HMN Financial, Inc. Announces First Quarter Results

HMN Financial, Inc. (NASDAQ:HMNF):

HMN Financial, Inc. (HMN or the Company) (NASDAQ:HMNF), the $706 million holding company for Home Federal Savings Bank (the Bank), today reported net income of $2.8 million for the first quarter of 2012, an improvement of $2.4 million, compared to net income of $0.4 million for the first quarter of 2011. Net income available to common shareholders was $2.3 million for the first quarter of 2012, an improvement of $2.3 million, from the net loss available to common shareholders of $32,000 for the first quarter of 2011. Diluted earnings per common share for the first quarter of 2012 were $0.58, an improvement of $0.59 from the diluted loss per common share of $0.01 for the first quarter of 2011. The improvement in net income was due primarily to a $2.1 million decrease in the provision for loan losses between the periods, $0.6 million gain on the previously announced branch sale, and $0.4 million increase in the gains recognized on the sales of loans between the periods. These increases in income were partially offset by a $1.2 million decrease in net interest income as a result of a decrease in interest earning assets between the periods.

President’s Statement
"We are pleased to report net income for the first quarter of 2012, a reduction in our non-performing assets, and the achievement of the minimum core capital ratio established by our primary banking regulator,” said Home Federal Savings Bank President, Bradley Krehbiel. “We will continue to focus our efforts on increasing our core deposit relationships while reducing non-performing assets and expenses. We believe that, over time, our focus on these areas will be effective in generating improved financial results.”

First Quarter Results

Net Interest Income
Net interest income was $6.2 million for the first quarter of 2012, a decrease of $1.2 million, or 16.5%, compared to $7.4 million for the first quarter of 2011. Interest income was $8.3 million for the first quarter of 2012, a decrease of $2.4 million, or 22.8%, from $10.7 million for the first quarter of 2011. Interest income decreased between the periods primarily because of a $125 million decrease in average interest-earning assets between the periods. Average interest earning assets decreased between the periods primarily because of a decrease in the commercial loan portfolio, which occurred because of declining loan demand and the Company’s focus on improving credit quality, reducing loan concentrations, managing interest rate risk and improving capital ratios. The average yield earned on interest-earning assets was 4.70% for the first quarter of 2012, a decrease of 51 basis points from the 5.21% average yield for the first quarter of 2011.

Interest expense was $2.1 million for the first quarter of 2012, a decrease of $1.2 million, or 36.9%, compared to $3.3 million for the first quarter of 2011. Interest expense decreased primarily because of a $119 million decrease in the average interest-bearing liabilities between the periods. The decrease in average interest-bearing liabilities is primarily the result of a decrease in the outstanding borrowings and brokered certificates of deposits between the periods and a decrease in other deposits as a result of the branch sale that was completed in the first quarter of 2012. The decrease in borrowings and brokered deposits between the periods was the result of using the proceeds from loan principal payments to fund maturing borrowings and brokered deposits. Interest expense also decreased because of the lower interest rates paid on money market accounts and certificates of deposits. The decreased rates were the result of the low interest rate environment that continued to exist during the first quarter of 2012. The average interest rate paid on interest-bearing liabilities was 1.22% for the first quarter of 2012, a decrease of 44 basis points from the 1.66% average interest rate paid in the first quarter of 2011. Net interest margin (net interest income divided by average interest earning assets) for the first quarter of 2012 was 3.53%, a decrease of 9 basis points, compared to 3.62% for the first quarter of 2011.

Provision for Loan Losses
The provision for loan losses was ($0.1) million for the first quarter of 2012, a decrease of $2.1 million compared to $2.0 million for the first quarter of 2011. The provision for loan losses decreased in the first quarter of 2012 primarily because there were fewer decreases in the estimated value of the underlying collateral supporting commercial real estate loans that required additional allowances in the current period when compared to the first quarter of 2011. The provision also decreased because of a decrease in the required reserves for certain risk rated commercial loans as a result of an internal loan portfolio analysis that was performed during the quarter. Total non-performing assets were $46.6 million at March 31, 2012, a decrease of $4.0 million, or 7.9%, from $50.6 million at December 31, 2011. Non-performing loans decreased $1.0 million and foreclosed and repossessed assets decreased $3.0 million during the first quarter of 2012. The non-performing loan and foreclosed and repossessed asset activity for the first quarter of 2012 was as follows:

Of the $2.9 million in charge offs recorded during the first quarter of 2012, $1.7 million related to a charge off of a commercial development loan and an additional $0.8 million related to a charge off of a residential development loan as a result of obtaining updated appraisals of the underlying collateral on these loans. The impact of the charge offs on the provision for loan losses in the first quarter of 2012 was mitigated because of the $2.3 million in allocated loan loss reserves that had been previously recorded on the charged off loans.

A reconciliation of the Company’s allowance for loan losses for the first quarters of 2012 and 2011 is summarized as follows:

The following table summarizes the amounts and categories of non-performing assets in the Bank’s portfolio and loan delinquency information as of the two most recently completed quarters.

(1) Excludes non-accrual loans.

The following table summarizes the number and types of commercial real estate loans (the largest category of non-performing loans) that were non-performing as of the end of the two most recently completed quarters.

The decrease in the non-performing commercial real estate loans is due primarily to the $2.6 million in commercial real estate loans that were charged off during the quarter.

The following table summarizes the number of lending relationships and industry of commercial business loans that were non-performing as of the end of the two most recently completed quarters.

Non-Interest Income and Expense
Non-interest income was $2.7 million for the first quarter of 2012, an increase of $0.9 million, or 51.5%, from $1.8 million for the first quarter of 2011. We realized a one time gain on sale of branch office of $0.6 million as a result of the previously announced sale of the Toledo, Iowa branch. Gain on sales of loans increased $0.4 million between the periods due to an increase in the gains recognized on both commercial government guaranteed loans and single family loans between the periods. The increase in the gains recognized on single family loans was due to an increase in loan originations and sales as a result of the low interest rate environment that existed during the first quarter of 2012. Other non-interest income increased $67,000 between the periods because of an increase in rental income on other real estate owned and an increase in the sale of non-insured investment products. Fees and service charges decreased $95,000 between the periods primarily because of a decrease in late fees and overdraft charges. Loan servicing fees decreased $18,000 between the periods primarily because of a decrease in the number of single family loans that are being serviced for others.

Non-interest expense was $6.2 million for the first quarter of 2012, a decrease of $0.6 million, or 8.1%, from $6.8 million for the first quarter of 2011. Other non-interest expense decreased $170,000 between the periods primarily because of decreased legal expenses related to non-performing assets and regulatory compliance. Compensation expense decreased $147,000 primarily because of a decrease in the number of employees between the periods. Deposit insurance expense decreased $134,000 primarily because of the decrease in assets between the periods. The loss on real estate owned decreased $124,000 between the periods from a loss in the first quarter of 2011 to a gain in the first quarter of 2012 primarily because of the gain recognized on a commercial office building that was sold during the quarter. Occupancy expense decreased $58,000 primarily because of a decrease in depreciation expense as a result of having fewer branch facilities. Data processing expense increased $84,000 between the periods primarily because of a one time incentive that was received by the Company in the first quarter of 2011 related to a change in our ATM and debit card vendor.

The effect of income taxes changed $76,000 between the periods from an expense of $76,000 in the first quarter of 2011 to no expense in the first quarter of 2012. In the second quarter of 2010, the Company recorded a deferred tax asset valuation reserve against its entire deferred tax asset balance and the Company continued to maintain a valuation reserve against the entire deferred tax asset balance at March 31, 2012. Since the valuation reserve is established against the entire deferred tax asset balance, no income tax expense was recorded for the first quarter of 2012. The income tax expense recorded in the first quarter of 2011 relates to the taxes on the change in the fair market value of the available for sale investment portfolio.

Net Income (Loss) Available to Common Shareholders
The net income (loss) available to common shareholders was $2.3 million for the first quarter of 2012, an increase of $2.3 million from the $32,000 net loss available to common shareholders in the first quarter of 2011. The net income (loss) available to common shareholders increased primarily because of the change in the net income (loss) between the periods. The Company has deferred the last five quarterly dividend payments, beginning with the February 15, 2011 dividend payment, on its Fixed Rate Cumulative Perpetual Preferred Stock, Series A issued to the United States Treasury Department as part of the TARP Capital Purchase Program. The deferred dividend payments have been accrued for payment in the future and are being reported for the deferral period as a preferred dividend requirement that is deducted from income for financial statement purposes to arrive at the net income (loss) available to common shareholders. Under the terms of the certificate of designations for the preferred stock, dividend payments may be deferred without default, but the dividend is cumulative and, if the Company fails to pay dividends for six quarters, whether or not consecutive, the Treasury will have the right to appoint two representatives to the Company’s board of directors. Under the terms of the Company’s and Bank’s Supervisory Agreements with their federal banking regulators, neither the Company nor the Bank may declare or pay any cash dividends, or purchase or redeem any capital stock, without prior notice to, and consent of these regulators. The Company does not anticipate requesting consent from the FRB to make any payments of dividends on, or purchase of, its common or preferred stock in 2012.

Return on Assets and Equity
Return on average assets for the first quarter of 2012 was 1.57%, compared to 0.19% for the first quarter of 2011. Return on average equity was 19.32% for the first quarter of 2012, compared to 2.41% for the first quarter of 2011. Book value per common share at March 31, 2012 was $7.81, compared to $10.31 at March 31, 2011.

General Information
HMN Financial, Inc. and Home Federal Savings Bank are headquartered in Rochester, Minnesota. Home Federal Savings Bank operates nine full service offices in Minnesota located in Albert Lea, Austin, Eagan, La Crescent, Rochester (3), Spring Valley and Winona; one full service office in Iowa located in Marshalltown; one loan origination office in Sartell, Minnesota; and two Private Banking offices in 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 are often identified by such forward-looking terminology as “expect,” “intent,” “look,” “believe,” “anticipate,” “estimate,” “project,” “seek,” “may,” “will,” “would,” “could,” “should,” “trend,” “target,” and “goal” or similar statements or variations of such terms and include, but are not limited to, those relating to increasing our core deposit relationships, reducing non-performing assets, reducing expense and generating improved financial results; the adequacy and amount of available liquidity and capital resources to the Bank; the Company’s liquidity and capital requirements; our expectations for core capital and our strategies and potential strategies for improvement thereof; changes in the size of the Bank’s loan portfolio; the recovery of the valuation allowance on deferred tax assets; the amount and mix of the Bank’s non-performing assets and the appropriateness of the allowance therefor; future losses on non-performing assets; the amount of interest-earning assets; the amount and mix of brokered and other deposits (including the Company’s ability to renew brokered deposits); the availability of alternate funding sources; the payment of dividends; 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 trust preferred securities held by the Bank; expectations relating to the change in Company and Bank primary banking regulators from the Office of Thrift Supervision to the Office of the Comptroller of the Currency (OCC) and Federal Reserve Board (FRB); and the Bank’s compliance with regulatory standards generally (including the Bank’s status as “well-capitalized”), and supervisory agreements, individual minimum capital requirements or other supervisory directives or requirements to which the Company or the Bank are or may become expressly subject, specifically, and possible responses of the OCC and FRB and the Bank and the Company to any failure to comply with any such regulatory standard, agreement or requirement. A number of factors could cause actual results to differ materially from the Company’s assumptions and expectations. These include but are not limited to the adequacy and marketability of real estate and other collateral securing loans to borrowers; federal and state regulation and enforcement, including restrictions set forth in the supervisory agreements between each of the Company and Bank and the OCC and FRB; possible legislative and regulatory changes, including changes in the degree and manner of regulatory supervision, the ability of the Company and the Bank to establish and adhere to plans and policies relating to, among other things, capital, business, non-performing assets, loan modifications, documentation of loan loss allowance and concentrations of credit that are satisfactory to the OCC and FRB, as applicable, in accordance with the terms of the Company and Bank supervisory agreements and to otherwise manage the operations of the Company and the Bank to ensure compliance with other requirements set forth in the supervisory agreements; the ability of the Company and the Bank to obtain required consents from the OCC and FRB, as applicable, under the supervisory agreements or other directives; the ability of the Bank to comply with its individual minimum capital requirement and other applicable regulatory capital requirements; enforcement activity of the OCC and FRB in the event of our non-compliance with any applicable regulatory standard, agreement or requirement; adverse economic, business and competitive developments such as shrinking interest margins, reduced collateral values, deposit outflows, changes in credit or other risks posed by the Company’s loan and investment portfolios, changes in costs associated with alternate funding sources, including changes in collateral advance rates and policies of the Federal Home Loan Bank, technological, computer-related or operational difficulties, results of litigation, and reduced demand for financial services and loan products; changes in accounting policies and guidelines, or monetary and fiscal policies of the federal government or tax laws; international economic developments; the Company’s access to and adverse changes in securities markets; the market for credit related assets; or other significant uncertainties. Additional factors that may cause actual results to differ from the Company’s assumptions and expectations include those set forth in the Company’s most recent filing on Form 10-K with the Securities and Exchange Commission. All forward-looking statements are qualified by, and should be considered in conjunction with, such cautionary statements. For additional discussion of the risks and uncertainties applicable to the Company, see the “Risk Factors” sections of the Company’s Annual Report on Form 10-K for the year ended December 31, 2011 and Part II, Item 1A of its Quarterly Reports on Forms 10-Q. We undertake no duty to update any of the forward-looking statements after the date of this press release.

(1) Average balances were calculated based upon amortized cost without the market value impact of ASC 320.