utilizes a
system on non-homogenous
commercial real estate and commercial business loans that
includes regular credit reviews to identify and quantify the
risk in the commercial portfolio. Management conducts
quarterly reviews of the entire loan portfolio and evaluates
the need to adjust the allowance balance on the basis of
these reviews.
risk-rating
Management actively monitors asset quality and, when
appropriate, charges off loans against the allowance for
loan losses. Although management believes it uses the best
information available to make determinations with respect
to the allowance for loan losses, future adjustments may be
necessary if economic conditions differ substantially from
the economic conditions in the assumptions used to
determine the size of the allowance for loan losses.
The allowance for loan losses was $8.3 million, or 2.23%
of gross loans at December 31, 2014, compared to $11.4
million, or 2.88% of gross loans at December 31, 2013. The
allowance for loan losses decreased primarily because of a
$2.7 million decrease in allocated reserves for impaired
loans. The allowance for loan losses also decreased because
of the $22.5 million decrease in the loan portfolio between
the periods.
17
MANAGEMENT DISCUSSION AND ANALYSIS
The following table reflects the activity in the allowance for loan losses and selected statistics:
(Dollars in thousands)
Balance at beginning of year ................................ $
Provision for losses ...........................................
Charge-offs:
One-to-four family ........................................
Consumer ......................................................
Commercial business ....................................
Commercial real estate ..................................
Recoveries ........................................................
Net recoveries (charge-offs) ..........................
Balance at end of year .......................................... $
Year-end allowance for loan losses as a percent
2014
11,401
(6,998)
(92)
(131)
(55)
(936)
5,143
3,929
8,332
2013
December 31,
2012
2011
2010
21,608
(7,881)
23,888
2,544
42,828
17,278
23,812
33,381
(200)
(484)
(651)
(3,711)
2,720
(2,326)
11,401
(63)
(1,071)
(2,464)
(5,719)
4,493
(4,824)
21,608
(508)
(270)
(15,512)
(23,012)
3,084
(36,218)
23,888
(254)
(907)
(7,006)
(7,095)
897
(14,365)
42,828
of year end gross loan balance ...........................
2.23%
2.88%
4.54%
4.12%
6.04%
Ratio of net loan (recoveries) charge-offs to
average loans outstanding ..................................
(1.02)
0.53
0.91
5.62
1.87
The following table reflects the allocation of the allowance for loan losses:
2014
2013
December 31,
2012
2011
2010
Allocated
Allowance
as a % of
Loan
Category
Percent of
Loans in
Each
Category
to Total
Loans
Allocated
Allowance
as a % of
Loan
Category
Percent of
Loans in
Each
Category
to Total
Loans
Allocated
Allowance
as a % of
Loan
Category
Percent of
Loans in
Each
Category
to Total
Loans
Allocated
Allowance
as a % of
Loan
Category
Percent of
Loans in
Each
Category
to Total
Loans
Allocated
Allowance
as a % of
Loan
Category
Percent of
Loans
in Each
Category
to Total
Loans
One-to-four
family .............
Commercial real
estate ..............
Consumer ..........
Commercial
business ........
Total ...................
1.57%
18.70%
2.13%
19.31%
2.91%
20.40%
3.12%
20.52%
1.67%
18.14%
2.62
1.84
2.11
2.23
51.30
14.71
15.29
100.00%
3.32
2.07
3.08
2.88
49.09
13.49
18.11
100.00%
5.55
2.12
5.08
4.54
51.47
11.35
16.78
100.00%
4.70
1.86
4.93
4.12
49.95
10.71
18.82
100.00%
6.90
1.31
9.91
6.04
50.30
9.96
21.60
100.00%
The allocated reserve percentages for commercial real
estate, commercial business, one-to-four family, and
consumer loan categories decreased in 2014 due primarily
to the decrease in the allocated reserves for impaired loans.
The allocation of the allowance for loan losses also
decreased in 2014 because of the $22.5 million decrease in
the loan portfolio between 2013 and 2014.
Allowance for Real Estate Losses
Real estate properties acquired or expected to be acquired
through loan foreclosures are initially recorded at fair value
less estimated selling costs. Management periodically
performs valuations and an allowance for losses is
established if the carrying value of a property exceeds its
fair value less estimated selling costs. The balance in the
allowance for real estate losses was $1.7 million at
December 31, 2014 and $2.4 million at December 31, 2013.
18
if
least quarterly and
Non-performing Assets
Loans are reviewed at
the
collectability of any loan is doubtful, it is placed on non-
accrual status. Loans are placed on non-accrual status when
either principal or interest is 90 days or more past due,
unless, in the judgment of management, the loan is well
collateralized and in the process of collection. Interest
accrued and unpaid at the time a loan is placed on non-
accrual status
income.
is charged against
Subsequent payments are either applied to the outstanding
principal balance or recorded as interest income, depending
on the assessment of the ultimate collectability of the loan.
Restructured loans include the Bank's troubled debt
restructurings that involved forgiving a portion of interest
or principal or making a loan at a rate materially less than
the market rate to borrowers whose financial condition had
deteriorated. Foreclosed and repossessed assets include
interest
MANAGEMENT DISCUSSION AND ANALYSIS
in settlement of
loans. Total non-
assets acquired
performing assets were $14.0 million at December 31,
2014, a decrease of $10.4 million from $24.4 million at
December 31, 2013. Non-performing loans decreased $6.6
million and foreclosed and repossessed assets decreased
$3.8 million during 2014. The decrease in non-performing
loans is primarily due to principal payments received and
loans being classified as accruing due to improved
performance in 2014. The following table sets forth the
amounts and categories of non-performing assets (non-
accrual loans and foreclosed and repossessed assets) in the
Company’s portfolio:
(Dollars in thousands)
Non-performing loans:
2014
2013
December 31,
2012
2011
2010
One-to-four family ............................................ $
Commercial real estate .....................................
Consumer ..........................................................
Commercial business ........................................
Total ..............................................................
1,564
8,750
486
120
10,920
Foreclosed and repossessed assets:
One-to-four family ............................................
Commercial real estate .....................................
Consumer ..........................................................
Total ..............................................................
Total non-performing assets ................................. $
Total as a percentage of total assets .....................
Total non-performing loans .................................. $
Total as a percentage of total loans receivable,
50
3,053
0
3,103
14,023
$
2.43%
$
10,920
1,602
14,549
737
608
17,496
0
6,898
0
6,898
24,394 $
3.76%
17,496 $
2,492
25,543
300
1,640
29,975
1,595
9,000
0
10,595
40,570 $
6.21%
29,975 $
4,435
22,658
699
6,201
33,993
352
16,264
0
16,616
50,609 $
6.40%
33,993 $
4,844
36,737
224
26,269
68,074
972
15,409
14
16,395
84,469
9.59%
68,074
net ......................................................................
2.99%
4.55%
6.60%
6.10%
10.25%
Allowance for loan losses to non-performing
loans ...................................................................
76.30%
65.17%
72.09%
70.27%
62.91%
Gross interest income which would have been recorded had
the non-accruing loans been current in accordance with
their original terms amounted to $0.9 million for 2014, $1.8
million for 2013, and $2.4 million for 2012. The amounts
that were included in interest income on a cash basis for
these loans were $0.2 million, $0.1 million, and $0.5
million, respectively.
The following table summarizes the number and property
types of commercial real estate loans that were non-
performing (the largest category of non-performing loans)
at December 31, 2014, 2013 and 2012.
(Dollars in thousands)
Property Type
Developments/land .......................
Retail ............................................
Other buildings .............................
# of
Relationships
3
0
0
3
$
$
Principal
Amount
of Loans at
December
31, 2014
8,750
0
0
8,750
Principal
Amount
of Loans at
December
31, 2013
14,549
0
0
14,549
# of
Relationships
9
2
4
15
$
$
Principal
Amount
of Loans at
December
31, 2012
24,339
386
818
25,543
# of
Relationships
9
0
0
9
$
$
19
MANAGEMENT DISCUSSION AND ANALYSIS
The Company had allocated reserves established against the
above commercial real estate loans of $0.3 million, $2.2
million, and $2.4 million, respectively, at December 31,
2014, 2013, and 2012.
For the loans that had been modified in 2014, $0.1 million
were unclassified and performing and $0.1 million were
non-performing at December 31, 2014. The decrease in
troubled debt restructurings (TDRs) in 2014 relates
primarily to two related commercial development loans
totaling $3.5 million that were charged down to $2.5
million and paid off during the year. Troubled debt
restructurings also decreased during the year by $1.4
million due to the paydown of six loans in an unrelated
commercial development, as well as $1.0 million due to the
payoff of a loan for another unrelated commercial
development.
Of the loans that were modified in 2014 and outstanding at
December 31, 2014, $0.2 million related to loans secured
by first or second mortgages on one-to-four family
property, and the remaining modifications related to other
consumer loans.
For the loans that had been modified in 2013, $0.3 million
were unclassified and performing and $0.8 million were
non-performing at December 31, 2013. The decrease in
TDRs in 2013 relates primarily to two commercial
development loans for which $3.6 million in charge-offs
were recorded during the year due to a decrease in the
estimated value of the collateral supporting the loans. TDRs
also decreased during the year by $4.0 million due to the
paydown or payoff of four other unrelated commercial
development loans, as well as $1.0 million due to the
repossession and sale of collateral related to a consumer
equity loan. The restructurings included reducing loan rates
and restructuring repayment schedules to improve the
borrower’s cash flow. Additional collateral was also
obtained for some loans. Of the loans that were modified in
2013, $0.6 million related to loans secured by first or
second mortgages on one-to-four family property, and the
to other consumer,
remaining modifications related
commercial real estate or commercial business loans. Of the
loans that were modified in 2012, $14.0 million related to
commercial
remaining
modifications related to single family, consumer and
commercial loans.
real estate
loans and
the
The following table sets forth the amount of TDRs in the Company’s portfolio:
(Dollars in thousands)
2014
2013
December 31,
2012
2011
2010
One-to-four family ............................................ $
Commercial real estate .....................................
Consumer ..........................................................
Commercial business ........................................
Total TDRs ....................................................
TDRs on accrual status .....................................
TDRs on non-accrual status ..............................
Total .............................................................. $
368
7,956
571
555
9,450
7,414
2,036
9,450
840
14,781
697
1,074
17,392
3,780
13,612
17,392
3,540
24,702
1,814
1,614
31,670
7,125
24,545
31,670
3,752
19,524
578
4,692
28,546
10,802
17,744
28,546
2,569
14,791
75
1,732
19,167
10,886
8,281
19,167
In addition to the troubled debt restructurings and the non-
performing loans set forth in the table above of all non-
performing assets, as of December 31, 2014, there were
three other potential problem loan relationships. Potential
problem loans are loans that are not in non-performing
status, however, there are circumstances present to create
doubt as to the ability of the borrower to comply with
present repayment terms. The decision of management to
include performing loans in potential problem loans does
not necessarily mean that the Company expects losses to
occur but that management recognized a higher degree of
risk associated with these loans. The level of potential
problem loans is another predominant factor in determining
the relative level of the allowance for loan losses. The three
loan relationships that have been reported as potential
problem loans at December 31, 2014 are a $3.8 million loan
to an educational institution, a $0.6 million loan to a small
manufacturing business, and three loans totaling $0.3
million to a golf course. The five loan relationships reported
as potential problem loans at December 31, 2013 were a
$0.7 million loan secured by an auto salvage business, and
four other loans to unrelated borrowers totaling $0.9 million
that are secured by restaurant business assets. The two loan
relationships reported as potential problem loans at
December 31, 2012 were a $1.4 million loan for a retail
commercial development and a $0.2 million loan for a
manufacturing business.
20
MANAGEMENT DISCUSSION AND ANALYSIS
Liquidity and Capital Resources
The Company attempts to manage its liquidity position so
that the funding needs of borrowers and depositors are met
timely and in a cost effective manner. Asset liquidity is the
ability to convert assets to cash through the maturity or sale
of the asset. Liability liquidity is the ability of the Bank to
attract retail, internet, or brokered deposits or to borrow
funds from third parties such as the FHLB or the Federal
Reserve Bank of Minneapolis.
The primary investing activities are the origination of loans
and the purchase of securities. Principal and interest
payments on loans and securities along with the proceeds
from the sale of loans held for sale are the primary sources
of cash for the Company. Additional cash can be obtained
by selling securities from the available for sale portfolio or
by selling loans or mortgage servicing rights. Unpledged
securities could also be pledged and used as collateral for
additional borrowings with the FHLB or Federal Reserve
Bank to generate additional cash.
The primary financing activity is the attraction of retail and
internet deposits. The Bank has the ability to borrow
additional funds from the FHLB or Federal Reserve Bank
by pledging additional securities or loans, subject to
applicable borrowing base and collateral requirements. See
“Note 11 Federal Home Loan Bank Advances (FHLB) and
Other Borrowings” in the Notes to the Consolidated
Financial Statements for more information on additional
advances that could be drawn based upon existing collateral
levels with the FHLB and the Federal Reserve Bank.
The Company's most liquid assets are cash and cash
equivalents, which consist of short-term highly liquid
investments with original maturities of less than three
months that are readily convertible to known amounts of
cash and interest-bearing deposits. The level of these assets
is dependent on the operating, financing and investing
activities during any given period.
the following major
Cash and cash equivalents at December 31, 2014 were
$46.6 million, a decrease of $74.1 million, compared to
$120.7 million at December 31, 2013. Net cash provided by
operating activities during 2014 was $17.3 million. The
Company conducted
investing
activities during 2014: principal payments and maturity
proceeds received on securities available for sale and FHLB
stock were $127.1 million, purchases of securities available
for sale and FHLB stock were $157.0 million, proceeds
from the sale of premises and other real estate were $4.8
million, and loans receivable decreased $13.5 million. The
Company disbursed $0.8 million for the purchase of
equipment and updating its premises. Net cash used by
investing activities during 2014 was $12.4 million. The
Company conducted
the following major financing
activities during 2014: customer escrows increased $0.2
21
million, redemptions of preferred stock were $16.0 million,
dividends paid to preferred stockholders totaled $6.0
million, and deposits decreased $57.2 million. Net cash
used by financing activities was $79.0 million.
The Company has certificates of deposit with outstanding
balances of $59.7 million that mature during 2015, none of
which were obtained from brokers. Based upon past
experience, management anticipates that the majority of the
deposits will renew for another term. The Company
believes that deposits that do not renew will be replaced
with a combination of other customers’ deposits and FHLB
advances. Proceeds from the sale of securities could also be
used to fund unanticipated outflows of deposits.
The Company has deposits of $63.6 million in checking and
money market accounts of customers that have relationship
balances greater than $5.0 million. These funds may be
withdrawn at any time, however, management anticipates
that the majority of these deposits will remain on deposit
with the Bank over the next twelve months. If these deposits
are withdrawn, it is anticipated that they would be funded
with available cash or replaced with deposits from other
customers or FHLB advances. Proceeds from the sale of
securities could also be used to fund unanticipated outflows
of deposits.
Dividends from the Bank have been the Company’s
primary source of cash. The Bank is restricted under
applicable federal banking law from paying dividends to
the Company without prior notice to and non-objection of
the applicable regulator. During 2014, the Bank paid
dividends to the Company of $22.5 million which were
used to redeem $16.0 million in outstanding Preferred
Stock, pay $6.0 million in dividends on the Preferred Stock,
and to fund the ongoing operating expenses of the
Company. At December 31, 2014, the Company had $1.5
million in cash and other assets that could readily be turned
into cash.
The Company’s primary use of cash is the payment of
dividends on the Preferred Stock, the payment of principal
and interest on the third party note payable, and holding
company level expenses, including the payment of director
and management fees as well as legal expenses and other
regulatory costs. The Company does not anticipate that it
will have on a stand-alone basis adequate liquid resources
to make future interest and principal payments on its third
party note payable and fund the Company-level expenses.
The Company plans to continue to fund its liquidity needs
through dividends from the Bank or external capital.
Provided that no default or event of default has occurred
and is continuing, the Company may also, at its option, elect
to defer payment of one installment of principal of the third
party note payable otherwise due prior to the maturity date,
MANAGEMENT DISCUSSION AND ANALYSIS
in which event such installment will become due and
payable on the maturity date.
On February 17, 2015, the Company redeemed the
remaining 10,000 shares of outstanding Preferred Stock.
After giving effect to a dividend of $22.50 per share on the
Preferred Stock that was paid on the same date, the
redemption price per share was $1,000. The Preferred Stock
redemption was funded through a $10.0 million term loan
to HMN from an unrelated third party that was evidenced
by a promissory note. The principal balance of the note
bears interest at a rate of 6.5% and is payable in consecutive
annual installments of $1.0 million on each December 15,
beginning December 15, 2015, with the balance due on
December 15, 2021. The Preferred Stock dividend was
funded by HMN through internally available funds.
Contractual Obligations and Commercial Commitments
The Company has certain obligations and commitments to make future payments under existing contracts. At December 31,
2014, the aggregate contractual obligations (excluding bank deposits) and commercial commitments were as follows:
(Dollars in thousands)
Contractual Obligations:
Annual rental commitments under non-
Total
Payments Due by Period
1-3
Years
Less than 1
Year
4-5
Years
After
5 Years
cancellable operating leases ............................... $
$
7,265
7,265
802
802
1,557
1,557
1,360
1,360
3,546
3,546
Other Commercial Commitments:
Commercial lines of credit ................................... $
Commitments to lend ...........................................
Standby letters of credit........................................
$
37,660
23,734
1,506
62,900
19,901
3,571
1,506
24,978
7,806
7,972
0
15,778
2,569
7,257
0
9,826
7,384
4,934
0
12,318
Amount of Commitments Expiring by Period
Regulatory Capital Requirements
As a result of the Federal Deposit Insurance Corporation
Improvement Act of 1991 (FDICIA), banking and thrift
regulators are required to take prompt regulatory action
against institutions which are undercapitalized. FDICIA
requires banking and thrift regulators to categorize
institutions as "well capitalized", "adequately capitalized",
"undercapitalized", "significantly undercapitalized", or
"critically undercapitalized". For the year ended December
31, 2014, a savings institution was deemed to be well
capitalized if it: (i) has a total risk-based capital ratio of
10% or greater, (ii) has a Tier 1 (core) risk-based capital
ratio of 6% or greater, (iii) has a leverage ratio of 5% or
greater, and (iv) is not subject to any order or written
directive by the OCC to meet and maintain a specific capital
level for any capital measure. On and after January 1, 2015,
a savings institution will be deemed to be "well capitalized"
if it (i) has a total risk-based capital ratio of 10% or greater,
(ii) has a Tier 1 (core) risk-based capital ratio of 8% or
greater, (iii) has a Common Equity Tier 1 risk-based capital
ratio of 6.5% or greater, (iv) has a leverage ratio of 5% or
greater, and (v) is not subject to any order or written
directive by the OCC to meet and maintain a specific capital
level for any capital measure. Management believes that, as
of December 31, 2014, the Bank’s capital ratios were in
excess of those quantitative capital ratio standards set forth
under the prompt corrective action regulations in effect on
that date. However, there can be no assurance that the Bank
will continue to maintain such status in the future under the
heightened standards that went into effect on January 1,
2015. The OCC has extensive discretion in its supervisory
and enforcement activities, and can further adjust the
requirement to be “well-capitalized” in the future. Refer to
Note 16 of the Notes to Consolidated Financial Statements
for a table which reflects the Bank’s capital compared to
these capital requirements.
As required by the Company Supervisory Agreement that
was in effect at December 31, 2013, the Company
submitted an updated two-year capital plan in January
2014. The Company was required to operate within the
parameters of the capital plan and was required to monitor
and submit periodic reports on its compliance with the plan.
Effective May 1, 2014, the FRB terminated the Supervisory
Agreement to which the Company was subject. In addition,
the OCC had established an individual minimum capital
requirement (IMCR) for the Bank that was also in effect at
22
MANAGEMENT DISCUSSION AND ANALYSIS
December 31, 2013. An IMCR requires a bank to establish
and maintain levels of capital greater than those generally
required for a bank to be classified as “well-capitalized.”
Effective December 31, 2011, the Bank was required to
establish, and subsequently maintain, core capital at least
equal to 8.50% of adjusted total assets. The Bank’s core
capital to adjusted total assets ratio was 12.22% at
December 31, 2013. The OCC terminated its Supervisory
Agreement and the IMCR effective February 11, 2014.
The Company also serves as a source of capital, liquidity
and financial support to the Bank. Depending upon the
operating performance of the Bank and the Company’s
other liquidity and capital needs, including potentially
Company-level expenses and the payment of principal and
interest payments on the third party note payable, the
Company may find it prudent, subject to prevailing capital
market conditions and other factors, to raise additional
capital through issuance of its common stock or other
equity securities. In addition, regulators have placed
increasing emphasis on the amount of common equity as a
component of core bank capital, and revised capital
regulations (described below) incorporating specific levels
of common equity capital both at the Bank and the
Company. Additional capital would also potentially permit
the Company to implement a strategy of growing Bank
assets. Depending on the circumstances, if it were to raise
capital, the Company may deploy it to the Bank for general
banking purposes, or may retain some or all of it for use by
the Company.
If the Company raises capital through the issuance of
additional shares of common stock or other equity
securities, it would dilute the ownership interests of existing
stockholders and, if issued at less than the Company’s book
value would dilute the per share book value of the
Company’s common stock, dilute the Company’s earnings
per share, and could result in a change of control of the
Company and the Bank. New investors may also have
rights, preferences and privileges senior to the Company’s
current stockholders, which may adversely impact the
Company’s current stockholders. The Company’s ability to
raise additional capital through the issuance of equity
securities, if deemed prudent, will depend on, among other
factors, conditions in the capital markets at that time, which
are outside of its control, and on the Company’s financial
performance and plans. Accordingly, the Company may not
be able to raise additional capital, if deemed prudent, on
favorable economic terms, or other terms acceptable to it.
If the Company or the Bank cannot satisfactorily address
their respective capital needs as they arise, the Company’s
ability to maintain or expand its operations, maintain
compliance with the regulatory capital requirements, to
operate without additional regulatory or other restrictions,
and its operating results, could be materially adversely
affected.
The capital requirements of the Company and the Bank will
be affected by regulatory capital changes issued in July
2013 by the FRB, the FDIC and the OCC. The changes
establish an integrated regulatory capital framework for
the Basel Committee on Banking
implementing
Supervision’s Basel III regulatory capital reforms and
implement the changes required by the Dodd-Frank Wall
Street Reform and Consumer Protection Act of 2010. The
new capital requirements are effective for the Company
beginning January 1, 2015, and among other things, apply
a strengthened set of capital requirements to both the Bank
and the Company and revise the rules for calculating risk-
weighted assets for purposes of such requirements.
Management believes that the Company and the Bank were
“well capitalized” under these new capital standards when
they were implemented on January 1, 2015. See “Item 1 –
Business – Regulation and Supervision” in our Form 10-K
and Note 16 of the Consolidated Financial Statements for
the fiscal year ended December 31, 2014 for additional
information on the new regulatory capital rules.
regulatory
restrictions,
Dividends
The declaration of dividends is subject to, among other
things, the Company's financial condition and results of
operations, the Bank's compliance with regulatory capital
requirements and other
tax
considerations, industry standards, economic conditions,
general business practices and other factors. The Company
suspended dividend payments to common stockholders in
the fourth quarter of 2008 due to the net operating losses
experienced and the challenging economic environment.
The Company began deferring dividend payments to its
preferred stockholders in the first quarter of 2011 due to the
net operating losses experienced and regulatory restrictions
on their payment. While Preferred Stock dividends were in
arrears, no dividend could be paid on the common stock of
the Company. The deferred dividends were subsequently
paid and all of the outstanding Preferred Stock had been
redeemed as of February 17, 2015.
Under applicable federal banking laws and regulations, no
dividends can be declared or paid by the Bank to the
Company without notice to and non-objection from the
applicable banking regulator. There is no assurance that the
Bank and the Company would satisfy the applicable
regulatory requirements necessary to effect any such
dividends. The payment of dividends by the Company is
dependent upon the Company having adequate cash or
other assets that can be converted to cash to pay dividends
to its stockholders. Further, any determination as to
whether, when and in what amount to declare and pay any
such dividends would be subject to the discretion of the
boards of directors of the Bank and the Company and would
depend on numerous factors including the results of
operations, financial conditions and cash flow requirements
of the Company and the Bank.
23
MANAGEMENT DISCUSSION AND ANALYSIS
Impact of Inflation and Changing Prices
The impact of inflation is reflected in the increased cost of
operations. Unlike most industrial companies, nearly all of
the assets and liabilities of the Company are monetary in
nature. As a result, interest rates have a greater impact on
the Company's performance than do the effects of general
levels of inflation. Interest rates do not necessarily move in
the same direction or to the same extent as the prices of
goods and services.
New Accounting Pronouncements
In January 2014, the FASB issued ASU 2014-04,
Receivables – Troubled Debt Restructurings by Creditors
(Subtopic 310-40) Reclassification of Residential Real
Estate Collateralized Consumer Mortgage Loans upon
Foreclosure. The amendments in this ASU clarify when a
repossession or foreclosure occurs, and a creditor is
considered to have received physical possession of
residential real estate property collateralizing a consumer
mortgage loan. Under the amendment, physical possession
occurs, upon either (1) the creditor obtaining legal title to
the residential real estate property upon completion of a
foreclosure or (2) the borrower conveying all interest in the
residential real estate property to the creditor to satisfy that
loan through completion of a deed in lieu of foreclosure or
through a similar legal agreement. The ASU is intended to
reduce diversity in practice and is effective for public
business entities for annual periods, and interim periods
within those annual periods, beginning after December 15,
2014. The adoption of this ASU in the first quarter of 2015
did not have a material impact on the Company’s
consolidated financial statements.
the FASB
In August 2014,
issued ASU 2014-14,
Receivables – Troubled Debt Restructurings by Creditors
(Subtopic 310-40) Classification of Certain Government-
Guaranteed Mortgage Loans upon Foreclosure. The
amendments in this ASU require that a mortgage loan be
derecognized and that a separate other receivable be
recognized upon foreclosure of a government-guaranteed
loan if certain conditions are met. Upon foreclosure, the
separate other receivable should be measured based on the
amount of the loan balance (principal and interest) expected
to be recovered from the guarantor. The ASU is intended to
reduce diversity in practice and is effective for public
business entities for annual periods, and interim periods
within those annual periods, beginning after December 15,
2014. The adoption of this ASU in the first quarter of 2015
did not have a material impact on the Company’s
consolidated financial statements.
in
the FASB
In August 2014,
issued ASU 2014-15,
Presentation of Financial Statements – Going Concern
(Subtopic 205-40) Disclosure of Uncertainties about an
Entity’s Ability to Continue as a Going Concern. The
amendments
this ASU provide guidance about
management’s responsibility to evaluate whether there is
substantial doubt about an entity’s ability to continue as a
going concern and to provide certain related footnote
disclosures. The ASU is intended to reduce diversity in the
timing and content of footnote disclosures and is effective
for all entities for the annual period ending after December
15, 2016 and for annual and interim periods thereafter. The
adoption of this ASU in the fourth quarter of 2016 is not
anticipated to have a material impact on the Company’s
consolidated financial statements.
Market Risk
Market risk is the risk of loss from adverse changes in
market prices and rates. The Company's market risk arises
primarily from interest rate risk inherent in its investing,
lending and deposit taking activities. Management actively
monitors and manages its interest rate risk exposure.
The Company's profitability is affected by fluctuations in
interest rates. A sudden and substantial change in interest
rates may adversely impact the Company's earnings to the
extent that the interest rates borne by assets and liabilities
do not change at the same speed, to the same extent, or on
the same basis. The Company monitors the projected
changes in net interest income that occur if interest rates
were to suddenly change up or down. The Rate Shock Table
located in the following Asset/Liability Management
section of this Management’s Discussion and Analysis
discloses the Company's projected changes in net interest
income based upon immediate interest rate changes called
rate shocks.
The Company utilizes a model that uses the discounted cash
flows from its interest-earning assets and its interest-
bearing liabilities to calculate the current market value of
those assets and liabilities. The model also calculates the
changes in market value of the interest-earning assets and
interest-bearing liabilities under different interest rate
changes.
24
MANAGEMENT DISCUSSION AND ANALYSIS
The following table discloses the projected changes in market value to the Company’s interest-earning assets and interest-
bearing liabilities based upon incremental 100 basis point changes in interest rates from interest rates in effect on December
31, 2014.
(Dollars in thousands)
Basis point change in interest rates
Total market-risk sensitive assets ................................................ $ 570,149
488,174
Total market-risk sensitive liabilities ..........................................
(204)
Off-balance sheet financial instruments ......................................
82,179
Net market risk ............................................................................ $
(22.54)%
Percentage change from current market value ............................
-100
Market Value
0
+100
564,339 555,005
458,245 439,479
44
106,094 115,482
8.85%
0.00%
0
+200
542,961
422,117
104
120,740
13.80%
(the Model Assumptions)
The preceding table was prepared utilizing the following
assumptions
regarding
prepayment and decay ratios that were determined by
management based upon
their review of historical
prepayment speeds and future prepayment projections.
Fixed rate loans were assumed to prepay at annual rates of
between 4% and 61%, depending on the note rate and the
period to maturity. Adjustable rate mortgages (ARMs) were
assumed to prepay at annual rates of between 18% and
138%, depending on the note rate and the period to
maturity. Mortgage-backed securities were projected to
have prepayments based upon the underlying collateral
securing the instrument. Certificate accounts were assumed
not to be withdrawn until maturity. Passbook and money
market accounts were assumed to decay at annual rates of
6% and 8%, respectively. Non-interest checking and NOW
accounts were both assumed to decay at an annual rate of
3%. Commercial non-interest checking and NOW accounts
were assumed to decay at an annual rate of 9%. Commercial
MMDA accounts were assumed to decay at annual rates of
12%.
Certain shortcomings are inherent in the method of analysis
presented in the foregoing table. The interest rates on
certain types of assets and liabilities may fluctuate in
advance of changes in market interest rates, while interest
rates on other types of assets and liabilities may lag behind
changes in market interest rates. The model assumes that
the difference between the current interest rate being earned
or paid compared to a treasury instrument or other interest
index with a similar term to maturity (the interest spread)
will remain constant over the interest changes disclosed in
the table. Changes in interest spread could impact projected
market value changes. Certain assets, such as ARMs, have
features that restrict changes in interest rates on a short-term
basis and over the life of the assets. The market value of the
interest-bearing assets that are approaching their lifetime
interest rate caps or floors could be different from the values
calculated
liabilities, such as
table. Certain
certificates of deposit, have fixed rates that restrict interest
rate changes until maturity. In the event of a change in
the
in
interest rates, prepayment and early withdrawal levels may
deviate significantly from those assumed in calculating the
foregoing table. The ability of many borrowers to service
their debt may also decrease in the event of a substantial
sustained increase in interest rates.
Asset/Liability Management
The Company's management reviews the impact that
changing interest rates will have on the net interest income
projected for the twelve months following December 31,
2014 to determine if its current level of interest rate risk is
acceptable. The following table projects the estimated
impact on net interest income during the 12 month period
ending December 31, 2015 of immediate interest rate
changes called rate shocks:
(Dollars in thousands)
Rate Shock
in Basis Points
+200
+100
0
-100
Net Interest
Change
Percent
Change
$
2,287
1,306
0
(1,978)
12.62%
7.20
0.00
(10.92)
The preceding table was prepared utilizing the Model
Assumptions. Certain shortcomings are inherent in the
method of analysis presented in the foregoing table. In the
event of a change in interest rates, prepayment and early
withdrawal levels would likely deviate significantly from
those assumed in calculating the foregoing table. The
ability of many borrowers to service their debt may
decrease in the event of a substantial increase in interest
rates and could impact net interest income. The increase in
interest income in a rising rate environment is because there
are more adjustable rate loans that would re-price to higher
interest rates in the next twelve months than there are
deposits that would re-price.
25
MANAGEMENT DISCUSSION AND ANALYSIS
In an attempt to manage its exposure to changes in interest
rates, management closely monitors interest rate risk. The
Company has an Asset/Liability Committee that meets
frequently to discuss changes in the interest rate risk
position and projected profitability. The Committee makes
adjustments to the asset-liability position of the Bank that
are reviewed by the Board of Directors of the Bank. This
Committee also reviews the Bank's portfolio, formulates
timing and
investment strategies and oversees
implementation of transactions as intended to assure
attainment of the Bank's objectives in an effective manner.
In addition, the Board reviews, on a quarterly basis, the
Bank's asset/liability position, including simulations of the
effect on the Bank's capital of various interest rate
scenarios.
the
In managing its asset/liability mix, the Bank may, at times,
depending on the relationship between long and short-term
interest rates, market conditions and consumer preference,
place more emphasis on managing net interest margin than
on better matching the interest rate sensitivity of its assets
and liabilities in an effort to enhance net interest income.
Management believes that the increased net interest income
resulting from a mismatch in the maturity of its asset and
liability portfolios can, in certain situations, provide high
enough returns to justify the increased exposure to sudden
and unexpected changes in interest rates.
To the extent consistent with its interest rate spread
objectives, the Bank attempts to manage its interest rate risk
and has taken a number of steps to restructure its balance
sheet in order to better match the maturities of its assets and
liabilities. In the past, more long term fixed rate loans were
placed into the single family loan portfolio. In recent years,
the Bank has continued to focus its 30 year fixed rate one-
to-four family residential lending program on loans that are
saleable to third parties and generally places only shorter
term fixed rate loans that meet certain risk characteristics
into its loan portfolio. A significant portion of the Bank’s
commercial loan production continues to be in adjustable
rate loans that re-price every one, two, or three years.
Off-Balance Sheet Arrangements
The Company has no off-balance sheet arrangements other
than commitments to originate and sell loans in the ordinary
course of business which are more fully discussed in Note
17 of the Notes to Consolidated Financial Statements.
Management believes that the Company has sufficient
liquidity to satisfy its off-balance sheet obligations.
26
CONSOLIDATED BALANCE SHEETS
December 31 (Dollars in thousands)
2014
2013
ASSETS
Cash and cash equivalents ................................................................................................ $
Securities available for sale:
Mortgage-backed and related securities
46,634
120,686
(amortized cost $2,755 and $4,899) ..........................................................................
2,909
5,213
Other marketable securities
(amortized cost $135,772 and $103,788) .................................................................
Loans held for sale ...........................................................................................................
Loans receivable, net ........................................................................................................
Accrued interest receivable ..............................................................................................
Real estate, net .................................................................................................................
Federal Home Loan Bank stock, at cost ...........................................................................
Mortgage servicing rights, net ..........................................................................................
Premises and equipment, net ...........................................................................................
Prepaid expenses and other assets ....................................................................................
Deferred tax asset, net ......................................................................................................
Total assets ................................................................................................................... $
LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits ............................................................................................................................ $
Accrued interest payable ..................................................................................................
Customer escrows ............................................................................................................
Accrued expenses and other liabilities .............................................................................
Total liabilities ..............................................................................................................
134,925
137,834
2,076
365,113
1,713
3,103
777
1,507
6,982
1,157
10,530
577,426
496,750
93
788
3,782
501,413
102,743
107,956
1,502
384,615
1,953
6,898
784
1,708
6,711
698
15,111
648,622
553,930
146
614
8,257
562,947
Commitments and contingencies
Stockholders’ equity:
Serial preferred stock: ($.01 par value)
Authorized 500,000 shares; issued and outstanding shares 10,000 and 26,000 ........
10,000
26,000
Common stock ($.01 par value):
Authorized 16,000,000; issued shares 9,128,662 ......................................................
Additional paid-in capital .................................................................................................
Retained earnings, subject to certain restrictions .............................................................
Accumulated other comprehensive loss ...........................................................................
Unearned employee stock ownership plan shares ............................................................
Treasury stock, at cost 4,658,323 and 4,704,313 shares ..................................................
Total stockholders’ equity ............................................................................................
Total liabilities and stockholders’ equity ......................................................................... $
91
50,207
77,805
(418)
(2,610)
(59,062)
76,013
577,426
91
51,175
72,211
(674)
(2,804)
(60,324)
85,675
648,622
See accompanying notes to consolidated financial statements.
27
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Years ended December 31 (Dollars in thousands)
Interest income:
Loans receivable ............................................................................. $
Securities available for sale:
Mortgage-backed and related ......................................................
Other marketable .........................................................................
Cash equivalents .............................................................................
Other ...............................................................................................
Total interest income ...................................................................
Interest expense:
Deposits ..........................................................................................
Federal Home Loan Bank advances ...............................................
Total interest expense ..................................................................
Net interest income ..................................................................
Provision for loan losses ....................................................................
Net interest income after provision for loan losses ..................
Non-interest income:
Fees and service charges .................................................................
Loan servicing fees .........................................................................
Gain on sales of loans .....................................................................
Gain on sale of branch office ..........................................................
Other ...............................................................................................
Total non-interest income ...........................................................
Non-interest expense:
Compensation and benefits ............................................................
(Gains) losses on real estate owned ................................................
Occupancy ......................................................................................
Deposit insurance ...........................................................................
Data processing...............................................................................
Other ...............................................................................................
Total noninterest expense ............................................................
Income before income tax expense .........................................
Income tax expense (benefit) .............................................................
Net income ..................................................................................
Preferred stock dividends and discount ..............................................
Net income available to common shareholders ........................... $
Other comprehensive income (loss), net of tax ..................................
Comprehensive income attributable to common shareholders ........... $
Basic earnings per common share ...................................................... $
Diluted earnings per common share ................................................... $
See accompanying notes to consolidated financial statements.
2014
2013
2012
18,987
21,887
29,257
164
1,269
189
4
20,613
1,211
0
1,211
19,402
(6,998)
26,400
3,458
1,058
1,828
0
940
7,284
13,332
(1,194)
3,691
435
1,011
4,128
21,403
12,281
4,902
7,379
(1,710)
5,669
256
5,925
1.40
1.23
300
614
129
53
22,983
1,804
1,485
3,289
19,694
(7,881 )
27,575
3,513
1,029
2,102
0
668
7,312
12,680
(830 )
3,338
868
1,289
5,278
22,623
12,264
(14,406 )
26,670
(2,068 )
24,602
(625 )
23,977
6.15
5.71
604
737
101
117
30,816
3,741
3,398
7,139
23,677
2,544
21,133
3,325
964
3,574
552
575
8,990
12,452
181
3,358
1,255
1,434
5,990
24,670
5,453
132
5,321
(1,861)
3,460
(520)
2,940
0.88
0.86
28
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
Preferred
Common
Stock
Stock
Additional
Paid-in
Capital
Accumulated
Other
Comprehensive
Unearned
Employee
Stock
Retained
Earnings
Income
(Loss)
Ownership
Treasury
Plan
Stock
24,780
91
53,462
42,983
5,321
471
(3,191)
(61,535)
(520)
Total
Stock-
holders’
Equity
57,061
5,321
(520)
0
7
0
0
233
(1,300)
32
60,834
26,670
(625)
0
4
0
(119)
202
(1,463)
172
85,675
7,379
256
(16,000)
1
0
240
(1,785)
247
76,013
1,199
(10)
194
(2,997)
(60,346)
(49)
(625)
349
(327)
193
(2,804)
(60,324)
(674)
256
1,262
(1,300)
47,004
26,670
(1,463)
72,211
7,379
(1,785)
77,805
(418)
194
(2,610)
(59,062)
(Dollars in thousands)
Balance, December 31, 2011 ......... $
Net income ...............................
Other comprehensive loss ........
Preferred stock discount
amortization ..........................
Stock compensation expense ....
Restricted stock awards ............
Restricted stock awards
forfeited .................................
Amortization of restricted
stock awards ..........................
Preferred stock dividends
accrued ..................................
Earned employee stock
ownership plan shares ...........
Balance, December 31, 2012 ......... $
Net income ...............................
Other comprehensive loss ........
Preferred stock discount
amortization ..........................
Stock compensation expense ....
Restricted stock awards ............
Restricted stock awards
forfeited .................................
Amortization of restricted
stock awards ..........................
Preferred stock dividends
accrued ..................................
Earned employee stock
ownership plan shares ...........
Balance, December 31, 2013 ....... $
Net income ...............................
Other comprehensive income
Redemption of preferred
556
25,336
91
664
(556)
7
(1,199)
10
233
(162)
51,795
(664)
4
(349)
208
202
26,000
91
(21)
51,175
stock ......................................
(16,000 )
Stock compensation tax
benefits .................................
Restricted stock awards .........
Amortization of restricted
stock awards ........................
Preferred stock dividends ......
Earned employee stock
ownership plan shares ........
Balance, December 31, 2014 ....... $
1
(1,262)
240
53
50,207
10,000
91
See accompanying notes to consolidated financial statements.
29
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31 (Dollars in thousands)
Cash flows from operating activities:
Net income ................................................................................................. $
Adjustments to reconcile net income to cash provided by operating
activities:
Provision for loan losses ........................................................................
Depreciation ...........................................................................................
Amortization of discounts, net ...............................................................
Amortization of deferred loan fees .........................................................
Amortization of mortgage servicing rights .............................................
Capitalized mortgage servicing rights ....................................................
Deferred income tax expense (benefit)...................................................
(Gains) losses on sales of real estate and premises .................................
Gain on sales of loans ............................................................................
Proceeds from sales of loans held for sale ..............................................
Disbursements on loans held for sale .....................................................
Amortization of restricted stock awards .................................................
Amortization of unearned ESOP shares .................................................
Cancellation of vested restricted stock awards .......................................
Earned ESOP shares priced above (below) original cost .......................
Stock option compensation expense .......................................................
Gain on sale of branch office ................................................................
Decrease in accrued interest receivable ..................................................
Decrease in accrued interest payable ......................................................
(Increase) decrease in other assets ..........................................................
(Decrease) increase in other liabilities ...................................................
Other, net ...............................................................................................
Net cash provided by operating activities...........................................
Cash flows from investing activities:
Principal collected on securities available for sale .....................................
Proceeds collected on maturity of securities available for sale ..................
Purchases of securities available for sale ...................................................
Purchase of Federal Home Loan Bank stock .............................................
Redemption of Federal Home Loan Bank stock ........................................
Proceeds from sales of real estate and premises .........................................
Net decrease in loans receivable ...............................................................
Payment on sale of branch office ...............................................................
Purchases of premises and equipment ........................................................
Net cash (used) provided by investing activities ................................
Cash flows from financing activities:
(Decrease) increase in deposits ..................................................................
Redemption of preferred stock ...................................................................
Dividends paid to preferred stockholders ...................................................
Proceeds from borrowings .........................................................................
Repayment of borrowings ..........................................................................
Increase (decrease) in customer escrows ....................................................
Net cash used by financing activities .................................................
(Decrease) increase in cash and cash equivalents ...............................
Cash and cash equivalents, beginning of year ................................................
Cash and cash equivalents, end of year .......................................................... $
Supplemental cash flow disclosures:
Cash paid for interest ................................................................................. $
Cash paid for income taxes ........................................................................
Supplemental noncash flow disclosures:
Loans transferred to loans held for sale ......................................................
Transfer of loans to real estate ...................................................................
See accompanying notes to consolidated financial statements.
30
2014
2013
2012
7,379
26,670
5,321
(6,998)
576
18
(340)
517
(316)
4,566
(1,194)
(1,828)
56,040
(41,557)
240
194
0
53
1
0
240
(53)
(444)
(265)
515
17,344
2,148
125,000
(157,004)
0
7
4,816
13,455
0
(847)
(12,425)
(57,182)
(16,000)
(5,964)
0
0
175
(78,971)
(74,052)
120,686
46,634
1,264
0
13,243
142
(7,881 )
880
80
(249 )
592
(568 )
(14,464 )
(830 )
(2,102 )
84,718
(69,347 )
202
193
(119 )
(21 )
4
0
65
(101 )
842
364
64
18,992
4,933
21,000
(49,090 )
(178 )
3,457
5,786
63,814
0
(425 )
49,297
38,953
0
0
12,000
(82,000 )
(216 )
(31,263 )
37,026
83,660
120,686
3,390
205
12,183
1,563
2,544
1,091
98
(528)
732
(979)
0
181
(3,574)
131,494
(118,661)
233
194
0
(162)
7
(552)
431
(533)
696
(1,776)
580
16,837
9,770
108,000
(78,072)
0
159
7,503
89,591
(36,981)
(295)
99,675
(100,591)
0
0
1
(1)
(101)
(100,692)
15,820
67,840
83,660
7,672
60
8,196
2,225
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2014, 2013 and 2012
NOTE 1 Description of the Business and Summary of
Significant Accounting Policies
HMN Financial, Inc. (HMN or the Company) is a stock
savings bank holding company that owns 100 percent of
Home Federal Savings Bank (the Bank). The Bank has a
community banking philosophy and operates retail banking
and loan production facilities in Minnesota, Iowa, and
Wisconsin. The Bank has two wholly owned subsidiaries,
Osterud Insurance Agency, Inc. (OIA), which offers
financial planning products and services, and HFSB
Property Holdings, LLC (HPH), which acts as an
intermediary for the Bank in holding and operating certain
foreclosed properties.
The consolidated financial statements included herein are
for HMN, the Bank, OIA, and HPH. All significant
intercompany accounts and
transactions have been
eliminated in consolidation.
The Company evaluated subsequent events through the
filing date of our annual 10-K with the Securities and
Exchange Commission on March 13, 2015. See Note 11
Federal Home Loan Bank Advances (FHLB) and Other
Borrowings for discussion of the advance on the note
payable and
redemption of remaining Fixed Rate
Cumulative Perpetual Preferred Stock, Series A (“Preferred
Stock”) on February 17, 2015.
the consolidated
Use of Estimates
In preparing
financial statements,
management is required to make estimates and assumptions
that affect the reported amounts of assets and liabilities as
of the date of the balance sheet and revenues and expenses
for the period. Actual results could differ from those
estimates.
the date of
An estimate that is particularly susceptible to change relates
to the determination of the allowance for loan losses.
Management believes that the allowance for loan losses is
appropriate to cover probable losses inherent in the
the balance sheet. While
portfolio at
management uses available information to recognize losses
on loans, future additions to the allowance may be
necessary based on changes in economic conditions and
other factors. In addition, various regulatory agencies, as an
integral part of their examination process, periodically
review the allowance for loan losses. Such agencies may
require changes to the allowance based on their judgment
about information available to them at the time of their
examination.
31
Cash and Cash Equivalents
The Company considers highly liquid investments with
original maturities of three months or less to be cash
equivalents.
Securities
Securities are accounted for according to their purpose and
holding period. The Company classifies its debt and equity
securities in one of three categories:
Trading Securities
Securities held principally for resale in the near term
are classified as trading securities and are recorded at
their fair values. Unrealized gains and losses on trading
securities are included in other income.
Securities Held to Maturity
Securities that the Company has the positive intent and
ability to hold to maturity are reported at cost and
that are
adjusted for premiums and discounts
recognized in interest income using the interest method
over the period to maturity. Unrealized losses on
securities held to maturity reflecting a decline in value
judged to be other than temporary are charged to
income and a new cost basis is established.
Securities Available for Sale
Securities available for sale consist of securities not
classified as trading securities or as securities held to
maturity. They include securities that management
intends to use as part of its asset/liability strategy or
that may be sold in response to changes in interest
rates, changes in prepayment risk, or similar factors.
Unrealized gains and losses, net of income taxes, are
reported as a separate component of stockholders’
equity until realized. Gains and losses on the sale of
securities available for sale are determined using the
specific identification method and recognized on the
trade date. Premiums and discounts are recognized in
interest income using the interest method over the
period to maturity. Unrealized losses on securities
available for sale reflecting a decline in value judged
to be other than temporary are charged to income and
a new cost basis is established.
the
investment
security
Management monitors
portfolio for impairment on an individual security basis
and has a process in place to identify securities that
could potentially have a credit impairment that is other
than temporary. This process involves analyzing the
length of time and extent to which the fair value has
been less than the amortized cost basis, the market
liquidity for the security, the financial condition and
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
near-term prospects of the issuer, expected cash flows,
and the Company's intent and ability to hold the
investment for a period of time sufficient to recover the
temporary loss, including determining whether it is
the Company will be
more-likely-than-not
required to sell the security prior to recovery. To the
extent it is determined that a security is deemed to be
other-than-temporarily impaired, an impairment loss is
recognized.
that
Loans Held for Sale
Mortgage loans originated or purchased which are intended
for sale in the secondary market are carried at the lower of
cost or estimated market value in the aggregate. Net fees
and costs associated with acquiring or originating loans
held for sale are deferred and included in the basis of the
loan in determining the gain or loss on the sale of the loans.
Gains on the sale of loans are recognized on the settlement
date. Net unrealized losses are recognized through a
valuation allowance by charges to income.
Loans Receivable, net
Loans receivable, net, are carried at amortized cost. Loan
origination fees received, net of certain loan origination
costs, are deferred as an adjustment to the carrying value of
the related loans, and are amortized into income using the
interest method over the estimated life of the loans.
Premiums and discounts on purchased loans are amortized
into interest income using the interest method over the
period to contractual maturity, adjusted for estimated
prepayments.
The allowance for loan losses is based on a periodic
analysis of the loan portfolio and is maintained at an
amount considered to be appropriate by management to
provide for probable losses inherent in the loan portfolio as
of the balance sheet dates. In this analysis, management
considers factors including, but not limited to, specific
occurrences of loan impairment, actual and anticipated
changes in the size of the portfolios, national and regional
economic conditions (such as unemployment data, loan
delinquencies, local economic conditions, demand for
single-family homes, demand for commercial real estate
and building lots, loan portfolio composition and historical
loss experience) and observations made by the Company's
ongoing internal audit and regulatory exam processes. In
connection with the determination of the allowance for loan
losses, management obtains independent appraisals for
significant properties or other collateral securing classified
loans. Appraisals on collateral dependent commercial real
estate and commercial business loans are obtained when it
the borrower’s risk profile has
is determined
deteriorated and the loan is classified as impaired.
Subsequent new third party appraisals of properties
securing impaired commercial real estate and commercial
that
business loans are prepared at least every two years. For all
land development loan types, a new third party appraisal is
prepared on an annual basis where current activity is not
consistent with the assumptions made in the most recent
third party appraisal. Non-performing residential and
consumer home equity loans and home equity lines may
have a third party appraisal or an internal evaluation
completed depending on the size of the loan and location of
the property. These appraisals, or internal valuations, are
generally completed when a residential or consumer home
equity loan or home equity line of credit becomes 120 days
past due and are typically updated after possession of the
property is obtained. Valuations are reviewed on a quarterly
basis and adjustments are made to the allowance for loan
losses for temporary impairments and charge-offs are taken
when the impairment is determined to be permanent. The
fair market value of the properties for all loan types are
adjusted for estimated selling costs in order to determine
the net realizable value of the properties. The allowance for
loan losses is established for known problem loans, as well
as for loans which are not currently known to require an
allowance. Loans are charged off to the extent they are
deemed to be uncollectible. The appropriateness of the
allowance for loan losses is dependent upon management’s
estimates of variables affecting valuation, appraisals of
collateral, evaluations of performance and status, and the
amounts and timing of future cash flows expected to be
received on impaired loans. Such estimates, appraisals,
evaluations and cash flows may be subject to adjustments
due to changing economic prospects of borrowers or
properties. The fair market value of collateral dependent
loans are typically based on the appraised value of the
property less estimated selling costs. The estimates are
reviewed periodically and adjustments, if any, are recorded
in the provision for loan losses in the periods in which the
adjustments become known. The allowance is allocated to
individual loan categories based upon the relative risk
characteristics of the loan portfolios and the actual loss
experience. The Company increases its allowance for loan
losses by charging the provision for loan losses against
income and decreases its allowance by crediting the
provision for loan losses. The methodology for establishing
the allowance for loan losses takes into consideration
probable losses that have been identified in connection with
specific loans as well as losses in the loan portfolio that
have not been specifically identified.
Interest income is recognized on an accrual basis except
when collectability is in doubt. When loans are placed on a
non-accrual basis, generally when the loan is 90 days past
due, previously accrued but unpaid interest is reversed from
income. If the ultimate collectability of a loan is in doubt
and the loan is placed in nonaccrual status, the cost recovery
method is used and cash collected is applied to first reduce
the principal outstanding. Generally, the Company returns
a loan to accrual status when all delinquent interest and
32
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
principal becomes current under the terms of the loan
agreement and collectability of remaining principal and
interest is no longer doubtful.
maintain effective control over the transferred assets
through an agreement to repurchase them before their
maturity.
All impaired loans are valued at the present value of
expected future cash flows discounted at the loan's initial
effective interest rate. The fair value of the collateral of an
impaired collateral-dependent loan or an observable market
price, if one exists, may be used as an alternative to
discounting. If the value of the impaired loan is less than
the recorded investment in the loan, the impaired amount is
charged off. A loan is considered impaired when, based on
current information and events, it is probable that the
Company will be unable to collect all amounts due
according to the contractual terms of the loan agreement.
Impaired loans include all loans which are on non-accrual,
delinquent as to principal and interest for 90 days or greater,
or restructured in a troubled debt restructuring involving a
modification of terms. All non-accruing loans are reviewed
for impairment on an individual basis.
Included in loans receivable, net, are certain loans that have
been modified in order to maximize collection of the loan
balances. The Company evaluates all loan modifications
and if the Company, for legal or economic reasons related
to the borrower's financial difficulties, grants a concession
compared to the original terms and conditions of the loan
that the Company would not otherwise consider, the
modified loan is considered a troubled debt restructuring
(TDR) and is classified as an impaired loan. If the TDR loan
was performing (accruing) prior to the modification, it
typically will remain accruing after the modification as long
as it continues to perform according to the modified terms.
If the TDR loan was non-performing (non-accruing) prior
to the modification, it will remain non-accruing after the
modification for a minimum of six months. If the loan
performs according to the modified terms for a minimum of
six months, it typically will be returned to accruing status.
In general, there are two conditions in which a TDR loan is
no longer considered to be a TDR and potentially not
classified as impaired. The first condition is whether the
loan is refinanced with terms that reflect normal market
terms for the type of credit involved. The second condition
is whether the loan is repaid or charged off.
Transfers of Financial Assets and Participating Interests
Transfers of an entire financial asset or a participating
interest in an entire financial asset are accounted for as sales
when control over the assets has been surrendered. Control
over transferred assets is deemed to be surrendered when
(1) the assets have been isolated from the Company, (2) the
transferee obtains the right (free of conditions that constrain
it from taking advantage of that right) to pledge or exchange
the transferred assets, and (3) the Company does not
The transfer of a participating interest in an entire financial
asset must also meet the definition of a participating
interest. A participating interest in a financial asset has all
of the following characteristics: (1) from the date of
transfer, it must represent a proportionate (pro rata)
ownership interest in the financial asset, (2) from the date
of transfer, all cash flows received, except any cash flows
allocated as any compensation for servicing or other
services performed, must be divided proportionately among
participating interest holders in the amount equal to their
share ownership, (3) the rights of each participating interest
holder must have the same priority, (4) no party has the
right to pledge or exchange the entire financial asset unless
all participating interest holders agree to do so.
Mortgage Servicing Rights
Mortgage servicing rights are capitalized at fair value and
amortized in proportion to, and over the period of,
estimated net servicing income. The Company evaluates its
capitalized mortgage servicing rights for impairment each
quarter. Loan type and note rate are the predominant risk
characteristics of the underlying loans used to stratify
capitalized mortgage servicing rights for purposes of
measuring impairment. Any impairment is recognized
through a valuation allowance.
Real Estate, net
Real estate acquired through loan foreclosure or deed in lieu
of foreclosure, is initially recorded at the fair value less
estimated selling costs. Third party appraisals are obtained
as soon as practical after obtaining possession of property.
Valuations are reviewed quarterly by management and an
allowance for losses is established if the carrying value of a
property exceeds its fair value less estimated selling costs.
Premises and Equipment
Land is carried at cost. Office buildings, improvements,
furniture and equipment are carried at cost less accumulated
depreciation. Depreciation is computed on a straight-line
basis over estimated useful lives of 5 to 40 years for office
buildings and improvements and 3 to 10 years for furniture
and equipment.
Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of
The Company reviews long-lived assets and certain
identifiable intangibles for impairment whenever events or
changes in circumstances indicate that the carrying amount
of an asset may not be recoverable.
33
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Stock Based Compensation
The Company recognizes the grant-date fair value of stock
option and restricted stock awards issued as compensation
expense, amortized over the vesting period.
Employee Stock Ownership Plan (ESOP)
The Company has an ESOP that borrowed funds from the
Company and purchased shares of HMN common stock.
The Company makes quarterly principal and interest
payments on the ESOP loan. As the debt is repaid, ESOP
shares that were pledged as collateral for the debt are
released from collateral and allocated to eligible employees
based on the proportion of debt service paid in the year. The
Company accounts for its ESOP in accordance with ASC
718, Employers' Accounting for Employee Stock Ownership
Plans. Accordingly, the shares pledged as collateral are
reported as unearned ESOP shares in stockholders' equity.
As shares are determined to be ratably released from
collateral, the Company reports compensation expense
equal to the current market price of the shares, and the
shares become outstanding for earnings per share
computations.
Income Taxes
Deferred tax assets and liabilities are recognized for future
tax consequences attributable to temporary differences
between the financial statement carrying amounts of
existing assets and liabilities and their respective tax basis.
Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to
be recovered or settled. The effect on deferred tax assets
and liabilities of a change in tax rates is recognized in
income in the period that includes the enactment date. A
valuation allowance is required to be recognized if it is
“more likely than not” that the deferred tax asset will not be
realized. The determination of the realizability of the
deferred tax asset is subjective and dependent upon
judgment concerning management’s evaluation of both
positive and negative evidence regarding the ultimate
realizability of deferred tax assets.
Preferred Stock Dividends and Discount
The proceeds received from the Company’s Preferred
Stock, and related warrant to purchase 833,333 shares of
the Company’s common stock issued to the U.S. Treasury
were allocated between the Preferred Stock and the warrant
based on their relative fair values at the time of issuance in
accordance with the requirements of ASC 470, Accounting
for Convertible Debt Issued with Stock Purchase Warrants.
Because of the increasing rate dividend feature of the shares
of Preferred Stock, the discount on the warrant was
amortized using the constant effective yield method over
the five year period preceding the scheduled rate increase
on the Preferred Stock in accordance with the requirements
of ASC 505.
Earnings per Common Share
Basic earnings per common share excludes dilution and is
computed by dividing the income available to common
stockholders by the weighted-average number of common
shares outstanding for the period. Diluted earnings per
common share reflects the potential dilution that could
occur if securities or other contracts to issue common stock
were exercised or converted into common stock or resulted
in the issuance of common stock that shared in the earnings
of the entity.
Comprehensive Income
Comprehensive income is defined as the change in equity
during a period from transactions and other events from
nonowner sources. Comprehensive income is the total of
net income and other comprehensive income (loss), which
for the Company is comprised of unrealized gains and
losses on securities available for sale.
Segment Information
The amount of each segment item reported is the measure
reported to the chief operating decision maker for purposes
of making decisions about allocating resources to the
segment and assessing its performance. Adjustments and
eliminations made in preparing an enterprise’s general-
purpose financial statements and allocations of revenues,
expenses and gains or losses are included in determining
reported segment profit or loss if they are included in the
measure of the segment’s profit or loss that is used by the
chief operating decision maker. Similarly, only those assets
that are included in the measure of the segment’s assets that
are used by the chief operating decision maker are reported
for that segment.
New Accounting Pronouncements
In January 2014, the FASB issued ASU 2014-04,
Receivables – Troubled Debt Restructurings by Creditors
(Subtopic 310-40) Reclassification of Residential Real
Estate Collateralized Consumer Mortgage Loans upon
Foreclosure. The amendments in this ASU clarify when a
repossession or foreclosure occurs, and a creditor is
considered to have received physical possession of
residential real estate property collateralizing a consumer
mortgage loan. Under the amendment, physical possession
occurs, upon either (1) the creditor obtaining legal title to
the residential real estate property upon completion of a
foreclosure or (2) the borrower conveying all interest in the
residential real estate property to the creditor to satisfy that
loan through completion of a deed in lieu of foreclosure or
through a similar legal agreement. The ASU is intended to
reduce diversity in practice and is effective for public
business entities for annual periods, and interim periods
within those annual periods, beginning after December 15,
2014. The adoption of this ASU in the first quarter of 2015
did not have a material impact on the Company’s
consolidated financial statements.
34
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
the FASB
issued ASU 2014-14,
In August 2014,
Receivables – Troubled Debt Restructurings by Creditors
(Subtopic 310-40) Classification of Certain Government-
Guaranteed Mortgage Loans upon Foreclosure. The
amendments in this ASU require that a mortgage loan be
derecognized and that a separate other receivable be
recognized upon foreclosure of a government-guaranteed
loan if certain conditions are met. Upon foreclosure, the
separate other receivable should be measured based on the
amount of the loan balance (principal and interest) expected
to be recovered from the guarantor. The ASU is intended to
reduce diversity in practice and is effective for public
business entities for annual periods, and interim periods
within those annual periods, beginning after December 15,
2014. The adoption of this ASU in the first quarter of 2015
did not have a material impact on the Company’s
consolidated financial statements.
the FASB
In August 2014,
issued ASU 2014-15,
Presentation of Financial Statements – Going Concern
(Subtopic 205-40) Disclosure of Uncertainties about an
Entity’s Ability to Continue as a Going Concern. The
this ASU provide guidance about
amendments
management’s responsibility to evaluate whether there is
in
substantial doubt about an entity’s ability to continue as a
going concern and to provide certain related footnote
disclosures. The ASU is intended to reduce diversity in the
timing and content of footnote disclosures and is effective
for all entities for the annual period ending after December
15, 2016 and for annual and interim periods thereafter. The
adoption of this ASU in the fourth quarter of 2016 is not
anticipated to have a material impact on the Company’s
consolidated financial statements.
Derivative Financial Instruments
The Company uses derivative financial instruments in order
to manage the interest rate risk on residential loans held for
sale and its commitments to extend credit for residential
loans. The Company may also from time to time use interest
rate swaps to manage interest rate risk. Derivative financial
instruments include commitments to extend credit and
forward mortgage loan sales commitments.
Reclassifications
Certain amounts in the consolidated financial statements
for prior years have been reclassified to conform to the
current year presentation.
NOTE 2 Other Comprehensive Income (Loss)
The components of other comprehensive income (loss) and the related tax effects were as follows:
(Dollars in thousands)
Securities available for sale:
Gross unrealized gains (losses)
Before
Tax
2014
Tax
Effect
For the years ended December 31,
2013
Tax
Effect
Net
of Tax
Before
Tax
Net
of Tax
Before
Tax
2012
Tax
Effect
Net
of Tax
arising during the period ............. $
38 (218)
256 (1,272)
(647)
(625) (520)
0
(520)
Less reclassification of net gains
included in net income ...............
0
0
0
0
0
0
0
0
0
Net unrealized gains (losses)
arising during the period .............
38 (218)
256 (1,272)
(647)
(625) (520)
0
(520)
Other comprehensive income
(loss) .......................................... $
38 (218)
256 (1,272)
(647)
(625) (520)
0
(520)
The tax effect in 2014 includes the impact of the reversal of certain deferred tax asset valuation reserve components that
reversed in 2014 as a result of the changes that occurred in the investment portfolio during the year.
35
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3 Securities Available for Sale
A summary of securities available for sale at December 31, 2014 and 2013 is as follows:
(Dollars in thousands)
December 31, 2014
Mortgage-backed securities:
Amortized
cost
Gross
unrealized
gains
Gross
unrealized
losses
Fair value
Federal Home Loan Mortgage Corporation ........................ $
Federal National Mortgage Association ...............................
Other marketable securities:
U.S. Government agency obligations ....................................
Corporate preferred stock .....................................................
Corporate equity .....................................................................
December 31, 2013
Mortgage-backed securities:
Federal Home Loan Mortgage Corporation .............................. $
Federal National Mortgage Association ...................................
$
Other marketable securities:
U.S. Government agency obligations .......................................
Corporate preferred stock .........................................................
Corporate equity .......................................................................
$
1,418
1,337
2,755
135,014
700
58
135,772
138,527
2,749
2,150
4,899
103,030
700
58
103,788
108,687
90
64
154
31
0
3
34
188
183
131
314
1
0
11
12
326
0
0
0
(601)
(280)
0
(881)
(881)
0
0
0
(637)
(420)
0
(1,057)
(1,057)
1,508
1,401
2,909
134,444
420
61
134,925
137,834
2,932
2,281
5,213
102,394
280
69
102,743
107,956
The Company did not sell any available for sale securities
and did not recognize any gains or losses on investments in
2014, 2013, or 2012.
The following table presents the amortized cost and
estimated fair value of securities available for sale at
December 31, 2014 based upon contractual maturity
adjusted for scheduled repayments of principal and
projected prepayments of principal based upon current
economic conditions and interest rates. Actual maturities
may differ from the maturities in the following table
because obligors may have the right to call or prepay
obligations with or without call or prepayment penalties:
(Dollars in thousands)
Due one year or less ................. $
Due after one year through five
Amortized
Cost
Fair Value
85,843
86,160
years.......................................
51,609
51,510
Due after five years through
ten years .................................
Due after ten years ...................
No stated maturity ....................
0
700
58
Total .................................. $ 138,527
0
420
61
137,834
The allocation of mortgage-backed securities in the table
above is based upon the anticipated future cash flow of the
securities using estimated mortgage prepayment speeds.
36
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table shows the gross unrealized losses and fair values for the securities available for sale portfolio aggregated
by investment category and length of time that individual securities have been in a continuous unrealized loss position at
December 31, 2014 and 2013:
(Dollars in thousands)
December 31, 2014
Other marketable
securities:
U.S. Government
Less Than Twelve Months
Fair
Value
# of
Investments
Unrealized
Losses
Twelve Months or More
Fair
Value
# of
Investments
Unrealized
Losses
Total
Fair Value
Unrealized
Losses
agency obligations.....
22 $ 104,453
(551)
1 $
4,970
(50) $ 109,423
(601)
Corporate preferred
stock ...........................
Total temporarily
0
0
0
1
420
(280)
420
(280)
impaired securities .......
22 $ 104,453
(551)
2 $
5,390
(330) $ 109,823
(881)
December 31, 2013
Other marketable
securities:
U.S. Government
agency obligations ......
20 $ 93,390
(637)
0 $
0
0 $
93,390
(637)
Corporate preferred
stock ...........................
0
0
0
1
280
(420)
280
(420)
Total temporarily impaired
securities .........................
20 $ 93,390
(637)
1 $
280
(420) $
93,670
(1,057)
We review our investment portfolio on a quarterly basis for
indications of impairment. This review includes analyzing
the length of time and the extent to which the fair value has
been lower than the cost, the market liquidity for the
investment, the financial condition and near-term prospects
of the issuer, including any specific events which may
influence the operations of the issuer, and our intent and
ability to hold the investment for a period of time sufficient
to recover the temporary loss. The unrealized losses on
U.S. Government agency obligations are the result of
changes in interest rates. The unrealized losses reported for
corporate preferred stock at December 31, 2014 relates to a
single trust preferred security that was issued by the holding
company of a small community bank. Typical of most trust
preferred issuances, the issuer has the ability to defer
interest payments for up to five years with interest payable
on the deferred balance. In September 2014, the issuer paid
all deferred interest that was due and all payments were
current as of September 30, 2014. In January 2015, the
issuer deferred its scheduled interest payment as allowed by
the terms of the security agreement. The issuer’s subsidiary
bank has incurred operating losses over the past several
years due to increased provisions for loan losses but still
met the regulatory requirements to be considered “well
capitalized” based on its most recent regulatory filing in
2014. Based on a review of the issuer, it was determined
that the trust preferred security was not other-than-
temporarily impaired at December 31, 2014. The Company
does not intend to sell the preferred stock and has the intent
and ability to hold it for a period of time sufficient to
recover the temporary loss. Management believes that the
Company will receive all principal and interest payments
contractually due on the security and that the decrease in
the market value is primarily due to a lack of liquidity in the
market for trust preferred securities. Management will
continue to monitor the credit risk of the issuer and may be
required to recognize other-than-temporary impairment
charges on this security in future periods.
37
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4 Loans Receivable, Net
A summary of loans receivable at December 31 is as
follows:
(Dollars in thousands)
Residential real estate loans:
2014
2013
1-4 family conventional ............. $ 69,372 75,958
464
1-4 family FHA .........................
45
1-4 family VA ............................
69,841 76,467
426
43
Commercial real estate:
Lodging...................................... 28,466 33,603
Retail/office ............................... 40,279 42,490
6,558
Nursing home/health care ..........
Land developments .................... 17,766 28,643
6,574
Golf courses ...............................
5,505
3,609
Restaurant/bar/café ....................
3,370
9,783
5,377
Alternative fuel plants ...............
Warehouse ................................. 10,137
9,180
Construction:
7,032
7,299
6,454
1-4 family builder...................
0
1,062
Multi-family ...........................
5,087
552
Commercial real estate ...........
8,022 11,344
Manufacturing ...........................
7,199
Churches/community service .....
8,385
Multi-family .............................. 15,700
8,113
0
8,562
Convenience stores ....................
Other .......................................... 20,464 19,503
191,668 194,450
Consumer:
1,124
971
Autos .........................................
Home equity line ....................... 36,832 36,178
Home equity .............................. 12,420 11,629
1,070
Consumer – secured ...................
1,827
Land/lot loans ............................
177
Savings ......................................
360
Mobile home ..............................
1,211
Consumer – unsecured ...............
54 ,925 53,423
1,168
1,670
128
263
1,320
Commercial business .................... 57,122 71,709
Total loans .............................. 373,556 396,049
Less:
Unamortized discounts ..............
Net deferred loan fees ................
Allowance for loan losses ..........
33
0
8,332 11,401
Total loans receivable, net ...... $ 365,113 384,615
14
97
Commitments to originate or
purchase loans ............................. $ 29,635 39,507
Commitments to deliver loans to
secondary market ........................ $ 3,279
2,025
Weighted average contractual rate
of loans in portfolio.....................
4.52%
4.71%
38
Included in total commitments to originate or purchase
loans are fixed rate loans aggregating $21.2 million and
$26.3 million as of December 31, 2014 and 2013,
respectively. The interest rates on these loan commitments
ranged from 3.00% to 6.00% at December 31, 2014 and
from 3.38% to 5.79% at December 31, 2013.
loans
The aggregate amounts of loans to executive officers and
directors of the Company was $2.8 million, $3.1 million
and $3.1 million at December 31, 2014, 2013 and 2012,
respectively. During 2014, repayments on
to
executive officers and directors were $128,000, new loans
to executive officers and directors totaled $224,000, sales
of executive officer and director loans were $224,000, loans
reclassified due to change in officers were $139,000, and
no loans were closed or paid off. During 2013, repayments
on loans to executive officers and directors were $106,000,
new loans to executive officers and directors totaled
$281,000, there were no sales of executive officer and
director loans, and no loans were removed from the
executive officer listing due to change in status of the
officer or loan. All loans were made in the ordinary course
of business on normal credit terms, including interest rates
and collateral, as those prevailing at the time for
comparable transactions with unrelated parties and did not
involve more than the normal risk of collectability or
present other unfavorable features.
At December 31, 2014, 2013, and 2012, the Company was
servicing loans for others with aggregate unpaid principal
balances of approximately $379.7 million, $411.8 million
and $428.2 million, respectively.
The Company originates residential, commercial real estate
and other loans primarily in Minnesota, Iowa, and
Wisconsin. At December 31, 2014 and 2013, the Company
had in its portfolio single-family residential loans located in
the following states:
2014
2013
thousands)
(Dollars in
Percent
of
Percent
of
Total
Total Amount
5.0%
4.5% $ 3,793
89.1 69,219 90.5
2.3
4.5 1,770
2.2
1.9 1,685
Total ............... $ 69,841 100.0% $ 76,467 100.0%
Amount
Iowa ................... $ 3,145
Minnesota........... 62,219
Wisconsin...........
3,160
Other states ........
1,317
Amounts under one million dollars in both years are
included in “Other states”.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
At December 31, 2014 and 2013, the Company had in its portfolio commercial real estate loans located in the following
states:
(Dollars in thousands)
Alabama .................................................................................................. $
Florida .....................................................................................................
Idaho .......................................................................................................
Indiana ....................................................................................................
Iowa ........................................................................................................
Michigan .................................................................................................
Minnesota ...............................................................................................
North Carolina ........................................................................................
North Dakota...........................................................................................
Wisconsin ...............................................................................................
Other states .............................................................................................
Total .................................................................................................... $
2014
2013
Percent
of Total
Amount
Percent
of Total
Amount
2,202
2,253
3,810
3,501
0
2,558
145,341
5,598
1,572
22,354
2,479
191,668
1.2% $
1.2
2.0
1.8
0.0
1.3
75.8
2.9
0.8
11.7
1.3
100.0% $
0
2,312
3,936
5,023
1,267
0
163,040
5,576
1,282
10,589
1,425
194,450
0.0%
1.2
2.0
2.6
0.6
0.0
83.9
2.9
0.7
5.4
0.7
100.0%
Amounts under one million dollars in both years are included in “Other states”.
NOTE 5 Allowance for Loan Losses and Credit Quality Information
The allowance for loan losses is summarized as follows:
(Dollars in thousands)
Balance, December 31, 2011..................................................... $
1-4 Family
Commercial
Real Estate
Consumer
Commercial
Business
Total
3,718
13,622
1,159
5,389
23,888
Provision for losses ...............................................................
Charge-offs ...........................................................................
Recoveries .............................................................................
Balance, December 31, 2012..................................................... $
Provision for losses ............................................................... $
Charge-offs ...........................................................................
Recoveries .............................................................................
Balance, December 31, 2013..................................................... $
Provision for losses.............................................................. $
Charge-offs ..........................................................................
Recoveries ............................................................................
Balance, December 31, 2014 ................................................... $
Allocated to:
Specific reserves ................................................................... $
General reserves ....................................................................
Balance, December 31, 2013..................................................... $
Allocated to:
Specific reserves .................................................................. $
General reserves ..................................................................
Balance, December 31, 2014 ................................................... $
(834)
(63)
0
2,821
(1,206)
(200)
213
1,628
(440)
(92)
0
1,096
404
1,224
1,628
270
826
1,096
3,864
(5,719)
1,821
13,588
(5,190)
(3,711)
1,771
6,458
(3,518)
(936)
3,020
5,024
2,403
4,055
6,458
370
4,654
5,024
686
(1,071)
372
1,146
347
(484)
97
1,106
(4)
(131)
38
1,009
382
724
1,106
307
702
1,009
(1,172)
(2,464)
2,300
4,053
(1,832)
(651)
639
2,209
(3,036)
(55)
2,085
1,203
589
1,620
2,209
127
1,076
1,203
2,544
(9,317)
4,493
21,608
(7,881)
(5,046)
2,720
11,401
(6,998)
(1,214)
5,143
8,332
3,778
7,623
11,401
1,074
7,258
8,332
Loans receivable at December 31, 2013:
Individually reviewed for impairment .................................. $
Collectively reviewed for impairment ..................................
Ending balance ...................................................................... $
1,888
74,579
76,467
17,190
177,260
194,450
917
52,506
53,423
1,281
70,428
71,709
21,276
374,773
396,049
Loans receivable at December 31, 2014:
Individually reviewed for impairment.............................. $
Collectively reviewed for impairment ..............................
Ending balance .................................................................... $
1,867
67,974
69,841
9,728
181,940
191,668
806
54,119
54,925
555
56,567
57,122
12,956
360,600
373,556
39
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes the amount of classified and unclassified loans at December 31:
December 31, 2014
Classified
Unclassified
(Dollars in thousands)
1-4 family ........................................ $
Commercial real estate:
Special
Mention Substandard Doubtful Loss
2,493
207
0
Total Total
0
2,700
Total
Loans
67,141 69,841
Residential developments ...........
Other ............................................
323
7,376
9,960
8,792
0
0
0 10,283
0 16,168
9,677 19,960
155,540 171,708
Consumer ........................................
Commercial business:
0
489
55
261
805
54,120 54,925
Construction industry ................
Other ............................................
0
4,255
$ 11,954
439
1,156
23,329
0
0
262
0
0
439
5,411
261 35,806
7,121
6,682
44,590 50,001
337,750 373,556
December 31, 2013
Classified
Unclassified
(Dollars in thousands)
1-4 family ......................................... $
Commercial real estate:
Special
Mention Substandard Doubtful Loss
6,987
322
738
Total
0
8,047
Total
Total
Loans
68,420 76,467
Residential developments .............
Other .............................................
0
5,337
19,229
13,092
0
0
0 19,229
0 18,429
13,755 32,984
143,037 161,466
Consumer .........................................
Commercial business:
0
524
152
240
916
52,507 53,423
Construction industry ...................
Other .............................................
0
1,419
$ 7,494
401
6,433
46,666
0
0
474
0
0
401
7,852
240 54,874
5,933
6,334
57,523 65,375
341,175 396,049
Classified loans represent special mention, performing
substandard, and non-performing loans categorized as
substandard, doubtful and loss. Loans classified as special
mention are loans that have potential weaknesses that, if left
uncorrected, may result in deterioration of the repayment
prospects for the asset or in the Bank’s credit position at
some future date. Loans classified as substandard are loans
that are generally inadequately protected by the current net
worth and paying capacity of the obligor, or by the
collateral pledged, if any. Loans classified as substandard
have a well-defined weakness or weaknesses
that
jeopardize the liquidation of the debt. Substandard loans are
characterized by the distinct possibility that the Bank will
sustain some loss if the deficiencies are not corrected.
Loans classified as doubtful have the weaknesses of those
classified as substandard, with additional characteristics
that make collection in full on the basis of currently existing
facts, conditions and values questionable, and there is a
high possibility of loss. A loan classified as loss is
considered uncollectible and of such little value that
continuance as an asset on the balance sheet is not
warranted. Loans classified as substandard or doubtful
require the Bank to perform an analysis of the individual
loan and charge off any loans, or portion thereof, that are
deemed uncollectible.
40
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The aging of past due loans at December 31 is summarized as follows:
(Dollars in thousands)
2014
30-59
Days Past
Due
60-89
Days Past
Due
90 Days
or More
Past Due
Total
Past Due
Current
Loans
Total
Loans
Loans 90
Days or
More
Past Due
and Still
Accruing
1-4 family ...................................... $
Commercial real estate:
Residential developments ........
Other .........................................
Consumer .....................................
Commercial business:
413
673
841
1,927 67,914 69,841
0
0
0
0
0
0
0 19,960 19,960
0 171,708 171,708
550
176
131
857 54,068 54,925
Construction industry ..............
Other .........................................
0
136
$ 1,099
0
0
849
0
0
972
0
7,121
7,121
136 49,865 50,001
2,920 370,636 373,556
2013
1-4 family ...................................... $ 1,542
Commercial real estate:
128
322
1,992 74,475 76,467
Residential developments...........
Other ..........................................
0
0
1,426
0
0
0
1,426 31,558 32,984
0 161,466 161,466
Consumer .......................................
Commercial business:
418
256
57
731 52,692 53,423
Construction industry .................
Other ..........................................
0
800
$ 2,760
1,934
104
3,848
0
0
379
1,934
6,334
4,400
904 64,471 65,375
6,987 389,062 396,049
0
0
0
0
0
0
0
0
0
0
0
0
0
0
41
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Impaired loans include loans that are non-performing (non-
accruing) and loans that have been modified in a troubled
table summarizes
debt restructuring. The following
impaired loans and related allowances for the years ended
December 31, 2014 and 2013:
(Dollars in thousands)
Loans with no related allowance recorded:
December 31, 2014
Recorded
Investment
Unpaid
Principal
Balance
Related
Allowance
Average
Recorded
Investment
Interest
Income
Recognized
1-4 family ......................................................... $
Commercial real estate:
Residential developments ...........................
Other ............................................................
Consumer ........................................................
Commercial business:
Construction industry .................................
Other ............................................................
755
755
7,416
48
463
10,040
216
464
80
0
198
0
0
0
0
0
0
0
432
7,633
50
467
87
0
Loans with an allowance recorded:
1-4 family .........................................................
Commercial real estate:
Residential developments ...........................
Other ............................................................
Consumer ........................................................
Commercial business:
Construction industry .................................
Other ............................................................
Total:
1-4 family .........................................................
Commercial real estate:
Residential developments ...........................
Other ............................................................
Consumer ........................................................
Commercial business:
1,112
1,112
270
1,543
1,522
742
343
0
475
1,522
743
360
0
1,026
240
130
307
0
127
3,121
847
451
0
887
1,867
1,867
270
1,975
8,938
790
806
11,562
959
824
198
1,026
16,436
240
130
307
0
127
1,074
10,754
897
918
87
887
15,518
Construction industry .................................
Other ............................................................
$
80
475
12,956
42
32
219
6
15
0
0
14
0
32
9
0
20
46
219
38
24
0
20
347
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands)
Loans with no related allowance recorded:
December 31, 2013
Recorded
Investment
Unpaid
Principal
Balance
Related
Allowance
Average
Recorded
Investment
Interest
Income
Recognized
1-4 family ......................................................... $
Commercial real estate:
Residential developments..............................
Other .............................................................
Consumer ..........................................................
Commercial business:
Construction industry ....................................
Other .............................................................
88
88
0
1,304
8,257
52
487
13,636
52
491
93
0
296
0
0
0
0
0
0
9,122
350
350
91
7
Loans with an allowance recorded:
1-4 family .........................................................
Commercial real estate:
Residential developments..............................
Other .............................................................
Consumer ..........................................................
Commercial business:
Construction industry ....................................
Other .............................................................
Total:
1-4 family .........................................................
Commercial real estate:
Residential developments..............................
Other .............................................................
Consumer ..........................................................
Commercial business:
Construction industry ....................................
Other .............................................................
$
1,800
1,844
404
2,417
7,994
888
429
0
1,188
12,725
888
429
0
1,984
2,260
143
382
12,414
1,977
1,057
0
589
29
1,647
1,888
1,932
404
3,721
16,251
940
916
93
1,188
21,276
26,361
940
920
296
1,984
32,433
2,260
143
382
0
589
3,778
21,536
2,327
1,407
120
1,654
30,765
2
81
55
12
2
0
36
54
202
14
0
36
38
135
257
26
2
36
494
At December 31, 2014, 2013 and 2012, non-accruing loans
totaled $10.9 million, $17.5 million and $30.0 million,
respectively, for which the related allowance for loan losses
was $0.8 million, $3.4 million and $3.9 million,
respectively. Non-accruing loans for which no specific
allowance has been recorded because management
determined that the value of the collateral was sufficient to
repay the loan totaled $8.0 million, $7.8 million and $10.3
million, respectively. Had
in
accordance with their original terms, the Company would
loans performed
the
have recorded gross interest income on the loans of $0.9
million, $1.8 million and $2.4 million in 2014, 2013 and
2012, respectively. For the years ended December 31, 2014,
2013 and 2012, the Company recognized interest income
on these loans of $0.2 million, $0.1 million and $0.5
million, respectively. All of the interest income that was
recognized for non-accruing loans was recognized using the
cash basis method of income recognition. Non-accrual
loans also include some of the loans that have had terms
modified in a troubled debt restructuring.
43
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes non-accrual loans at
December 31:
following
The
restructurings at December 31:
table
summarizes
troubled
debt
(Dollars in thousands)
1-4 family .................................. $
Commercial real estate:
Residential developments ......
Other ......................................
Consumer ..................................
Commercial business:
Construction industry ............
Other ......................................
$
80
40
10,920
2014
2013
1,564
1,602
8,483
267
486
14,146
403
737
93
515
17,496
Included in loans receivable, net, are certain loans that have
been modified in order to maximize collection of loan
balances. If the Company, for legal or economic reasons
related to the borrower’s financial difficulties, grants a
concession compared to the original terms and conditions
of the loan, the modified loan is considered a troubled debt
restructuring (TDR).
At December 31, 2014, 2013 and 2012, there were loans
included in loans receivable, net, with terms that had been
modified in a troubled debt restructuring totaling $9.4
million, $17.4 million and $31.7 million, respectively. Had
these loans been performing in accordance with their
original terms throughout 2014, 2013 and 2012, the
Company would have recorded gross interest income of
$0.9 million, $1.8 million and $2.5 million, respectively.
During 2014, 2013 and 2012, the Company recorded
interest income of $0.3 million, $0.5 million and $0.9
million on these loans, respectively. For the loans that were
in 2014, $0.1 million are classified and
modified
performing, and $0.1 million are non-performing at
December 31, 2014.
(Dollars in thousands)
1-4 family ................................. $
Commercial real estate:
Residential developments .....
Other .....................................
Consumer .................................
Commercial business:
Construction industry ...........
Other .....................................
$
2014
2013
368
840
7,432
524
571
80
475
9,450
14,244
537
697
93
981
17,392
There were no material commitments to lend additional
funds to customers whose loans were restructured or
classified as non-accrual at December 31, 2014 or
December 31, 2013.
TDR concessions can include reduction of interest rates,
extension of maturity dates, forgiveness of principal and/or
interest due, or acceptance of real estate or other assets in
full or partial satisfaction of the debt. Loan modifications
are not reported as TDRs after 12 months if the loan was
modified at a market rate of interest for comparable risk
loans, and the loan is performing in accordance with the
terms of the restructured agreement. All loans classified as
TDRs are considered to be impaired.
When a loan is modified as a TDR, there may be a direct,
material impact on the loans within the Consolidated
Balance Sheets, as principal balances may be partially
forgiven. The financial effects of TDRs are presented in the
following table and represent the difference between the
outstanding recorded balance pre-modification and post-
modification, for the periods ending December 31, 2014
and 2013:
(Dollars in thousands)
Troubled debt restructurings:
1-4 family ..............................................
Commercial real estate:
Residential developments ..................
Other ..................................................
Consumer ...............................................
Commercial business:
Construction industry ........................
Other ..................................................
Total ......................................................
Year ended December 31, 2014
Pre-
modification
Outstanding
Recorded
Investment
Post-
modification
Outstanding
Recorded
Investment
Number of
Contracts
Year ended December 31, 2013
Pre-
modification
Outstanding
Recorded
Investment
Post-
modification
Outstanding
Recorded
Investment
Number of
Contracts
760
0
155
140
0
25
1,080
2 $
0
3
21
1
5
32 $
210
0
754
528
41
194
1,727
219
0
329
548
41
218
1,355
2 $
0
1
4
0
1
8 $
760
0
155
155
0
31
1,101
44
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Loans that were restructured within the 12 months preceding December 31, 2014 and 2013 and defaulted during the year are
presented in the table below:
Year ended
December 31, 2014
Year ended
December 31, 2013
(Dollars in thousands)
Troubled debt restructurings that subsequently defaulted:
1-4 family .....................................................................................
Total .............................................................................................
Number of
Contracts
Outstanding
Recorded
Investment
Number of
Contracts
Outstanding
Recorded
Investment
1 $
1 $
640
640
0 $
0 $
0
0
NOTE 7 Mortgage Servicing Rights, Net
A summary of mortgage servicing activity is as follows:
2014 2013
(Dollars in thousands)
Mortgage servicing rights:
Balance, beginning of year ...................... $ 1,708 1,732
568
Originations ............................................
Amortization ...........................................
(592)
Balance, end of year ................................ 1,507 1,708
Valuation reserve ....................................
0
Mortgage servicing rights, net ................ $ 1,507 1,708
Fair value of mortgage servicing rights .. $ 2,562 2,801
316
(517)
0
All of the single family loans sold where the Company
continues to service the loans are serviced for Federal
the
National Mortgage Association (FNMA) under
individual loan sale program. The following is a summary
of the risk characteristics of the loans being serviced for
FNMA at December 31, 2014:
Loan
Principal
Balance
Weighted
Average
Interest
Rate
Weighted
Average
Remaining
Term
(months)
Number
of
Loans
(Dollars in thousands)
Original term:
30 year fixed rate ............... $205,032
15 year fixed rate ............... 110,912
181
Adjustable rate ......................
4.30%
3.33
3.96
299 1,758
140 1,256
3
318
The Company considers a loan to have defaulted when it
becomes 90 or more days past due under the modified
terms, when it is placed in non-accrual status, when it
becomes other real estate owned, or when it becomes non-
compliant with some other material requirement of the
modification agreement.
Loans that were non-accrual prior to modification remain
non-accrual for at least six months following modification.
Non-accrual TDR loans that have performed according to
the modified terms for six months may be returned to
accruing status. Loans that were accruing prior to
modification remain on accrual status after the modification
as long as the loan continues to perform under the new
terms.
TDRs are reviewed for impairment following the same
methodology as other impaired loans. For loans that are
collateral dependent, the value of the collateral is reviewed
and additional reserves may be added to general reserves as
needed. Loans that are not collateral dependent may have
additional reserves established if deemed necessary. The
allocated allowance for TDRs was $0.4 million, or 5.1%, of
the total $8.3 million in allowance for loan losses at
December 31, 2014, and $2.9 million, or 25.6%, of the total
$11.4 million in allowance for loan losses at December 31,
2013.
NOTE 6 Accrued Interest Receivable
Accrued interest receivable at December 31 is summarized
as follows:
2014 2013
(Dollars in thousands)
Securities available for sale ..................... $
338
348
Loans receivable ...................................... 1,365 1,615
$ 1,713 1,953
45
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The gross carrying amount of mortgage servicing rights and
the associated accumulated amortization at December 31,
2014 and 2013 are presented in the following table.
Amortization expense for mortgage servicing rights was
$0.5 million, $0.6 million, and $0.7 million for the years
ended December 31, 2014, 2013 and 2012, respectively.
Gross
Carrying
Amount
Unamortized
Mortgage
Accumulated Servicing
Amortization Rights
(Dollars in thousands)
December 31, 2014
Mortgage servicing rights ...... $
3,600
(2,093)
1,507
December 31, 2013
Mortgage servicing rights ......... $
3,638
(1,930)
1,708
NOTE 8 Real Estate
A summary of real estate at December 31 is as follows:
The following
amortization expense for mortgage servicing rights:
indicates
the estimated future
table
(Dollars in thousands)
Year ended December 31,
2015 ........................................................................................ $
2016 ........................................................................................
2017 ........................................................................................
2018 ........................................................................................
2019 ........................................................................................
Thereafter ...............................................................................
$
Mortgage
Servicing
Rights
425
382
297
199
132
72
1,507
Projections of amortization are based on asset balances and
the interest rate environment that existed at December 31,
2014. The Company’s actual experience may be
significantly different depending upon changes in mortgage
interest rates and other market conditions.
(Dollars in thousands)
Real estate in judgment subject to
Residential
2014
Commercial
& Other
Total
2013
Commercial
& Other
Residential
Total
redemption ................................. $
30
0
30
0
0
0
Real estate acquired through
foreclosure .................................
Real estate acquired through deed
0
3,648
3,648
0
7,520
7,520
in lieu of foreclosure ..................
28
1,126
1,154
0
1,759
1,759
Real estate acquired in
satisfaction of debt .....................
Allowance for losses .....................
$
0
58
(8)
50
0
4,774
(1,721)
3,053
0
4,832
(1,729)
3,103
0
0
0
0
63
9,342
(2,444)
6,898
63
9,342
(2,444)
6,898
NOTE 9 Premises and Equipment
A summary of premises and equipment at December 31 is
as follows:
2014
(Dollars in thousands)
2013
Land ..................................................... $ 1,978 1,978
Office buildings and improvements ..... 8,526 8,490
Furniture and equipment ...................... 12,049 11,350
22,553 21,818
Accumulated depreciation .................... (15,571) (15,107)
$ 6,982 6,711
46
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 10 Deposits
Deposits and their weighted average interest rates at December 31 are summarized as follows:
(Dollars in thousands)
Noninterest checking ......
NOW accounts ...............
Savings accounts ............
Money market accounts .
Certificates by rate:
0-0.99% ..........................
1-1.99% ..........................
2-2.99% ..........................
3-3.99% ..........................
Total certificates .............
Total deposits .................
2014
2013
Weighted
Average
Rate
Amount
Percent
of Total
Weighted
Average
Rate
Amount
Percent
of Total
0.00% $
0.02
0.07
0.25
0.61
0.21 $
118,073
75,553
46,672
158,798
399,096
81,197
13,629
2,721
107
97,654
496,750
23.8%
15.2
9.4
32.0
80.4
16.3
2.7
0.6
0.0
19.6
100.0%
0.00% $
0.03
0.07
0.28
0.80
0.26 $
169,362
70,407
44,823
139,818
424,410
85,705
38,456
4,798
561
129,520
553,930
30.6%
12.7
8.1
25.2
76.6
15.5
6.9
0.9
0.1
23.4
100.0%
At December 31, 2014 and 2013, the Company had $166.9
million and $200.8 million, respectively, of deposit
accounts with balances of $250,000 or more. At December
31, 2014 and 2013, the Company had $0.0 and $7.6 million
of certificate accounts, respectively, that had been acquired
through a broker.
Certificates had the following maturities at December 31:
(Dollars in thousands)
Remaining term to maturity
1-6 months .................................................................................... $
7-12 months ..................................................................................
13-36 months ................................................................................
Over 36 months ............................................................................
$
2014
2013
Weighted
Average
Rate
Amount
Weighted
Average
Rate
Amount
32,925
26,764
29,929
8,036
97,654
0.52% $
0.49
0.68
1.03
0.61
$
43,618
43,462
35,542
6,898
129,520
0.84%
0.64
0.86
1.14
0.80
At December 31, 2014 and 2013, the Company had pledged
mortgage loans and mortgage-backed and related securities
with an amortized cost of approximately $19.4 million and
$18.9 million, respectively, as collateral for certain
deposits. An additional $1.0 million of letters of credit from
the FHLB were pledged at December 31, 2014 and 2013 as
collateral on certain Bank deposits.
47
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Interest expense on deposits is summarized as follows for the years ended December 31:
(Dollars in thousands)
NOW accounts ................................................................................... $
Savings accounts ................................................................................
Money market accounts .....................................................................
Certificates .........................................................................................
$
2014
2013
2012
15
31
414
751
1,211
15
34
372
1,383
1,804
35
67
447
3,192
3,741
NOTE 12 Income Taxes
Income tax expense (benefit) for the years ended December
31 is as follows:
(Dollars in thousands)
Current:
2014 2013 2012
Federal ................................... $
State .......................................
Total current .......................
262
74
336
227
64
291
108
24
132
Deferred:
Federal ................................... 3,753 3,554 1,598
280
State .......................................
Total deferred ..................... 4,566 4,905 1,878
0 (19,602) (1,878)
132
Change in valuation allowance
Income tax expense (benefit) ... $ 4,902 (14,406)
813 1,351
The reasons for the difference between expected income tax
expense utilizing the federal corporate tax rate of 34% and
the actual income tax expense (benefit) are as follows:
(Dollars in thousands)
Expected federal income tax
2014 2013 2012
expense .................................. $ 4,176 4,170 1,854
Items affecting federal income
tax:
State income taxes, net of
federal income tax expense
Tax exempt interest ..............
Decrease in valuation
698
(45)
706
(69)
327
(86)
allowance ...........................
Other, net ..............................
0 (19,602) (1,878)
(85)
389
73
132
Income tax expense (benefit) ... $ 4,902 (14,406)
NOTE 11 Federal Home Loan Bank Advances (FHLB)
and Other Borrowings
The Bank had no outstanding advances from the FHLB or
borrowings from the Federal Reserve Bank as of December
31, 2014 or December 31, 2013. As of December 31, 2014
it had collateral pledged to the FHLB consisting of FHLB
stock, mortgage loans, and investments with unamortized
principal balances of approximately $99.1 million. The
Bank has the ability to draw additional borrowings of $98.1
million from the FHLB, based upon the mortgage loans and
securities that are currently pledged, subject to approval
from the FHLB and a requirement to purchase additional
FHLB stock. The Bank also has the ability to draw
additional borrowings of $58.7 million from the Federal
Reserve Bank, based upon the loans that are currently
pledged to them, subject to approval from the FRB.
the date of
On December 15, 2014, the Company entered into a Loan
Agreement with an unrelated third party, providing for a
term loan of up to $10 million that will be evidenced by a
promissory note (“the Note”) with an interest rate of 6.5%
per annum. The principal balance of the loan is payable in
consecutive equal annual installments of $1 million on each
anniversary of
the Loan Agreement,
commencing on December 15, 2015, with the balance due
on the maturity date. The maturity date will be on the earlier
of (a) the anniversary of the date of the Loan Agreement
obtained by dividing the original principal amount of the
loan by $1 million (rounded up to the nearest number of
whole years) and (b) the seventh anniversary of the date of
the Loan Agreement. Provided that no default or event of
default has occurred and is continuing, the Company may,
at its option, elect to defer payment of one installment of
principal of the Note otherwise due prior to the maturity
date, in which event such installment will become due and
payable on
the maturity date. The Company may
voluntarily prepay the Note in whole or in part without
payment or penalty. The Company had no outstanding
advances on the Note at December 31, 2014. On February
17, 2015, the Company advanced $10 million on the Note
and used the proceeds to redeem the remaining $10 million
in outstanding Preferred Stock.
48
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The tax effects of temporary differences that give rise to the
deferred tax assets and deferred tax liabilities are as follows
at December 31:
(Dollars in thousands)
Deferred tax assets:
Allowances for loan and real estate
2014 2013
losses ................................................. $ 3,984 5,486
233
706
558
Deferred compensation costs ...............
Deferred ESOP loan asset ....................
Nonaccruing loan interest ....................
Federal net operating loss
205
711
627
carryforward ...................................... 1,730 3,983
State net operating loss carryforward .. 2,448 2,802
Alternative minimum tax credit
carryforward ......................................
716
700
Capitalized other real estate owned
expenses ............................................
851 1,284
Net unrealized loss on securities
available for sale ...............................
Other ....................................................
291
340
Total gross deferred tax assets ......... 11,785 16,383
276
237
Deferred tax liabilities:
Deferred loan fees and costs ................
Premises and equipment basis
250
284
difference...........................................
Originated mortgage servicing rights ..
Other ....................................................
132
677
179
Total gross deferred tax liabilities .... 1,255 1,272
Net deferred tax assets ..................... $ 10,530 15,111
141
597
267
The Company has cumulative federal net operating loss
carryforwards of $7.3 million at December 31, 2014 that
expire beginning in 2029. The Company also has state net
operating loss carryforwards of $25.4 million at December
31, 2014 that expire beginning in 2023.
included
Retained earnings at December 31, 2014
approximately $8.8 million for which no provision for
income taxes was made. This amount represents allocations
of income to bad debt deductions for tax purposes.
Reduction of amounts so allocated for purposes other than
absorbing losses will create income for tax purposes, which
will be subject to the then-current corporate income tax
rate.
The Company considers the determination of the deferred
tax asset amount and the need for any valuation reserve to
be a critical accounting policy that requires significant
judgment. The Company has, in its judgment, made
reasonable assumptions and considered both positive and
negative evidence relating to the ultimate realization of
deferred
the
cumulative net income generated over the prior three year
tax assets. Positive evidence
includes
period and the probability that taxable income will be
generated in future periods. Negative evidence includes the
general business and economic environment. Based upon
this evaluation, the Company determined that no valuation
allowance was required with respect to the net deferred tax
assets at December 31, 2014 and 2013.
NOTE 13 Employee Benefits
All eligible full-time employees of the Bank that were hired
prior to 2002 were included in a noncontributory retirement
plan sponsored by the Financial Institutions Retirement
Fund (FIRF). The Home Federal Savings Bank (Employer
#8006) plan participates in the Pentegra Defined Benefit
Plan for Financial Institutions (the Pentegra DB Plan). The
Pentegra DB Plan’s Employer Identification Number is 13-
5645888 and the Plan number is 333. The Pentegra DB Plan
operates as a multi-employer plan for accounting purposes
and as a multi-employer plan under the Employee
Retirement Income Security Act of 1974, as amended
(ERISA) and the Internal Revenue Code. There are no
collective bargaining agreements in place that require
contributions to the Pentegra DB Plan.
The Pentegra DB Plan is a single plan under Internal
Revenue Code Section 413(c) and, as a result, all of the
assets stand behind all of the liabilities. Accordingly, under
the
the Pentegra DB Plan, contributions made by
participating employer may be used to provide benefits to
participants of other participating employers.
Effective September 1, 2002, the accrual of benefits for
existing participants was frozen and no new enrollments
were permitted into the plan. The actuarial present value of
accumulated plan benefits and net assets available for
benefits relating to the Bank's employees was not available
at December 31, 2014 because such information is not
accumulated for each participating institution. As of June
30, 2014, the Pentegra DB Plan valuation report reflected
that the Bank was obligated to make a contribution totaling
$0.2 million which was expensed during 2014.
Funded status (market value of plan assets divided by
funding target) as of July 1 for the 2014, 2013 and 2012
plan years were 97.98%, 89.51% and 95.77%, respectively.
Market value of plan assets reflects any contribution
received through June 30, 2014.
Total employer contributions made to the Pentegra DB
Plan, as reported on Form 5500, equal $136.5 million,
$196.5 million and $299.7 million for the plan years ended
June 30, 2013, 2012 and 2011, respectively. The Bank’s
contributions to the Pentegra DB Plan are not more than 5%
of the total contributions to the Pentegra DB Plan. There is
no funding improvement plan or rehabilitation plan as part
of this multi-employer plan.
49
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following contributions were paid by the Bank during the fiscal years ending December 31,
(Dollars in thousands)
2014
Date Paid
10/15/2014 .......... $
12/30/2014 ..........
Amount
Date Paid
Amount
Date Paid
Amount
2013
2012
46 10/15/2013
164 12/30/2013
$
$
42 1/09/2012
215 10/12/2012
12/31/2012
257
$
$
234**
38
134
406
Total ................... $
210
**An additional contribution of $234,000 was accrued at December 31, 2011 and paid in the first quarter of 2012.
The Company has a qualified, tax-exempt savings plan with
a deferred feature qualifying under Section 401(k) of the
Internal Revenue Code (the 401(k) Plan). All employees
who have attained 18 years of age are eligible to participate
in the 401(k) Plan. Participants are permitted to make
contributions to the 401(k) Plan equal to the lesser of 50%
of the participant’s annual salary or the maximum allowed
by law, which was $17,500 for 2014 and 2013, and $17,000
for 2012. The Company matches 25% of each participant’s
contributions up to a maximum of 8% of the participant’s
annual salary. Participant contributions and earnings are
fully
vested. The Company’s
contributions are vested on a three year cliff basis, are
expensed annually, and were $0.1 million, $0.2 million, and
$0.2 million in 2014, 2013 and 2012, respectively.
immediately
and
The Company has adopted an Employee Stock Ownership
Plan (the ESOP) that meets the requirements of Section
4975(e)(7) of the Internal Revenue Code and Section
407(d)(6) of ERISA and, as such, the ESOP is empowered
to borrow in order to finance purchases of the common
stock of HMN. The ESOP borrowed $6.1 million from the
Company to purchase 912,866 shares of common stock in
the initial public offering of HMN in 1994. As a result of a
merger with Marshalltown Financial Corporation (MFC),
the ESOP borrowed $1.5 million in 1998 to purchase an
additional 76,933 shares of HMN common stock to account
for the additional employees and avoid dilution of the
benefit provided by the ESOP. The ESOP debt requires
quarterly payments of principal plus interest at 7.52%. The
Company has committed to make quarterly contributions to
the ESOP necessary to repay the loans including interest.
The Company contributed $0.5 million in 2014, 2013, and
2012.
As the debt is repaid, ESOP shares that were pledged as
collateral for the debt are released from collateral and
allocated to eligible employees based on the proportion of
debt service paid in the year. The Company accounts for its
in accordance with ASU 718, Employers'
ESOP
for Employee Stock Ownership Plans.
Accounting
Accordingly, the shares pledged as collateral are reported
as unearned ESOP shares in stockholders' equity. As shares
are determined to be ratably released from collateral, the
Company reports compensation expense equal to the
current market price of the shares, and the shares become
outstanding for earnings per share computations. ESOP
compensation expense was $0.3 million, $0.2 million, and
$0.1 million, respectively, for 2014, 2013 and 2012.
All employees of the Bank are eligible to participate in the
ESOP after they attain age 18 and complete one year of
service during which they worked at least 1,000 hours. A
summary of the ESOP share allocation is as follows for the
years ended:
Shares held by participants
2014
2013
2012
beginning of the year ..................... 347,887 350,539 339,991
24,378
2,353
(16,183)
Shares allocated to participants ........
Shares purchased ...............................
Shares distributed to participants ......
Shares held by participants end of
24,317
0
(36,180)
24,317
9
(26,978)
year ................................................. 336,024 347,887 350,539
Unreleased shares beginning of the
year ................................................. 352,757 377,074 401,452
Shares released during year ..............
(24,378)
Unreleased shares end of year .......... 328,440 352,757 377,074
Total ESOP shares end of year ......... 664,464 700,644 727,613
Fair value of unreleased shares at
(24,317)
(24,317)
December 31 .................................. $4,072,656 3,728,641 1,308,447
In March 2001, the Company adopted the HMN Financial,
Inc. 2001 Omnibus Stock Plan (2001 Plan). In April 2009,
this plan was superseded by the HMN Financial, Inc. 2009
Equity and Incentive Plan (2009 Plan) and options or
restricted shares may no longer be awarded from the 2001
Plan. As of December 31, 2014, there were 15,000 vested
options under the 2001 Plan that remained unexercised.
These options expire 10 years from the date of grant and
have an average exercise price of $30.00. As of December
31, 2014, all shares of restricted stock granted under the
2001 Plan have vested.
50
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In April 2009, the Company adopted the 2009 Plan. The
purpose of the 2009 Plan is to provide key personnel and
advisors with an opportunity to acquire a proprietary
interest in the Company. The opportunity to acquire a
proprietary interest in the Company is intended to aid in
attracting, motivating and retaining key personnel and
advisors, including non-employee directors, and to align
their interests with those of the Company’s stockholders.
350,000 shares of HMN common stock were initially
available for distribution under the 2009 Plan in either
restricted stock or stock options, subject to adjustment for
future stock splits, stock dividends and similar changes to
the capitalization of the Company. Additionally, shares of
restricted stock that are awarded are counted as 1.2 shares
for purposes of determining the total shares available for
issuance under the 2009 Plan. As of December 31, 2014,
there were vested options to purchase 15,000 shares under
the 2009 Plan that remain unexercised. These options
expire 10 years from the date of grant and have an average
exercise price of $4.77.
A summary of activities under all plans for the past three years is as follows:
Shares
available
for grant
Unvested
Restricted
shares
outstanding
Options
outstanding
Unvested options
Award
value/
weighted
average
exercise
price
Weighted
average
grant date
fair value
Vesting
Period
Number
0
0
0
0
0
0
0
0
0
0
0
0
0
0
139,450 $
(93,910)
0
45,540
45,540
(30,540)
15,000
20.07
16.13
0
28.21
28.21
27.33
30.00
72,516 $
0
(72,516)
0
0
0
0
1.43
1.43
70,821
162,770
15,000 $
4.77
9,000
4.41
(43,236)
470
93,910
0
121,965
(37,531)
5,400
31,219
0
121,053
36,030
(392)
0
(50,075)
148,333
31,276
(4,500)
0
(73,303)
101,806
0
0
0
0
15,000
0
0
0
0
15,000
N/A
4.77
N/A
4.77
0
0
0
(3,000)
6,000
0
0
0
(3,000)
3,000
2001 Plan
December 31, 2011 .......
Forfeited/expired .......
Vested ........................
December 31, 2012 .......
December 31, 2013 .......
Forfeited/expired ......
December 31, 2014 ......
2009 Plan
December 31, 2011 .......
Granted January 27,
2012 .........................
Forfeited ....................
Forfeited/expired .......
Vested ........................
December 31, 2012 .......
Granted October 4,
2013 .........................
Forfeited ....................
Cancelled ...................
Vested ........................
December 31, 2013 .......
Granted January 7,
2014 .........................
(28,627)
23,856
0
N/A
0
Granted May 27,
2014 .........................
Forfeited/expired .....
Vested........................
December 31, 2014 ......
Total all plans ..............
(26,561)
30,540
0
96,405
96,405
22,134
0
(62,938)
84,858
84,858
0
0
0
15,000
30,000 $
N/A
4.77
17.39
0
0
(3,000)
0
0
51
3 years
3 years
3 years
3 years
4.41
4.41
4.41
4.41
4.41
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Due to the Bank’s participation in the Treasury’s Capital
Purchase Program (CPP) (see discussion elsewhere in this
report), a portion of the vested restricted stock awards
granted to certain executives during the period that
Treasury held the Preferred Stock were to remain subject to
transfer restrictions if, and so long as, the Treasury does not
receive repayment of all of the financial assistance provided
under the CPP. In accordance with Treasury policy, any
such shares that would remain nontransferable indefinitely
were to be cancelled. Following the sale by Treasury of the
Preferred Stock
in 2013,
third party
approximately 82% of the CPP financial assistance to the
Bank had been repaid, meaning that 25% of the shares
subject to these restricted stock awards that had vested in
2011, 2012 and 2013 remained nontransferable and subject
to possible cancellation. Based on an assessment, at the
investors
to
time, that these shares were likely to remain restricted
indefinitely, they were cancelled during the first half of
2013 and returned to the Bank as treasury stock, and the
number of shares cancelled were added back to the total
shares available for future equity awards under the 2009
Plan. In light of the Company’s stock price performance
since these cancellations occurred, the value that Treasury
may be able to realize from the warrant to acquire Company
common stock it continues to hold as a result of the CPP
may be sufficient to enable the Treasury to receive
repayment in full of all of the CPP financial assistance
provided to the Bank, which would eliminate ongoing
transfer restrictions on the restricted stock awards that vest
in the future and the obligation to cancel any such vested
shares. Accordingly, no additional shares were cancelled in
2014.
The following table summarizes information about stock options outstanding at December 31, 2014:
Weighted
Average
Remaining
Contractual
Life in
Years
Exercise
Price
$
30.00
4.77
Number
Outstanding
15,000
15,000
30,000
Number
Exercisable
15,000
15,000
30,000
0.4
4.4
Number
Unexercisable
Unrecognized
Compensation
Expense
0 $
0
0 $
0
0
0
Weighted Average Years Over
Which Unrecognized
Compensation will be
Recognized
N/A
N/A
The Company will issue shares from treasury stock upon
the exercise of outstanding options.
Prior to January 1, 2006, the Company used the intrinsic
value method as described in APB Opinion No. 25 and
related interpretations to account for its stock incentive
plans. Accordingly, there were no charges or credits to
expense with respect to the granting or exercise of options
since the options were issued at fair value on the respective
grant dates. In accordance with ASC 718, the Company
recognized compensation expense in 2014, 2013 and 2012
relating to stock options over the vesting period. The
amount of the expense was determined under the fair value
method.
The fair value for each option grant is estimated on the date
of the grant using a Black Scholes option valuation model.
There were no options granted in 2014, 2013 or 2012.
52
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 14 Earnings per Common Share
The following table reconciles the weighted average shares outstanding and net income for basic and diluted earnings per
common share:
(Dollars in thousands, except per share data)
Weighted average number of common shares outstanding used in
Year ended December 31,
2013
2012
2014
basic earnings per common share calculation ..................................
4,060,404
4,001,288
3,946,314
Net dilutive effect of :
Options and warrant ........................................................................
Restricted stock awards ..................................................................
507,856
55,783
266,391
42,487
0
84,338
Weighted average number of common shares outstanding adjusted
for effect of dilutive securities .........................................................
4,624,043
4,310,166
4,030,652
Net income available to common shareholders .................................. $
Basic earnings per common share ...................................................... $
Diluted earnings per common share ................................................... $
5,669
1.40
1.23
24,602
6.15
5.71
3,460
0.88
0.86
NOTE 15 Stockholders' Equity
The Company did not repurchase any shares of its common
stock in the open market during 2014, 2013 or 2012. The
Company has not made any dividend payments on its
common stock since the third quarter of 2008.
The Company's certificate of incorporation authorizes the
issuance of up to 500,000 shares of preferred stock, and on
December 23, 2008, the Company completed the sale of
26,000 shares of Preferred Stock to the United States
Treasury. The Preferred Stock has a liquidation value of
$1,000 per share and a related warrant was also issued to
purchase 833,333 shares of HMN common stock at an
exercise price of $4.68 per share. The transaction was part
of the United States Treasury’s CPP under the Emergency
Economic Stabilization Act of 2008. Under the terms of the
sale, the shares of Preferred Stock were entitled to a
quarterly cumulative compounding dividend at a stated rate
of 5% per annum for each of the first five years of the
investment, which increased to 9% on February 15, 2014,
until HMN redeems the shares.
On February 8, 2013, the Treasury sold the Preferred Stock
issued to unaffiliated third party investors in a private
transaction for $18.8 million. The Company received no
proceeds from the sale and it had no effect on the terms of
the outstanding Preferred Stock. Further, the sale of the
Preferred Stock had no effect on the Company’s capital,
financial condition or results of operations. Because of the
sale, the Company generally is no longer subject to the
various executive compensation and corporate governance
requirements to which participants in Treasury’s CPP were
subject while Treasury held the Preferred Stock.
Treasury continues to hold the warrant to purchase 833,333
shares of the Company’s common stock at an exercise price
of $4.68, which Treasury may sell in its discretion, subject
to applicable securities laws and the Company’s right to
repurchase the warrant at fair market value under the terms
of the Company’s agreements with Treasury. The warrant
may be exercised at any time over its ten-year term and
Treasury has agreed not to exercise any voting rights
received by acquiring common stock on the exercise of the
warrant. The discount on the common stock warrant was
amortized over the first five years the preferred stock was
outstanding.
All dividends on the Preferred Stock were current as of
December 31, 2014. During 2014, the Company paid the
following dividends on, and effected the following
redemptions of, its Preferred Stock:
Date
Dividend Redemption
May 15, 2014
$201.71
per share
10,000 shares of Preferred Stock on a
pro rata basis at $1,000 per share
August 15, 2014
$22.50
per share
None
November 17, 2014 $22.50
per share
6,000 shares of Preferred Stock on a
pro rata basis at $1,000 per share
Following the redemption on November 17, 2014, 10,000
shares of Preferred Stock remained outstanding. The
Company did not pay any dividends on the Preferred Stock
or redeem any shares of Preferred Stock in 2013.
53
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
On February 17, 2015, the Company redeemed the
remaining 10,000 shares of outstanding Preferred Stock.
After giving effect to a dividend of $22.50 per share on the
Preferred Stock that was paid on the same date, the
redemption price per share was $1,000. The Preferred Stock
redemption was funded with a $10 million term loan to
HMN from an unrelated third party that was evidenced by
a promissory note. The principal balance of the note bears
interest at a rate of 6.5% and is payable in consecutive
annual installments of $1 million on each December 15,
beginning December 15, 2015, with the balance due on
December 15, 2021. The Preferred Stock dividend was
funded by HMN through internally available funds.
In order to grant a priority to eligible accountholders in the
event of future liquidation, the Bank, at the time of
conversion
to a stock savings bank, established a
liquidation account equal to its regulatory capital as of
September 30, 1993. In the event of future liquidation of the
Bank, an eligible accountholder who continues to maintain
their deposit account shall be entitled to receive a
distribution from the liquidation account. The total amount
of the liquidation account will decrease as the balance of
eligible accountholders is reduced subsequent to the
conversion, based on an annual determination of such
balance.
is subject
NOTE 16 Regulatory Matters/Supervisory Agreements
and IMCR
The Bank
to various regulatory capital
requirements administered by the federal banking agencies.
Failure to meet minimum capital requirements can initiate
certain mandatory and possibly additional discretionary
actions by regulators that, if undertaken, could have a direct
material effect on the Company's financial statements.
Under capital adequacy guidelines and the regulatory
framework for prompt corrective action, the Bank must
meet specific capital guidelines that involve quantitative
measures of the Bank's assets, liabilities and certain off-
items as calculated under regulatory
balance sheet
accounting practices. The Bank's capital amounts and
classification are also subject to qualitative judgments by
the regulators about components, risk weightings and other
factors.
replaced
The Bank entered into a written Supervisory Agreement
with the OTS, its primary regulator at the time, effective
February 22, 2011, that primarily related to the Bank’s
financial performance and credit quality issues. This
agreement
of
understanding that the Bank entered into with its primary
regulator on December 9, 2009. In accordance with the
agreement, the Bank submitted a two year business plan in
May of 2011 that the OCC (as successor to the OTS)
accepted with the expectation that the Bank would be in
adherence with the OCC’s Notification of Establishment of
prior memorandum
the
Higher Minimum Capital Ratios, dated August 8, 2011, or
IMCR, which required the Bank to establish and maintain a
minimum core capital ratio of 8.50% by December 31,
2011. The IMCR is discussed more fully below. As
the Bank
the Supervisory Agreement,
required by
submitted updated two year business plans in January of
2012, 2013, and 2014. The Bank was required to operate
within the parameters of the business plan and was required
to monitor and submit periodic reports on its compliance
with the plan. The Bank also submitted problem asset
reduction plans at the same time that the business plans
were submitted. The Bank was required to operate within
the parameters of the problem asset plan and to monitor and
submit periodic reports on its compliance with the plan. The
Bank has also revised its loan modification policies and its
program for identifying, monitoring and controlling risk
associated with concentrations of credit, and improved the
documentation relating to the allowance for loan and lease
losses as required by the agreement. In addition, prior to
termination of the Bank Supervisory Agreement, as
described below, the Bank could not declare or pay any
cash dividends, increase its total assets during any quarter
in excess of the amount of the net interest credited on
deposit liabilities during the prior quarter, enter into any
new contractual arrangement or renew or extend any
existing arrangement related to compensation or benefits
with any directors or officers, make any golden parachute
payments, or enter into any significant contracts with a third
party service provider without the consent of the OCC.
Pursuant to the IMCR, effective December 31, 2011, the
Bank was required to establish, and subsequently maintain,
core capital at least equal to 8.50% of adjusted total assets.
The Bank’s core capital to adjusted total assets ratio
improved to 12.22% at December 31, 2013. Effective
February 11, 2014 the OCC terminated the Supervisory
Agreement and the IMCR to which the Bank was a party or
was subject. As a result, the capital ratio and periodic
reporting requirements, asset growth restrictions and
significant contract restrictions are no longer applicable to
the Bank. The dividend and compensation restrictions
expressly set forth in the Bank Supervisory Agreement also
terminated, although the Bank remains subject to generally
certain
applicable
compensation arrangements under federal banking laws
and regulations.
limitations on dividends
and
the
replaced
prior memorandum
The Company also entered into a written Supervisory
Agreement with the OTS effective February 22, 2011. This
agreement
of
understanding that the Company entered into with its
primary regulator on December 9, 2009. As required by the
Supervisory Agreement, the Company submitted updated
two year consolidated capital plans in January of 2012,
2013, and 2014. The Company was required to operate
within the parameters of the capital plan and to monitor and
54
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
submit periodic reports on its compliance with the plan. In
addition, without the consent of the FRB (as successor to
the OTS), the Company could not incur or issue any debt,
guarantee the debt of any entity, declare or pay any cash
dividends or repurchase any of the Company’s capital
stock, enter into any new contractual arrangement or renew
or extend any existing arrangement related to compensation
or benefits with any director or officer, or make any golden
parachute payments. Effective May 1, 2014, the FRB
terminated the Supervisory Agreement to which the
Company was subject.
Quantitative measures established by regulations to ensure
capital adequacy require the Bank to maintain minimum
amounts and ratios (set forth in the following table) of Tier
I (Core) capital, and Risk-based capital (as defined in the
regulations) to total assets (as defined).
As of January 1, 2015, the Bank is also required to maintain
minimum amounts and ratios of Common Equity Tier I risk
based capital, a new measure introduced by the FRB, FDIC
and OCC (as described below).
At December 31, 2014 and 2013, the Bank's capital
amounts and ratios are presented for actual capital, required
capital and excess capital including amounts and ratios in
order to qualify as being well capitalized under the prompt
corrective action regulations:
Actual
Required to be
Adequately Capitalized
Excess Capital
To Be Well Capitalized
Under Prompt
Corrective Action
Provisions
(Dollars in thousands)
December 31, 2014
Amount
Percent of
Assets(1)
Amount
Percent of
Assets(1) Amount
Percent of
Assets(1)
Amount
Percent of
Assets(1)
Tier I or core capital ... $ 66,976
Tier I risk-based
11.76% $
22,775
4.00% $
44,201
7.76% $ 28,469
5.00%
capital ........................
66,976
17.21
15,562
4.00
51,414
13.21
23,343
6.00
Risk-based capital to
risk-weighted assets ..
71,882
18.48
31,125
8.00
40,757
10.48
38,906
10.00
December 31, 2013
Tier I or core capital ...... $ 77,848
Tier I risk-based capital .
77,848
Risk-based capital to
12.22 % $
19.51
25,478
15,963
4.00% $
4.00
52,370
61,885
8.22 % $ 31,847
23,944
15.51
5.00%
6.00
risk-weighted assets ....
10.00
(1) Based upon the Bank’s adjusted total assets for the purpose of the Tier I or core capital ratios and risk-weighted assets for the
82,916
31,926
50,990
39,907
8.00
20.78
12.78
purpose of the risk-based capital ratio.
Management believes that, as of December 31, 2014, the
Bank’s capital ratios were in excess of those quantitative
capital ratio standards applicable on that date, set forth
under the prompt corrective action regulations referenced
above. However, as noted below, these measures have
changed and there can be no assurance that the Bank will
continue to maintain such status in the future. The OCC has
extensive discretion in its supervisory and enforcement
activities, and can further adjust the requirement to be
“well-capitalized” in the future.
The capital requirements of the Company and the Bank are
affected by regulatory changes issued in July 2013 by the
FRB, the FDIC and the OCC. The changes establish an
integrated regulatory capital framework for implementing
the Basel Committee on Banking Supervision’s Basel III
regulatory capital reforms and implementing the changes
required by the Dodd-Frank Wall Street Reform and
Consumer Protection Act of 2010. The new capital
requirements are effective for the Company beginning
January 1, 2015, and among other things, apply a
strengthened set of capital requirements to both the Bank
and the Company and revise the rules for calculating risk-
weighted assets for purposes of such requirements. Among
other new restrictions implemented by these rules, on and
after January 1, 2015, a savings institution will be deemed
to be "well capitalized" if it (i) has a total risk-based capital
ratio of 10% or greater, (ii) has a Tier 1 (core) risk-based
capital ratio of 8% or greater, (iii) has a Common Equity
Tier 1 risk-based capital ratio of 6.5% or greater, (iv) has a
leverage ratio of 5% or greater, and (v) is not subject to any
order or written directive by the OCC to meet and maintain
a specific capital level for any capital measure; and
"adequately capitalized" if it (i) has a total risk-based
capital ratio of 8% or greater, (ii) has a Tier 1 (core) risk-
based capital ratio of 6% or greater, (iii) has a Common
Equity Tier 1 risk-based capital ratio of 4.5% or greater, and
(iv) has a leverage ratio of 4% or greater. Management
believes that, as of January 1, 2015, both the Bank’s and
Company’s capital positions were in excess of the amounts
required to be considered well capitalized under the revised
Basel III capital requirements.
55
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
by-case basis. The amount of collateral obtained, if deemed
necessary by the Bank upon extension of credit, is based on
the loan type and on management's credit evaluation of the
borrower. Collateral consists primarily of residential and
commercial real estate and personal property.
Forward commitments represent commitments to sell loans
to a third party following the closing of the loan and are
entered into in the normal course of business by the Bank.
The Bank issued standby letters of credit which guarantee
the performance of customers to third parties. The standby
letters of credit outstanding expire over the next 18 months
and totaled $1.5 million at December 31, 2014 and $1.0
million at December 31, 2013. The letters of credit are
collateralized primarily with commercial real estate
mortgages. Draws on standby letters of credit would be
initiated by the secured party under the terms of the
underlying obligation. Since the conditions under which the
Bank is required to fund the standby letters of credit may
not materialize, the cash requirements are expected to be
less than the total outstanding commitments.
The Company also has certain obligations and
commitments to make future payments under existing
contracts. At December 31, 2014, the aggregate contractual
obligations (excluding bank deposits) and commercial
commitments were as follows:
Payments Due by Period
Total
(Dollars in thousands)
Contractual Obligations:
Annual rental commitments
under non-cancellable
operating leases .................. $ 7,265
$ 7,265
Less
than 1
Year
1-3
Years
4-5
Years
After 5
Years
802 1,557 1,360 3,546
802 1,557 1,360 3,546
Other Commercial
Commitments:
Amount of Commitments
Expiring by Period
Commercial lines of credit .... $37,660 19,901 7,806 2,569 7,384
Commitments to lend ............ 23,734 3,571 7,972 7,257 4,934
0
Standby letters of credit ........ 1,506 1,506
$62,900 24,978 15,778 9,826 12,318
0
0
NOTE 17 Financial Instruments with Off-Balance Sheet
Risk
The Company is a party to financial instruments with off-
balance sheet risk in the normal course of business to meet
the financing needs of its customers. These financial
instruments include commitments to extend credit. These
instruments involve, to varying degrees, elements of credit
and interest rate risk in excess of the amounts recognized in
these
the balance sheet. The contract amounts of
instruments reflect the extent of involvement by the
Company.
The Company's exposure to credit loss in the event of
nonperformance by the other party to the financial
instrument for commitments to extend credit is represented
by the contract amount of these commitments. The
Company uses the same credit policies in making
commitments as it does for on-balance sheet instruments.
(Dollars in thousands)
Financial instruments whose contract
amount represents credit risk:
Commitments to originate, fund or
December 31,
Contract Amount
2014 2013
1,204
purchase loans:
1-4 family mortgages ............................. $
523
Commercial real estate mortgages ......... 24,956 25,514
1,288 13,095
Non-real estate commercial loans ..........
Undisbursed balance of loans closed ...... 25,875
7,586
Unused lines of credit ............................ 86,714 79,136
1,017
Letters of credit ......................................
Total commitments to extend credit ........... $141,578 126,871
2,025
Forward commitments ............................... $
3,279
1,541
Commitments to extend credit are agreements to lend to a
customer, at the customer’s request, as long as there is no
violation of any condition established in the contract.
Commitments generally have fixed expiration dates or
other termination clauses and may require payment of a fee.
Since a portion of the commitments are expected to expire
without being drawn upon, the total commitment amounts
do not necessarily represent future cash requirements. The
Bank evaluates each customer's creditworthiness on a case-
56
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 18 Derivative Instruments and Hedging
Activities
The Company originates single-family residential loans for
sale into the secondary market and enters into commitments
to sell those loans in order to mitigate the interest rate risk
associated with holding the loans until they are sold. The
Company accounts for its commitments in accordance with
ASC 815, Accounting for Derivative Instruments and
Hedging Activities.
The Company had commitments outstanding to extend
credit to future borrowers that had not closed prior to the
end of the year, which is referred to as its mortgage
pipeline. As commitments to originate loans enter the
mortgage pipeline, the Company generally enters into
commitments to sell the loans into the secondary market.
The commitments to originate and sell loans are derivatives
that are recorded at fair value. As a result of marking these
derivatives to fair value for the period ended December 31,
2014, the Company recorded an increase in other liabilities
of $7,000, an increase in other assets of $15,000 and a net
gain on the sale of loans of $8,000. As a result of marking
these derivatives to fair value for the period ended
December 31, 2013, the Company recorded a decrease in
other liabilities of $24,000, a decrease in other assets of
$26,000 and a net loss on the sale of loans of $2,000.
As of December 31, 2014 and 2013,
the current
commitments to sell loans held for sale are derivatives that
do not qualify for hedge accounting. The loans held for sale
that are not hedged are recorded at the lower of cost or
market. As a result of marking these loans for the period
ended December 31, 2014, the Company recorded an
increase in other liabilities of $1,000, and a net loss on the
sales of loans of $1,000. As a result of marking these loans
for the period ended December 31, 2013, the Company
recorded an increase in other liabilities of $6,000, and a net
loss on the sales of loans of $6,000.
NOTE 19 Fair Value Measurement
ASC 820, Fair Value Measurements, establishes a
framework for measuring the fair value of assets and
liabilities using a hierarchy system consisting of three
levels, based on the markets in which the assets and
liabilities are traded and the reliability of the assumptions
used to determine fair value. These levels are:
Level 1 - Valuation is based upon quoted prices for
identical instruments traded in active markets that the
Company has the ability to access.
Level 2 - Valuation is based upon quoted prices for
similar instruments in active markets, quoted prices
for identical or similar instruments in markets that are
not active, and model-based valuation techniques for
which significant assumptions are observable in the
market.
Level 3 – Valuation is generated from model-based
techniques that use significant assumptions not
observable in the market and are used only to the
extent that observable inputs are not available. These
unobservable assumptions reflect our own estimates
of assumptions that market participants would use in
pricing the asset or liability. Valuation techniques
include use of option pricing models, discounted cash
flow models and similar techniques.
The following table summarizes the assets of the Company
for which fair values are determined on a recurring basis as
of December 31, 2014 and 2013.
Carrying Value at December 31, 2014
(Dollars in thousands)
Securities available for sale ....................................................... $
Mortgage loan commitments .....................................................
Total ............................................................................................ $
Total
137,834
16
137,850
Level 1 Level 2
Level 3
0
0
0
137,834
16
137,850
0
0
0
Carrying Value at December 31, 2013
(Dollars in thousands)
Securities available for sale .......................................................... $
Mortgage loan commitments ........................................................
Total ............................................................................................. $
Level 1
Total
107,956
2
107,958
57
Level 3
Level 2
0
0
0
107,956
2
107,958
0
0
0
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company may also be required, from time to time, to
measure certain other financial assets at fair value on a
nonrecurring basis in accordance with generally accepted
accounting principles. These adjustments to fair value
usually result from the application of the lower-of-cost-or-
market accounting or write-downs of individual assets. For
assets measured at fair value on a nonrecurring basis in
2014 and 2013 that were still held at December 31, the
following table provides the level of valuation assumptions
used to determine each adjustment and the carrying value
of the related individual assets or portfolios at December
31, 2014 and 2013.
Carrying Value at December 31, 2014
(Dollars in thousands)
Loans held for sale .......................... $
Mortgage servicing rights ...............
Loans (1) ............................................
Real estate, net (2) .............................
Total ................................................. $
Total
Level 1 Level 2 Level 3
2,076
1,507
11,882
3,103
18,568
0
0
0
0
0
2,076
1,507
11,882
3,103
18,568
Carrying Value at December 31, 2013
(Dollars in thousands)
Loans held for sale ............................ $
Mortgage servicing rights ..................
Loans (1) .............................................
Real estate, net (2) ...............................
Total .................................................. $
Total
Level 1
1,502
1,708
17,498
6,898
27,606
Level 3
Level 2
0
0
0
0
0
1,502
1,708
17,498
6,898
27,606
Year Ended
December 31, 2014
Total gains (losses)
(1)
0
532
(134)
397
Year Ended
December 31, 2013
Total gains (losses)
21
0
(1,728)
(429)
(2,136)
0
0
0
0
0
0
0
0
0
0
(1) Represents carrying value and related specific reserves on loans for which adjustments are based on the appraised value of the collateral. The carrying
value of loans fully charged-off is zero.
(2) Represents the fair value and related losses of foreclosed real estate and other collateral owned that were measured at fair value subsequent to their
initial classification as foreclosed assets.
NOTE 20 Fair Value of Financial Instruments
ASC 825, Disclosures about Fair Values of Financial
Instruments, requires disclosure of estimated fair values of
the Company's financial instruments, including assets,
liabilities and off-balance sheet items for which it is
practicable to estimate fair value. The fair value estimates
are made as of December 31, 2014 and 2013 based upon
relevant market information, if available, and upon the
characteristics of the financial instruments themselves.
Because no market exists for a significant portion of the
Company's financial instruments, fair value estimates are
based upon judgments regarding future expected loss
experience,
risk
characteristics of various financial instruments, and other
conditions,
economic
current
factors. The estimates are subjective in nature and involve
uncertainties and matters of significant judgment and
therefore cannot be determined with precision. Changes in
assumptions could significantly affect the estimates.
Fair value estimates are based only on existing financial
instruments without attempting to estimate the value of
anticipated future business or the value of assets and
liabilities that are not considered financial instruments. In
addition, the tax ramifications related to the realization of
the unrealized gains and losses can have a significant effect
on the fair value estimates and have not been considered in
any of the estimates.
58
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The estimated fair value of the Company's financial instruments are shown below. Following the table, there is an explanation
of the methods and assumptions used to estimate the fair value of each class of financial instruments.
December 31, 2014
December 31, 2013
(Dollars in thousands)
Financial assets:
Carrying
amount
Estimated
fair value
Fair value hierarchy
Level
3
Level
1
Level
2
Contract
amount
Carrying
amount
Estimated
fair value
Contract
amount
Cash and cash equivalents ............. $ 46,634
Securities available for sale ........... 137,834 137,834
Loans held for sale ........................
2,076
Loans receivable, net ..................... 365,113 364,509
Federal Home Loan Bank stock ....
777
Accrued interest receivable ...........
1,713
777
1,713
2,076
46,634 46,634
137,834
2,076
364,509
777
1,713
1,502
120,686 120,686
107,956 107,956
1,502
384,615 388,263
784
1,953
784
1,953
Financial liabilities:
Deposits ........................................ 496,750 496,494
Accrued interest payable ...............
93
93
496,494
93
553,930 554,160
146
146
Off-balance sheet financial
instruments:
Commitments to extend credit ......
Commitments to sell loans ............
16
(30)
16
(30)
141,578
3,279
2
(22)
2 126,871
2,025
(22)
Cash and Cash Equivalents
The carrying amount of cash and cash equivalents
approximates their fair value.
Securities Available for Sale
The fair values of securities were based upon quoted market
prices.
Loans Held for Sale
The fair values of loans held for sale were based upon
quoted market prices for loans with similar interest rates
and terms to maturity.
Loans Receivable
The fair values of loans receivable were estimated for
groups of loans with similar characteristics. The fair value
of the loan portfolio, with the exception of the adjustable
rate portfolio, was calculated by discounting the scheduled
cash flows through the estimated maturity using anticipated
prepayment speeds and using discount rates that reflect the
credit and interest rate risk inherent in each loan portfolio.
The fair value of the adjustable loan portfolio was estimated
by grouping the loans with similar characteristics and
comparing the characteristics of each group to the prices
quoted for similar types of loans in the secondary market.
Federal Home Loan Bank Stock
The carrying amount of FHLB stock approximates its fair
value.
Accrued Interest Receivable
The carrying amount of accrued interest receivable
approximates its fair value since it is short-term in nature
and does not present unanticipated credit concerns.
Deposits
The fair value of demand deposits, savings accounts and
certain money market account deposits is the amount
payable on demand at the reporting date. The fair value of
fixed maturity certificates of deposit is estimated using the
rates currently offered for deposits of similar remaining
maturities.
The fair value estimate for deposits does not include the
benefit that results from the low cost funding provided by
the Company's existing deposits and long-term customer
relationships compared to the cost of obtaining different
sources of funding. This benefit is commonly referred to as
the core deposit intangible.
Federal Home Loan Bank Advances
The fair values of advances with fixed maturities are
estimated based on discounted cash flow analysis using as
discount rates the interest rates charged by the FHLB for
borrowings of similar remaining maturities.
Accrued Interest Payable
The carrying amount of accrued
interest payable
approximates its fair value since it is short-term in nature.
Commitments to Extend Credit
The fair values of commitments to extend credit are
estimated using the fees normally charged to enter into
similar agreements, taking into account the remaining terms
of the agreements and the present creditworthiness of the
counter parties.
Commitments to Sell Loans
The fair values of commitments to sell loans are estimated
using the quoted market prices for loans with similar
interest rates and terms to maturity.
59
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 21 HMN Financial, Inc. Financial Information (Parent Company Only)
The following are the condensed financial statements for the parent company only as of December 31, 2014 and 2013 and
for the years ended December 31, 2014, 2013 and 2012.
(Dollars in thousands)
Condensed Balance Sheets
Assets:
Cash and cash equivalents .......................................................................................... $
Investment in subsidiaries ...........................................................................................
Loans receivable, net ..................................................................................................
Prepaid expenses and other assets ..............................................................................
Deferred tax asset, net .................................................................................................
Total assets ............................................................................................................. $
Liabilities and Stockholders' Equity:
Accrued expenses and other liabilities ....................................................................... $
Total liabilities ........................................................................................................
Serial preferred stock ..................................................................................................
Common stock ............................................................................................................
Additional paid-in capital ...........................................................................................
Retained earnings ........................................................................................................
Net unrealized losses on securities available for sale ................................................
Unearned employee stock ownership plan shares ......................................................
Treasury stock, at cost, 4,658,323 and 4,704,313 shares ...........................................
Total stockholders' equity ......................................................................................
Total liabilities and stockholders' equity................................................................ $
Condensed Statements of Income
Interest income ............................................................................................................ $
Equity income of subsidiaries .....................................................................................
Compensation and benefits .........................................................................................
Occupancy ...................................................................................................................
Data processing ...........................................................................................................
Other............................................................................................................................
Income before income tax expense ........................................................................
Income tax (benefit) expense ......................................................................................
Net income ............................................................................................................. $
Condensed Statements of Cash Flows
Cash flows from operating activities:
Net income ................................................................................................................. $
Adjustments to reconcile net income to cash used by operating activities:
Equity income of subsidiaries ................................................................................
Deferred income tax benefit ...................................................................................
Earned employee stock ownership shares priced below original cost ..................
Stock option compensation ....................................................................................
Cancellation of restricted stock awards .................................................................
Amortization of restricted stock awards ................................................................
Decrease in unearned ESOP shares .......................................................................
(Decrease) increase in accrued expenses and other liabilities ...............................
Decrease (increase) in other assets .........................................................................
Other, net ................................................................................................................
Net cash used by operating activities ................................................................
Cash flows from investing activities:
Decrease (increase) in loans receivable, net ...............................................................
Net cash provided (used) by investing activities ...............................................
Cash flows from financing activities:
Redemption of preferred stock ...............................................................................
Dividends to preferred stockholders ......................................................................
Dividends received from Bank ..............................................................................
Net cash provided by financing activities ..............................................................
Increase (decrease) in cash and cash equivalents ..................................................
Cash and cash equivalents, beginning of year ................................................................
Cash and cash equivalents, end of year ........................................................................... $
60
2014
2013
2012
557
73,733
900
10
1,022
76,222
209
209
10,000
91
50,207
77,805
(418)
(2,610)
(59,062)
76,013
76,222
1
7,644
(233)
(24)
(6)
(539)
6,843
(536)
7,379
141
88,332
1,000
79
931
90,483
4,808
4,808
26,000
91
51,175
72,211
(674 )
(2,804 )
(60,324 )
85,675
90,483
1
26,792
(235 )
(24 )
(6 )
(498 )
26,030
(640 )
26,670
7,379
26,670
(7,644)
(92)
53
1
0
240
194
(420)
69
0
(220)
100
100
(16,000)
(5,964)
22,500
536
416
141
557
(26,792 )
(931 )
(21 )
4
(119 )
202
193
47
(65 )
(1 )
(813 )
(200 )
(200 )
0
0
1,000
1,000
(13 )
154
141
3
6,220
(227)
(24)
(6)
(513)
5,453
132
5,321
5,321
(6,220)
0
(162)
7
0
233
194
65
22
0
(540)
600
600
0
0
0
0
60
94
154
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 22 Business Segments
The Bank has been identified as a reportable operating
segment in accordance with the provisions of ASC 280.
HMN, the holding company, did not meet the quantitative
thresholds for a reportable segment and therefore is
included in the “Other” category. The Company evaluates
performance and allocates resources based on
the
segment’s net income, return on average assets and return
on average equity. Each corporation is managed separately
with its own officers and board of directors.
The following table sets forth certain information about the reconciliations of reported net income and assets for each of the
Company’s reportable segments.
(Dollars in thousands)
At or for the year ended December 31, 2014:
Interest income - external customers ..................................... $
Non-interest income - external customers..............................
Intersegment interest income ..................................................
Intersegment non-interest income ..........................................
Interest expense ........................................................................
Non-interest expense ................................................................
Income tax expense (benefit) ...................................................
Net income ................................................................................
Total assets ...............................................................................
At or for the year ended December 31, 2013:
Interest income - external customers ......................................... $
Non-interest income - external customers .................................
Intersegment interest income .....................................................
Intersegment non-interest income ..............................................
Interest expense .........................................................................
Non-interest expense ..................................................................
Income tax benefit ....................................................................
Net income .................................................................................
Total assets .................................................................................
At or for the year ended December 31, 2012:
Interest income - external customers ......................................... $
Non-interest income - external customers .................................
Intersegment interest income .....................................................
Intersegment non-interest income ..............................................
Interest expense .........................................................................
Non-interest expense ..................................................................
Income tax expense ...................................................................
Net income .................................................................................
Total assets .................................................................................
Home
Federal
Savings
Bank
20,613
7,284
0
180
1,213
20,781
5,438
7,644
576,397
22,983
7,312
0
182
3,290
22,039
(13,766)
26,795
647,679
30,816
8,990
0
186
7,143
24,077
0
6,228
653,315
Other
Eliminations
Consolidated
Total
0
0
2
7,644
0
802
(536)
7,379
76,221
0
0
1
26,792
0
766
(640)
26,667
90,483
0
0
4
6,220
0
779
132
5,313
64,135
0
0
(2)
(7,824)
(2)
(180)
0
(7,644)
(75,192)
0
0
(1)
(26,974)
(1)
(182)
0
(26,792)
(89,540)
0
0
(4)
(6,406)
(4)
(186)
0
(6,220)
(64,123)
20,613
7,284
0
0
1,211
21,403
4,902
7,379
577,426
22,983
7,312
0
0
3,289
22,623
(14,406)
26,670
648,622
30,816
8,990
0
0
7,139
24,670
132
5,321
653,327
61
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
HMN Financial, Inc. and Subsidiaries
Rochester, Minnesota
We have audited the accompanying consolidated balance sheet of HMN Financial, Inc. and subsidiaries (the Company) as of
December 31, 2014, and the related consolidated statements of comprehensive income, stockholders’ equity, and cash flows for
the year then ended. These consolidated financial statements are the responsibility of the Company’s management. Our
responsibility is to express an opinion of these consolidated financial statements based on our audit. The consolidated balance
sheet of HMN Financial, Inc. and subsidiaries as of December 31, 2013, and the related consolidated statements of comprehensive
income, stockholders’ equity, and cash flows for the years ended December 31, 2013 and 2012 were audited by other auditors
whose report dated March 11, 2014, was unqualified.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States).
Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures
in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable
basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position
of HMN Financial, Inc. and subsidiaries as of December 31, 2014, and the results of their operations and their cash flows for the
year then ended in conformity with accounting principles generally accepted in the United States of America.
Minneapolis, Minnesota
March 13, 2015
62
OTHER FINANCIAL DATA
The following tables set forth certain information as to the Bank’s Federal Home Loan Bank (FHLB) advances.
(Dollars in thousands)
Maximum Balance:
FHLB advances .................................................................................. $
FHLB short-term advances ................................................................
Average Balance:
FHLB advances ..................................................................................
FHLB short-term advances ................................................................
Year Ended December 31,
2013
2012
2014
0
0
0
0
70,000
70,000
30,329
30,329
70,000
70,000
70,000
39,317
2014
December 31,
2013
2012
(Dollars in thousands)
FHLB short-term advances .......... $
FHLB long-term advances ...........
Total ............................................. $
Amount
0
0
0
Weighted
Average
Rate
Amount
Weighted
Average
Rate
Amount
Weighted
Average
Rate
0.00% $
0.00
0.00% $
0
0
0
0.00% $
0.00
0.00% $
70,000
0
70,000
4.77%
0.00
4.77%
Refer to Note 11 of the Notes to Consolidated Financial Statements for more information on the Bank’s FHLB advances and
Other Borrowings.
63
COMMON STOCK INFORMATION
The common stock of the Company is listed on the Nasdaq Stock Market under the symbol HMNF. As of December 31, 2014,
the Company had 9,128,662 shares of common stock issued and 4,658,323 shares in treasury stock. As of December 31, 2014,
there were 605 stockholders of record and 1,026 estimated beneficial stockholders. The following table presents the stock price
information for the Company as furnished by Nasdaq for each quarter for the last two fiscal years. On February 13, 2015, the last
reported sale price of shares of our common stock on the Nasdaq Stock Market was $12.01 per share. The Company has not paid
a dividend on its common stock since 2008 and no common stock dividends are anticipated to be paid in 2015.
December 31,
HIGH .......... $
LOW ..........
CLOSE .......
2014
13.95
10.06
12.40
September 30,
2014
13.20
10.95
13.20
June 30,
2014
11.98
8.94
11.00
March 31,
2014
13.44
9.82
9.85
December 31,
2013
10.98
7.57
10.57
September 30,
2013
9.94
6.39
7.90
June 28,
2013
7.84
5.84
7.11
March 28,
2013
6.40
2.99
5.85
The following graph and table compares the total cumulative stockholders’ return on the Company’s common stock to the
NASDAQ U.S. Stock Index (“NASDAQ Composite”), which includes all NASDAQ traded stocks of U.S. companies, and the
SNL Bank NASDAQ Index. The graph and table assume that $100 was invested on December 31, 2009 and that all dividends
were reinvested.
Index
HMN Financial, Inc. .........................
NASDAQ Composite .......................
SNL Bank NASDAQ Index .............
12/31/09
$100.00
$100.00
$100.00
12/31/10
66.90
118.15
117.98
12/31/11
46.10
117.22
104.68
12/31/12
82.65
138.02
124.77
12/31/13
251.67
193.47
179.33
12/31/14
295.24
222.16
185.73
Period Ending
64
SELECTED QUARTERLY FINANCIAL DATA
(Dollars in thousands, except per share data)
Selected Operations Data (3 months ended):
Interest income .................................................................................. $
Interest expense .................................................................................
Net interest income ........................................................................
Provision for loan losses ...................................................................
Net interest income after provision for loan losses ........................
Noninterest income:
Fees and service charges ................................................................
Loan servicing fees ........................................................................
Gain on sales of loans ....................................................................
Other noninterest income ...............................................................
Total noninterest income ............................................................
Noninterest expense:
Compensation and benefits ............................................................
(Gains) losses on real estate owned ...............................................
Occupancy .....................................................................................
Deposit insurance ..........................................................................
Data processing..............................................................................
Other noninterest expense..............................................................
Total noninterest expense ...........................................................
Income before income tax expense ................................................
Income tax expense (benefit) ............................................................
Net income .....................................................................................
Preferred stock dividends and discount .........................................
Net income available to common stockholders ............................. $
Basic earnings per common share ..................................................... $
Diluted earnings per common share .................................................. $
Financial Ratios:
Return on average assets(1) ................................................................
Return on average common equity(1) .................................................
Average equity to average assets .......................................................
Net interest margin(1)(2) ......................................................................
(Dollars in thousands)
Selected Financial Condition Data:
Total assets ........................................................................................ $
Securities available for sale:
Mortgage-backed and related securities.........................................
Other marketable securities ...........................................................
Loans held for sale ............................................................................
Loans receivable, net .........................................................................
Deposits .............................................................................................
Federal Home Loan Bank advances ..................................................
Stockholders’ equity ..........................................................................
December 31,
2014
September 30,
2014
June 30,
2014
5,035
274
4,761
(2,221)
6,982
831
271
348
230
1,680
3,388
(64)
1,037
107
276
1,073
5,817
2,845
1,167
1,678
(293)
1,385
0.34
0.30
1.13%
8.74
13.25
3.42
5,131
297
4,834
(989)
5,823
903
263
804
224
2,194
3,193
(78)
896
74
240
1,100
5,425
2,592
1,054
1,538
(360)
1,178
0.29
0.25
1.01%
7.89
13.37
3.31
5,020
306
4,714
(2,178)
6,892
901
263
330
228
1,722
3,273
(1,120)
876
97
249
1,089
4,464
4,150
1,620
2,530
(524)
2,006
0.50
0.44
1.62%
12.32
13.68
3.20
577,426
594,433
609,882
2,909
134,925
2,076
365,113
496,750
0
76,013
3,361
137,180
1,235
365,572
504,908
0
80,611
3,878
123,369
3,861
367,667
522,853
0
79,376
(1) Annualized
(2) Net interest income divided by average interest-earning assets
(3) Relates to the elimination of the deferred tax asset valuation reserve at December 31, 2013. See “Results of Operations
- Income Taxes” in the Management Discussion and Analysis for further information.
65
March 31,
2014
December 31,
2013
September 30,
2013
June 30,
2013
March 31,
2013
5,787
1,115
4,672
(520)
5,192
883
257
702
145
1,987
2,980
(306)
826
190
351
1,284
5,325
1,854
55
1,799
(547)
1,252
0.32
0.30
1.21%
11.78
10.05
3.28
560,974
7,042
83,251
3,212
415,534
491,753
0
61,162
6,323
1,392
4,931
0
4,931
789
248
678
159
1,874
3,199
(19)
850
318
355
1,336
6,039
766
25
741
(476)
265
0.07
0.06
0.48%
4.90
9.82
3.34
627,086
8,586
82,438
2,210
434,634
487,645
70,000
61,053
5,427
334
5,093
(1,610)
6,703
823
261
346
258
1,688
3,478
68
882
157
246
866
5,697
2,694
1,062
1,632
(532)
1,100
0.27
0.24
1.08%
7.61
14.23
3.59
620,775
4,462
98,031
1,425
383,020
522,383
0
87,226
5,144
378
4,766
(3,031)
7,797
912
257
289
170
1,628
3,492
(223)
795
188
242
1,479
5,973
3,452
(14,644)(3)
18,096
(522)
17,574
4.37
3.93
12.23%
106.72
10.77
3.37
648,622
5,213
102,743
1,502
384,615
553,930
0
85,675
5,729
404
5,325
(4,330)
9,655
929
267
433
194
1,823
3,009
(282)
867
172
341
1,179
5,286
6,192
158
6,034
(523)
5,511
1.38
1.27
4.44%
38.17
10.54
4.10
562,565
5,973
83,714
1,180
393,322
485,921
0
67,376
66
This page intentionally left blank
HMN FINANCIAL, INC.
1016 Civic Center Drive NW
Rochester, MN 55901
(507) 535-1200
ANNUAL MEETING
The annual meeting of shareholders
will be held on Tuesday, April 28,
2015 at 10:00 a.m. (Central Time) at
the Rochester Golf and Country Club,
3100 West Country Club Road,
Rochester, Minnesota.
LEGAL COUNSEL
Faegre Baker Daniels LLP
2200 Wells Fargo Center
90 South Seventh Street
Minneapolis, MN 55402-3901
INDEPENDENT REGISTERED PUBLIC
ACCOUNTING FIRM
CliftonLarsonAllen LLP
220 South Sixth Street, Suite 300
Minneapolis, MN 55402-1436
INVESTOR INFORMATION AND FORM
10-K
HMN’s Form 10-K, filed with the
Securities and Exchange Commission,
is available without charge upon
written request from:
HMN Financial, Inc.
Attn: Cindy Hamlin, Investor
Relations
1016 Civic Center Drive NW
Rochester, MN 55901
or at www.hmnf.com
TRANSFER AGENT AND REGISTRAR
Inquiries regarding change of address,
transfer requirements, and lost
certificates should be directed to
HMN’s transfer agent:
Wells Fargo Bank, N.A.
Shareowner Services
1110 Centre Pointe Curve, Suite 101
MAC N9173-010
Mendota Heights, MN 55120
www.wellsfargo.com/
shareownerservices
(800) 468-9716
BRANCH OFFICES OF BANK
Albert Lea
143 West Clark Street
Albert Lea, MN 56007
(507) 379-2551
Austin
201 Oakland Avenue West
Austin, MN 55912
(507) 434-2500
Eagan
2805 Dodd Road, Suite 160
Eagan, MN 55121
(651) 405-2000
La Crescent
208 South Walnut
La Crescent, MN 55947
(507) 895-9200
Marshalltown
303 West Main Street
Marshalltown, IA 50158
(641) 754-6198
Rochester
1201 South Broadway
Rochester, MN 55901
(507) 536-2416
1016 Civic Center Drive NW
Rochester, MN 55901
(507) 535-1309
Spring Valley
715 North Broadway
Spring Valley, MN 55975
(507) 346-9709
Winona
175 Center Street
Winona, MN 55987
(507) 453-6460
Home Federal Private Banking
100 1st Avenue Bldg., Suite 200
Rochester, MN 55902
(507) 280-7256
2048 Superior Drive NW, Suite 400
Rochester, MN 55901
(507) 226-0800
DIRECTORS
DR. HUGH C. SMITH
Chairman of the Board
HMN and Home Federal Savings Bank
Retired Professor of Medicine, Mayo
Clinic College of Medicine and
Consultant in Cardiovascular Division,
Mayo Clinic
ALLEN J. BERNING
Chief Executive Officer
Ambient Clinical Analytics
MICHAEL J. FOGARTY
Retired Vice President
C.O. Brown Agency, Inc.
KAREN L. HIMLE
Vice President Corporate Affairs
Thrivent Financial
BRADLEY C. KREHBIEL
President and Chief Executive Officer
HMN and Home Federal Savings Bank
MALCOLM W. MCDONALD
Retired Senior Vice President
Space Center, Inc.
BERNARD R. NIGON
Retired Audit Partner with
McGladrey LLP
WENDY S. SHANNON
Assistant Professor
Winona State University
MARK E. UTZ
Attorney at law, Wendlund Utz, Ltd.
EXECUTIVE OFFICERS WHO ARE NOT
DIRECTORS
JON J. EBERLE
Senior Vice President,
Chief Financial Officer
and Treasurer of HMN and
Executive Vice President, Chief
Financial Officer and Treasurer of
Home Federal Savings Bank
SUSAN K. KOLLING
Senior Vice President
HMN and Home Federal Savings Bank
LAWRENCE D. MCGRAW
Executive Vice President and
Chief Operating Officer
Home Federal Savings Bank
1016 Civic Center Drive NW
Rochester, Minnesota 55901
507.535.1200 • www.hmnf.com
2015_AnnualReport_back.indd 1
2/5/2015 1:51:50 PM