HMN Financial Inc. Annual Report 2019

FY2019 Annual Report · HMN Financial Inc.

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1016 Civic Center Drive NW

Rochester, Minnesota 55901

507.535.1200 • www.hmnf.com

2019
ANNUAL REPORT

TABLE OF CONTENTS

1
Financial Highlights ............................................................................................................................................................
2
Letter to Shareholders and Clients ......................................................................................................................................
4
Board of Directors ...............................................................................................................................................................
5
Five-year Consolidated Financial Highlights ......................................................................................................................
Management Discussion and Analysis ................................................................................................................................
6
Consolidated Financial Statements ...................................................................................................................................... 22
Notes to Consolidated Financial Statements ....................................................................................................................... 26
Report of Independent Registered Public Accounting Firm ................................................................................................ 54
Other Financial Data ........................................................................................................................................................... 55
Selected Quarterly Financial Data ....................................................................................................................................... 56
Common Stock Information ................................................................................................................................................ 58
Corporate and Shareholder Information .................................................................................................... Inside Back Cover
Directors and Officers ............................................................................................................................... Inside Back Cover

HMN Financial, Inc. and Home Federal Savings Bank are headquartered in Rochester, Minnesota. Home Federal
Savings Bank operates twelve full service offices in Minnesota located in Albert Lea, Austin, Eagan, Kasson, La Crescent,
Owatonna, Rochester (4), Spring Valley and Winona, one full service office in Marshalltown, Iowa, and one full service
office in Pewaukee, Wisconsin. The Bank also operates a loan origination office in Sartell, Minnesota.

At or For the Year Ended
December 31,

2019

2018

Percentage
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 .........................................................................
Net income ............................................................................... $

31,890
3,339
28,551
(1,216 )
29,767
3,100
1,278
2,941
1,136
8,455
27,105
11,117
3,324
7,793

Per Common Share Information:
Earnings per common share and common share equivalents:

Basic ......................................................................................... $
Diluted ......................................................................................

1.69
1.68

Stock price (for the year):

High .......................................................................................... $
Low ..........................................................................................
Close ........................................................................................
Book value per common share ........................................................
Closing price to book value .............................................................

23.34
19.01
21.01
19.13
109.83 %

Financial Ratios:
Return on average assets .................................................................
Return on average stockholders’ equity ..........................................
Net interest margin ..........................................................................
Operating expenses to average assets ..............................................
Average stockholders’ equity to average assets ..............................
Stockholders’ equity to total assets at year end ...............................
Non-performing assets to total assets ..............................................
Efficiency ratio ................................................................................

1.05 %
8.74
4.04
3.67
12.06
11.91
0.34
73.25

30,381
2,233
28,148

(649)

28,797
3,330
1,255
2,095
1,034
7,714
25,387
11,124
2,888
8,236

1.89
1.71

21.90
18.05
19.62
17.19
114.14%

1.14%
9.88
4.03
3.51
11.52
11.67
0.43
70.79

5.0%

49.5
1.4
(87.4)
3.4
(6.9)
1.8
40.4
9.9
9.6
6.8
(0.1)
15.1
(5.4)

(7.9)%
(11.5)
0.2
4.6
4.7
2.1
(20.9)
3.5

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:

Common equity Tier 1 capital ..................................................
Tier 1 leverage .........................................................................
Tier 1 risk-based capital ...........................................................
Total risk-based capital ............................................................

December 31,

2019

2018

Percentage
Change

777,639
107,592
3,606
596,392
673,870
92,648

712,315
79,859
3,444
586,688
623,352
83,147

13.21 %
10.89
13.21
14.46

13.26 %
11.00
13.26
14.52

9.2%
34.7
4.7
1.7
8.1
11.4

(0.4)%
(1.0)
(0.4)
(0.4)

LETTER TO SHAREHOLDERS AND CLIENTS

I am very pleased with the financial performance that HMN Financial, Inc. (HMN) reported
for 2019. Our dedicated staff worked very hard to execute our strategic plan and improve the
financial performance and asset quality of the bank.

As of year-end, total assets had increased over $65 million since last year. While net loans
increased approximately $10 million, new commercial loan production exceeded $90 million
for the year while mortgage loan production exceeded $150 million - both substantial increases
over the previous year’s levels. Most importantly, deposits rose over $50 million during the
year which can be attributed to a number of initiatives:

•

In October 2018, we purchased an existing branch facility in Pewaukee, Wisconsin,
fully aware that deed restrictions would prevent us from opening a branch there for
twelve months. We used this time to update both the interior and exterior of the
facility and implemented the latest technology in order to reduce the number of
employees needed to operate the branch. This way, production staff is able to spend
more time out in the community meeting with prospective clients and serving existing ones. During the year, we
also recruited a number of excellent local community bankers to staff the office. We opened a full service branch
in October 2019 and have been very pleased with the support of the local community and the performance of the
branch.

In early 2019, we commenced construction of an expansion to our drive-up branch facility in Kasson, Minnesota.
Once again, we utilized the latest technology and completely remodeled the original floorplan in order to operate
the branch as efficiently as possible. In September 2019, we closed on the sale of our downtown branch location in
Kasson to another local business which allowed us to consolidate all of our operations into a single convenient
location for that market. The community response has been very positive as evidenced by the deposit growth that
we experienced during the year - in large part due to our efforts to ensure that our original main street storefront
was not abandoned but repurposed.

In the second half of 2018, a number of new product and marketing initiatives were launched in order to increase
organic deposit growth. The implementation of these initiatives resulted in a substantial increase in the number of
new retail and commercial deposit accounts opened in 2019 compared to the previous year’s results.

While pleased with the organic deposit growth we experienced in 2019, we continue to look for acquisition targets that will
grow the asset size of the bank, enhance our franchise value and improve our financial performance. During this past year
we analyzed a number of acquisition opportunities and aggressively pursued some of those opportunities but ultimately, we
determined not to go forward with any acquisitions in 2019. We are very sensitive to the potential dilution an acquisition
could have on our common shareholders and will continue to remain disciplined in our approach to valuing and pursuing
acquisition targets.

Another area of focus this past year was the management of our net interest margin. Maintaining net interest margins was a
challenge in 2019 due to the Federal Open Market Committee’s decision to reduce the Federal Funds rate by 75 basis points
during the year which resulted in a corresponding decrease in the Prime interest rate. The decrease in the Prime interest rate
resulted in fierce pricing competition on loans for quality borrowers which resulted in lower loan rates while deposit costs
fell more slowly. Fortunately, our net interest margin for the year held steady from the previous year at 4.04%.

Once again, our asset quality improved with past due loans declining to just 19 basis points of total loans at year-end. During
the year, we were able to move a number of our weakest, but performing, commercial loan relationships out of the bank. We
believe this proactive approach capitalized on the fierce competition for loan growth in our markets and left our bank in a
better position should economic conditions deteriorate.

The capital positions of both the bank and HMN remain very strong when compared to our peers. Over the past several years
we have strategically deployed excess capital to repurchase preferred stock, repay outstanding debt, and repurchase common
stock warrants. All of this was accomplished while continuing to maintain adequate liquidity and capital at HMN to ensure
that it remains a source of strength for the bank. After considering HMN’s capital positon, our Board of Directors has
approved a stock repurchase plan which provides management the ability to repurchase up to $6 million of outstanding HMN
common stock. Repurchases of common stock could support the stock price, if needed, and return excess capital to our
shareholders should it not be needed to support anticipated growth. Management and the Board will continue to evaluate the
most prudent use of our capital resources on a quarterly basis.

We appreciate your interest in HMN and thank you for your continued support of our mission.

Best Regards,

Bradley Krehbiel
President/CEO

BOARD OF DIRECTORS

Dr. Hugh Smith
Chairman of the Board

Bradley Krehbiel
President and CEO

Dr. Wendy Shannon
Vice Chair

Allen Berning

Michael Bue

Sequoya Borgman

Bernard Nigon

Mark Utz

Hans Zietlow

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 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 ..........................................................
Net income ................................................................
Preferred stock dividends and discount .....................
Net income available to common shareholders ......... $

2019

31,890
3,339
28,551
(1,216)
29,767
3,100
1,278
2,941
1,136
8,455
27,105
11,117
3,324
7,793
0
7,793

Year Ended December 31,
2017

2018

30,381
2,233
28,148
(649)
28,797
3,330
1,255
2,095
1,034
7,714
25,387
11,124
2,888
8,236
0
8,236

27,680
1,797
25,883
(523)
26,406
3,354
1,202
2,138
960
7,654
25,254
8,806
4,402(1)
4,404
0
4,404

(645 )

2015

2016
27,349 21,453
1,593 1,507
25,756 19,946
(164)
26,401 20,110
3,427 3,316
1,108 1,046
2,618 1,964
1,048 1,327
8,201 7,653
24,130 23,196
10,472 4,567
4,122 1,611
6,350 2,956
(108)
6,350 2,848

Basic earnings per common share ............................. $
Diluted earnings per common share ..........................

1.69
1.68

1.89
1.71

1.04
0.90

1.52
1.34

0.69
0.61

(1) Relates to the decrease in the Company’s net deferred tax asset as a result of the reduction in the corporate federal tax rate from 34% to 21% in the fourth
quarter of 2017.

2019

Selected Financial Condition Data:
(Dollars in thousands, except per share data)
Total assets ........................................................................... $ 777,639
Securities available for sale .................................................. 107,592
3,606
Loans held for sale ...............................................................
Loans receivable, net ............................................................ 596,392
Deposits ................................................................................ 673,870
Federal Home Loan Bank advances and other borrowings ..
0
Stockholders’ equity ............................................................. 92,648
19.13
Book value per common share .............................................

2018
712,315
79,859
3,444
586,688
623,352
0
83,147
17.19

At December 31,
2017
722,685
77,472
1,837
585,931
635,601
0
80,818
17.97

2016
682,023
78,477
2,009
551,171
592,811
7,000
75,919
16.91

2015
643,161
111,974
3,779
463,185
559,387
9,000
69,645
15.54

Number of full service offices(2)............................................
Number of loan origination offices(2) ....................................

14
1

14
2

13
3

Key Ratios: (3)
Stockholders’ equity to total assets at year end ....................
Average stockholders’ equity to average assets ...................
Return on stockholders’ equity (ratio of net income to

11.91 % 11.67 % 11.18 % 11.13 % 10.83 %
12.06

11.70

11.07

11.43

11.52

average equity) ..................................................................
Return on assets (ratio of net income to average assets) ......

8.74
1.05

9.88
1.14

5.52
0.63

8.71
0.96

4.27
0.50

(2) In 2019, converted Wisconsin loan origination office to a full service office and consolidated the two Kasson offices into one location.
(3) Average balances were calculated based upon amortized cost without the market value impact of ASC 320.

See accompanying notes to consolidated financial statements.

MANAGEMENT DISCUSSION AND ANALYSIS

the allowance

the appropriateness of

This Annual Report, other reports filed by HMN Financial,
Inc. (HMN or the Company) with the Securities and
Exchange Commission (SEC), and the Company’s proxy
statement may contain forward-looking statements within
the meaning of the safe harbor provisions of the Private
Securities Litigation Reform Act of 1995. These statements
are often identified by such forward-looking 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 growing our core
deposit relationships and loan balances, enhancing the
financial performance of our core banking operations,
maintaining credit quality, maintaining net
interest
margins, reducing non-performing assets, and generating
improved financial results (including profitability); the
adequacy and amount of available liquidity and capital
resources to Home Federal Savings Bank (the Bank); the
Company’s
liquidity and capital requirements; our
expectations for core capital and our strategies and
potential strategies for maintenance 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
therefor;
anticipated future levels of the provision for loan losses;
future losses on non-performing assets; the amount and
composition of interest-earning assets; the amount of yield
enhancements relating to non-accruing and purchased
loans; the amount and composition of non-interest and
interest-bearing liabilities; 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 anticipated
results of litigation and our assessment of the impact on our
financial statements; the ability of the Bank to pay dividends
to HMN; the ability to remain well capitalized; the impact
of new accounting pronouncements; and compliance by 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 such regulatory standard,
directive or requirement.

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

from

adequacy and marketability of real estate and other
collateral securing loans to borrowers; federal and state
regulation and enforcement; possible legislative and
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
continued 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 traditional and alternate
funding sources, including changes in collateral advance
rates and policies of the Federal Home Loan Bank (FHLB);
technological, computer-related or operational difficulties,
including those from any third party cyberattack; results of
litigation; 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
economic
and
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; our ability to
attract and retain employees; 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 “Risk Factors”
sections of the Company’s Annual Report on Form 10-K for
the year ended December 31, 2019. All forward-looking
statements are qualified by, and should be considered in
conjunction with, such cautionary statements.

laws; domestic

international

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 is the stock savings bank holding company for the
Bank, which operates community 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
interest earned on loans and investments, and the interest
paid on interest-bearing liabilities such as deposits and other
borrowings. 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 are
affected by changes in interest rates, the volume and
composition of interest-earning assets and interest-bearing

MANAGEMENT DISCUSSION AND ANALYSIS

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, commissions on the sale of uninsured
investment products, and service charges on deposit
accounts. The Bank incurs expenses in addition to interest
expense in the form of compensation and benefits,
occupancy and equipment expenses, provisions for loan
losses, data processing costs, professional services, deposit
insurance, amortization expense on mortgage servicing
assets, advertising expenses, 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.

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 identified 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.

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, 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

for

the

the non-homogeneous

to determine
loss allowance for

the
has established separate processes
appropriateness of
its
loan
homogeneous and non-homogeneous loan portfolios. The
determination of the allowance on the homogeneous single
family and consumer loan portfolios is calculated on a
pooled basis with individual determination of the allowance
for all non-performing loans. The determination of the
allowance
commercial,
commercial real estate and multi-family loan portfolios
involves assigning standardized risk ratings and loss factors
that are periodically reviewed. The loss factors are
estimated 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 uncollectible.

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.
reviewed periodically and any
The estimates are
adjustments 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 by receiving recoveries of
previously charged off loans. The Company decreases its
allowance by crediting the provision for loan losses and
recording loan charge offs. The current year activity in the
allowance resulted in a 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.

Litigation
Estimates related to litigation are inherently subjective and
the ultimate resolution of any litigation may be different
than current management estimates. See “Note 18
Commitments and Contingencies” for further information.

Results of Operations

Comparison of 2019 with 2018
Net income was $7.8 million for 2019, a decrease of $0.4
million, or 5.4%, compared to net income of $8.2 million
for 2018. Diluted earnings per share for the year ended
December 31, 2019 was $1.68, a decrease of $0.03 per share
compared to diluted earnings per share of $1.71 for the year
ended December 31, 2018. The decrease in net income
between the periods was because of a $1.7 million increase
in non-interest expenses primarily related to increased
compensation and professional services expense and a $0.4
million increase in income tax expense. These decreases in
net income were partially offset by a $0.8 million increase
in the gain on sales of loans, a $0.6 million decrease in the
loan loss provision, and a $0.5 million increase in net
interest income due to an increase in the average interest-
earning assets between the periods.

Net Interest Income
Net interest income was $28.6 million for 2019, an increase
of $0.5 million, or 1.4%, from $28.1 million for the same
period of 2018. Interest income was $31.9 million for 2019,
an increase of $1.5 million, or 5.0%, from $30.4 million for
the same period of 2018. Interest income increased
primarily because of the increase in the average yield earned
on interest-earning assets between the periods. The average
yield earned on interest-earning assets was 4.51% for 2019,
an increase of 16 basis points from 4.35% for 2018. The
increase in the average yield is primarily related to the
increase in the average prime rate between the periods.

Interest expense was $3.3 million for 2019, an increase of
$1.1 million, or 49.5%, compared to $2.2 million in 2018.
The average interest rate paid on interest-bearing liabilities
and non-interest-bearing deposits was 0.52% for 2019, an
increase of 17 basis points from 0.35% for 2018. The
increase in interest paid on interest-bearing liabilities was
primarily because of a lag in the timing of the market’s
response in lowering deposit pricing when the federal funds
rate decreased in the second half of 2019. Interest expense
also increased as a result of an increase in the average
federal funds rate between the periods.

MANAGEMENT DISCUSSION AND ANALYSIS

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 losses. For tax purposes
only the net charge-offs are deductible while the entire
provision for loan losses is used to determine book income.
A deferred tax asset is created because of the timing
difference of when the expense is recognized for book and
tax purposes. Under U.S. generally accepted accounting
principles (GAAP), 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 positive evidence considered
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. The Company could not currently identify any
negative evidence. It is possible that future conditions may
differ substantially from those anticipated in determining
that no valuation allowance was required on deferred tax
assets and adjustments may be required in the future.

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

MANAGEMENT DISCUSSION AND ANALYSIS

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.

Average
Outstanding
Balance

2019
Interest
Earned/
Paid

Average
Yield/
Rate

Average
Outstanding
Balance

2018
Interest
Earned/
Paid

Average
Yield/
Rate

Average
Outstanding
Balance

2017
Interest
Earned/
Paid

Average
Yield/
Rate

Year Ended December 31,

(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 and other earning assets

including cash equivalents ..........................
Total interest-earning assets .......................... $

Interest-bearing liabilities:
Checking accounts ......................................... $
Passbooks .......................................................
Money market accounts .................................
Certificate accounts .......................................
FHLB advances and other borrowings ..........
Total interest-bearing liabilities ..................... $
Noninterest checking .....................................
Other noninterest-bearing liabilities ..............
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 ...........................................

15,308
343
67,075 1,157
125
589,521 29,662

2,959

2.24 % $
1.72
4.22
5.03

8,550

197
70,827 1,138
89
586,664 28,446

1,765

2.30 % $
1.61
5.04
4.85

2,524

57
74,035 1,103
94
573,894 26,274

1,905

603
31,679
706,542 31,890

1.90
4.51

511
30,567
698,373 30,381

1.67
4.35

152
18,088
670,446 27,680

103
96,387
79,587
63
177,587 1,171
121,914 1,995
7

287
475,762
163,420
2,057

641,239 3,339
28,551

65,303

0.11 % $
0.08
0.66
1.64
2.54

0.52 % $

3.99 %
$
4.04 %

62
86,750
61
77,630
865
199,202
114,243 1,243
2

140
477,965
156,482
1,534

635,981 2,233
28,148

62,392

0.07 % $
0.08
0.43
1.09
1.71

0.35 % $

4.00 %
$
4.03 %

77
63
560
770
327

87,416
76,592
179,675
106,006
6,335
456,024
156,149
1,279

613,452 1,797
25,883

56,994

110.18 %

109.81 %

109.29 %

2.26 %
1.49
4.93
4.58

0.84
4.13

0.09 %
0.08
0.31
0.73
5.16

0.29 %

3.84 %

3.86 %

(1) Tax exempt income was not material; therefore, the yield was not presented on a tax equivalent basis for any of the years presented.
(2) Calculated net of deferred loan costs, loan discounts, loans in process and loss reserves.

Net interest margin (net interest income divided by average
interest-earning assets) for 2019 was 4.04%, an increase of
1 basis point compared to 4.03% for 2018. The increase in
the net interest margin is primarily related to the increase in
interest income as a result of the increase in the average
yield earned on the interest-earning assets between the

periods. Average net earning assets increased from $62.4
million in 2018 to $65.3 million in 2019. The $2.9 million
increase in the net earning assets in 2019 is due primarily to
the net income earned in 2019 that was partially offset by
the purchase of premises and equipment.

MANAGEMENT DISCUSSION AND ANALYSIS

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
the average
interest expense related
outstanding balances (volume) and those changes caused by

to changes

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 current
volume).

Year Ended December 31,

2019 vs. 2018
Increase
(Decrease)
Due to

2018 vs. 2017
Increase
(Decrease)
Due to

Volume (1)

Rate (1)

Total
Increase

Volume (1)

Rate (1)

Total
Increase
(Decrease)

(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 .............................
Other .......................................................
Total interest-earning assets .............. $

Interest-bearing liabilities:

Checking accounts ................................. $
Passbooks ...............................................
Money market accounts .........................
Certificates of deposit ............................
FHLB advances and other borrowings ..
Total interest-bearing liabilities ........ $
Increase in net interest income ................... $

156
(60)
60
105
17
278

1
2
(21)
53
3
38
240

(10)
79
(24)
1,111
75
1,231

40
0
327
699
2
1,068
163

146
19
36
1,216
92
1,509

41
2
306
752
5
1,106
403

136
(48)
(7)
806
102
989

6
0
37
79
(325)
(203)
1,192

4
83
2
1,366
257
1,712

(21 )
(2 )
268
394
0
639
1,073

140
35
(5)
2,172
359
2,701

(15)
(2)
305
473
(325)
436
2,265

(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.

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, 2019

Weighted average rate on:

Mortgage-backed and related securities .............................. 2.13 % Checking accounts ........................................................................ 0.13 %
Other marketable securities ................................................. 1.72
Loans held for sale ................................................................... 3.99
Loans receivable, net ............................................................... 4.79
FHLB stock and other interest-earning assets ......................... 1.71
Combined weighted average yield on interest-earning assets . 4.22

Passbook accounts ........................................................................ 0.08
Money market accounts ................................................................ 0.65
Certificates of deposit ................................................................... 1.84
Combined weighted average rate on interest-bearing liabilities .. 0.56
Interest rate spread ........................................................................ 3.66

Provision for Loan Losses
The provision for loan losses was ($1.2) million for 2019, a
decrease of $0.6 million compared to the ($0.6) million
provision for loan losses for 2018. The credit provision
amount for the period was primarily the result of the
increase in net recoveries received during 2019 when

compared to the same period of 2018. The net recoveries,
combined with the changes in the credit reserve amounts
required on the existing portfolio, resulted in a reduction of
the overall provision for loan losses between the periods.

MANAGEMENT DISCUSSION AND ANALYSIS

A reconciliation of the allowance for loan losses for 2019 and 2018 is summarized as follows:

(Dollars in thousands)
Balance beginning of period ..................................................................................................................................... $
Provision ...................................................................................................................................................................
Charge offs:

Single family ........................................................................................................................................................
Consumer .............................................................................................................................................................
Commercial business ...........................................................................................................................................
Recoveries ................................................................................................................................................................
Balance at December 31, .......................................................................................................................................... $

Allocated to:
General allowance .................................................................................................................................................... $
Specific allowance ....................................................................................................................................................
$

2019

2018

8,686 $
(1,216 )

(1 )
(107 )
(880 )
2,082
8,564 $

7,839
725
8,564

9,311
(649)

(24)
(226)
(270)
544
8,686

7,892
794
8,686

Non-Interest Income
Non-interest income was $8.5 million for the year ended December 31, 2019, an increase of $0.8 million, or 9.6%, from $7.7
million for the year ended December 31, 2018. The following table presents the components of non-interest income:

(Dollars in thousands)
Fees and service charges ............................... $
Loan servicing fees ........................................
Gain on sales of loans ....................................
Other non-interest income .............................
Total non-interest income ......................... $

2019

Year ended December 31,
2018

3,100
1,278
2,941
1,136
8,455

3,330
1,255
2,095
1,034
7,714

Percentage
Increase (Decrease)

2017

2019/2018

2018/2017

3,354
1,202
2,138
960
7,654

(6.9)%
1.8
40.4
9.9
9.6

(0.7)%
4.4
(2.0)
7.7
0.8

Gain on sales of loans increased $0.8 million between the
periods primarily because of an increase in single family
loan sales. Other non-interest income increased $0.1 million
due primarily to an increase in the gains recognized on
equity securities between the periods. Loan servicing fees

increased slightly due to an increase in single family loan
servicing fees earned between the periods. These increases
were partially offset by a decrease of $0.2 million in fees
and service charges due to a decrease in commitment fees
and late charges earned on loans between the periods.

Non-Interest Expense
Non-interest expense was $27.1 million for the year ended December 31, 2019, an increase of $1.7 million, or 6.8%, from
$25.4 million for the year ended December 31, 2018. The following table presents the components of non-interest expense:

(Dollars in thousands)
Compensation and benefits ........................... $
Occupancy and equipment ............................
Data processing..............................................
Professional services .....................................
Other ..............................................................
Total non-interest expense ............................. $

2019

Year ended December 31,
2018

15,659
4,442
1,263
1,573
4,168
27,105

14,728
4,304
1,270
1,137
3,948
25,387

Percentage
Increase (Decrease)

2017

2019/2018

2018/2017

15,007
4,068
1,106
1,285
3,788
25,254

6.3 %
3.2
(0.6 )
38.3
5.6
6.8

(1.9)%
5.8
14.8
(11.5)
4.2
0.5

Compensation and benefits expense increased $0.9 million
primarily because of annual salary increases, the opening of
a new branch location, and an increase in the compensation
paid as a result of the increased mortgage loan production
the periods. Professional services expense
between
increased $0.4 million between the periods due primarily to
an increase in legal expenses relating to a bankruptcy

litigation claim. Other non-interest expense increased $0.2
million due to an increase in mortgage loan servicing
expenses because of the increase in serviced loans that were
refinanced between the periods. Occupancy and equipment
costs increased $0.1 million between the periods due to an
increase in depreciation and maintenance costs.

MANAGEMENT DISCUSSION AND ANALYSIS

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. Income tax expense was
$3.3 million for the year ended December 31, 2019, an
increase of $0.4 million from $2.9 million for the year ended
December 31, 2018. Income tax expense increased between
the periods because of an increase in the effective tax rate.
The effective tax rate increased primarily because of a
change in the deductibility of certain expenses between the
periods.

Interest expense was $2.2 million for 2018, an increase of
$0.4 million, or 24.3%, from $1.8 million for 2017. The
average interest rate paid on non-interest and interest-
bearing liabilities was 0.35% for 2018, an increase of 6 basis
points from 0.29% paid in 2017. The increase in the interest
paid on non-interest and interest-bearing liabilities was
primarily because of the 100 basis point increase in the
federal funds rate which increased the cost of deposits
between the periods and a $22.5 million increase in the
average non-interest and interest-bearing liabilities held
between the periods.

Comparison of 2018 with 2017
Net income was $8.2 million for 2018, an increase of $3.8
million, or 87.0%, compared to net income of $4.4 million
for 2017. Diluted earnings per share for the year ended
December 31, 2018 was $1.71, an increase of $0.81 per
share compared to diluted earnings per share of $0.90 for
the year ended December 31, 2017. The increase in net
income for 2018 is due primarily to a $2.2 million increase
in net interest income and a $1.5 million decrease in income
tax expense between the periods. Net interest income
increased primarily because of the higher interest income
earned on loans and cash balances as a result of the 100 basis
point increase in the federal funds rate between the periods.
The decrease in income tax expense is primarily because of
the enactment of the Tax Cuts and Jobs Act of 2017 (the
Act) on December 22, 2017 which required the Company to
record $1.1 million in additional income tax expense in the
fourth quarter of 2017 and reduced the Company’s federal
income tax rate in 2018.

Net Interest Income
Net interest income was $28.1 million for 2018, an increase
of $2.2 million, or 8.8%, from $25.9 million for the same
period of 2017. Interest income was $30.4 million for 2018,
an increase of $2.7 million, or 9.8%, from $27.7 million for
the same period of 2017. Interest income increased
primarily because of the higher interest amounts earned on
loans and cash balances as a result of the 100 basis point
increase in the federal funds rate between the periods and a
$27.9 million increase in the average interest-earning assets
held between the periods. Interest income also increased
$0.5 million because of a change in the amount of yield
enhancements recognized on purchased and non-accruing
loans between the periods. The average yield earned on
interest-earning assets was 4.35% for 2018, an increase of
22 basis points from 4.13% for 2017. The average yield
earned on interest-earning assets increased 8 basis points as
a result of the change in yield enhancements recognized
between the periods.

Net interest margin for 2018 was 4.03%, an increase of 17
basis points, compared to 3.86% for 2017. The increase in
the net interest margin is primarily related to the increase in
interest income which is primarily due to the increase in the
average yields earned on the average interest-earning assets
held between the periods. Average net earning assets
increased from $57.0 million in 2017 to $62.4 million in
2018. The $5.4 million increase in the net earning assets in
2018 is due primarily to the net income earned in 2018 that
was partially offset by the purchase of fixed assets and
warrants.

Provision for Loan Losses
The provision for loan losses was ($0.6) million for the year
ended December 31, 2018, a decrease of $0.1 million, from
($0.5) million for the year ended December 31, 2017. The
provision for loan losses decreased between the periods
primarily because of the improved credit quality of the loan
the payoff of certain non-performing
portfolio and
commercial loans which resulted in a decrease in the
reserves required between the periods.

Non-Interest Income
Non-interest income was $7.7 million for the year ended
December 31, 2018, the same as for the year ended
December 31, 2017. Other non-interest income increased
$0.1 million primarily because of an increase in the revenue
earned on the sale of uninsured investment products
between the periods. Loan servicing fees increased $0.1
million between the periods due to an increase in the single
family loans being serviced. These increases in non-interest
income were offset by a decrease in the gain on sales of
loans due to a decrease in single family loan originations
and sales between the periods. Fees and service charges
decreased slightly between the periods primarily because of
a decrease in overdraft fees.

MANAGEMENT DISCUSSION AND ANALYSIS

Non-Interest Expense
Non-interest expense was $25.4 million for the year ended
December 31, 2018, an increase of $0.1 million, or 0.5%,
from $25.3 million for the year ended December 31, 2017.
Occupancy and equipment expense increased $0.2 million
because of increases in depreciation and real estate tax
expenses. Data processing costs increased $0.2 million
primarily because of an increase in mobile and on-line
banking costs between the periods. Other non-interest
expense increased $0.2 million between the periods due to
an increase in the fraud losses incurred on deposit accounts
and an increase in deposit insurance rates. These increases
in non-interest expense were partially offset by a $0.3
million decrease in compensation and benefits expense
primarily because of a decrease in employees between the

periods. Professional services expense decreased $0.2
million between the periods primarily because of a decrease
in legal expenses.

Income Taxes
Income tax expense was $2.9 million for the year ended
December 31, 2018, a decrease of $1.5 million, from $4.4
million for the year ended December 31, 2017. The decrease
in income tax expense is due primarily to the enactment of
the Act which required the Company to record $1.1 million
in additional income tax expense in the fourth quarter of
2017 and reduced the Company’s federal income tax rate in
2018.

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 costs/fees and discounts and the allowance for losses as of the dates indicated:

2019
Amount Percent

2018
Amount Percent

December 31,
2017
Amount Percent

2016
Amount Percent

2015
Amount Percent

(Dollars in thousands)
Real Estate Loans:

Single family .................. $ 120,064 19.86 % $ 110,698 18.61 % $ 107,005 17.99 % $ 103,255 18.41 % $ 90,945 19.24 %
Multi-family ................... 48,663
8.05
Commercial .................... 270,410 44.74
Construction or

28,649
4.81
259,024 43.55

50,150
8.43
257,036 43.21

12,324
2.61
196,926 41.65

36,777
6.56
230,955 41.18

development ................ 31,122

5.15
Total real estate loans 470,259 77.80

28,944
4.87
446,828 75.12

46,444
7.81
441,122 74.16

31,348
5.59
402,335 71.74

38,103
8.05
338,298 71.55

Other Loans:

Consumer Loans:
2,608
Automobile ...................
Home equity line ........... 28,004
Home equity .................. 16,422
Recreational vehicles .... 17,266
Other..............................
5,649

0.43
4.63
2.72
2.86
0.93
Total consumer loans 69,949 11.57

Commercial business

2,483
32,273
16,733
16,226
4,817

0.42
5.42
2.81
2.73
0.81
72,532 12.19

2,894
36,869
15,823
13,181
5,000

0.49
6.20
2.66
2.21
0.84
73,767 12.40

3,036
40,476
16,302
7,553
5,916

0.54
7.22
2.91
1.35
1.05
73,283 13.07

2,885
38,980
14,782
2,650
5,118

0.61
8.24
3.13
0.56
1.08
64,415 13.62

loans ............................. 64,227 10.63
Total other loans ........ 134,176 22.20
Total loans

79,909 13.44
153,676 25.84
$ 604,435 100.00 % $ 594,856 100.00 % $ 594,798 100.00 % $ 560,794 100.00 % $ 472,819 100.00 %

70,106 14.83
134,521 28.45

75,496 12.69
148,028 24.88

85,176 15.19
158,459 28.26

Less:

Unamortized discounts ..
Net deferred loan costs ..
Allowance for losses ......
Total loans receivable,

15
(536 )
8,564

17
(535 )
8,686

19
(463)
9,311

20
(300)
9,903

16
(91 )
9,709

net .............................. $ 596,392

$ 586,688

$ 585,931

$ 551,171

$ 463,185

The modest growth in the loan portfolio in 2019 was
primarily because the growth experienced in commercial
and single family real estate loans was offset by a decrease
in other loan categories. Based on current economic
conditions and
loan origination and
prepayment amounts, it is anticipated that any growth in the
overall loan portfolio will be limited in 2020.

the projected

Single family real estate loans were $120.1 million at
December 31, 2019, an increase of $9.4 million, compared

to $110.7 million at December 31, 2018. The single family
loan portfolio increased in 2019 due to an increase in the
single family loans that were originated due to the low
interest rate environment and an increased emphasis on
originating shorter term and adjustable rate mortgage loans
that were placed into the portfolio. The majority of the
longer term mortgage 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.

MANAGEMENT DISCUSSION AND ANALYSIS

Multi-family real estate loans were $48.7 million at
December 31, 2019, a decrease of $1.5 million, compared
to $50.2 million at December 31, 2018. The decrease in
multi-family real estate loans in 2019 is primarily the result
of having an increase in loan payoffs and fewer originations
in 2019.

Commercial real estate loans were $270.4 million at
December 31, 2019, an increase of $13.4 million, compared
to $257.0 million at December 31, 2018. The increase in
commercial real estate loans is primarily due to an increase
in the originations of these types of loans in 2019.

Construction or development loans were $31.1 million at
December 31, 2019, an increase of $2.2 million, compared
to $28.9 million at December 31, 2018. The increase in
construction loans is primarily related to the $21.8 million
in new construction loans and the $4.1 million in advances
on existing loans. These increases were partially offset by
the $10.2 million in paid off loans and the $13.5 million of
loans on construction projects that were completed during
the year and were moved to a permanent classification.

Home equity lines of credit were $28.0 million at December
31, 2019, a decrease of $4.3 million, compared to $32.3
million at December 31, 2018. The open-end home equity
lines are generally written with an adjustable rate and a two
to ten year draw period which requires interest only
payments followed by a ten year repayment period which
fully amortizes the outstanding balance. Home equity loans
were $16.4 million at December 31, 2019, a decrease of $0.3
million, compared to $16.7 million at December 31, 2018.
Closed-end home equity loans are written with fixed or
adjustable rates with terms up to fifteen years. The decrease
in the open-end equity lines and closed-end equity loans is
primarily the result of an increase in the payoffs of open-
ended home equity lines of credit. The increased payoffs are
the result of borrowers’ continued preference to obtain a
fixed rate closed-equity loan or to refinance their first
mortgage and roll their outstanding open-end equity loan
balances into their new home loan.

Recreational vehicle loans were $17.3 million at December
31, 2019, an increase of $1.1 million, compared to $16.2
million at December 31, 2018. These loans have been made
primarily to finance the recreational vehicle sales of a single
dealer within the Bank’s market area and the increase in the

balance between the periods is due to loan originations
exceeding principal repayments during 2019.

Commercial business loans were $64.2 million at December
31, 2019, a decrease of $11.3 million, compared to $75.5
million at December 31, 2018. The decrease in commercial
business loans in 2019 is because loan payoffs exceeded
loan originations during the year, with some of the payoffs
related to the Bank’s initiative to maintain the credit quality
of the loan portfolio.

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. The current
level of the allowance for loan losses is a result of
management’s assessment of the risks within the portfolio
based on the information obtained through the credit
evaluation process. The Company utilizes a risk-rating
system on non-homogeneous 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.

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 $8.6 million, or 1.42% of
gross loans at December 31, 2019, compared to $8.7
million, or 1.46% of gross loans at December 31, 2018. The
allowance for loan losses decreased primarily because of a
decrease in the reserve percentages applied to certain
classified commercial loans. These percentages were
reduced based on a historical loss analysis that was
performed during the year. This decrease was partially
offset by an increase in reserves as a result of an increase in
outstanding balances and a change in the composition of the
loan portfolio between the periods.

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:

Single family ................................................................................................
Commercial real estate .................................................................................
Consumer ......................................................................................................
Commercial business ....................................................................................
Recoveries .........................................................................................................
Net recoveries (charge-offs) .........................................................................
Balance at end of year ........................................................................................... $
Year end allowance for loan losses as a percent of year end gross loan balance .
Ratio of net loan recoveries (charge-offs) to average loans outstanding ..............
Allowance as a percent of total assets at year end ................................................

2019

2018

December 31,
2017

2016

2015

8,686
(1,216)

(1)
0
(107)
(880)
2,082
1,094
8,564

1.42%
0.18
1.10

9,311
(649)

9,903
(523)

9,709
(645)

8,332
(164)

(24)
0
(226)
(270)
544
24
8,686

1.46%
0.00
1.22

(6)
(50)
(288)
(311)
586
(69)

9,311

1.57%
(0.01)
1.29

(66)
(67)
(108)
(180)
1,260
839
9,903

1.77%
0.16
1.45

(19)
0
(105)
(69)
1,734
1,541
9,709

2.05%
0.36
1.51

The following table reflects the allocation of the allowance for loan losses:

2019

2018

December 31,
2017

2016

2015

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

Single family .......................
Commercial real estate .......
Consumer ............................
Commercial business ..........
Total ....................................

0.71 %
1.44
2.15
1.78
1.42

19.86 %
57.94
11.57
10.63
100.00 %

0.75 % 18.61 %
1.45
2.24
1.80
1.46

56.51
12.19
12.69
100.00 %

0.84 % 17.99 %
1.52
2.21
2.14
1.57

56.17
12.40
13.44
100.00 %

1.15 % 18.41 %
1.66
2.20
2.53
1.77

53.33
13.07
15.19
100.00 %

1.09 % 19.24 %
2.46
1.86
2.05
2.05

52.31
13.62
14.83
100.00 %

The allocated allowance percentages for all loan categories
decreased in 2019 primarily because of an improvement in
the credit quality of the loans held in the various portfolios.

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. There was no
allowance for real estate losses at December 31, 2019 or
December 31, 2018.

Non-performing Assets
Loans are reviewed at least quarterly and if 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 is charged

against interest income. Subsequent payments are either
applied to the outstanding principal balance or recorded as
interest income, depending on the assessment of the
ultimate collectability of the loan. Restructured loans
include the Bank's troubled debt restructurings (TDRs) 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 has deteriorated.
Foreclosed and repossessed assets include assets acquired in
settlement of loans. Total non-performing assets were $2.7
million at December 31, 2019, a decrease of $0.4 million,
or 13.9%, from $3.1 million at December 31, 2018. Non-
performing loans decreased $0.6 million and foreclosed and
repossessed assets increased $0.2 million during 2019. The
decrease in the non-performing loans between the periods
was primarily the result of the reclassification of a $1.3
million non-performing
the
manufacturing industry to an accruing loan during 2019.
This decrease in non-performing loans was partially offset
by a $0.6 million increase in non-accruing loans related to a
loan in the trucking industry that was reclassified as non-
accruing during the year.

relationship

loan

MANAGEMENT DISCUSSION AND ANALYSIS

The following table sets forth the amounts and categories of non-performing assets in the Company’s portfolio:

(Dollars in thousands)
Non-performing loans:

Single family ................................................................ $
Commercial real estate .................................................
Consumer .....................................................................
Commercial business ...................................................
Total .........................................................................

Foreclosed and repossessed assets:

Single 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, net ..........
Allowance for loan losses to non-performing loans ........

2019

2018

December 31,
2017

2016

2015

617
184
659
621
2,081

166
414
0
580
2,661

730
1,311
489
148
2,678

0
414
0
414
3,092

949
1,364
553
278
3,144

0
627
0
627
3,771

916
1,384
630
343
3,273

0
611
16
627
3,900

1,655
1,694
786
46
4,181

48
1,997
0
2,045
6,226

2,081

0.34 %
$
0.35 %
411.25 %

2,678

0.43 %
$
0.46 %
324.27 %

3,144

0.52 %
$
0.54 %
296.11 %

3,273

0.57 %
$
0.59 %
302.56 %

0.97 %

4,181

0.90 %
232.22 %

Gross interest income which would have been recorded had
the non-accruing loans been current in accordance with their
original terms amounted to $0.2 million for the year ended
December 31, 2019, and $0.3 million for the years ended
December 31, 2018 and 2017. The amounts that were
included in interest income on a cash basis for these loans
were $0.1 million for each of the three years.

At December 31, 2019, 2018 and 2017, there were loans
included in loans receivable, net, with terms that had been
modified in a TDR totaling $2.5 million, $2.5 million and
$3.0 million, respectively. Had the loans performed in
accordance with their original terms throughout 2019, 2018
and 2017, the Company would have recorded gross interest
income of $0.2 million, $0.3 million and $0.4 million,
respectively. During 2019, 2018 and 2017 the Company
recorded gross interest income of $0.1 million, $0.2 million
and $0.2 million, respectively.

For the loans that were modified in 2019, $0.1 million were
classified and performing and $0.5 million were non-
performing at December 31, 2019. Total TDRs of $2.5
million remained the same at December 31, 2019 when
compared to December 31, 2018. During 2019, several
single family and retail consumer TDRs paid off and were
replaced by new TDRs. Of the loans that were modified in
2019 and outstanding at December 31, 2019, $0.5 million
related to first or second mortgages on single-family

properties, and the remaining modifications related to other
consumer loans.

For the loans that were modified in 2018, $0.4 million were
classified and performing and $1.2 million were non-
performing at December 31, 2018. The decrease in TDRs in
2018 related primarily to several retail consumer TDRs that
were paid or charged off during the year, as well as one
commercial business loan that was charged off. Of the loans
that were modified in 2018 and outstanding at December 31,
2018, $1.1 million related to loans secured by commercial
real estate, $0.4 million related to first or second mortgages
on single family properties and the remaining modifications
related to other consumer or commercial business loans.

For the loans that were modified in 2017, $0.6 million were
classified and performing and $0.4 million were non-
performing at December 31, 2017. The decrease in TDRs in
2017 related primarily to one commercial relationship
totaling $0.5 million that had performed according to the
restructured terms and met the criteria to be upgraded to
non-TDR status during the year. Of the loans that were
modified in 2017 and outstanding at December 31, 2017,
$0.8 million related to loans secured by first or second
mortgages on single family properties and the remaining
modifications related to other consumer or commercial
business loans.

MANAGEMENT DISCUSSION AND ANALYSIS

The following table sets forth the amount of TDRs in the Company’s portfolio:

(Dollars in thousands)

Single family ................................................................................... $
Commercial real estate ....................................................................
Consumer ........................................................................................
Commercial business ......................................................................
Total TDRs ................................................................................. $

TDRs on accrual status ................................................................... $
TDRs on non-accrual status ............................................................
Total ............................................................................................ $

2019

2018

December 31,
2017

2016

2015

623
983
745
114
2,465

1,770
695
2,465

636
1,110
522
208
2,476

1,018
1,458
2,476

685
1,210
758
391
3,044

1,129
1,915
3,044

448
1,774
709
369
3,300

1,297
2,003
3,300

647
725
732
415
2,519

1,618
901
2,519

In addition to the TDRs and the non-performing loans set
forth in the previous table of all non-performing assets, the
Company may identify other potential problem loans.
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. There
were no potential problem loans identified by the Company
as of December 31, 2019 or 2018. There was one potential
problem loan relationship totaling $7.5 million identified by
the Company as of December 31, 2017, however, the issues
with the loan improved in 2018 and it did not progress to a
problem loan status.

Liquidity and Capital Resources
The Company manages 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 obtain
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 Bank. Additional cash can be obtained by
selling securities from the available for sale portfolio or by
selling loans or mortgage servicing rights.

The primary financing activity is the attraction of retail,
commercial, and internet deposits. The Bank also has the
ability to borrow funds from the FHLB or Federal Reserve

Bank of Minneapolis based on the collateral value of the
loans pledged, subject to applicable borrowing base and
collateral requirements. See “Note 12 Federal Home Loan
Bank (FHLB) Advances and Other Borrowings” in the
Notes to Consolidated Financial Statements for more
information on the advances that could be drawn based upon
existing collateral levels with the FHLB and the Federal
Reserve Bank of Minneapolis. Unpledged securities could
also be pledged and used as collateral for additional
borrowings with the FHLB or Federal Reserve Bank of
Minneapolis.

The Bank'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, 2019 were $44.4
million, an increase of $23.7 million, compared to $20.7
million at December 31, 2018. Net cash provided by
operating activities during 2019 was $15.2 million. The
Company conducted
investing
activities during 2019: purchases of securities available for
sale and FHLB stock were $55.5 million; principal
payments and maturity proceeds received on securities
available for sale and FHLB stock were $29.3 million; and
the proceeds from the sale of premises and other real estate
were $0.2 million. Net loans receivable increased $14.7
million and the Company also purchased premises and
equipment of $2.2 million. Net cash used by investing
activities during 2019 was $42.9 million. The Company
conducted the following major financing activities during
2019: deposits increased $50.5 million; received and repaid
borrowings of $26.0 million; customer escrows increased
$1.0 million; and withheld stock of $0.1 million to cover
taxes due on vested stock awards. Net cash provided by
financing activities was $51.4 million for 2019.

MANAGEMENT DISCUSSION AND ANALYSIS

The Bank has certificates of deposits from customers with
outstanding balances of $82.5 million that mature during
2020. Based upon past experience, management anticipates
that the majority of the deposits will renew for another term.
The Company believes that deposits that do not renew will
be replaced with deposits from other customers or FHLB
advances. Proceeds from the sale of securities could also be
used to fund unanticipated outflows of deposits.

The Bank has deposits of $60.4 million in checking and
money market accounts of five customers that have
individual 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 advances from the FHLB.

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 2019, the Bank paid dividends to the
Company of $5.0 million and at December 31, 2019, the
Company had $7.7 million in cash.

The Company’s primary use of cash is the payment of
holding company level expenses including the payment of
legal expenses and
director and management fees,
regulatory costs. The Company plans to continue to fund its
liquidity needs through dividends from the Bank, or if
deemed prudent, by obtaining external capital.

Contractual Obligations and Commercial Commitments
The Company has certain obligations and commitments to make future payments under existing contracts. At December 31,
2019, the aggregate contractual obligations (excluding bank deposits) and commercial commitments were as follows:

(Dollars in thousands)
Contractual Obligations:

Annual rental commitments under non-
cancellable operating leases ................................. $
Total contractual obligations ......................... $

Total

Less than
1 Year

1-3 Years

4-5 Years

More than
5 Years

Payments Due by Period

4,266
4,266

887
887

1,829
1,829

1,536
1,536

14
14

Other Commercial Commitments:

Commercial lines of credit ...................................... $
Commitments to lend ..............................................
Standby letters of credit ..........................................
Total other commercial commitments ........... $

63,322
22,757
2,810
88,889

23,742
8,716
2,108
34,566

27,240
2,668
702
30,610

12,340
4,090
0
16,430

0
7,283
0
7,283

Amount of Commitments Expiring by Period

Regulatory Capital Requirements
The Company and the Bank are subject to the Basel III
regulatory capital requirements. The Basel III requirements,
among other things, (i) apply a set of capital requirements
to the Bank (the Company is exempt, pursuant to the Small
(Policy
Bank Holding Company Policy Statement
Statement) described below),
including requirements
relating to common equity as a component of core capital,
(ii) implement a “capital conservation buffer” against risk
and a minimum Tier 1 capital requirement, and (iii) set forth
rules for calculating risk-weighted assets for purposes of
such requirements. The rules made corresponding revisions
to the prompt corrective action framework and include
capital ratios and buffer requirements which are fully

phased in as of January 1, 2019. 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 its assets,
liabilities and certain off-balance sheet items as calculated
under regulatory accounting practices. The capital amounts
and classification are also subject to qualitative judgments
by the regulators about components, risk weightings and
other factors.

MANAGEMENT DISCUSSION AND ANALYSIS

The Policy Statement of the FRB exempts small bank and
savings and loan holding companies with assets less than $3
billion from the above capital requirements. The Company
currently meets the qualitative exemption requirements, and
therefore, is exempt from the above capital requirements.

Quantitative measures established by regulations to ensure
capital adequacy require the Bank to maintain minimum
amounts and ratios of common equity Tier 1 capital to risk
weighted assets, Tier 1 capital to adjusted total assets, Tier
1 capital to risk weighted assets and total capital to risk
weighted assets. The Bank must maintain a capital
conservation buffer composed of common equity Tier 1
capital above its minimum risk-based capital requirements
in order to avoid limitations on capital distributions,
including dividend payments and certain discretionary
bonus payments to executive officers. On January 1, 2019,
the capital conservation buffer amount increased to the fully
phased in amount of 2.50%. Management believes that, as
of December 31, 2019, the Bank’s capital ratios were in
excess of those quantitative capital ratio standards set forth
under the current prompt corrective action regulations,
including the capital conservation buffer described above.
However, 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 adjust the requirement to be “well-
capitalized” in the future. See “Note 17 Regulatory
Capital” of the Notes to Consolidated Financial Statements
for a table which reflects the Bank’s capital compared to
these capital requirements.

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, 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. Additional
capital would 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 in 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 the Company’s 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 Bank cannot satisfactorily
address its capital needs as they arise, the Bank’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.

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,
anticipated asset growth, general business practices and
other factors. The Company has not made any dividend
payments to common stockholders during the three year
period ending December 31, 2019 but will continue to
evaluate the best use of the Company’s capital based on the
factors identified above.

restrictions,

regulatory

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 board of
directors of both the Bank and the Company and would
depend on numerous factors including the results of
operations, financial conditions, asset growth plans and the
cash flow requirements of the Company and the Bank.

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.

MANAGEMENT DISCUSSION AND ANALYSIS

New Accounting Pronouncements
Note 1 of the Notes to Consolidated Financial Statements
discusses recently issued accounting pronouncements that
we will be required to adopt. Also discussed is our
these new accounting
expectation of
pronouncements will have on our consolidated financial
statements.

impact

the

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.

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 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.

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

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, 2019.

(Dollars in thousands)

Basis point change in interest rates
Total market-risk sensitive assets
Total market-risk sensitive liabilities
Off-balance sheet financial instruments
Net market risk
Percentage change from current market value

Market Value

-200

-100

790,627
752,616
198
37,813
(64.50 )%

781,112
703,845
90
77,177
(27.55)%

0
767,305
660,785
0
106,520

+100

+200

753,086
622,784

(132)

130,434

739,106
590,543
(246)
148,809

0.00 %

22.45%

39.70%

(the Model Assumptions)

The preceding table was prepared utilizing the following
assumptions
regarding
prepayment and decay ratios that were determined by
management based upon its review of historical prepayment
speeds and decay rates. Fixed rate loans were assumed to
prepay at annual rates of between 2% and 51%, depending
on the note rate and the period to maturity. Adjustable rate
mortgages (ARMs) were assumed to prepay at annual rates
of between 5% and 61%, 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. All loan prepayments
vary based on the note rate and period to maturity of the
individual loans. Certificate accounts were assumed not to
be withdrawn until maturity. Retail money market demand
accounts (MMDAs) and passbook accounts were assumed
to decay at annual rates of 9% and 6%, respectively. Retail
non-interest and interest-bearing checking accounts were
assumed to decay at annual rates of 8% and 11%,
respectively. Commercial non-interest and interest-bearing
checking accounts were assumed to decay at annual rates of
10% and 19%, respectively. Commercial MMDAs were
assumed to decay at annual rates of between 0% and 30%.

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 in the table. Certain liabilities, such as certificates
of deposit, have fixed rates that restrict interest rate changes
until maturity. In the event of a change in interest rates,
prepayment and early withdrawal levels may deviate
significantly from
the
those assumed
foregoing table. The ability of many borrowers to service
their debt may also decrease in the event of a substantial
increase in interest rates.

in calculating

MANAGEMENT DISCUSSION AND ANALYSIS

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,
2019 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 twelve month
period ending December 31, 2020 of immediate interest rate
changes called rate shocks:

(Dollars in thousands)
Rate Shock
in Basis Points
+200
+100
0
-100
-200

Net Interest
Change

Percent
Change

1,927
962
0
(1,068)
(2,284)

7.04 %
3.52
0.00
(3.90 )
(8.35 )

The preceding table was prepared utilizing the Model
Assumptions. Certain shortcomings are inherent in the
method of analysis presented in the preceding 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 preceding 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 loans
that are anticipated to re-price to higher interest rates in the
next twelve months than there are deposits that would re-
price.

In managing the Company’s 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
investment strategies and oversees
timing and
implementation of transactions as intended to assure

the

attainment of the Bank's objectives in an effective manner.
In addition, each quarter the Board reviews the Bank's
asset/liability position, including simulations of the effect
on the Bank's capital of various interest rate scenarios.

In managing its asset/liability composition, the Bank may,
at times, depending on the relationship between long-term
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 structure its balance sheet
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 focused its 30 year fixed rate single family residential
lending program on loans that are saleable to third parties
and generally places only adjustable rate or 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 reprice 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. See “Note 18 Commitments and
Contingencies” in the Notes to Consolidated Financial
Statements
information. Management
believes that the Company has sufficient liquidity to satisfy
its off-balance sheet obligations.

for additional

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands)

December 31, December 31,

2019

2018

ASSETS
Cash and cash equivalents ............................................................................................... $
Securities available for sale:

Mortgage-backed and related securities (amortized cost $54,777 and $8,159) ...........
Other marketable securities (amortized cost $52,751 and $73,222) ............................

Equity securities ..............................................................................................................
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 ...........................................................................................
Goodwill ..........................................................................................................................
Core deposit intangible ....................................................................................................
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 ......................................................................................................

44,399

20,709

54,851
52,741
107,592

167
3,606
596,392
2,251
580
854
2,172
10,515
802
156
6,451
1,702
777,639

673,870
420
2,413
8,288
684,991

8,023
71,836
79,859

121
3,444
586,688
2,356
414
867
1,855
9,635
802
255
2,668
2,642
712,315

623,352
346
1,448
4,022
629,168

Commitments and contingencies
Stockholders’ equity:

Serial-preferred stock ($.01 par value):

authorized 500,000 shares; issued 0 .........................................................................

Common stock ($.01 par value):

authorized 16,000,000 shares; issued 9,128,662 ......................................................
Additional paid-in capital ................................................................................................
Retained earnings, subject to certain restrictions ............................................................
Accumulated other comprehensive gain (loss) ................................................................
Unearned employee stock ownership plan shares ...........................................................
Treasury stock, at cost 4,284,840 and 4,292,838 shares ..................................................
Total stockholders’ equity ....................................................................................
Total liabilities and stockholders’ equity .............................................................. $

91
40,365
107,547
46
(1,643)
(53,758)
92,648
777,639

91
40,090
99,754
(1,096)
(1,836)
(53,856)
83,147
712,315

See accompanying notes to consolidated financial statements.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

Years ended December 31
(Dollars in thousands, except per share amounts)
Interest income:

Loans receivable ......................................................................... $
Securities available for sale:

Mortgage-backed and related .................................................
Other marketable ....................................................................
Other ..........................................................................................
Total interest income ..............................................................

Interest expense:

Deposits ......................................................................................
Advances and other borrowings .................................................
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 ................................................................
Other ..........................................................................................
Total non-interest income .......................................................

Non-interest expense:

Compensation and benefits ........................................................
Occupancy and equipment .........................................................
Data processing ..........................................................................
Professional services ..................................................................
Other ..........................................................................................
Total non-interest expense ......................................................
Income before income tax expense .....................................
Income tax expense ...........................................................................
Net income ..............................................................................
Other comprehensive income (loss), net of tax .................................
Comprehensive income available to common shareholders .............. $
Basic earnings per common share ..................................................... $
Diluted earnings per common share .................................................. $

See accompanying notes to consolidated financial statements.

2019

2018

2017

29,787

28,535

26,368

343
1,157
603
31,890

3,332
7
3,339
28,551
(1,216)
29,767

3,100
1,278
2,941
1,136
8,455

15,659
4,442
1,263
1,573
4,168
27,105
11,117
3,324
7,793
1,142
8,935
1.69
1.68

197
1,138
511
30,381

2,231
2
2,233
28,148
(649 )
28,797

3,330
1,255
2,095
1,034
7,714

14,728
4,304
1,270
1,137
3,948
25,387
11,124
2,888
8,236
(69 )
8,167
1.89
1.71

57
1,103
152
27,680

1,470
327
1,797
25,883
(523)
26,406

3,354
1,202
2,138
960
7,654

15,007
4,068
1,106
1,285
3,788
25,254
8,806
4,402
4,404
(137)
4,267
1.04
0.90

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

Additional

Accumulated

Other

Unearned
Employee
Stock

Total
Stock-

Common Paid-in
Capital

Stock

Retained Comprehensive Ownership Treasury holders’
Earnings

Income (Loss)

Equity

Stock

Plan

(Dollars in thousands)
Balance, December 31, 2016 ............................ $
Net income ...................................................
Other comprehensive income ......................
Reclassification of certain income tax

effects from accumulated other
comprehensive income ..............................
Stock compensation expense .......................
Restricted stock awards................................
Stock awards withheld for tax withholding .
Amortization of restricted stock awards ......
Earned employee stock ownership plan

shares..........................................................
Balance, December 31, 2017 ............................ $
Net income ...................................................
Other comprehensive loss ............................
Reclassification due to adjustments for
equity securities as required by ASU
2016-01 ......................................................
Stock warrants purchased ............................
Exercise of stock warrants ...........................
Exercise of stock options .............................
Tax benefits of exercised stock options .......
Stock compensation expense .......................
Restricted stock awards................................
Amortization of restricted stock awards ......
Earned employee stock ownership plan

shares..........................................................
Balance, December 31, 2018 ............................ $
Net income ..................................................
Other comprehensive income ...................
Stock compensation expense .....................
Restricted stock awards .............................
Stock awards withheld for tax

withholding ...............................................
Amortization of restricted stock awards .
Earned employee stock ownership plan

shares .........................................................
Balance, December 31, 2019 .......................... $

50,566

86,886
4,404

(820)

(2,223)

(58,581) 75,919
4,404
21

158

(158)

41
(278)

147

278
(54)

0
41
0
(54)
147

147
50,623

91,448
8,236

(957)

(69)

193
(2,030)

340
(58,357) 80,818
8,236
(69)

(70)

99,754
7,793

(1,096)

1,142

194
(1,836)

4,168
145

188

0
(6,453)
0
0
64
17
0
134

400
(53,856) 83,147
7,793
1,142
1
0

143

(45)

(45)
187

(6,453)
(4,168)
(145)
64
17
(188)
134

206
40,090

1
(143)

187

230

40,365 107,547

193
(1,643)

423
(53,758) 92,648

See accompanying notes to consolidated financial statements.

CONSOLIDATED STATEMENTS OF CASH FLOWS

Years ended December 31 (Dollars in thousands)
Cash flows from operating activities:

Provision for loan losses ......................................................................................
Depreciation .........................................................................................................
Amortization of premiums (discounts), net .........................................................
Amortization of deferred loan fees ......................................................................
Amortization of core deposit intangible ...............................................................
Amortization of purchased asset fair value adjustments .....................................
Amortization of mortgage servicing rights ..........................................................
Capitalized mortgage servicing rights ..................................................................
Deferred income tax expense ...............................................................................
Reclassification of certain income tax effects from accumulated other

comprehensive loss ..........................................................................................
Securities (gains) losses, net .................................................................................
Loss (gain) on sale of premises ............................................................................
Gains on real estate owned, net ............................................................................
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 ...............................................................
Earned ESOP shares priced above original cost ..................................................
Stock compensation expense ................................................................................
Decrease (increase) in accrued interest receivable ..............................................
Increase (decrease) in accrued interest payable ...................................................
Decrease (increase) in other assets .......................................................................
Decrease 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 owned .................................................................
Net increase in loans receivable ...............................................................................
Proceeds from sale of premises ................................................................................
Purchases of premises and equipment ......................................................................
Net cash used by investing activities ...............................................................

Cash flows from financing activities:

Increase (decrease) in deposits .................................................................................
Warrants purchased ...................................................................................................
Stock awards withheld for tax withholding ..............................................................
Excess tax benefit from options exercised ...............................................................
Proceeds from borrowings ........................................................................................
Repayment of borrowings .........................................................................................
Increase in customer escrows ...................................................................................
Net cash provided (used) by financing activities ............................................
Increase (decrease) 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 ....................................................................
Loans held for sale transferred to loans ....................................................................
Transfer of loans to real estate owned, net ...............................................................
Right to use assets and lease obligations ..................................................................

See accompanying notes to consolidated financial statements.

2019

2018

2017

7,793

(1,216)
1,129
3
(91)
99
(41)
780
(1,097)
496

0
(46)
24
0
(2,941)
124,858
(115,861)
187
193
230
1
105
74
693
(199)
28
15,201

2,867
25,400
(54,427)
(1,040)
1,053
0
(14,765)
195
(2,232)
(42,949)

50,518
0
(45)
0
26,001
(26,001)
965
51,438
23,690
20,709
44,399

3,265
2,911

6,253
0
166
4,505

8,236

(649)
1,078
16
(260)
99
(70)
551
(682)
1,084

0
36
11
(80)
(2,095)
88,649
(76,489)
134
194
206
17
(12)
200
(1,343)
(1,024)
2
17,809

1,914
310
(4,888)
(322)
272
367
(11,483)
0
(2,497)
(16,327)

(12,249)
(6,453)
0
64
6,801
(6,801)
301
(18,337)
(16,855)
37,564
20,709

2,034
4,264

11,642
0
74
0

4,404

(523)
949
(3)
(240)
99
(85)
555
(675)
2,105

158
0
(8)
(72)
(2,138)
90,127
(78,751)
147
193
147
41
282
(91)
417
(62)
67
17,043

953
20,100
(20,035)
(3,999)
3,952
309
(43,194)
8
(1,011)
(42,917)

42,794
0
(54)
0
99,200
(106,200)
137
35,877
10,003
27,561
37,564

1,887
1,879

9,211
164
253
0

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2019, 2018 and 2017

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 does business
as Home Federal Investment Services and offers financial
planning products and services, and HFSB Property
Holdings, LLC (HPH), which is currently inactive, but has
acted in the past 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 (SEC) on March 6, 2020.

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.

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 portfolio
at the date of the balance sheet. While management uses
available information to recognize losses on loans, future
additions to the allowance may be necessary based on
changes in economic conditions and other factors. In
addition, various regulatory agencies, as an integral part of
the
their examination process, periodically
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.

review

tax consequences attributable

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. 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.

Estimates related to litigation are inherently subjective and
the ultimate resolution of any litigation may be different
than current management estimates. See “Note 18
Commitments and Contingencies” for further information.

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 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
adjusted
that are
for premiums and discounts
recognized in interest income using the interest method
with discounts amortized over the period to maturity
and premiums amortized to the earliest call date.
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,
in prepayment risk, or similar factors.
changes
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
interest method with
the
discounts amortized over the period to maturity and
premiums amortized to the earliest call date. Unrealized

income using

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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.

Management monitors the investment security 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
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 more-likely-than-not
that the Company will be required to sell the security prior
to recovery. To the extent it is determined that a security is
impaired, an
deemed
impairment loss is recognized.

to be other-than-temporarily

Equity Securities
Equity securities are carried at their fair market value with
any changes during the period recognized in other income
on the consolidated statements of comprehensive income.

Loans Held for Sale
Mortgage loans originated 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 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 participation 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, 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 is determined that the
borrower’s risk profile has deteriorated and the loan is
classified as
third party
impaired. Subsequent new
appraisals of properties securing impaired commercial real
estate and commercial 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 materially 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. 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 is 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.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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
principal becomes current under the terms of the loan
agreement, the borrower has consistently made the required
payments for a period of six months, and the collectability
of remaining principal and interest is no longer doubtful.
Previously collected interest payments that were applied to
principal when the loan was classified as non-accrual are
recorded as interest income using the effective yield method
over the estimated life of the loan, including expected
renewal terms.

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 more,
or restructured in a troubled debt restructuring (TDR)
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 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 when the loan is refinanced with terms that
reflect normal market terms for the type of credit involved
and performs according to the modified terms for a period
of at least one year. The second condition is when 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
maintain effective control over the transferred assets
through an agreement to repurchase them before their
maturity.

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 of ownership, (3) the rights of each participating
interest holder must have the same priority, and (4) no party
has the right to pledge or exchange the entire financial asset
unless all participating interest holders agree to do so.

Real Estate, net
Real estate acquired through loan foreclosure or deed in lieu
of foreclosure is initially recorded at its fair value less
estimated selling costs. Third party appraisals are obtained
as soon as practical after obtaining possession of the
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.

Mortgage Servicing Rights, net
Mortgage servicing rights are capitalized at their 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.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Premises and Equipment, net
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 their estimated useful lives of 5 to 40 years for
office buildings and improvements and 3 to 10 years for
furniture and equipment.

Goodwill
The Company records goodwill for acquisition amounts
paid in excess of the net assets purchased. Goodwill is not
amortized, but is tested for impairment at least annually or
more frequently if there are indications of impairment.

Core Deposit Intangible, net
The Company records the estimated fair value of the deposit
base acquired in an acquisition as a core deposit intangible
asset. The recorded amount is amortized on a straight line
basis over the estimated life of the deposits acquired.

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.

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 based on the proportion of debt
service paid in the year and then allocated to eligible
employees. 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 of a change in tax rates
on deferred tax assets and liabilities 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. The Company is no longer subject to federal or state
income tax examinations by tax authorities for years before
2016.

Earnings per Common Share
Basic earnings per common share excludes dilution and is
computed by dividing the income available to common
shareholders 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
non-owner 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.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

financial

losses on

the current

New Accounting Pronouncements
In June 2016, the Financial Accounting Standards Board
(FASB) issued Accounting Standards Update (ASU) 2016-
13, Financial Instruments-Credit Losses (Topic 326):
Measurement of Credit Losses on Financial Instruments.
The amendments in this ASU affect all entities that measure
credit losses on financial instruments including loans, debt
securities, trade receivables, net investments in leases, off-
balance sheet credit exposures, reinsurance receivables, and
any other financial asset that has a contractual right to
receive cash that is not specifically excluded. The main
objective of this ASU is to provide financial statement users
with more decision-useful information about the expected
instruments and other
credit
commitments to extend credit held by a reporting entity at
each reporting date. To achieve this objective, the
amendments in this ASU replace the incurred loss
impairment methodology required in current GAAP with a
methodology that reflects expected credit losses that
requires consideration of a broader range of reasonable and
supportable information to estimate credit losses. The
amendments in this ASU will affect entities to varying
degrees depending on the credit quality of the assets held by
the entity, the duration of the assets held, and how the entity
applies
loss methodology. The
amendments in this ASU, for public business entities that
are filers with the SEC, were originally effective for fiscal
years beginning after December 15, 2019, including interim
periods within those annual periods. On November 26,
2019, the FASB issued ASU 2019-11, Codification
Improvements to Topic 326, Financial Instruments – Credit
Losses which delayed the implementation date of ASU
2016-13 for small SEC reporting companies, such as HMN,
from the first quarter of 2020 to the first quarter of 2023. All
entities may adopt the amendments in the ASU early as of
the fiscal years beginning after December 15, 2018,
including
those fiscal years.
Amendments should be applied using a modified
retrospective transition method by means of a cumulative-
effect adjustment to equity as of the beginning of the period
in which the guidance is adopted. The Company has not
early adopted this ASU. Management has accumulated the
charge off
the
appropriate life of loan loss percentages for the various loan
categories, has identified several key metrics to help
identify and project anticipated changes in the credit quality
of our loan portfolio upon enactment, and is in the process
of evaluating the determination of potential qualitative
reserve amounts and the impact that the adoption of this
ASU will have on the Company’s consolidated financial
statements when it is adopted in the first quarter of 2023.

interim periods within

information necessary

to calculate

incurred

In August 2018, the FASB issued ASU 2018-13, Fair Value
Measurement (Topic 820), Disclosure Framework –
Changes to the Disclosure Requirements for Fair Value
Measurement. The amendments in this ASU apply to all
entities that are required, under existing GAAP, to make

disclosures about recurring or nonrecurring fair value
measurements and modify the disclosure requirements on
fair value measurements in Topic 820, Fair Value
Measurement, including the consideration of costs and
benefits. The ASU removed, modified, and added various
disclosure requirements in Topic 820. The amendments also
eliminate at a minimum from the phrase an entity shall
disclose at a minimum to promote the appropriate exercise
of discretion by entities when considering fair value
measurement disclosures and to clarify that materiality is an
appropriate consideration of entities and their auditor when
evaluating disclosure requirements. The amendments in the
ASU are effective for all entities for fiscal years, and interim
periods within those fiscal years, beginning after December
15, 2019. An entity is permitted to early adopt the
implementation of any removed or modified disclosures
upon issuance of the ASU and delay adoption of the
additional disclosures until their effective date. The
Company has not opted to early adopt any portion of this
ASU and the adoption in the first quarter of 2020 did not
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
the prior year have been reclassified to conform to the
current year presentation.

NOTE 2 Revenue Recognition
Effective January 1, 2018, the Company adopted ASU
2014-09, Revenue from Contracts with Customers (Topic
606) and all subsequent amendments
the ASU
(collectively, “ASC 606”), which (1) creates a single
framework for recognizing revenue from contracts with
customers that fall within its scope and (2) revises when it
is appropriate to recognize a gain (loss) from the transfer of
nonfinancial assets, such as securities and premises and
equipment. The majority of the Company’s revenues come
from interest income on loans and securities that are outside
the scope of ASC 606. The Company’s services that fall
within the scope of ASC 606 are presented on the income
statement within non-interest income and are recognized as
revenue as the Company satisfies its performance obligation
to the customer. Services within the scope of ASC 606
include fees and service charges on deposit accounts, ATM
and debit card interchange income, safe deposit box rental
fees, check printing charges and income earned on the sale
of uninsured investment products.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The Company, using a modified retrospective transition
approach, determined that there was no cumulative effect
adjustment to retained earnings as a result of adopting the
new standard, nor did the standard have a material impact
on our consolidated financial statements relating to the
timing or amounts of revenue recognized.

All of the Company’s revenue from contracts with
customers within the scope of ASC 606 is recognized within
non-interest income. The following table presents the
Company’s sources of non-interest income for the years
ended December 31, 2019 and 2018. Sources of revenue
outside the scope of ASC 606 are noted as such.

(Dollars in thousands)
Non-interest income:

Fees and service charges on deposit

accounts ................................................ $
Other fees and service charges................
Debit card interchange fees .....................
Gain on sale of loans (1) ...........................
Loan servicing fees (1) .............................
Uninsured investment product sales .......
Other ........................................................
Total non-interest income ............................

(1) Not within the scope of ASC 606.

Year ended
December 31,

2019

2018

1,257
433
1,410
2,941
1,278
909
227
8,455

1,308
585
1,437
2,095
1,255
870
164
7,714

A description of the Company’s revenue categories that are
accounted for under ASC 606 is as follows:

Fees and Service Charges on Deposit Accounts
The Company earns fees from deposit customers for
transaction-based, account maintenance, and overdraft
services. Transaction-based fees, which include services
such as ATM use fees, wire transfer fees, check cashing
fees, stop payment charges, statement rendering, ACH fees,
and other deposit related fees, are recognized at the time the
transaction is executed or when the Company fulfills the
customer’s request. Account maintenance fees, which relate
primarily to monthly maintenance, are earned over the
course of a month, representing the period over which the
Company satisfies the performance obligation. Overdraft
fees are recognized at the point in time that the overdraft
occurs. Service charges on deposits are withdrawn from the
customer’s account balance.

Other Fees and Service Charges
Other fees and service charges consist of revenues that are
both within the scope of and outside the scope of ASC 606.
Other fees and service charges within the scope of ASC 606
consist of fees for the rental of safe deposit boxes and check
printing charges. Revenues for these fees are recognized at
the point the service is provided or the fee is incurred by the
customer. Other fees and service charges outside the scope
of ASC 606 consist of loan commitment fees and late
charges on loans.

Debit Card Interchange Fees
The Company earns interchange fees from debit card holder
transactions conducted through various payment networks.
transactions are
Interchange
from cardholder
recognized daily, concurrently with
transaction
the
processing services provided by an outsourced technology
solution and are presented on a net basis.

fees

Uninsured Investment Product Sales
Commission revenues on the sale of uninsured investment
products may be recognized up front on the sale date of the
investment or monthly over a period of years depending on
the product being sold. The commissions on investment
sales are recognized when the product sale is completed or
monthly for trailer fees in accordance with the customer
agreement. Any subsequent commission adjustments are
recognized upon our receipt of notification from the
investment companies concerning matters necessitating
such adjustments. Profit-sharing contingent commissions
are recognized when determinable, which is generally when
such commissions are received from the investment
companies.

Other
Other consists of revenues that are both within the scope of
and outside the scope of ASC 606. Other income within the
scope of ASC 606 consists of gains and losses on asset sales.
Other income outside the scope of ASC 606 consists of
gains and losses on equity securities and rental income on
buildings.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 3 Other Comprehensive Income (Loss)
The components of other comprehensive income (loss) and the related tax effects were as follows:

2019
Before Tax
Tax

Net

Effect of Tax

For the years ended December 31,
2018

2017

Before Tax
Effect
Tax

Net

of Tax

Before Tax
Effect
Tax

Net

of Tax

(Dollars in thousands)
Securities available for sale:
Unrealized gains (losses) arising

during the period .............................. $ 1,585

443

1,142

(94 )

(25)

(69)

Reclassification of certain income tax

effects from accumulated other
comprehensive income(1) ..................

0
Other comprehensive income (loss) ... $ 1,585

0
443

0
1,142

0
(94 )

0
(25)

0
(69)

0
33

(158)
170

158
(137)

(1) The reclassification in 2017 relates to the change in the tax rate that occurred because of the enactment of the Tax Cuts and Jobs Act in the fourth quarter

of 2017.

NOTE 4 Securities Available for Sale
A summary of securities available for sale at December 31, 2019 and 2018 is as follows:

(Dollars in thousands)
December 31, 2019
Mortgage-backed securities:

Federal National Mortgage Association (FNMA) .................... $
Federal Home Loan Mortgage Corporation (FHLMC) ..........

Collateralized mortgage obligations:

FNMA ............................................................................................

Other marketable securities:

U.S. Government agency obligations .........................................
Municipal obligations ..................................................................
Corporate obligations ..................................................................
Corporate preferred stock ..........................................................

December 31, 2018
Mortgage-backed securities:

FNMA ............................................................................................ $
FHLMC ..........................................................................................

Collateralized mortgage obligations:

FNMA ............................................................................................

Other marketable securities:

U.S. Government agency obligations ............................................
Municipal obligations ....................................................................
Corporate obligations .....................................................................
Corporate preferred stock ..............................................................

Amortized
Cost

Gross
Unrealized
Gains

Gross
Unrealized
Losses

Fair Value

46,604
8,004

169
54,777

49,974
1,969
108
700
52,751
107,528

3,886
4,074

199
8,159

69,971
2,378
173
700
73,222
81,381

47
88

4
139

39
7
0
0
46
185

0
0

0
1
0
0
1
1

(65)
0

0
(65)

(21)
0
0
(35)
(56)
(121)

(117)
(10)

(9)
(136)

(1,236)
(10)
(1)
(140)
(1,387)
(1,523)

46,586
8,092

173
54,851

49,992
1,976
108
665
52,741
107,592

3,769
4,064

190
8,023

68,735
2,369
172
560
71,836
79,859

The Company did not sell any available for sale securities and did not recognize any gains or losses on securities available
for sale in 2019, 2018 or 2017.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The following table presents the amortized cost and
estimated fair value of securities available for sale at
December 31, 2019, 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 years .............................................................................................
Due after five years through ten years ............................................................................................
Due after ten years ...........................................................................................................................
Total ........................................................................................................................................ $

Amortized Cost

Fair Value

46,931
44,262
14,991
1,344
107,528

46,962
44,308
15,011
1,311
107,592

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.

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, 2019 and 2018:

(Dollars in thousands)
December 31, 2019
Mortgage backed securities:

# of

Less Than Twelve Months
Fair
Value

Unrealized
Losses

Investments

# of

Twelve Months or More
Fair
Value

Unrealized
Losses

Investments

Total

Fair
Value

Unrealized
Losses

FNMA ..............................................

4 $ 12,143

(65 )

0 $

0 $ 12,143

(65)

Other marketable securities:
U.S. Government agency

obligations .....................................
Corporate preferred stock ............
Total temporarily impaired

securities .......................................

December 31, 2018
Mortgage backed securities:

FNMA ..............................................
FHLMC ............................................

Collateralized mortgage obligations:

0
0

4 19,972
665
1

(21) 19,972
665
(35)

(21)
(35)

4 $ 12,143

(65 )

5 $ 20,637

(56) $ 32,780

(121)

0
0 $
1 4,060

0
(10 )

2 $ 3,769
0
0

(117) $ 3,769
0 4,060

(117)
(10)

FNMA ..............................................

190

(9)

190

(9)

Other marketable securities:
U.S. Government agency

obligations ......................................
Municipal obligations ......................
Corporate obligations .......................
Corporate preferred stock ................
Total temporarily impaired

securities ........................................

0
3
0
0

0
498
0
0

0
(2 )
0
0

14 68,735
8 1,467
172
1
560
1

(1,236) 68,735
(8) 1,965
172
(1)
560
(140)

(1,236)
(10)
(1)
(140)

4 $ 4,558

(12 )

27 $ 74,893

(1,511) $ 79,451

(1,523)

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
impaired securities other than the corporate preferred stock
are the result of changes in interest rates. The unrealized
losses reported for the corporate preferred stock at
December 31, 2019 relates to a single trust preferred
security that was issued by the holding company of a small
community bank. As of December 31, 2019 all payments
were current on the trust preferred security and the issuer’s

subsidiary bank was considered to be “well capitalized”
based on its most recent regulatory filing. Based on a review
of the issuer, it was determined that the trust preferred
security was not other-than-temporarily
impaired at
December 31, 2019. 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.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The aggregate amount of loans to executive officers and
directors of the Company was $0.1 million at December 31,
2019, 2018 and 2017. The entire balance for all three years
represents a Home Equity Line of Credit for one executive
officer and there has been no activity on the line of credit
during 2019, 2018 or 2017. All loans to executive officers
and directors are 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.

At December 31, 2019, 2018 and 2017, the Company was
servicing loans for others with aggregate unpaid principal
balances of $505.7 million, $480.6 million and $471.4
million, respectively.

The Company originates residential, commercial real estate
and other loans primarily in Minnesota, Wisconsin and
Iowa. At December 31, 2019 and 2018, the Company had
in its portfolio single family residential loans located in the
following states:

2019

2018

Percent
of Total

Amount
(Dollars in thousands)
Iowa ......................... $ 1,937
Minnesota ................ 107,607
8,483
Wisconsin ................
Other states (1) ..........
2,037

Amount
1.6 % $ 2,778
98,505
89.6
8,105
7.1
1,310
1.7

Percent
of Total

2.5 %
89.0
7.3
1.2

Total .................... $ 120,064 100.0 % $ 110,698 100.0 %

(1) Amounts under two million dollars in both years are included in “Other

states”.

NOTE 5 Loans Receivable, Net
A summary of loans receivable at December 31, 2019 and
2018, is as follows:

(Dollars in thousands)
Residential real estate loans:

2019

2018

Single family conventional .................... $ 119,805
259
Single family government guaranteed ...
120,064

110,580
118
110,698

Commercial real estate:

Lodging ..................................................
Retail/office ............................................
Nursing home/health care ......................
Land developments ................................
Golf courses ...........................................
Restaurant/bar/café ................................
Warehouse ..............................................
Construction:

58,643
71,730
7,767
13,167
1,597
6,752
32,064

Single family .....................................
Multi-family ......................................
Commercial real estate ......................
Manufacturing ........................................
Churches/community service .................
Multi-family ...........................................
Other .......................................................

23,256
1,858
6,008
20,027
10,156
48,663
48,507
350,195

Consumer:

Autos ......................................................
Home equity line ....................................
Home equity ...........................................
Recreational vehicles .............................
Land/lots .................................................
Other – secured ......................................
Other – unsecured ..................................

2,608
28,004
16,422
17,266
3,358
1,195
1,096
69,949
64,227
Total loans ......................................... 604,435

Commercial business ..................................

45,259
69,539
3,712
18,865
397
8,196
34,634

20,442
4,931
3,571
22,029
11,103
50,150
43,302
336,130

2,483
32,273
16,733
16,226
2,145
1,423
1,249
72,532
75,496
594,856

Less:

Unamortized discounts...........................
Net deferred loan costs...........................
Allowance for loan losses ......................

15
(536 )
8,564
Total loans receivable, net ................. $ 596,392

17
(535)
8,686
586,688

Commitments to originate or purchase

loans .......................................................... $

38,157

13,183

Commitments to deliver loans to

secondary market ...................................... $

10,098

7,289

Weighted average contractual rate of loans

in portfolio ................................................

4.75 %

4.83%

Included in total commitments to originate or purchase
loans are fixed rate loans aggregating $19.0 million and
$11.0 million as of December 31, 2019 and 2018,
respectively. The interest rates on these loan commitments
ranged from 3.00% to 5.65% at December 31, 2019 and
from 4.125% to 6.375% at December 31, 2018.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

At December 31, 2019 and 2018, the Company had in its portfolio commercial real estate loans located in the following
states:

(Dollars in thousands)
Florida ............................................................................ $
Idaho ..............................................................................
Illinois ............................................................................
Indiana ...........................................................................
Iowa ...............................................................................
Minnesota ......................................................................
North Carolina ...............................................................
Ohio ...............................................................................
Wisconsin ......................................................................
Other states(1) .................................................................
Total .......................................................................... $

2019

2018

Amount

Percent of Total

Amount

Percent of Total

6,520
2,980
2,513
2,691
6,794
244,572
4,624
2,140
73,122
4,239
350,195

1.9 % $
0.9
0.7
0.8
1.9
69.8
1.3
0.6
20.9
1.2

100.0 % $

4,795
3,171
851
3,031
7,563
238,397
5,442
1,566
67,196
4,118
336,130

1.4 %
0.9
0.2
0.9
2.3
70.9
1.6
0.5
20.0
1.3
100.0 %

(1) Amounts under two million dollars in both years are included in “Other states”.

NOTE 6 Allowance for Loan Losses and Credit Quality Information
The allowance for loan losses is summarized as follows:

(Dollars in thousands)
Balance, December 31, 2016 ........................... $

Provision for losses ..................................... $
Charge-offs ..................................................
Recoveries ...................................................
Balance, December 31, 2017 ........................... $

Provision for losses .................................... $
Charge-offs ................................................
Recoveries ..................................................
Balance, December 31, 2019 ......................... $

Allocated to:
Specific reserves ......................................... $
General reserves ..........................................
Balance, December 31, 2018 ........................... $

Allocated to:
Specific reserves ........................................ $
General reserves ........................................
Balance, December 31, 2019 ......................... $

Loans receivable at December 31, 2018:

Individually reviewed for impairment ........ $
Collectively reviewed for impairment ........
Ending balance ............................................ $

Loans receivable at December 31, 2019:

Individually reviewed for impairment .... $
Collectively reviewed for impairment .....
Ending balance .......................................... $

Single
Family

Commercial
Real Estate

Consumer

Commercial
Business

Total

1,186

4,953

1,613

2,151

263
(288)
42
1,630

202
(226)
16
1,622

(29)
(107)
21
1,507

172
1,450
1,622

119
1,388
1,507

856
71,676
72,532

976
68,973
69,949

(431)
(311)
299
1,708

(386)
(270)
310
1,362

297
(880)
361
1,140

73
1,289
1,362

93
1,047
1,140

303
75,193
75,496

735
63,492
64,227

(280)
(6)
0
900

(44)
(24)
1
833

25
(1)
0
857

98
735
833

62
795
857

(75 )
(50 )
245
5,073

(421 )
0
217
4,869

(1,509 )
0
1,700
5,060

451
4,418
4,869

451
4,609
5,060

1,226
109,472
110,698

1,311
334,819
336,130

974
119,090
120,064

1,166
349,029
350,195

9,903

(523)
(655)
586
9,311

(649)
(520)
544
8,686

(1,216)
(988)
2,082
8,564

794
7,892
8,686

725
7,839
8,564

3,696
591,160
594,856

3,851
600,584
604,435

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The following table summarizes the amount of classified and unclassified loans at December 31, 2019 and 2018:

(Dollars in thousands)
Single family ................................. $
Commercial real estate:

Real estate rental and leasing
Other .........................................
Consumer .....................................
Commercial business ...................
$

(Dollars in thousands)
Single family .................................. $
Commercial real estate:

Real estate rental and leasing ....
Other ..........................................
Consumer .......................................
Commercial business .....................
$

December 31, 2019

Classified

Unclassified

Special
Mention

Substandard

Doubtful

Loss

Total

1,118

1,765

2,918

117,146

Total Loans
120,064

3,489
4,451
0
5,710
14,768

9,114
5,253
842
2,516
19,490

0
0
69
0
104

0
0
65
0
65

12,603
9,704
976
8,226
34,427

179,899
147,989
68,973
56,001
570,008

192,502
157,693
69,949
64,227
604,435

December 31, 2018

Classified

Unclassified

Special
Mention

Substandard

Doubtful

Loss

Total

150

1,771

1,961

108,737

Total Loans
110,698

5,564
4,879
0
6,647
17,240

4,805
5,118
709
2,761
15,164

0
0
41
0
81

0
0
106
0
106

10,369
9,997
856
9,408
32,591

185,195
130,569
71,676
66,088
562,265

195,564
140,566
72,532
75,496
594,856

Classified loans represent special mention, substandard
(performing and non-performing), and non-performing
loans categorized as 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 essentially uncollateralized and/or considered
uncollectible and of such little value that continuance as an
asset on the balance sheet may not be 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.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The aging of past due loans at December 31, 2019 and 2018 is summarized as follows:

(Dollars in thousands)
2019

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

Single family .............................................. $
Commercial real estate:

Real estate rental and leasing ..............
Other ......................................................
Consumer ...................................................
Commercial business ................................
$

2018

Single family ............................................... $
Commercial real estate:

Real estate rental and leasing .................
Other .......................................................
Consumer ....................................................
Commercial business ..................................
$

786

922 119,142

120,064

0
0
527
147
1,460

0
0
31
13
121

0
0
206
550
815

0 192,502
0 157,693
69,185
63,517
2,396 602,039

764
710

192,502
157,693
69,949
64,227
604,435

680

325

1,082 109,616

110,698

0
0
391
21
1,092

0
0
100
0
425

0
0
279
0
356

0 195,564
0 140,566
71,762
75,475
1,873 592,983

770
21

195,564
140,566
72,532
75,496
594,856

0
0
0
0
0

0
0
0

Impaired loans include loans that are non-performing (non-accruing) and loans that have been modified in a TDR.

The following table summarizes impaired loans and related allowances for the years ended December 31, 2019 and 2018:

(Dollars in thousands)
Loans with no related allowance recorded:

December 31, 2019

Recorded
Investment

Unpaid
Principal
Balance

Related
Allowance

Average
Recorded
Investment

Interest
Income
Recognized

Single family ....................................................................... $
Commercial real estate:

Other ...............................................................................
Consumer ............................................................................

544

563

0
781

0
0

508

10
580

Loans with an allowance recorded:

Single family .......................................................................
Commercial real estate:

Real estate rental and leasing .......................................
Other ...............................................................................
Consumer ............................................................................
Commercial business .........................................................

Total:

430

633

184
982
195
735

184
982
195
1,287

16
435
119
93

193
1,048
231
476

Single family .......................................................................
Commercial real estate:

974

993

1,141

184
982
976
735
3,851

184
982
976
1,287
4,422

16
435
119
93
725

193
1,058
811
476
3,679

0
26

0
71
14
24

0
71
40
24
171

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in thousands)
Loans with no related allowance recorded:

December 31, 2018

Recorded
Investment

Unpaid
Principal
Balance

Related
Allowance

Average
Recorded
Investment

Interest
Income
Recognized

Single family ........................................................................ $
Commercial real estate:

Real estate rental and leasing ..........................................
Other ................................................................................
Consumer .............................................................................

458

477

0
25
515

0
1,682
515

0
0
0

465

27
81
510

Loans with an allowance recorded:

Single family ........................................................................
Commercial real estate:

Total:

768

859

201
1,085
341
303

201
1,085
341
854

21
430
172
73

82
1,673
395
385

Single family ........................................................................
Commercial real estate:

1,226

1,245

1,324

201
1,110
856
303
3,696

201
2,767
856
854
5,923

21
430
172
73
794

109
1,754
905
385
4,477

0
106
14

7
0
9
13

7
106
23
13
175

At December 31, 2019, 2018 and 2017, non-accruing loans
totaled $2.1 million, $2.7 million and $3.2 million,
respectively, for which the related allowance for loan losses
was $0.2 million, $0.7 million and $0.9 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 $0.8 million, $0.4 million and $0.4
million at December 31, 2019, 2018 and 2017, respectively.
Had the non-accruing loans performed in accordance with
their original terms, the Company would have recorded
gross interest income on the loans of $0.2 million, $0.3
million and $0.3 million in 2019, 2018 and 2017,
respectively. For each of the years ended December 31,
2019, 2018 and 2017, the Company recognized interest
income on these loans of $0.1 million. 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 TDR.

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 TDR.

At December 31, 2019, 2018 and 2017, there were loans
included in loans receivable, net, with terms that had been
modified in a TDR totaling $2.5 million, $2.5 million and
$3.0 million, respectively. Had these loans been performing
in accordance with their original terms throughout 2019,
2018 and 2017, the Company would have recorded gross
interest income of $0.2 million, $0.3 million and $0.4
million, respectively. During 2019, 2018 and 2017, the
Company recognized interest income of $0.1 million, $0.2
million and $0.2 million, respectively, on these loans. For
the loans that were modified in 2019, $0.1 million were
classified and performing and $0.5 million were non-
performing at December 31, 2019.

The following table summarizes non-accrual loans at
December 31, 2019 and 2018:

The following table summarizes TDRs at December 31,
2019 and 2018:

(Dollars in thousands)
Single family ................................................ $
Commercial real estate:

Real estate rental and leasing...................
Other ........................................................
Consumer ......................................................
Commercial business....................................
$

2019

2018

617

730

184
0
659
621
2,081

201
1,110
489
148
2,678

(Dollars in thousands)
Single family ................................................ $
Commercial real estate:

Other ........................................................
Consumer ......................................................
Commercial business....................................
$

2019

2018

623

636

983
745
114
2,465

1,110
522
208
2,476

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

As of December 31, 2019, the Bank had commitments to
lend an additional $0.8 million to a borrower who has a TDR
and non-accrual loans. These additional funds are for the
construction of single family homes with a maximum loan-
to-value ratio of 75%. These loans are secured by the home
under construction. There were commitments to lend
additional funds of $0.9 million to this same borrower at
December 31, 2018.

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 ended December 31, 2019 and
2018:

(Dollars in thousands)
Troubled debt restructurings:

Single family .........................................
Commercial real estate:

Real estate rental and leasing ...........
Other .................................................
Consumer ..............................................
Commercial business ............................
Total ......................................................

Year ended December 31, 2019
Pre-
modification
Outstanding
Recorded
Investment

Post-
modification
Outstanding
Recorded
Investment

Number of
Contracts

Year ended December 31, 2018
Pre-
modification
Outstanding
Recorded
Investment

Post-
modification
Outstanding
Recorded
Investment

Number of
Contracts

4 $

215

220

2 $

217

220

0
0
10
0
14 $

0
0
371
0
586

0
0
371
0
591

1
2
10
1
16 $

54
1,518
373
70
2,232

54
1,518
373
70
2,235

There were no loans that were restructured during the year
ended December 31, 2019 that subsequently defaulted
during the year. There was one consumer loan with a
balance of $17,000 that was restructured during the year
ended December 31, 2018 that subsequently defaulted
during 2018.

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
to
modification may remain on accrual status after the
modification as long as the loan continues to perform under
the new terms.

that were accruing prior

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 as needed. Loans that
are not collateral dependent may have additional reserves
established if deemed necessary. The allocated reserves for
TDRs was $0.6 million, or 7.2%, of the total $8.6 million in
allowance for loan losses at December 31, 2019, and $0.6
million, or 7.2%, of the total $8.7 million in allowance for
loan losses at December 31, 2018.

NOTE 7 Accrued Interest Receivable
Accrued interest receivable at December 31 is summarized
as follows:

(Dollars in thousands)
Securities available for sale .......................... $
Loans receivable ...........................................
$

2019

2018

378
1,873
2,251

381
1,975
2,356

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The following
amortization expense for amortizing intangible assets:

the estimated future

indicates

table

(Dollars in thousands)
Year ended December 31,
2020 ...................................... $
2021 ......................................
2022 ......................................
2023 ......................................
2024 ......................................
Thereafter .............................
$

Mortgage
Servicing
Rights

Core
Deposit
Intangible

Total
Amortizing
Intangible
Assets

505
455
402
330
251
229
2,172

99
47
10
0
0
0
156

604
502
412
330
251
229
2,328

No amortization expense relating to goodwill is recorded as
generally accepted accounting principles do not allow
goodwill to be amortized, but require that it be tested for
impairment at least annually, or sooner, if there are
indications that impairment may exist.

Projections of amortization are based on asset balances and
the interest rate environment that existed at December 31,
2019. The Company’s actual experience may be
significantly different depending upon changes in mortgage
interest rates and other market conditions.

NOTE 9 Premises and Equipment
A summary of premises and equipment at December 31,
2019 and 2018 is as follows:

(Dollars in thousands)
Land ............................................................. $
Office buildings and improvements ............
Furniture and equipment .............................

Accumulated depreciation ...........................
$

2019

2018

2,615
11,946
12,954
27,515
(17,000)
10,515

2,621
10,878
12,935
26,434
(16,799)
9,635

The increase in premises and equipment related primarily to
the remodeling of branch facilities.

NOTE 10 Leases
On January 1, 2019, the Company adopted ASU 2016-02,
Leases (Topic 842) and a $4.5 million right-of-use asset and
an offsetting lease payment obligation liability were
recorded on the consolidated balance sheet in other assets
and other liabilities, respectively.

NOTE 8 Intangible Assets
The Company’s intangible assets consist of core deposit
intangibles, goodwill, and mortgage servicing rights. A
summary of mortgage servicing rights activity for 2019 and
2018 is as follows:

(Dollars in thousands)
Mortgage servicing rights, net:
Balance, beginning of year .......................... $
Originations .................................................
Amortization ................................................
Balance, end of year ....................................
Fair value of mortgage servicing rights ...... $

2019

2018

1,855
1,097
(780)
2,172
3,390

1,724
682
(551)
1,855
3,901

All of the single family loans sold where the Company
continues to service the loans are serviced for FNMA under
the individual loan sale program. The following is a
summary of the risk characteristics of the loans being
serviced for FNMA at December 31, 2019:

Loan
Principal
Balance

Weighted
Average
Interest
Rate

Weighted
Average
Remaining
Term

(months)

Number
of
Loans

(Dollars in thousands)
Original term:
30 year fixed rate .. $ 333,300
15 year fixed rate .. 93,869
45
Adjustable rate ......

4.10 %
3.21
4.63

309 2,445
940
131
2
257

The gross carrying amount of intangible assets and the
associated accumulated amortization at December 31, 2019
and 2018 are presented in the following table. Amortization
expense for intangible assets was $0.9 million for the year
ended December 31, 2019, and $0.7 million for the years
ended December 31, 2018 and 2017.

(Dollars in thousands)
December 31, 2019

Gross
Carrying Accumulated Intangible
Amount Amortization Assets

Unamortized

Mortgage servicing
rights ................................ $
Core deposit intangibles ..
Goodwill ..........................
Total ................................. $

4,968
574
802
6,344

(2,796)
(418)
0
(3,214)

December 31, 2018

Mortgage servicing
rights ................................. $
Core deposit intangibles .....
Goodwill .............................
Total .................................... $

4,526
574
802
5,902

(2,671)
(319)
0
(2,990)

2,172
156
802
3,130

1,855
255
802
2,912

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

lease

liabilities are

Operating lease right-of-use assets represent our right to use
an underlying asset during the lease term and operating
lease liabilities represent our obligation to make lease
payments arising from the lease. Right-of-use assets and
lease
operating
commencement based on the present value of the remaining
lease payments using a discount rate that represents the
Company’s incremental borrowing rate at the lease
commencement date. Because the Company only has
operating leases and the right-of-use asset is offset by a lease
payment obligation liability, the lease payments are the only
amount that is recorded in occupancy expense in the
consolidated statements of comprehensive income.

recognized at

The Company’s leases relate to office space and Bank
branches with remaining lease terms between 32 and 64
months. Certain leases contain extension options which
typically range from 3 to 10 years. Because these extension
options are not considered reasonably certain of exercise,
they are not included in the lease term. As of December 31,
2019, operating lease right-of-use assets and liabilities were
$4.0 million.

The table below summarizes our net lease cost:

(Dollars in thousands)
Operating lease cost ................................................... $

For the Year
Ended
December 31,
2019

889

The table below summarizes other information related to
our operating leases:

(Dollars in thousands)
Cash paid for amounts included in the measurement
of lease liabilities:

Year Ended
December 31,
2019

Operating cash flows from operating leases.......... $

889

Weighted-average remaining lease term –
operating leases, in years ..........................................
Weighted-average discount rate – operating leases ...

4.7
2.19 %

The table below summarizes the maturity of remaining lease
liabilities:

(Dollars in thousands)
2020 ............................................................................ $
2021 ............................................................................
2022 ............................................................................
2023 ............................................................................
2024 ............................................................................
2025 and thereafter .....................................................
Total lease payments ..................................................
Less: Interest...............................................................
Present value of lease liabilities ................................. $

December 31,
2019

887
896
932
807
729
15
4,266
(221)
4,045

NOTE 11 Deposits
Deposits and their weighted average interest rates at December 31, 2019 and 2018 are summarized as follows:

(Dollars in thousands)
Noninterest checking ................
Interest checking .......................
Savings accounts ......................
Money market accounts ............

Certificates by rate:
0 - 0.99% ...............................
1 - 1.99% ...............................
2 - 2.99% ...............................
3 - 3.99% ...............................
Total certificates .......................
Total deposits ............................

Weighted
Average
Rate

2019

Amount

Percent
of Total

Weighted
Average
Rate

2018

Amount

Percent
of Total

0.00 % $
0.13
0.08
0.65

1.84
0.56

183,350
96,341
80,054
187,517
547,262

22,499
38,097
61,936
4,076
126,608
673,870

27.2 %
14.3
11.9
27.8
81.2

3.3
5.7
9.2
0.6
18.8
100.0 %

0.00 % $
0.10
0.08
0.56

1.32
0.43

163,500
88,715
76,839
181,374
510,428

32,904
47,627
31,680
713
112,924
623,352

26.2 %
14.3
12.3
29.1
81.9

5.3
7.6
5.1
0.1
18.1
100.0 %

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

At December 31, 2019 and 2018, the Company had $215.8
million and $182.0 million, respectively, of deposit
accounts with balances at $250,000 or more. At December

31, 2019 and 2018, the Company had no certificate accounts
that had been acquired through a broker.

Certificates had the following maturities at December 31, 2019 and 2018:

(Dollars in thousands)
Remaining term to maturity
1-6 months ..................................................................... $
7-12 months ...................................................................
13-36 months .................................................................
Over 36 months .............................................................
$

2019

2018

Amount

Weighted
Average Rate

Amount

Weighted
Average Rate

43,447
39,074
41,753
2,334
126,608

1.88 % $
1.63
2.00
1.71
1.84

39,004
36,711
33,941
3,268
112,924

1.23 %
1.29
1.46
1.44
1.32

At December 31, 2019 and 2018, the Company had pledged
mortgage-backed and agency securities with an amortized
cost of approximately $14.9 million and $17.9 million,
respectively, as collateral for certain deposits. Interest
expense on deposits is summarized as follows for the years
ended December 31, 2019, 2018 and 2017:

(Dollars in thousands)
Checking accounts ................ $
Savings accounts ..................
Money market accounts ........
Certificates ............................
$

2019

2018

2017

103
63
1,171
1,995
3,332

62
61
865
1,243
2,231

77
63
560
770
1,470

NOTE 13 Income Taxes
Income tax expense for the years ended December 31, 2019,
2018 and 2017 is as follows:

(Dollars in thousands)
Current:

2019

2018

2017

Federal ....................................... $
State ...........................................
Total current .........................

2,141
687
2,828

1,690
115
1,805

2,287
10
2,297

Deferred:

Federal .......................................
State ...........................................
Total deferred .......................
Income tax expense ....................... $

256
240
496
3,324

234
849
1,083
2,888

1,412
693
2,105
4,402

The reasons for the difference between the expected income
tax expense utilizing the federal corporate tax rate of 21%
in 2019 and 2018, and 34% in 2017 and the actual income
tax expense are as follows:

(Dollars in thousands)
Expected federal income tax

2019

2018

2017

expense ...................................... $

2,334

2,336

2,994

Items affecting federal income

tax:

State income taxes, net of

federal income tax deduction
Change in federal tax rate .......
Other, net .................................
Income tax expense ..................... $

852
0
138
3,324

559
0
(7)
2,888

529
1,062
(183)
4,402

NOTE 12 Federal Home Loan Bank (FHLB) Advances
and Other Borrowings
The Bank had no outstanding advances from the FHLB or
borrowings from the Federal Reserve Bank of Minneapolis
as of December 31, 2019 or December 31, 2018. At
December 31, 2019 the Bank had collateral pledged to the
FHLB consisting of FHLB stock, mortgage loans, and
investments with a borrowing capacity of approximately
$181.2 million, subject to a requirement to purchase FHLB
stock. The Bank also had the ability to borrow $65.3 million
from the Federal Reserve Bank of Minneapolis, based upon
the loans that were pledged to them as of December 31,
2019, subject to approval from the Board of Governors of
the Federal Reserve System (FRB).

At December 31, 2018 the Bank had collateral pledged to
the FHLB consisting of FHLB stock, mortgage loans, and
investments with a borrowing capacity of approximately
$167.6 million, subject to a requirement to purchase FHLB
stock. The Bank also had the ability to borrow of $73.0
million from the Federal Reserve Bank of Minneapolis,
based upon the loans that were pledged to them as of
December 31, 2018, subject to approval from the FRB.

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:

2019

2018

Allowances for loan losses ........................... $
Deferred compensation costs ........................
Deferred ESOP loan asset .............................
Nonaccruing loan interest .............................
State net operating loss carryforward ...........
Alternative minimum tax credit

2,394
158
453
78
42

2,428
154
473
185
160

carryforward................................................

208

Net unrealized loss on securities available

for sale .........................................................
Other ..............................................................
Total gross deferred tax assets .................

0
140
3,265

426
91
4,125

Deferred tax liabilities:

Deferred loan costs .......................................
Premises and equipment basis difference .....
Originated mortgage servicing rights ...........
Federal tax liability on state net operating

344
526
607

367
509
519

loss carryforwards .......................................

Net unrealized gain on securities available

for sale .........................................................
Other ..............................................................
Total gross deferred tax liabilities ............
Net deferred tax assets .............................. $

18
59
1,563
1,702

0
54
1,483
2,642

The Company has no federal and $0.8 million of state net
operating loss carryforwards at December 31, 2019.

On December 22, 2017 the Tax Cuts and Jobs Act became
law. Among other things, this law reduced the corporate tax
rate for the Company from 34% to 21% effective January 1,
2018. In accordance with accounting guidelines, this change
in the tax rate was reflected as an adjustment to the
Company’s deferred tax items at December 31, 2017. The
net result of this adjustment was to reduce the Company’s
net deferred tax asset by $1.1 million with a corresponding
increase to income tax expense in the fourth quarter of 2017.

included
Retained earnings at December 31, 2019
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. The Company could not
currently identify any negative evidence. Based upon this
evaluation, the Company determined that no valuation
allowance was required with respect to the net deferred tax
assets at December 31, 2019 and 2018.

NOTE 14 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. 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 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 Pentegra DB Plan, contributions made by a 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
have been 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, 2019 because such information is
not accumulated for each participating institution. As of
June 30, 2019, the Pentegra DB Plan valuation report
reflected that the Bank was obligated to make a contribution
totaling $0.3 million which was paid and expensed in 2019.

Funded status (market value of plan assets divided by
funding target) as of July 1 for the 2019, 2018 and 2017 plan
years were 87.67%, 89.86% and 95.45%, respectively.
Market value of plan assets reflects contributions received
through June 30, 2019.

Total employer contributions made to the Pentegra DB Plan,
as reported on Form 5500, equal $164.6 million, $367.1
million, and $153.2 million for the plan years ended June
30, 2018, 2017 and 2016, 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.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The following contributions were paid by the Bank during the fiscal years ending December 31:

(Dollars in thousands)

2019

2018

Date Paid

Amount

10/02/2019 ................ $
12/23/2019 .................

Date Paid
29 10/11/2018 ................ $
244 12/27/2018 ................

Amount

Total .......................... $

273

2017

Date Paid
26 01/06/2017 .............. (1) $
92 10/15/2017 ..............
12/27/2017 ..............
$

118

Amount

119
27
99
245

(1) The contribution relates to the 2016 plan year and was accrued at December 31, 2016.

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 their annual salary or the maximum allowed by law,
which was $19,000 for 2019, $18,500 for 2018 and $18,000
for 2017, with additional “catch up” contributions allowed
for employees over 50 years of age. The Company matches
25% of each participant’s contributions up to a maximum of
8% of their annual salary. Participant contributions and
earnings are fully and immediately vested. The Company’s
contributions are vested on a three year cliff basis, are
expensed annually, and were $0.2 million in 2019, 2018 and
2017.

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 to 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 2019, 2018 and
2017.

As the debt is repaid, ESOP shares that were pledged as
collateral for the debt are released from collateral based on
the proportion of debt service paid in the year and then
allocated to eligible employees. The Company accounts for
its ESOP in accordance with ASU 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 common share computations.
ESOP compensation expense was $0.5 million for 2019 and
2018, and $0.4 million for 2017.

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 December 31:

Shares held by participants

beginning of the year .......... 340,237 357,135 339,870

2019

2018

2017

Shares allocated to

participants .........................

24,317

Shares distributed to

participants .........................

(18,457 )

(41,215)

(7,052)

Shares held by participants

end of year .......................... 346,097 340,237 357,135

Unreleased shares beginning

of the year ........................... 231,112 255,429 279,746
(24,317)

(24,317 )

(24,317)

Shares released during year ..
Unreleased shares end of year

............................................ 206,795 231,112 255,429

Total ESOP shares end of

year ..................................... 552,892 571,349 612,564

Fair value of unreleased

shares at December 31 ....... $ 4,344,763 4,534,417 4,878,694

In April 2009 the HMN Financial, Inc. 2009 Equity and
Incentive Plan (2009 Plan) was adopted by the Company. In
April 2017, the 2009 Plan was superseded by the HMN
Financial, Inc. 2017 Equity Incentive Plan (2017 Plan) and
options or restricted shares were no longer awarded from
the 2009 Plan. As of December 31, 2019 there were 34,229
vested options outstanding under the 2009 Plan. These
options expire 10 years from the date of grant and have an
average exercise price of $11.21. There were also 3,102
shares of restricted stock previously granted to current
employees under the 2009 Plan that as of December 31,
2019 remained unvested.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The purpose of the 2017 Plan is to attract and retain the best
available personnel for positions of responsibility with the
Company, to provide additional incentives to them and align
their interests with those of the Company’s stockholders,
and to thereby promote the Company’s long-term business
success. 375,000 shares of HMN common stock were
initially available for distribution under the 2017 Plan in
either restricted stock or 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 1.5 shares
for purposes of determining the total shares available for
issuance under the 2017 Plan. As of December 31, 2019,
there were no options outstanding under the 2017 Plan.
There were 14,787 shares of restricted stock previously
granted to current employees and directors under the 2017
Plan that remained unvested at December 31, 2019.

A summary of activities under all plans for the past three years is as follows:

Shares
Available
For Grant

Unvested
Restricted
Shares

Award Value/
Weighted
Average

Options

Outstanding

Exercise Price Number

Weighted
Average
Grant Date
Fair Value

Vesting
Period
(in years)

Unvested options

34,229 $

4.04

2009 Plan
December 31, 2016 .............................
Granted January 31, 2017 ..............
Transferred to 2017 Plan ................
Vested .............................................
December 31, 2017 .............................
Options Exercised ..........................
Vested .............................................
December 31, 2018 .............................
Vested ............................................
December 31, 2019 ............................

2017 Plan
April 25, 2017 .....................................
Granted May 5, 2017 .....................
Transferred from 2009 Plan ...........
December 31, 2017 .............................
Granted January 23, 2018 ..............
Granted April 24, 2018 ..................
Vested .............................................
December 31, 2018 .............................
Granted January 22, 2019 ...........
Granted April 23, 2019 ................
Vested ............................................
December 31, 2019 ............................

54,876
(11,164 )
(43,712 )
0
0
0
0
0
0
0

375,000
(3,420 )
43,712
415,292
(10,044 )
(792 )
0
404,456
(12,971 )
(2,514 )
0
388,971

20,596
9,303
0
(15,018)
14,881
0
(7,541)
7,340
(4,238)
3,102

0
2,280
0
2,280
6,696
528
(2,280)
7,224
8,647
1,676
(2,760)
14,787

49,229 $
0
0
0
49,229 $
(15,000 )
0
34,229 $
0
34,229 $

0
0
0
0
0
0
0
0
0
0
0
0

9.25
N/A
N/A
N/A
9.25

(11,409)
22,820 $

N/A
11.21

11.21

(11,410)
11,410 $
(11,410)
0

N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A

0
0

4.04
4.04

4.04
4.04
4.04

3
1

Total all plans ....................................

388,971

17,889

34,229 $

11.21

0 $

4.04

The following table summarizes information about stock options outstanding at December 31, 2019:

Date of
Grant

Exercise
Price

Number
Outstanding

Weighted
Average
Remaining
Contractual
Life in Years

Number
Exercisable

Number
Unexercisable

January 26, 2016 ..................... $

11.21

34,229
34,229

6.1

34,229
34,229

0
0

The Company will issue shares from treasury stock upon the
exercise of outstanding options.

In accordance with ASC 718, the Company recognizes
compensation expense 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 the Black
Scholes option valuation method. There were no options
granted in 2019, 2018 or 2017.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 15 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 basic earnings per

2019

Year ended December 31,
2018

2017

common share calculation ................................................................................................

4,610,469

4,368,289

4,215,899

Net dilutive effect of :

Options and warrants ........................................................................................................
Restricted stock awards.....................................................................................................

16,018
12,443

423,818
10,868

640,410
11,662

Weighted average number of common shares outstanding adjusted for effect of dilutive

securities ............................................................................................................................

4,638,930

4,802,975

4,867,971

Net income available to common shareholders .................................................................... $
Basic earnings per common share ......................................................................................... $
Diluted earnings per common share ...................................................................................... $

7,793
1.69
1.68

8,236
1.89
1.71

4,404
1.04
0.90

NOTE 16 Stockholders' Equity
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 Fixed Rate Cumulative Perpetual Preferred
Stock, Series A (Preferred Stock) to the United States
Department of Treasury (Treasury). The Preferred Stock
had 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
Warrant). The transaction was part of the Treasury’s Capital
Purchase Program under
the Emergency Economic
Stabilization Act of 2008.

On February 17, 2015, the Company redeemed the final
10,000 shares of outstanding Preferred Stock. On May 21,
2015, the Treasury sold the Warrant at an exercise price of
$4.68 per share to three unaffiliated third party investors for
an aggregate purchase price of $5.7 million. In 2018, all of
the outstanding Warrants were either exercised by the
Warrant holder or repurchased by the Company. These
Warrant transactions resulted in the Company issuing an
additional 319,651 shares of common stock from treasury
shares for Warrants that were exercised and paying $6.5
million in cash to repurchase the remaining Warrants. As a
result of these transactions, the Company no longer has any
obligations under the Warrant.

On November 28, 2018, the Board of Directors announced
a new share repurchase program, pursuant to which the
Company may purchase shares of its common stock for an
aggregate purchase price not to exceed $6 million. The
share repurchase program does not obligate the Company to
purchase any shares and has no set expiration date. No
shares were repurchased in the open market by the
Company in 2019 or 2018 under the share repurchase
program. The Company did not pay any dividends on its
common stock during 2019, 2018 or 2017.

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.

such

requirements. The

NOTE 17 Regulatory Capital
The Company and the Bank are subject to the Basel III
regulatory capital requirements. The Basel III requirements,
among other things, (i) apply a set of capital requirements
to the Bank (the Company is exempt, pursuant to the Small
(Policy
Bank Holding Company Policy Statement
Statement) described below),
including requirements
relating to common equity as a component of core capital,
(ii) implement a “capital conservation buffer” against risk
and a higher minimum Tier 1 capital requirement, and (iii)
set forth rules for calculating risk-weighted assets for
purposes of
rules made
corresponding revisions to the prompt corrective action
framework and
ratios and buffer
requirements which are fully phased in as of January 1,
2019. 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 its assets, liabilities and certain off-
balance sheet
items as calculated under regulatory
accounting practices. The capital amounts and classification
are also subject to qualitative judgments by the regulators
about components, risk weightings and other factors.

include capital

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The FRB amended its Policy Statement, to exempt small
bank and savings and loan holding companies with assets
less than $3 billion from the above capital requirements.
The Company currently meets the qualitative exemption
requirements, and therefore, is exempt from the above
capital requirements.

Quantitative measures established by regulations to ensure
capital adequacy require the Bank to maintain minimum
amounts and ratios (set forth in the following table and
defined in the regulation) of Common Equity Tier 1 capital
to risk weighted assets, Tier 1 capital to adjusted total assets,
Tier 1 capital to risk weighted assets, and total capital to risk
weighted assets.

At December 31, 2019 and 2018, 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:

Amount

(Dollars in thousands)
December 31, 2019
Common equity Tier 1 capital ....... $ 83,525
Tier 1 leverage ................................. 83,525
Tier 1 risk-based capital ................ 83,525
Total risk-based capital .................. 91,438

Required to be
Adequately Capitalized

Amount

Percent of
Assets(1)

Capital in Excess of
Minimum
Requirements

To Be Well Capitalized
Under Prompt
Corrective Action
Provisions

Amount

Percent of
Assets(1)

Amount

Percent of
Assets(1)

Actual

Percent of
Assets(1)

13.21 % $ 28,458
30,684
10.89
37,944
13.21
50,591
14.46

4.50 % $ 55,067
52,841
4.00
45,581
6.00
40,847
8.00

8.71 % $ 41,106
38,355
6.89
50,591
7.21
63,239
6.46

6.50 %
5.00
8.00
10.00

December 31, 2018
Common equity Tier 1 capital .......... $ 79,552
Tier 1 leverage .................................. 79,552
Tier 1 risk-based capital ................... 79,552
Total risk-based capital..................... 87,063
(1) Based upon the Bank’s adjusted total assets for the purpose of the Tier 1 leverage capital ratio and risk-weighted assets for the purpose of the risk-based

13.26 % $ 26,988
28,923
11.00
35,983
13.26
47,978
14.52

8.76 % $ 38,982
36,154
7.00
47,978
7.26
59,972
6.52

4.50 % $ 52,564
50,629
4.00
43,569
6.00
39,085
8.00

6.50 %
5.00
8.00
10.00

capital ratios.

The Bank must maintain a capital conservation buffer
composed of common equity Tier 1 capital above its
minimum risk-based capital requirements in order to avoid
limitations on capital distributions, including dividend
payments and certain discretionary bonus payments to
executive officers. On January 1, 2019, the capital
conservation buffer amount increased to 2.50% and is fully
phased in. Management believes that, as of December 31,
2019, the Bank’s capital ratios were in excess of those
quantitative capital ratio standards set forth under the
current prompt corrective action regulations, including the
capital conservation buffer described above. However, there
can be no assurance that the Bank will continue to maintain
such status in the future. The Office of the Comptroller of
the Currency has extensive discretion in its supervisory and
enforcement activities, and can adjust the requirement to be
well-capitalized in the future. In addition, the Company
must adhere to various U.S. Department of Housing and
Urban Development (HUD) regulatory guidelines including
required minimum capital and liquidity amounts to maintain
their Federal Housing Administration approved status.
Failure to comply with the HUD guidelines could result in
withdrawal of this certification. As of December 31, 2019,
the Company was in compliance with HUD guidelines.

NOTE 18 Commitments and Contingencies
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 all commitments to extend credit. These
commitments involve, to varying degrees, elements of
credit and interest rate risk in excess of the amounts
recognized in the balance sheet. The contract amounts of
these instruments reflect the extent of involvement by the
Company.

The Company's exposure to credit loss in the event of
nonperformance by the other party to the financial
instrument for commitments to extend credit is represented
by the contract amount of these commitments. The
Company uses
in making
commitments as it does for on-balance sheet instruments.

the same credit policies

Contract Amount
December 31,

2019

2018

(Dollars in thousands)
Financial instruments whose contract

amount represents credit risk:

Commitments to originate, fund or

purchase loans:

Single family ...................................... $
Commercial real estate .......................
Commercial business ..........................
Undisbursed balance of loans closed .
Unused lines of credit .........................
Letters of credit ...................................

6,081
7,620
6,320
19,183
782
11,354
23,749
30,070
107,767 107,438
2,608
Total commitments to extend credit ....... $ 178,804 146,978
7,289
Forward commitments ............................ $

10,098

2,810

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

its

From time to time, the Company is party to legal
proceedings arising out of
lending and deposit
operations. The Company is, and expects to become,
engaged in foreclosure proceedings, collection actions, and
other litigation as part of its normal banking activities.
Among the various current litigation matters, the Company
is involved in a bankruptcy litigation claim where the
bankruptcy trustee is attempting to recover $3.7 million
related to the principal and interest payments made to the
Bank prior to the bankruptcy filing of a former customer of
the Bank.

The Company examines each legal matter, and, in those
situations where it determines that a particular legal matter
presents loss contingencies that are both probable and
reasonably estimable, establishes an appropriate accrual. In
many situations, the Company is not able to estimate
reasonably possible losses due to the preliminary nature of
the legal matter, as well as a variety of other factors and
uncertainties. For those legal matters where the Company is
able to estimate a range of reasonably possible losses,
management currently estimates that the aggregate range of
losses from all of our outstanding litigation is from $0 to
$1.2 million in excess of the amounts accrued, if any. This
estimated aggregate range is based on an assessment of the
information currently available to the Company and the
actual aggregate losses could be higher. However, the
Company does not believe these losses are probable to occur
at this time. The Company reassesses all of its potential loss
positions based on the available information each quarter
and the estimated range of reasonably possible losses may
change in the future. The Company typically vigorously
pursues all available defenses related to litigation but may
consider other alternatives,
in
situations where there is an opportunity to resolve a legal
matter on terms that are considered to be favorable to the
Company when considering the continued expense and
distraction of defending against any particular legal action.

including settlement,

Based on the Company’s current understanding of all of the
outstanding legal matters, management does not believe that
judgments or settlements arising from any pending or
threatened litigation, individually or in the aggregate, would
have a material adverse effect on the consolidated financial
condition or results of operations. However, litigation is
unpredictable and the actual results of litigation cannot be
determined with any certainty. Therefore, the ultimate
aggregate resolution of any, or all, of the current outstanding
legal matters could have a material adverse effect on the
Company’s results of operations in the future.

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 the payment of a fee.
Since a portion of the commitments are expected to expire
without being drawn upon, the total commitment amounts
do not necessarily represent future cash requirements. The
Bank evaluates each customer's creditworthiness on a case-
by-case basis. The amount of collateral obtained, if deemed
necessary by the Bank upon extension of credit, is based on
the loan type and on management's credit evaluation of the
borrower. Collateral consists primarily of residential and
commercial real estate and personal property. 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 32 months
and totaled $2.8 million at December 31, 2019 and $2.6
million at December 31, 2018. 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 has certain obligations and commitments to
make future payments under existing contracts. At
December 31, 2019, the aggregate contractual obligations
(excluding bank deposits) and commercial commitments
were as follows:

Payments Due by Period

Less
than 1
Year

1-3
Years

4-5
Years

More
than
5
Years

(Dollars in thousands) Total
Contractual

Obligations:
Annual rental

commitments under
non-cancellable
operating leases ....... $ 4,266 887 1,829 1,536

Total contractual

obligations........ $ 4,266 887 1,829 1,536

Amount of Commitments Expiring by Period

Other Commercial
Commitments:
Commercial lines of

credit........................ $ 63,322 23,742 27,240 12,340

0
Commitments to lend 22,757 8,716 2,668 4,090 7,283
Standby letters of

credit........................ 2,810 2,108

702

Total other

commercial
commitment ..... $ 88,889 34,566 30,610 16,430 7,283

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 19 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 secondary market. The
commitments to originate and sell loans are derivatives that
are recorded at fair value. The marking of these derivatives
to fair value for the periods ended December 31, 2019 and
December 31, 2018 did not have a material impact on the
Company’s consolidated financial statements.

loans

into

the

the current
As of December 31, 2019 and 2018,
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. The marking of these loans for the periods ended
December 31, 2019 and December 31, 2018 did not have a
material impact on the Company’s consolidated financial
statements.

NOTE 20 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
inputs are not available. These
that observable
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, 2019 and 2018.

(Dollars in thousands)
Securities available for sale ............................... $
Equity securities ..................................................
Mortgage loan commitments .............................
Total ..................................................................... $

Total

Level 1

Level 2

Level 3

Carrying Value at December 31, 2019

107,592
167
14
107,773

0
0
0
0

107,592
167
14
107,773

(Dollars in thousands)
Securities available for sale .................................. $
Equity securities ...................................................
Mortgage loan commitments ................................
Total ...................................................................... $

Total

79,859
121
40
80,020

Carrying Value at December 31, 2018

Level 1

Level 2

Level 3

0
0
0
0

79,859
121
40
80,020

0
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 2019
and 2018 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, 2019
and 2018.

Carrying Value at December 31, 2019

(Dollars in thousands)
Loans held for sale ................................................ $
Mortgage servicing rights, net .............................
Impaired loans ......................................................
Real estate, net ......................................................
Total ....................................................................... $

Total

Level 1

Level 2

Level 3

3,606
2,172
3,126
580
9,484

0
0
0
0
0

3,606
2,172
3,126
580
9,484

Carrying Value at December 31, 2018

(Dollars in thousands)
Loans held for sale .................................................. $
Mortgage servicing rights, net ................................
Impaired loans ........................................................
Real estate, net ........................................................
Total ........................................................................ $

Total

Level 1

Level 2

Level 3

3,444
1,855
2,902
414
8,615

0
0
0
0
0

3,444
1,855
2,902
414
8,615

Year Ended
December 31, 2019
Total losses

(40)
0
(28)
0
(68)

Year Ended
December 31, 2018
Total gains (losses)

45
0
(97)
0
(52)

0
0
0
0
0

NOTE 21 Fair Value of Financial Instruments
ASC 825, Disclosures about Fair Values of Financial
Instruments, requires disclosure of the 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, 2019 and 2018 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
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.

conditions,

economic

current

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.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The estimated fair value of the Company's financial instruments is 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, 2019

Fair value hierarchy

December 31, 2018

Carrying
amount

Estimated
fair value Level 1 Level 2 Level 3

Contract
amount

Carrying
amount

Estimated
fair value

Contract
amount

(Dollars in thousands)
Financial assets:

Cash and cash equivalents ......... $
44,399
Securities available for sale ....... 107,592
167
Equity securities ........................
Loans held for sale ....................
3,606
Loans receivable, net ................. 596,392
854
FHLB stock ...............................
2,251
Accrued interest receivable .......

44,399 44,399
107,592
167
3,606
600,863
854
2,251

107,592
167
3,606
600,863
854
2,251

Financial liabilities:

20,709
79,859
121
3,444

20,709
79,859
121
3,444
586,688 578,978
867
2,356

867
2,356

Deposits ..................................... 673,870
420
Accrued interest payable ...........

673,945
420

623,352 623,439
346

346

Off-balance sheet financial

instruments:
Commitments to extend credit ..
Commitments to sell loans ........

14
(16 )

14
(16)

178,804
10,098

40
(56)

40 146,978
7,289
(56)

Cash and Cash Equivalents
The carrying amount of cash and cash equivalents
approximates their fair value.

FHLB Stock
The carrying amount of FHLB stock approximates its fair
value.

Securities Available for Sale
The fair values of securities were based upon quoted market
prices.

Equity Securities
The fair values of equity 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 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. The fair value disclosures for both the
fixed and adjustable rate portfolios were adjusted to reflect
the exit price amount anticipated to be received from the
sale of the portfolio in an open market transaction as
required upon adoption of ASU 2016-01, Financial
Instruments – Overall (Subtopic 825-10) Recognition and
Measurement of Financial Assets and Financial Liabilities
beginning in the first quarter of 2018.

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 disclosures for all of the deposits
were adjusted to reflect the exit price amount anticipated to
be received from the sale of the deposits in an open market
transaction as required upon adoption of ASU 2016-01,
(Subtopic 825-10)
Financial
Recognition and Measurement of Financial Assets and
Financial Liabilities beginning in the first quarter of 2018.

Instruments – Overall

Accrued Interest Payable
The carrying amount of accrued
approximates its fair value since it is short-term in nature.

interest payable

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.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 22 HMN Financial, Inc. Financial Information (Parent Company Only)
The following are the condensed financial statements for the parent company only as of December 31, 2019 and 2018 and
for the years ended December 31, 2019, 2018 and 2017.

(Dollars in thousands)
Condensed Balance Sheets
Assets:

Cash and cash equivalents ........................................................................................ $
Investment in subsidiaries .........................................................................................
Prepaid expenses and other assets ............................................................................
Deferred tax asset, net ...............................................................................................
Total assets ........................................................................................................... $

Liabilities and Stockholders' Equity:

Accrued expenses and other liabilities ..................................................................... $
Total liabilities ......................................................................................................
Common stock ..........................................................................................................
Additional paid-in capital .........................................................................................
Retained earnings ......................................................................................................
Net unrealized gains (losses) on securities available for sale ..................................
Unearned employee stock ownership plan shares ....................................................
Treasury stock, at cost, 4,284,840 and 4,292,838 shares .........................................
Total stockholders' equity.....................................................................................
Total liabilities and stockholders' equity .............................................................. $

Condensed Statements of Income

Interest income (expense) ......................................................................................... $
Equity income of subsidiaries ...................................................................................
Compensation and benefits .......................................................................................
Occupancy and equipment ........................................................................................
Data processing .........................................................................................................
Professional services .................................................................................................
Other ..........................................................................................................................
Income before income tax expense (benefit) .......................................................
Income tax expense (benefit) ....................................................................................
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 above original cost .....................
Stock option compensation .......................................................................................
Amortization of restricted stock awards ...................................................................
Decrease in unearned ESOP shares ..........................................................................
Decrease (increase) in other assets ...........................................................................
Decrease in other liabilities .......................................................................................
Other, net ...................................................................................................................
Net cash provided (used) by operating activities .................................................

Cash flows from financing activities:

Warrants purchased ...................................................................................................
Excess tax benefit from options exercised ...............................................................
Stock awards withheld for tax withholding ..............................................................
Repayments of borrowings .......................................................................................
Dividends received from Bank .................................................................................
Net cash provided (used) by financing activities .....................................................
Increase (decrease) in cash and cash equivalents .....................................................
Cash and cash equivalents, beginning of year ..............................................................
Cash and cash equivalents, end of year ......................................................................... $

2019

2018

2017

7,722
84,507
610
24
92,863

215
215
91
40,365
107,547
46
(1,643)
(53,758)
92,648
92,863

21
8,627
(240)
(30)
(6)
(131)
(367)
7,874
81
7,793

1,534
79,737
2,014
95
83,380

233
233
91
40,090
99,754
(1,096)
(1,836)
(53,856)
83,147
83,380

0
8,800
(221)
(30)
(6)
(124)
(331)
8,088
(148)
8,236

7,793

8,236

(8,627)
71
230
1
187
193
1,404
(18)
(1)
1,233

0
0
(45)
0
5,000
4,955
6,188
1,534
7,722

(8,800)
46
206
17
134
194
(146)
(20)
(1)
(134)

(6,453)
64
0
0
6,000
(389)
(523)
2,057
1,534

(306)
4,878
(257)
(30)
(6)
(130)
(319)
3,830
(574)
4,404

4,404

(4,878)
615
147
41
147
193
(6)
(866)
0
(203)

0
0
(54)
(7,000)
6,000
(1,054)
(1,257)
3,314
2,057

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 23 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)

Home Federal
Savings Bank

Other

Eliminations

Consolidated
Total

At or for the year ended December 31, 2019:

Interest income – external customers ............................................................ $
Non-interest income – external customers ....................................................
Intersegment interest income ..........................................................................
Intersegment non-interest income ..................................................................
Interest expense ................................................................................................
Provision for loan losses ..................................................................................
Non-interest expense ........................................................................................
Income tax expense ..........................................................................................
Net income ........................................................................................................
Total assets ........................................................................................................

At or for the year ended December 31, 2018:

Interest income – external customers ................................................................ $
Non-interest income – external customers ........................................................
Intersegment non-interest income ......................................................................
Interest expense ..................................................................................................
Provision for loan losses ....................................................................................
Non-interest expense ..........................................................................................
Income tax expense (benefit) .............................................................................
Net income .........................................................................................................
Total assets .........................................................................................................

At or for the year ended December 31, 2017:

31,890
8,455
0
234
3,360
(1,216)
26,565
3,243
8,627
777,083

30,381
7,714
222
2,233
(649)
24,897
3,036
8,800
710,281

27,680
7,654
210
1,491
(523)
24,722
4,976
4,879
722,532

0
0
21
8,627
0
0
774
81
7,793
92,863

0
0
8,800
0
0
712
(148 )
8,236
83,380

0
0
4,879
306
0
742
(574 )
4,404
79,254

0
0
(21)
(8,861)
(21)
0
(234)
0
(8,627)
(92,307)

0
0
(9,022)
0
0
(222)
0
(8,800)
(81,346)

0
0
(5,089)
0
0
(210)
0
(4,879)
(79,101)

31,890
8,455
0
0
3,339
(1,216)
27,105
3,324
7,793
777,639

30,381
7,714
0
2,233
(649)
25,387
2,888
8,236
712,315

27,680
7,654
0
1,797
(523)
25,254
4,402
4,404
722,685

OTHER FINANCIAL DATA

The following tables set forth certain information as to the Bank’s FHLB advances.

(Dollars in thousands)
Maximum Balance:

2019

Year Ended December 31,
2018

FHLB advances ......................................................................................................... $
FHLB short-term advances .......................................................................................

13,800
13,800

Average Balance:

FHLB advances .........................................................................................................
FHLB short-term advances .......................................................................................

287
287

6,800
6,800

140
140

2017

18,800
18,800

1,693
1,693

See “Note 12 Federal Home Loan Bank (FHLB) Advances and Other Borrowings” in the Notes to Consolidated Financial
Statements for more information on the Bank’s FHLB advances and other borrowings.

December 31, 2019

September 30, 2019

June 30, 2019

7,861
914
6,947
236
6,711

795
321
1,106
294
2,516

4,163
1,158
338
492
1,193
7,344
1,883
647
1,236
0.27
0.27

7,998
906
7,092
(420)
7,512

820
324
845
238
2,227

3,849
1,142
319
428
1,009
6,747
2,992
916
2,076
0.45
0.45

0.64%
5.29
12.06
3.76

1.11%
9.10
12.07
3.97

777,639

763,228

54,851
52,741
3,606
596,392
673,870
92,648

22,187
62,665
7,819
583,102
659,608
91,190

8,299
829
7,470
(1,059 )
8,529

785
318
611
307
2,021

3,737
1,081
305
381
1,063
6,567
3,983
1,121
2,862
0.62
0.62

1.60
13.10
12.01
4.35

722,767

7,435
72,469
5,912
595,757
623,510
88,811

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 ....................

Non-interest income:

Fees and service charges .............................................................
Loan servicing fees .....................................................................
Gain on sales of loans .................................................................
Other ............................................................................................
Total non-interest income .......................................................

Non-interest expense:

Compensation and benefits .........................................................
Occupancy and equipment ..........................................................
Data processing ...........................................................................
Professional services ...................................................................
Other ............................................................................................
Total non-interest expense .....................................................
Income before income tax expense .............................................
Income tax expense .........................................................................
Net income .................................................................................. $
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 (end of period):
Total assets ...................................................................................... $
Securities available for sale:

Mortgage-backed and related securities .....................................
Other marketable securities ........................................................
Loans held for sale ...........................................................................
Loans receivable, net .......................................................................
Deposits ...........................................................................................
Stockholders’ equity ........................................................................

(1) Annualized
(2) Net interest income divided by average interest-earning assets

SELECTED QUARTERLY FINANCIAL DATA

March 31, 2019

December 31, 2018

September 30, 2018

June 30, 2018

March 31, 2018

7,732
690
7,042
27
7,015

700
315
379
297
1,691

3,910
1,061
301
272
903
6,447
2,259
640
1,619
0.35
0.35

7,797
650
7,147
(167)
7,314

909
314
483
242
1,948

3,652
1,062
331
264
997
6,306
2,956
604
2,352
0.51
0.51

7,970
587
7,383
(652)
8,035

870
343
489
234
1,936

3,574
1,073
310
326
931
6,214
3,757
1,045
2,712
0.62
0.56

7,456
526
6,930
295
6,635

785
297
679
293
2,054

3,678
1,072
334
298
931
6,313
2,376
649
1,727
0.40
0.35

0.91%
7.67
11.82
4.11

1.29%

11.24
11.52
4.06

1.47%

12.90
11.54
4.14

0.95 %
8.25
11.61
3.97

722,745

7,743
72,044
3,292
599,462
626,592
85,350

712,315

8,023
71,836
3,444
586,688
623,352
83,147

737,445

8,207
71,253
2,109
586,092
651,429
79,994

726,285

8,895
71,451
3,624
589,855
639,535
81,825

7,158
470
6,688
(125 )
6,813

766
301
444
265
1,776

3,824
1,097
295
249
1,089
6,554
2,035
590
1,445
0.34
0.29

0.82 %
7.07
11.65
3.95

722,339

9,455
71,545
2,234
591,840
633,805
82,056

COMMON STOCK INFORMATION

The common stock of the Company is listed on the Nasdaq Stock Market (Nasdaq) under the symbol HMNF. As of December
31, 2019, the Company had 9,128,662 shares of common stock issued and 4,284,840 shares in treasury stock. As of December
31, 2019, there were 462 stockholders of record and 992 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
5, 2020, the last reported sale price of shares of our common stock on the Nasdaq was $21.11 per share. The Company has
not paid a dividend on its common stock during the two year period ending December 31, 2019. See “Liquidity and Capital
Resources – Dividends” in the “Management Discussion and Analysis” section of this annual report for a description of
restrictions on the ability of the Company and the Bank to pay dividends.

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
Nasdaq Bank Index. The graph and table assume that $100 was invested on December 31, 2014 and that all dividends were
reinvested.

Index
HMN Financial, Inc. .................................. $
Nasdaq Composite ..................................... $
Nasdaq Bank .............................................. $

12/31/14

12/31/15

12/31/16

12/31/17

12/31/18

12/31/19

100.00 $
100.00 $
100.00 $

93.15 $
106.96 $
107.08 $

141.13 $
116.45 $
147.27 $

154.03 $
150.96 $
155.68 $

158.23 $
146.67 $
129.17 $

169.44
200.49
160.44

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, 2020 at 10:00
a.m. (Central Time) at the Rochester Golf
and Country Club, 3100 West Country Club
Road, Rochester, Minnesota.

LEGAL COUNSEL
Faegre Drinker Biddle & Reath 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:

Equiniti Trust Company
EQ Shareowner Services
1110 Centre Pointe Curve, Suite 101
Mendota Heights, MN 55120
www.shareowneronline.com
(800) 468-9716

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, a provider of
clinical decision support products

SEQUOYA S. BORGMAN
Borgman Capital LLC, Founder and
Managing Director

MICHAEL A. BUE
Retired President and Chief Executive Officer
Marquette Bank Rochester

BRADLEY C. KREHBIEL
President and Chief Executive Officer
HMN and Home Federal Savings Bank

BERNARD R. NIGON
Retired Audit Partner with RSM US LLP
(formerly McGladrey & Pullen, LLP)

DR. WENDY S. SHANNON
Vice Chair
HMN and Home Federal Savings Bank
Educational consultant, PTECH in Minnesota,
Former Assistant Professor, Winona State
University

MARK E. UTZ
Attorney at law, Wendland Utz, Ltd.

Eagan
2805 Dodd Road, Suite 160
Eagan, MN 55121
(651) 405-2000

Kasson
502 South Mantorville Avenue
Kasson, MN 55944
(507) 634-4141

La Crescent
208 South Walnut
La Crescent, MN 55947
(507) 895-9200

Marshalltown
303 West Main Street
Marshalltown, IA 50158
(641) 754-6198

Owatonna
1015 West Frontage Road, Suite 100
Owatonna, MN 55060
(507) 413-6420

Pewaukee
1870 Meadow Lane
Pewaukee, WI 53072
(262) 337-9511

Rochester
1201 South Broadway
Rochester, MN 55901
(507) 536-2416

1016 Civic Center Drive NW
Rochester, MN 55901
(507) 535-1309

HANS K. ZIETLOW
Former Director of Real Estate for Kwik Trip,
Inc.

100 1st Avenue Bldg., Suite 200
Rochester, MN 55902
(507) 280-7256

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

LAWRENCE D. MCGRAW
Executive Vice President and
Chief Operating Officer
Home Federal Savings Bank

BRANCH OFFICES OF THE 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

2048 Superior Drive NW, Suite 400
Rochester, MN 55901
(507) 226-0800

Spring Valley
715 North Broadway
Spring Valley, MN 55975
(507) 346-9709

Winona
175 Center Street
Winona, MN 55987
(507) 453-6460

LOAN PRODUCTION OFFICES
Sartell
50 14th Ave E, Suite 100
Sartell, MN 56377
(320) 654-4020

1016 Civic Center Drive NW
Rochester, Minnesota 55901

507.535.1200 • www.hmnf.com

2019

ANNUAL REPORT