HMNF HMN Financial Inc

HMN Financial, Inc. (NASDAQ:HMNF): Third Quarter Highlights Net interest income up $757,000, or 8.5%, over third quarter of 2005 Net interest margin of 4.06%, up 27 basis points over third quarter of 2005 Provision for loan losses up $5.1 million, or 533.0%, over third quarter of 2005 Net income of $74,000, down $2.2 million, or 96.8%, from third quarter of 2005 Diluted earnings per share of $0.02, down $0.55, or 96.5%, from third quarter of 2005 Year to Date Highlights Net interest income up $2.4 million, or 9.4%, over first nine months of 2005 Net interest margin of 4.08%, up 32 basis points over first nine months of 2005 Provision for loan losses up $5.0 million, or 201.4%, over first nine months of 2005 Net income of $5.8 million, down $1.8 million, or 24.2%, from first nine months of 2005 Diluted earnings per share of $1.43, down $0.46, or 24.3%, from first nine months of 2005 EARNINGS SUMMARY Three Months Ended Nine Months Ended September 30, September 30, 2006 2005 2006 2005 Net income $73,512� 2,276,401� $5,757,288� 7,590,918� Diluted earnings per share 0.02� 0.57� 1.43� 1.89� Return on average assets 0.03� 0.92% 0.78� 1.03% Return on average equity 0.30� 10.02% 8.07� 11.51% Book value per share $21.21� 19.97� $21.21� 19.97� HMN Financial, Inc. (HMN) (NASDAQ:HMNF), the $991 million holding company for Home Federal Savings Bank (the Bank), today reported net income of $74,000 for the third quarter of 2006, down $2.2 million, or 96.8%, from net income of $2.3 million for the third quarter of 2005. Diluted earnings per common share for the third quarter of 2006 were $0.02, down $0.55, or 96.5%, from $0.57 for the third quarter of 2005. The decrease in net income is due to a $5.1 million increase in the loan loss provision between the periods as a result of increased commercial loan charge offs. Third Quarter Results Net Interest Income Net interest income was $9.7 million for the third quarter of 2006, an increase of $757,000, or 8.5%, compared to $8.9 million for the third quarter of 2005. Interest income was $17.2 million for the third quarter of 2006, an increase of $2.0 million, or 12.7%, from $15.2 million for the same period in 2005. Interest income increased because of an increase in the average interest rates earned on loans and investments. Interest rates increased primarily because of the 150 basis point increase in the prime interest rate between the periods. Increases in the prime rate, which is the rate that banks charge their prime business customers, generally increase the rates on adjustable rate consumer and commercial loans in the portfolio and new loans originated. The increase in interest income due to increased rates was partially offset by a $59 million decrease in the average outstanding loan portfolio balance between the periods due to an increase in commercial loan prepayments and a decrease in loan originations. The average yield earned on interest-earning assets was 7.19% for the third quarter of 2006, an increase of 74 basis points from the 6.45% yield for the third quarter of 2005. Interest expense was $7.5 million for the third quarter of 2006, an increase of $1.2 million, or 18.8%, compared to $6.3 million for the third quarter of 2005. Interest expense increased primarily because of higher interest rates paid on deposits which were caused by the 150 basis point increase in the federal funds rate between the periods. Increases in the federal funds rate, which is the rate that banks charge other banks for short term loans, generally increase the rates banks pay for deposits. The increase in deposit rates was partially offset by a change in the mix of funding sources between the periods. The average outstanding balances of brokered deposits and Federal Home Loan Bank advances of $86 million were replaced with other less expensive deposits. The average interest rate paid on interest-bearing liabilities was 3.34% for the third quarter of 2006, an increase of 52 basis points from the 2.82% paid for the third quarter of 2005. Net interest margin (net interest income divided by average interest earning assets) for the third quarter of 2006 was 4.06%, an increase of 27 basis points, compared to 3.79% for the third quarter of 2005. Provision for Loan Losses The provision for loan losses was $6.0 million for the third quarter of 2006, an increase of $5.1 million, or 533.0%, from $952,000 for the third quarter of 2005. The provision for loan losses increased primarily because $7.4 million in related commercial real estate development loans were charged off during the quarter. Most of the charged off loans had been downgraded to substandard and classified as non-accruing in the second quarter of 2006 due to nonperformance. During the third quarter, it was determined that the properties securing the loans, primarily developed and undeveloped single family home lots and a golf course, would be sold at auction in order to liquidate the assets and repay the loans. The properties were sold late in the third quarter at amounts substantially less than the recorded amounts due to an unanticipated decrease in the values of the properties. The loans were personally guaranteed and the Company is continuing to pursue repayment from the guarantors. The amounts charged off represent an estimate of the loss incurred after considering the auction proceeds and reviewing each guarantor�s financial position and assessing their ability to repay their personal obligations. Of the $14.4 million principal balance of these loans at June 30, 2006, $4.2 million is recorded as non-accruing at September 30, 2006. The Company does not anticipate making any material future cash expenditures in connection with these loans except for those relating to possible collection costs associated with enforcement of the personal guarantees. The increase in the provision related to loan charge offs was partially offset by a $22 million decrease in outstanding commercial loans during the third quarter of 2006. Total non-performing assets were $10.3 million at September 30, 2006, a decrease of $3.2 million, or 23.7%, from $13.5 million at June 30, 2006. Non-performing loans decreased $3.1 million and foreclosed, repossessed, and other assets decreased $96,000. The decrease in non-performing loans during the quarter relates primarily to the charge off of $6.9 million in commercial real estate development loans described above that were previously classified as non-performing. The decrease related to the charge offs was partially offset by an increase in other non-performing commercial real estate loans of $1.3 million, a $524,000 increase in non-performing commercial business loans, an $895,000 increase in non-performing single family loans, and a $1.1 million increase in non-performing consumer loans. Non-Interest Income and Expense Non-interest income was $1.7 million for the third quarter of 2006, an increase of $14,000, or 0.8%, from $1.7 million for the same period in 2005. Fees and service charges increased $114,000 between the periods primarily because of increased retail deposit account activity and fees. Gains on sales of loans decreased $144,000 due to a decrease in the single-family mortgage loans that were sold and a decrease in the profit margins realized on the loans that were sold. Competition in the single-family loan origination market remained strong and profit margins were decreased in order to remain competitive. Other non-interest income increased $59,000 primarily because of a decrease in the losses on the sale of repossessed assets in the third quarter of 2006 when compared to the same period in 2005. Non-interest expense was $5.4 million for the third quarter of 2006, a decrease of $110,000, or 2.0%, from $5.5 million for the same period of 2005. Compensation expense decreased $75,000 between the periods due to a decrease in incentive compensation that was partially offset by increased pension costs. Occupancy expense increased $88,000 primarily because of the additional costs associated with the new branch and loan origination offices opened in Rochester in the first quarter of 2006. Data processing costs increased $28,000 primarily because of an increase in internet and other banking services provided by a third party processor between the periods. Other operating expenses decreased $97,000 primarily because of decreased mortgage loan and commercial foreclosure costs in the third quarter of 2006 when compared to the same period in 2005. Because of the pre-tax loss for the quarter, an income tax benefit of $102,000 was recorded for the third quarter of 2006, a decrease of $2.0 million, or 105.4%, compared to $1.9 million in expense for the same period of 2005. Return on Assets and Equity Return on average assets for the third quarter of 2006 was 0.03%, compared to 0.92% for the third quarter of 2005. Return on average equity was 0.30% for the third quarter of 2006, compared to 10.02% for the same period of 2005. Book value per common share at September 30, 2006 was $21.21, compared to $19.97 at September 30, 2005. Nine Month Period Results Net Income Net income was $5.8 million for the nine-month period ended September 30, 2006, a decrease of $1.8 million, or 24.2%, compared to $7.6 million for the nine-month period ended September 30, 2005. Diluted earnings per common share for the nine-month period in 2006 were $1.43, down $0.46, or 24.3%, from $1.89 for the same period in 2005. Net Interest Income Net interest income was $28.8 million for the first nine months of 2006, an increase of $2.4 million, or 9.4%, from $26.4 million for the same period in 2005. Interest income was $50.2 million for the nine-month period ended September 30, 2006, an increase of $6.0 million, or 13.5%, from $44.2 million for the same period in 2005. Interest income increased primarily because of an increase in the average interest rates earned on loans and investments. Interest rates increased primarily because of the 150 basis point increase in the prime interest rate between the periods. The increase in interest income due to increased rates was partially offset by a $40 million decrease in the average outstanding loan portfolio balance between the periods due to an increase in commercial loan prepayments and a decrease in loan originations. The yield earned on interest-earning assets was 7.10% for the first nine months of 2006, an increase of 80 basis points from the 6.30% yield for the same period in 2005. Interest expense was $21.3 million for the nine-month period ended September 30, 2006, an increase of $3.5 million, or 19.5%, from $17.8 million for the same period in 2005. Interest expense increased primarily because of higher interest rates paid on deposits which were caused by the 150 basis point increase in the federal funds rate between the periods. The increase in deposit rates was partially offset by a change in the mix of funding sources between the periods. The average outstanding balances of brokered deposits and Federal Home Loan Bank advances of $45 million were replaced with other less expensive deposits. The average interest rate paid on interest-bearing liabilities was 3.22% for the first nine-months of 2006, an increase of 53 basis points from the 2.69% paid for the same period of 2005. Net interest margin (net interest income divided by average interest earning assets) for the first nine months of 2006 was 4.08%, an increase of 32 basis points, compared to 3.76% for the same period of 2005. Provision for Loan Losses The provision for loan losses was $7.5 million for the first nine-months of 2006, an increase of $5.0 million, or 201.4%, from $2.5 million for the same nine-month period in 2005. The provision for loan losses increased primarily because $7.4 million in related commercial real estate development loans were charged off during the third quarter as more fully described above in the third quarter �Provision for Loan Losses� discussion. The increase in the provision related to loan charge offs was partially offset by the $45 million decrease in outstanding commercial loans during the first nine months of 2006. Total non-performing assets were $10.3 million at September 30, 2006, an increase of $6.4 million, or 165.1%, from $3.9 million at December 31, 2005. Non-performing loans increased $6.9 million and foreclosed, repossessed and other nonperforming assets decreased $477,000 during the first nine months of 2006. The increase in non-performing loans during the nine month period relates primarily to a $4.3 million increase in non-performing commercial real estate loans, a $573,000 increase in non-performing commercial business loans, a $583,000 increase in non-performing single-family mortgage loans, and a $879,000 increase in non-performing consumer loans. A reconciliation of the Company�s allowance for loan losses for the nine-month periods ended September 30, 2006 and 2005 is summarized as follows: (in thousands) 2006� 2005� Balance at January 1, $8,777,655� $8,995,892� Provision 7,521,000� 2,495,000� Charge offs: Commercial loans (7,373,569) (2,614,530) Consumer loans (234,323) (195,020) Single family mortgage loans 0� (230,934) Recoveries 55,172� 182,921� Balance at September 30, $8,745,935� $8,633,329� Non-Interest Income and Expense Non-interest income was $5.0 million for the first nine months of 2006, an increase of $265,000, or 5.6%, from $4.7 million for the same period in 2005. Fees and service charges increased $336,000 between the periods primarily because of increased retail deposit account activity and fees. Security gains increased $48,000 due to increased security sales. Gains on sales of loans decreased $212,000 between the periods due to a decrease in the number of single-family mortgage loans sold and a decrease in the profit margins realized on the loans that were sold. Competition in the single-family loan origination market remained strong and profit margins were lowered in order to remain competitive. Other non-interest income increased $100,000 primarily because of a decrease in the losses recognized on repossessed assets in the first nine months of 2006 when compared to the same period of 2005. Non-interest expense was $17.1 million for the first nine months of 2006, an increase of $781,000, or 4.8%, from $16.4 million for the same period in 2005. Compensation expense increased $743,000 primarily because of increases in payroll due to annual pay increases and pension costs. Occupancy expense increased $255,000 primarily because of the additional costs associated with new branch and loan origination offices opened in Rochester in the first quarter of 2006. Data processing costs increased $121,000 primarily because of an increase in internet and other banking services provided by a third party processor between the periods. Other non-interest expense decreased $269,000 primarily because of a decrease in mortgage loan expenses and professional fees. Income tax expense was $3.4 million for the first nine months of 2006, a decrease of $1.2 million, or 26.5%, compared to $4.6 million for the same period of 2005. Income tax expense decreased primarily because of a decrease in taxable income. Return on Assets and Equity Return on average assets for the nine-month period ended September 30, 2006 was 0.78%, compared to 1.03% for the same period in 2005. Return on average equity was 8.07% for the nine-month period ended September 30, 2006, compared to 11.51% for the same period in 2005. President�s Statement �The financial results for the third quarter were negatively impacted by the commercial loan charge offs that were recognized,� said HMN President Michael McNeil. �While we strive to maintain the highest credit quality in our loan portfolio, unintended results can occur due to changing credit and market conditions. The charged off loans related to one real estate development and we believe are not indicative of the overall commercial loan portfolio. We remain confident in our business strategy and look forward to improved financial results.� General Information HMN Financial, Inc. and Home Federal Savings Bank are headquartered in Rochester, Minnesota. The Bank operates ten full service offices in southern Minnesota located in Albert Lea, Austin, LaCrescent, Rochester, Spring Valley and Winona and two full service offices in Iowa located in Marshalltown and Toledo. Home Federal Savings Bank also operates loan origination offices located in Sartell and Rochester, Minnesota. Eagle Crest Capital Bank, a division of Home Federal Savings Bank, operates branches in Edina and Rochester, Minnesota. Safe Harbor Statement This press release may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements include, but are not limited to those relating to the Company�s financial expectations for earnings and revenues. A number of factors could cause actual results to differ materially from the Company�s assumptions and expectations. These factors include possible legislative changes and adverse economic, business and competitive developments such as shrinking interest margins; reduced collateral values; deposit outflows; reduced demand for financial services and loan products; changes in accounting policies and guidelines, changes in monetary and fiscal policies of the federal government or changes in tax laws. Additional factors that may cause actual results to differ from the Company�s assumptions and expectations include those set forth in the Company�s most recent filings on form 10-K and Form 10-Q with the Securities and Exchange Commission. All forward-looking statements are qualified by, and should be considered in conjunction with, such cautionary statements. HMN FINANCIAL, INC. AND SUBSIDIARIES Consolidated Balance Sheets � � � � September 30, December 31, 2006� 2005� � (unaudited) � � � Assets Cash and cash equivalents $71,239,159� 47,268,795� Securities available for sale: Mortgage-backed and related securities (amortized cost $6,806,874 and $7,428,504) 6,220,609� 6,879,756� Other marketable securities (amortized cost $139,850,065 and $113,749,841) 139,787,337� 112,778,813� 146,007,946� 119,658,569� � Loans held for sale 4,216,500� 1,435,141� Loans receivable, net 729,381,119� 785,678,461� Accrued interest receivable 4,659,303� 4,460,014� Real estate, net 1,033,111� 1,214,621� Federal Home Loan Bank stock, at cost 7,955,700� 8,364,600� Mortgage servicing rights, net 2,139,158� 2,653,635� Premises and equipment, net 11,674,555� 11,941,863� Investment in limited partnerships 118,989� 141,048� Goodwill 3,800,938� 3,800,938� Core deposit intangible 134,367� 219,760� Prepaid expenses and other assets 6,697,618� 1,854,948� Deferred tax asset 2,199,400� 2,544,400� Total assets $991,257,863� 991,236,793� � � Liabilities and Stockholders� Equity Deposits $741,617,758� 731,536,560� Federal Home Loan Bank advances 150,900,000� 160,900,000� Accrued interest payable 1,434,822� 2,085,573� Customer escrows 1,090,363� 1,038,575� Accrued expenses and other liabilities 4,150,742� 4,947,816� Total liabilities 899,193,685� 900,508,524� Commitments and contingencies Stockholders� equity: Serial preferred stock: ($.01 par value) authorized 500,000 shares; issued and outstanding none 0� 0� Common stock ($.01 par value): authorized 11,000,000; issued shares 9,128,662 91,287� 91,287� Additional paid-in capital 57,786,780� 58,011,099� Retained earnings, subject to certain restrictions 101,911,810� 98,951,777� Accumulated other comprehensive loss (391,792) (917,577) Unearned employee stock ownership plan shares (4,205,988) (4,350,999) Unearned compensation restricted stock awards 0� (182,521) Treasury stock, at cost 4,785,198 and 4,721,402 shares (63,127,919) (60,874,797) Total stockholders� equity 92,064,178� 90,728,269� Total liabilities and stockholders� equity $991,257,863� 991,236,793� HMN FINANCIAL, INC. AND SUBSIDIARIES Consolidated Statements of Income (unaudited) � Three Months Ended Nine Months Ended September 30, September 30, � 2006 � 2005 � 2006 � 2005 Interest income: Loans receivable $14,962,250� 14,385,320� 44,746,541� 41,487,679� Securities available for sale: Mortgage-backed and related 66,408� 78,645� 205,839� 252,701� Other marketable 1,511,616� 645,871� 3,723,794� 1,941,809� Cash equivalents 545,550� 114,872� 1,254,410� 342,812� Other 89,337� 13,525� 238,142� 182,285� Total interest income 17,175,161� 15,238,233� 50,168,726� 44,207,286� � Interest expense: Deposits 5,813,416� 4,456,305� 16,197,525� 12,358,727� Federal Home Loan Bank advances 1,659,472� 1,836,269� 5,130,207� 5,485,461� Total interest expense 7,472,888� 6,292,574� 21,327,732� 17,844,188� Net interest income 9,702,273� 8,945,659� 28,840,994� 26,363,098� Provision for loan losses 6,026,000� 952,000� 7,521,000� 2,495,000� Net interest income after provision for loan losses 3,676,273� 7,993,659� 21,319,994� 23,868,098� � Non-interest income: Fees and service charges 820,075� 706,337� 2,330,661� 1,994,291� Mortgage servicing fees 291,157� 305,417� 896,091� 901,760� Securities gains, net 0� 0� 48,122� 0� Gain on sales of loans 481,209� 624,947� 1,029,794� 1,242,436� Losses in limited partnerships (6,500) (6,500) (22,059) (20,710) Other 149,479� 90,957� 705,106� 604,711� Total non-interest income 1,735,420� 1,721,158� 4,987,715� 4,722,488� � Non-interest expense: Compensation and benefits 2,706,431� 2,781,366� 9,083,004� 8,340,048� Occupancy 1,130,755� 1,042,417� 3,334,439� 3,079,131� Deposit insurance premiums 23,348� 34,679� 79,337� 97,204� Advertising 108,013� 101,775� 346,172� 291,448� Data processing 306,542� 278,880� 882,300� 761,719� Amortization of mortgage servicing rights, net 208,202� 256,763� 661,293� 766,885� Other 956,490� 1,053,536� 2,756,276� 3,025,033� Total non-interest expense 5,439,781� 5,549,416� 17,142,821� 16,361,468� Income (loss) before income tax expense (28,088) 4,165,401� 9,164,888� 12,229,118� Income tax (benefit) expense (101,600) 1,889,000� 3,407,600� 4,638,200� Net income $73,512� 2,276,401� 5,757,288� 7,590,918� Basic earnings per share $0.02� 0.59� 1.50� 1.98� Diluted earnings per share $0.02� 0.57� 1.43� 1.89� HMN FINANCIAL, INC. AND SUBSIDIARIES Selected Consolidated Financial Information (unaudited) Three Months Ended Nine Months Ended SELECTED FINANCIAL DATA: September 30, September 30, (Dollars in thousands, except per share data) 2006 � 2005 � 2006 � 2005 I. OPERATING DATA: Interest income $17,175� 15,238� 50,169� 44,207� Interest expense 7,473� 6,292� 21,328� 17,844� Net interest income 9,702� 8,946� 28,841� 26,363� � II. AVERAGE BALANCES: Assets (1) 991,379� 983,244� 989,291� 981,123� Loans receivable, net 747,261� 807,046� 764,322� 804,585� Mortgage-backed and related securities (1) 6,916� 8,266� 7,144� 8,790� Interest-earning assets (1) 947,529� 937,400� 945,385� 937,715� Interest-bearing liabilities 887,037� 884,155� 886,403� 885,675� Equity (1) 96,248� 90,129� 95,339� 88,205� � III. PERFORMANCE RATIOS: (1) Return on average assets (annualized) 0.03% 0.92% 0.78% 1.03% Interest rate spread information: Average during period 3.85� 3.63� 3.88� 3.61� End of period 3.97� 3.51� 3.97� 3.51� Net interest margin 4.06� 3.79� 4.08� 3.76� Ratio of operating expense to average total assets (annualized) 2.18� 2.24� 2.32� 2.23� Return on average equity (annualized) 0.30� 10.02� 8.07� 11.51� Efficiency 47.56� � 52.03� � 50.68� 52.63� Sept. 30, Dec. 31, Sept. 30, 2006� � 2005� � 2005� IV. ASSET QUALITY: Total non-performing assets $10,294� 3,883� 4,651� Non-performing assets to total assets 1.04% 0.39% 0.47% Non-performing loans to total loans receivable, net 1.26% 0.30% 0.37% Allowance for loan losses $8,746� 8,778� 8,633� Allowance for loan losses to total loans receivable, net 1.20% 1.11% 1.06% Allowance for loan losses to non-performing loans 94.89� 376.88� 289.51� � V. BOOK VALUE PER SHARE: Book value per share $21.21� � 20.59� � 19.97� Nine Months Year Nine Months Ended Ended Ended Sept 30, 2006 � Dec 31, 2005 � Sept 30, 2005 VI. CAPITAL RATIOS: Stockholders� equity to total assets, at end of period 9.29% 9.15% 8.96% Average stockholders� equity to average assets (1) 9.64� 9.05� 8.99� Ratio of average interest-earning assets to average interest-bearing liabilities (1) 106.65� � 105.96� � 105.88� Sept. 30, Dec. 31, Sept. 30, 2006 � 2005 � 2005 VII. EMPLOYEE DATA: Number of full time equivalent employees 207� � 208� � 206� � � (1) Average balances were calculated based upon amortized cost without the market value impact of SFAS 115. HMN Financial, Inc. (NASDAQ:HMNF): Third Quarter Highlights -- Net interest income up $757,000, or 8.5%, over third quarter of 2005 -- Net interest margin of 4.06%, up 27 basis points over third quarter of 2005 -- Provision for loan losses up $5.1 million, or 533.0%, over third quarter of 2005 -- Net income of $74,000, down $2.2 million, or 96.8%, from third quarter of 2005 -- Diluted earnings per share of $0.02, down $0.55, or 96.5%, from third quarter of 2005 Year to Date Highlights -- Net interest income up $2.4 million, or 9.4%, over first nine months of 2005 -- Net interest margin of 4.08%, up 32 basis points over first nine months of 2005 -- Provision for loan losses up $5.0 million, or 201.4%, over first nine months of 2005 -- Net income of $5.8 million, down $1.8 million, or 24.2%, from first nine months of 2005 -- Diluted earnings per share of $1.43, down $0.46, or 24.3%, from first nine months of 2005 -0- *T EARNINGS SUMMARY Three Months Ended Nine Months Ended September 30, September 30, --------------------- --------------------- 2006 2005 2006 2005 --------------------- --------------------- Net income $73,512 2,276,401 $5,757,288 7,590,918 Diluted earnings per share 0.02 0.57 1.43 1.89 Return on average assets 0.03 0.92% 0.78 1.03% Return on average equity 0.30 10.02% 8.07 11.51% Book value per share $21.21 19.97 $21.21 19.97 *T HMN Financial, Inc. (HMN) (NASDAQ:HMNF), the $991 million holding company for Home Federal Savings Bank (the Bank), today reported net income of $74,000 for the third quarter of 2006, down $2.2 million, or 96.8%, from net income of $2.3 million for the third quarter of 2005. Diluted earnings per common share for the third quarter of 2006 were $0.02, down $0.55, or 96.5%, from $0.57 for the third quarter of 2005. The decrease in net income is due to a $5.1 million increase in the loan loss provision between the periods as a result of increased commercial loan charge offs. Third Quarter Results Net Interest Income Net interest income was $9.7 million for the third quarter of 2006, an increase of $757,000, or 8.5%, compared to $8.9 million for the third quarter of 2005. Interest income was $17.2 million for the third quarter of 2006, an increase of $2.0 million, or 12.7%, from $15.2 million for the same period in 2005. Interest income increased because of an increase in the average interest rates earned on loans and investments. Interest rates increased primarily because of the 150 basis point increase in the prime interest rate between the periods. Increases in the prime rate, which is the rate that banks charge their prime business customers, generally increase the rates on adjustable rate consumer and commercial loans in the portfolio and new loans originated. The increase in interest income due to increased rates was partially offset by a $59 million decrease in the average outstanding loan portfolio balance between the periods due to an increase in commercial loan prepayments and a decrease in loan originations. The average yield earned on interest-earning assets was 7.19% for the third quarter of 2006, an increase of 74 basis points from the 6.45% yield for the third quarter of 2005. Interest expense was $7.5 million for the third quarter of 2006, an increase of $1.2 million, or 18.8%, compared to $6.3 million for the third quarter of 2005. Interest expense increased primarily because of higher interest rates paid on deposits which were caused by the 150 basis point increase in the federal funds rate between the periods. Increases in the federal funds rate, which is the rate that banks charge other banks for short term loans, generally increase the rates banks pay for deposits. The increase in deposit rates was partially offset by a change in the mix of funding sources between the periods. The average outstanding balances of brokered deposits and Federal Home Loan Bank advances of $86 million were replaced with other less expensive deposits. The average interest rate paid on interest-bearing liabilities was 3.34% for the third quarter of 2006, an increase of 52 basis points from the 2.82% paid for the third quarter of 2005. Net interest margin (net interest income divided by average interest earning assets) for the third quarter of 2006 was 4.06%, an increase of 27 basis points, compared to 3.79% for the third quarter of 2005. Provision for Loan Losses The provision for loan losses was $6.0 million for the third quarter of 2006, an increase of $5.1 million, or 533.0%, from $952,000 for the third quarter of 2005. The provision for loan losses increased primarily because $7.4 million in related commercial real estate development loans were charged off during the quarter. Most of the charged off loans had been downgraded to substandard and classified as non-accruing in the second quarter of 2006 due to nonperformance. During the third quarter, it was determined that the properties securing the loans, primarily developed and undeveloped single family home lots and a golf course, would be sold at auction in order to liquidate the assets and repay the loans. The properties were sold late in the third quarter at amounts substantially less than the recorded amounts due to an unanticipated decrease in the values of the properties. The loans were personally guaranteed and the Company is continuing to pursue repayment from the guarantors. The amounts charged off represent an estimate of the loss incurred after considering the auction proceeds and reviewing each guarantor's financial position and assessing their ability to repay their personal obligations. Of the $14.4 million principal balance of these loans at June 30, 2006, $4.2 million is recorded as non-accruing at September 30, 2006. The Company does not anticipate making any material future cash expenditures in connection with these loans except for those relating to possible collection costs associated with enforcement of the personal guarantees. The increase in the provision related to loan charge offs was partially offset by a $22 million decrease in outstanding commercial loans during the third quarter of 2006. Total non-performing assets were $10.3 million at September 30, 2006, a decrease of $3.2 million, or 23.7%, from $13.5 million at June 30, 2006. Non-performing loans decreased $3.1 million and foreclosed, repossessed, and other assets decreased $96,000. The decrease in non-performing loans during the quarter relates primarily to the charge off of $6.9 million in commercial real estate development loans described above that were previously classified as non-performing. The decrease related to the charge offs was partially offset by an increase in other non-performing commercial real estate loans of $1.3 million, a $524,000 increase in non-performing commercial business loans, an $895,000 increase in non-performing single family loans, and a $1.1 million increase in non-performing consumer loans. Non-Interest Income and Expense Non-interest income was $1.7 million for the third quarter of 2006, an increase of $14,000, or 0.8%, from $1.7 million for the same period in 2005. Fees and service charges increased $114,000 between the periods primarily because of increased retail deposit account activity and fees. Gains on sales of loans decreased $144,000 due to a decrease in the single-family mortgage loans that were sold and a decrease in the profit margins realized on the loans that were sold. Competition in the single-family loan origination market remained strong and profit margins were decreased in order to remain competitive. Other non-interest income increased $59,000 primarily because of a decrease in the losses on the sale of repossessed assets in the third quarter of 2006 when compared to the same period in 2005. Non-interest expense was $5.4 million for the third quarter of 2006, a decrease of $110,000, or 2.0%, from $5.5 million for the same period of 2005. Compensation expense decreased $75,000 between the periods due to a decrease in incentive compensation that was partially offset by increased pension costs. Occupancy expense increased $88,000 primarily because of the additional costs associated with the new branch and loan origination offices opened in Rochester in the first quarter of 2006. Data processing costs increased $28,000 primarily because of an increase in internet and other banking services provided by a third party processor between the periods. Other operating expenses decreased $97,000 primarily because of decreased mortgage loan and commercial foreclosure costs in the third quarter of 2006 when compared to the same period in 2005. Because of the pre-tax loss for the quarter, an income tax benefit of $102,000 was recorded for the third quarter of 2006, a decrease of $2.0 million, or 105.4%, compared to $1.9 million in expense for the same period of 2005. Return on Assets and Equity Return on average assets for the third quarter of 2006 was 0.03%, compared to 0.92% for the third quarter of 2005. Return on average equity was 0.30% for the third quarter of 2006, compared to 10.02% for the same period of 2005. Book value per common share at September 30, 2006 was $21.21, compared to $19.97 at September 30, 2005. Nine Month Period Results Net Income Net income was $5.8 million for the nine-month period ended September 30, 2006, a decrease of $1.8 million, or 24.2%, compared to $7.6 million for the nine-month period ended September 30, 2005. Diluted earnings per common share for the nine-month period in 2006 were $1.43, down $0.46, or 24.3%, from $1.89 for the same period in 2005. Net Interest Income Net interest income was $28.8 million for the first nine months of 2006, an increase of $2.4 million, or 9.4%, from $26.4 million for the same period in 2005. Interest income was $50.2 million for the nine-month period ended September 30, 2006, an increase of $6.0 million, or 13.5%, from $44.2 million for the same period in 2005. Interest income increased primarily because of an increase in the average interest rates earned on loans and investments. Interest rates increased primarily because of the 150 basis point increase in the prime interest rate between the periods. The increase in interest income due to increased rates was partially offset by a $40 million decrease in the average outstanding loan portfolio balance between the periods due to an increase in commercial loan prepayments and a decrease in loan originations. The yield earned on interest-earning assets was 7.10% for the first nine months of 2006, an increase of 80 basis points from the 6.30% yield for the same period in 2005. Interest expense was $21.3 million for the nine-month period ended September 30, 2006, an increase of $3.5 million, or 19.5%, from $17.8 million for the same period in 2005. Interest expense increased primarily because of higher interest rates paid on deposits which were caused by the 150 basis point increase in the federal funds rate between the periods. The increase in deposit rates was partially offset by a change in the mix of funding sources between the periods. The average outstanding balances of brokered deposits and Federal Home Loan Bank advances of $45 million were replaced with other less expensive deposits. The average interest rate paid on interest-bearing liabilities was 3.22% for the first nine-months of 2006, an increase of 53 basis points from the 2.69% paid for the same period of 2005. Net interest margin (net interest income divided by average interest earning assets) for the first nine months of 2006 was 4.08%, an increase of 32 basis points, compared to 3.76% for the same period of 2005. Provision for Loan Losses The provision for loan losses was $7.5 million for the first nine-months of 2006, an increase of $5.0 million, or 201.4%, from $2.5 million for the same nine-month period in 2005. The provision for loan losses increased primarily because $7.4 million in related commercial real estate development loans were charged off during the third quarter as more fully described above in the third quarter "Provision for Loan Losses" discussion. The increase in the provision related to loan charge offs was partially offset by the $45 million decrease in outstanding commercial loans during the first nine months of 2006. Total non-performing assets were $10.3 million at September 30, 2006, an increase of $6.4 million, or 165.1%, from $3.9 million at December 31, 2005. Non-performing loans increased $6.9 million and foreclosed, repossessed and other nonperforming assets decreased $477,000 during the first nine months of 2006. The increase in non-performing loans during the nine month period relates primarily to a $4.3 million increase in non-performing commercial real estate loans, a $573,000 increase in non-performing commercial business loans, a $583,000 increase in non-performing single-family mortgage loans, and a $879,000 increase in non-performing consumer loans. A reconciliation of the Company's allowance for loan losses for the nine-month periods ended September 30, 2006 and 2005 is summarized as follows: -0- *T (in thousands) 2006 2005 ----------- ----------- Balance at January 1, $8,777,655 $8,995,892 Provision 7,521,000 2,495,000 Charge offs: Commercial loans (7,373,569) (2,614,530) Consumer loans (234,323) (195,020) Single family mortgage loans 0 (230,934) Recoveries 55,172 182,921 ----------- ----------- Balance at September 30, $8,745,935 $8,633,329 =========== =========== *T Non-Interest Income and Expense Non-interest income was $5.0 million for the first nine months of 2006, an increase of $265,000, or 5.6%, from $4.7 million for the same period in 2005. Fees and service charges increased $336,000 between the periods primarily because of increased retail deposit account activity and fees. Security gains increased $48,000 due to increased security sales. Gains on sales of loans decreased $212,000 between the periods due to a decrease in the number of single-family mortgage loans sold and a decrease in the profit margins realized on the loans that were sold. Competition in the single-family loan origination market remained strong and profit margins were lowered in order to remain competitive. Other non-interest income increased $100,000 primarily because of a decrease in the losses recognized on repossessed assets in the first nine months of 2006 when compared to the same period of 2005. Non-interest expense was $17.1 million for the first nine months of 2006, an increase of $781,000, or 4.8%, from $16.4 million for the same period in 2005. Compensation expense increased $743,000 primarily because of increases in payroll due to annual pay increases and pension costs. Occupancy expense increased $255,000 primarily because of the additional costs associated with new branch and loan origination offices opened in Rochester in the first quarter of 2006. Data processing costs increased $121,000 primarily because of an increase in internet and other banking services provided by a third party processor between the periods. Other non-interest expense decreased $269,000 primarily because of a decrease in mortgage loan expenses and professional fees. Income tax expense was $3.4 million for the first nine months of 2006, a decrease of $1.2 million, or 26.5%, compared to $4.6 million for the same period of 2005. Income tax expense decreased primarily because of a decrease in taxable income. Return on Assets and Equity Return on average assets for the nine-month period ended September 30, 2006 was 0.78%, compared to 1.03% for the same period in 2005. Return on average equity was 8.07% for the nine-month period ended September 30, 2006, compared to 11.51% for the same period in 2005. President's Statement "The financial results for the third quarter were negatively impacted by the commercial loan charge offs that were recognized," said HMN President Michael McNeil. "While we strive to maintain the highest credit quality in our loan portfolio, unintended results can occur due to changing credit and market conditions. The charged off loans related to one real estate development and we believe are not indicative of the overall commercial loan portfolio. We remain confident in our business strategy and look forward to improved financial results." General Information HMN Financial, Inc. and Home Federal Savings Bank are headquartered in Rochester, Minnesota. The Bank operates ten full service offices in southern Minnesota located in Albert Lea, Austin, LaCrescent, Rochester, Spring Valley and Winona and two full service offices in Iowa located in Marshalltown and Toledo. Home Federal Savings Bank also operates loan origination offices located in Sartell and Rochester, Minnesota. Eagle Crest Capital Bank, a division of Home Federal Savings Bank, operates branches in Edina and Rochester, Minnesota. Safe Harbor Statement This press release may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements include, but are not limited to those relating to the Company's financial expectations for earnings and revenues. A number of factors could cause actual results to differ materially from the Company's assumptions and expectations. These factors include possible legislative changes and adverse economic, business and competitive developments such as shrinking interest margins; reduced collateral values; deposit outflows; reduced demand for financial services and loan products; changes in accounting policies and guidelines, changes in monetary and fiscal policies of the federal government or changes in tax laws. Additional factors that may cause actual results to differ from the Company's assumptions and expectations include those set forth in the Company's most recent filings on form 10-K and Form 10-Q with the Securities and Exchange Commission. All forward-looking statements are qualified by, and should be considered in conjunction with, such cautionary statements. -0- *T HMN FINANCIAL, INC. AND SUBSIDIARIES Consolidated Balance Sheets ---------------------------------------------------------------------- September 30, December 31, 2006 2005 (unaudited) ---------------------------------------------------------------------- Assets Cash and cash equivalents................... $71,239,159 47,268,795 Securities available for sale: Mortgage-backed and related securities (amortized cost $6,806,874 and $7,428,504)............................. 6,220,609 6,879,756 Other marketable securities (amortized cost $139,850,065 and $113,749,841)..... 139,787,337 112,778,813 ------------- ------------ 146,007,946 119,658,569 ------------- ------------ Loans held for sale......................... 4,216,500 1,435,141 Loans receivable, net....................... 729,381,119 785,678,461 Accrued interest receivable................. 4,659,303 4,460,014 Real estate, net............................ 1,033,111 1,214,621 Federal Home Loan Bank stock, at cost....... 7,955,700 8,364,600 Mortgage servicing rights, net.............. 2,139,158 2,653,635 Premises and equipment, net................. 11,674,555 11,941,863 Investment in limited partnerships.......... 118,989 141,048 Goodwill.................................... 3,800,938 3,800,938 Core deposit intangible..................... 134,367 219,760 Prepaid expenses and other assets........... 6,697,618 1,854,948 Deferred tax asset.......................... 2,199,400 2,544,400 ------------- ------------ Total assets..............................$991,257,863 991,236,793 ============= ============ Liabilities and Stockholders' Equity Deposits....................................$741,617,758 731,536,560 Federal Home Loan Bank advances............. 150,900,000 160,900,000 Accrued interest payable.................... 1,434,822 2,085,573 Customer escrows............................ 1,090,363 1,038,575 Accrued expenses and other liabilities...... 4,150,742 4,947,816 ------------- ------------ Total liabilities......................... 899,193,685 900,508,524 ------------- ------------ Commitments and contingencies Stockholders' equity: Serial preferred stock: ($.01 par value) authorized 500,000 shares; issued and outstanding none......................... 0 0 Common stock ($.01 par value): authorized 11,000,000; issued shares 9,128,662...... 91,287 91,287 Additional paid-in capital.................. 57,786,780 58,011,099 Retained earnings, subject to certain restrictions............................... 101,911,810 98,951,777 Accumulated other comprehensive loss........ (391,792) (917,577) Unearned employee stock ownership plan shares..................................... (4,205,988) (4,350,999) Unearned compensation restricted stock awards..................................... 0 (182,521) Treasury stock, at cost 4,785,198 and 4,721,402 shares........................... (63,127,919) (60,874,797) ------------- ------------ Total stockholders' equity................ 92,064,178 90,728,269 ------------- ------------ Total liabilities and stockholders' equity..$991,257,863 991,236,793 ============= ============ *T -0- *T HMN FINANCIAL, INC. AND SUBSIDIARIES Consolidated Statements of Income (unaudited) ---------------------------------------------------------------------- Three Months Ended Nine Months Ended September 30, September 30, 2006 2005 2006 2005 ---------------------------------------------------------------------- Interest income: Loans receivable....$14,962,250 14,385,320 44,746,541 41,487,679 Securities available for sale: Mortgage-backed and related..... 66,408 78,645 205,839 252,701 Other marketable. 1,511,616 645,871 3,723,794 1,941,809 Cash equivalents.... 545,550 114,872 1,254,410 342,812 Other............... 89,337 13,525 238,142 182,285 ------------ ----------- ----------- ----------- Total interest income.......... 17,175,161 15,238,233 50,168,726 44,207,286 ------------ ----------- ----------- ----------- Interest expense: Deposits............ 5,813,416 4,456,305 16,197,525 12,358,727 Federal Home Loan Bank advances...... 1,659,472 1,836,269 5,130,207 5,485,461 ------------ ----------- ----------- ----------- Total interest expense.......... 7,472,888 6,292,574 21,327,732 17,844,188 ------------ ----------- ----------- ----------- Net interest income........... 9,702,273 8,945,659 28,840,994 26,363,098 Provision for loan losses............... 6,026,000 952,000 7,521,000 2,495,000 ------------ ----------- ----------- ----------- Net interest income after provision for loan losses...... 3,676,273 7,993,659 21,319,994 23,868,098 ------------ ----------- ----------- ----------- Non-interest income: Fees and service charges............ 820,075 706,337 2,330,661 1,994,291 Mortgage servicing fees............... 291,157 305,417 896,091 901,760 Securities gains, net................ 0 0 48,122 0 Gain on sales of loans.............. 481,209 624,947 1,029,794 1,242,436 Losses in limited partnerships....... (6,500) (6,500) (22,059) (20,710) Other............... 149,479 90,957 705,106 604,711 ------------ ----------- ----------- ----------- Total non-interest income........... 1,735,420 1,721,158 4,987,715 4,722,488 ------------ ----------- ----------- ----------- Non-interest expense: Compensation and benefits........... 2,706,431 2,781,366 9,083,004 8,340,048 Occupancy........... 1,130,755 1,042,417 3,334,439 3,079,131 Deposit insurance premiums........... 23,348 34,679 79,337 97,204 Advertising......... 108,013 101,775 346,172 291,448 Data processing..... 306,542 278,880 882,300 761,719 Amortization of mortgage servicing rights, net........ 208,202 256,763 661,293 766,885 Other............... 956,490 1,053,536 2,756,276 3,025,033 ------------ ----------- ----------- ----------- Total non-interest expense.......... 5,439,781 5,549,416 17,142,821 16,361,468 ------------ ----------- ----------- ----------- Income (loss) before income tax expense.......... (28,088) 4,165,401 9,164,888 12,229,118 Income tax (benefit) expense.............. (101,600) 1,889,000 3,407,600 4,638,200 ------------ ----------- ----------- ----------- Net income........ $73,512 2,276,401 5,757,288 7,590,918 ============ =========== =========== =========== Basic earnings per share................ $0.02 0.59 1.50 1.98 ============ =========== =========== =========== Diluted earnings per share................ $0.02 0.57 1.43 1.89 ============ =========== =========== =========== *T -0- *T HMN FINANCIAL, INC. AND SUBSIDIARIES Selected Consolidated Financial Information (unaudited) Three Months Ended Nine Months Ended SELECTED FINANCIAL DATA: September 30, September 30, (Dollars in thousands, except per share data) 2006 2005 2006 2005 ---------------------------------------------------------------------- I. OPERATING DATA: Interest income............. $17,175 15,238 50,169 44,207 Interest expense............ 7,473 6,292 21,328 17,844 Net interest income......... 9,702 8,946 28,841 26,363 II. AVERAGE BALANCES: Assets (1).................. 991,379 983,244 989,291 981,123 Loans receivable, net....... 747,261 807,046 764,322 804,585 Mortgage-backed and related securities (1)............. 6,916 8,266 7,144 8,790 Interest-earning assets (1). 947,529 937,400 945,385 937,715 Interest-bearing liabilities 887,037 884,155 886,403 885,675 Equity (1).................. 96,248 90,129 95,339 88,205 III. PERFORMANCE RATIOS: (1) Return on average assets (annualized)............... 0.03% 0.92% 0.78% 1.03% Interest rate spread information: Average during period.... 3.85 3.63 3.88 3.61 End of period............ 3.97 3.51 3.97 3.51 Net interest margin......... 4.06 3.79 4.08 3.76 Ratio of operating expense to average total assets (annualized)............... 2.18 2.24 2.32 2.23 Return on average equity (annualized)............... 0.30 10.02 8.07 11.51 Efficiency.................. 47.56 52.03 50.68 52.63 ---------------------------- Sept. 30, Dec. 31, Sept. 30, 2006 2005 2005 ---------------------------- IV. ASSET QUALITY: Total non-performing assets. $10,294 3,883 4,651 Non-performing assets to total assets............... 1.04% 0.39% 0.47% Non-performing loans to total loans receivable, net 1.26% 0.30% 0.37% Allowance for loan losses... $8,746 8,778 8,633 Allowance for loan losses to total loans receivable, net 1.20% 1.11% 1.06% Allowance for loan losses to non-performing loans....... 94.89 376.88 289.51 V. BOOK VALUE PER SHARE: Book value per share........ $21.21 20.59 19.97 ---------------------------- Nine Nine Months Year Months Ended Ended Ended Sept 30, Dec 31, Sept 30, 2006 2005 2005 ---------------------------- VI. CAPITAL RATIOS: Stockholders' equity to total assets, at end of period..................... 9.29% 9.15% 8.96% Average stockholders' equity to average assets (1)...... 9.64 9.05 8.99 Ratio of average interest- earning assets to average interest-bearing liabilities (1)............ 106.65 105.96 105.88 ---------------------------- Sept. 30, Dec. 31, Sept. 30, 2006 2005 2005 ---------------------------- VII. EMPLOYEE DATA: Number of full time equivalent employees....... 207 208 206 ---------------------------------------------------------------------- *T (1) Average balances were calculated based upon amortized cost without the market value impact of SFAS 115.