HMN FINANCIAL INC (Form: 10-Q, Received: 11/04/2015 11:09:41)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

[X]	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

	For the quarterly period ended September 30, 2015

[ ]	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

	For the transition period from _________ to _________

Commission File Number 0-24100

HMN FINANCIAL, INC.

(Exact name of registrant as specified in its charter)

Delaware		41-1777397
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

1016 Civic Center Drive N.W., Rochester, MN		55901
(Address of principal executive offices)		(Zip Code)

Registrant's telephone number, including area code:		(507) 535-1200

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer ☐	Accelerated filer ☐	Non-accelerated filer ☐	Smaller reporting company ☒
	(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ☐ No ☒

Indicate the number of shares outstanding of each of the issuer's classes of common stock as of the latest practicable date.

Class		Outstanding at October 20, 2015
Common stock, $0.01 par value		4,482,893

HMN FINANCIAL, INC.

CONTENTS

PART I - FINANCIAL INFORMATION
			Page
	Item 1:	Financial Statements

		Consolidated Balance Sheets at September 30, 2015 and December 31, 2014	3

		Consolidated Statements of Comprehensive Income for the Three Months and Nine Months Ended September 30, 2015 and 2014	4

		Consolidated Statement of Stockholders' Equity for the Nine-Month Period Ended September 30, 2015	5

		Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2015 and 2014	6

		Notes to Consolidated Financial Statements	7

	Item 2:	Management's Discussion and Analysis of Financial Condition and Results of Operations	25

	Item 3:	Quantitative and Qualitative Disclosures about Market Risk	37

	Item 4:	Controls and Procedures	37

PART II - OTHER INFORMATION

	Item 1:	Legal Proceedings	38

	Item 1A:	Risk Factors	38

	Item 2:	Unregistered Sales of Equity Securities and Use of Proceeds	38

	Item 3:	Defaults Upon Senior Securities	38

	Item 4:	Mine Safety Disclosures	38

	Item 5:	Other Information	38

	Item 6:	Exhibits	38

	Signatures		39

Part I – FINANCIAL INFORMATION

Item 1: Financial Statements

HMN FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

	September 30,			December 31,
(Dollars in thousands)	2015			2014
	(unaudited)
Assets
Cash and cash equivalents	$	10,359			46,634
Securities available for sale:
Mortgage-backed and related securities (amortized cost $6,979 and $2,755)		7,080			2,909
Other marketable securities (amortized cost $138,254 and $135,772)		138,258			134,925
		145,338			137,834

Loans held for sale		5,153			2,076
Loans receivable, net		432,174			365,113
Accrued interest receivable		2,162			1,713
Real estate, net		2,504			3,103
Federal Home Loan Bank stock, at cost		691			777
Mortgage servicing rights, net		1,446			1,507
Premises and equipment, net		7,426			6,982
Core deposit intangible		411			0
Prepaid expenses and other assets		1,040			1,157
Deferred tax asset, net		10,213			10,530
Total assets	$	618,917			577,426

Liabilities and Stockholders’ Equity
Deposits	$	531,586			496,750
Other borrowings		10,000			0
Accrued interest payable		252			93
Customer escrows		1,274			788
Accrued expenses and other liabilities		7,095			3,782
Total liabilities		550,207			501,413
Commitments and contingencies
Stockholders’ equity:
Serial preferred stock ($.01 par value): authorized 500,000 shares; issued and outstanding shares 0 and 10,000		0			10,000
Common stock ($.01 par value): authorized 16,000,000; issued shares 9,128,662		91			91
Additional paid-in capital		50,314			50,207
Retained earnings, subject to certain restrictions		79,446			77,805
Accumulated other comprehensive income (loss), net of tax		63			(418	)
Unearned employee stock ownership plan shares		(2,465	)		(2,610	)
Treasury stock, at cost 4,645,769 and 4,658,323 shares		(58,739	)		(59,062	)
Total stockholders’ equity		68,710			76,013
Total liabilities and stockholders’ equity	$	618,917			577,426

See accompanying notes to consolidated financial statements.

HMN FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income

(unaudited)

		Three Months Ended				Nine Months Ended
		September 30,				September 30,
(Dollars in thousands, except per share data)		2015		2014		2015		2014
Interest income:
Loans receivable	$	4,860		4,669		13,751		14,398
Securities available for sale:
Mortgage-backed and related		35		38		87		131
Other marketable		468		378		1,455		889
Cash equivalents		26		45		48		157
Other		1		1		3		3
Total interest income		5,390		5,131		15,344		15,578

Interest expense:
Deposits		231		297		705		937
Federal Home Loan Bank advances		0		0		1		0
Other borrowings		166		0		408		0
Total interest expense		397		297		1,114		937
Net interest income		4,993		4,834		14,230		14,641
Provision for loan losses		(56	)	(989	)	(239	)	(4,777	)
Net interest income after provision for loan losses		5,049		5,823		14,469		19,418

Non-interest income:
Fees and service charges		863		903		2,489		2,627
Mortgage servicing fees		262		263		778		787
Gain on sales of loans		613		804		1,428		1,480
Gain on acquisition		289		0		289		0
Other		204		224		708		710
Total non-interest income		2,231		2,194		5,692		5,604

Non-interest expense:
Compensation and benefits		3,299		3,193		10,285		9,944
Losses (gains) on real estate owned		168		(78	)	121		(1,130	)
Occupancy		936		896		2,741		2,654
Deposit insurance		125		74		269		328
Data processing		254		240		753		735
Other		1,187		1,100		3,031		3,055
Total non-interest expense		5,969		5,425		17,200		15,586
Income before income tax expense		1,311		2,592		2,961		9,436
Income tax expense		491		1,054		1,095		3,736
Net income	$	820		1,538		1,866		5,700
Preferred stock dividends		0		(360	)	(108	)	(1,417	)
Net income for common shareholders		820		1,178		1,758		4,283
Other comprehensive income (loss), net of tax		275		(70	)	481		302
Comprehensive income attributable to common shareholders	$	1,095		1,108		2,239		4,585
Basic earnings per common share	$	0.20		0.29		0.43		1.06
Diluted earnings per common share	$	0.18		0.25		0.38		0.93

See accompanying notes to consolidated financial statements.

HMN FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Statement of Stockholders' Equity

For the Nine-Month Period Ended September 30, 2015

(unaudited)


															Unearned
															Employee
												Accumulated			Stock						Total
	Serial					Additional						Other			Ownership						Stock-
	Preferred			Common		Paid-in			Retained			Comprehensive			Plan			Treasury			Holders’
(Dollars in thousands)	Stock			Stock		Capital			Earnings			Income (Loss)			Shares			Stock			Equity
Balance, December 31, 2014	$	10,000			91		50,207			77,805			(418	)		(2,610	)		(59,062	)		76,013
Net income										1,866												1,866
Other comprehensive income													481									481
Redemption of preferred stock		(10,000	)																			(10,000	)
Restricted stock awards							(332	)											332			0
Restricted stock awards forfeiture							9												(9	)		0
Amortization of restricted stock awards							387															387
Dividends on preferred stock										(225	)											(225	)
Earned employee stock ownership plan shares							43									145						188
Balance, September 30, 2015	$	0			91		50,314			79,446			63			(2,465	)		(58,739	)		68,710

See accompanying notes to consolidated financial statements.

HMN FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(unaudited)

	Nine Months Ended September 30,
(Dollars in thousands)	2015			2014
Cash flows from operating activities:
Net income	$	1,866			5,700
Adjustments to reconcile net income to cash provided by operating activities:
Provision for loan losses		(239	)		(4,777	)
Depreciation		516			416
Amortization of (discounts) premiums, net		(10	)		7
Amortization of deferred loan fees		(194	)		(175	)
Amortization of core deposit intangible		9			0
Amortization of purchased loan market adjustments		(112	)		0
Amortization of mortgage servicing rights and servicing costs		427			385
Capitalized mortgage servicing rights		(366	)		(219	)
Loss (gain) on sales of real estate		121			(1,130	)
Gain on sales of loans		(1,428	)		(1,480	)
Proceeds from sale of loans held for sale		55,995			42,724
Disbursements on loans held for sale		(50,952	)		(29,032	)
Amortization of restricted stock awards		387			176
Amortization of unearned ESOP shares		145			145
Earned employee stock ownership shares priced above original cost		43			37
Stock option compensation		0			1
(Increase) decrease in accrued interest receivable		(254	)		167
Increase (decrease) in accrued interest payable		148			(46	)
Decrease in other assets		195			170
Increase in other liabilities		3,252			3,508
Other, net		33			388
Net cash provided by operating activities		9,582			16,965
Cash flows from investing activities:
Principal collected on securities available for sale		1,257			1,726
Proceeds collected on maturities of securities available for sale		118,570			55,000
Purchases of securities available for sale		(109,070	)		(89,000	)
Purchase of Federal Home Loan Bank Stock		(119	)		0
Redemption of Federal Home Loan Bank Stock		205			7
Proceeds from sales of real estate and premises		772			4,382
Net (increase) decrease in loans receivable		(49,252	)		11,898
Gain on acquisition		(289	)		0
Acquisition of Kasson State Bank (net of cash acquired)		4,816			0
Purchases of premises and equipment		(570	)		(538	)
Net cash used by investing activities		(33,680	)		(16,525	)
Cash flows from financing activities:
Decrease in deposits		(12,438	)		(49,024	)
Redemption of preferred stock		(10,000	)		(10,000	)
Dividends to preferred stockholders		(225	)		(5,604	)
Proceeds from borrowings		41,000			0
Repayment of borrowings		(31,000	)		0
Increase in customer escrows		486			679
Net cash used by financing activities		(12,177	)		(63,949	)
Decrease in cash and cash equivalents		(36,275	)		(63,509	)
Cash and cash equivalents, beginning of period		46,634			120,686
Cash and cash equivalents, end of period	$	10,359			57,177
Supplemental cash flow disclosures:
Cash paid for interest	$	954			983
Cash paid for income taxes		191			0
Supplemental noncash flow disclosures:
Transfer of loans to real estate		110			142
Loans transferred to loans held for sale		6,701			11,954

See accompanying notes to consolidated financial statements.

HMN FINANCIAL, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(unaudited)

September 30, 201 5 and 201 4

(1) HMN Financial, Inc.

HMN Financial, Inc. (HMN or the Company) is a stock savings bank holding company that owns 100 percent of Home Federal Savings Bank (the Bank). The Bank has a community banking philosophy and operates retail banking and loan production facilities in Minnesota, Iowa, and Wisconsin. The Bank has two wholly owned subsidiaries, Osterud Insurance Agency, Inc. (OIA), which offers financial planning products and services, and HFSB Property Holdings, LLC (HPH), which acts as an intermediary for the Bank in holding and operating certain foreclosed properties.

The consolidated financial statements included herein are for HMN, the Bank, OIA and HPH. All significant intercompany accounts and transactions have been eliminated in consolidation.

(2) Basis of Preparation

The accompanying unaudited consolidated financial statements were prepared in accordance with instructions for Form 10-Q and, therefore, do not include all disclosures necessary for a complete presentation of the consolidated balance sheets, consolidated statements of comprehensive income, consolidated statement of stockholders' equity and consolidated statements of cash flows in conformity with U.S. generally accepted accounting principles. However, all normal recurring adjustments which are, in the opinion of management, necessary for the fair presentation of the interim financial statements have been included. The results of operations for the nine-month period ended September 30, 2015 are not necessarily indicative of the results which may be expected for the entire year.

(3) De rivative 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 quarter. The Company intends to sell these commitments, which are referred to as its mortgage pipeline. As commitments to originate or purchase loans enter the mortgage pipeline, the Company generally enters into commitments to sell the mortgage pipeline into the secondary market on a firm commitment or best efforts basis. The commitments to originate, purchase or sell loans on a firm commitment basis are derivatives and are recorded at market value. As a result of marking to market the mortgage pipeline and the related firm commitments to sell at September 30, 2015, the Company recorded an increase in other assets of $76,000, an increase in other liabilities of $9 ,000 and a gain included in the gain on sales of loans of $67,000.

The current commitments to sell loans held for sale are derivatives that do not qualify for hedge accounting. As a result, these derivatives are marked to market and the related loans held for sale are recorded at the lower-of-cost-or-market. As of and for the nine months ended September 30, 2015, t he Company recorded an increase in other liabilities of $75 ,000 and a loss included in the gain on sales of loans of $75 ,000.

( 4 ) Fair Value Measurements

ASC 820, Fair Value Measurements, establishes a framework for measuring the fair value of assets and liabilities using a hierarchy system consisting of three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:

Level 1 - Valuation is based upon quoted prices for identical instruments traded in active markets that the Company has the ability to access.

Level 2 - Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which significant assumptions are observable in the market.

Level 3 – Valuation is generated from model-based techniques that use significant assumptions not observable in the market and are used only to the extent that observable inputs are not available. These unobservable assumptions reflect our own estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.

The following table summarizes the assets and liabilities of the Company for which fair values are determined on a recurring basis as of September 30, 2015 and December 31, 2014.

	Carrying value at September 30, 2015

(Dollars in thousands)	Total		Level 1		Level 2		Level 3
Securities available for sale	$	145,338		0		145,338		0
Mortgage loan commitments		93		0		93		0
Total	$	145,431		0		145,431		0

	Carrying value at December 31, 2014

(Dollars in thousands)	Total		Level 1		Level 2		Level 3
Securities available for sale	$	137,834		0		137,834		0
Mortgage loan commitments		16		0		16		0
Total	$	137,850		0		137,850		0

There were no transfers between Levels 1, 2, or 3 during the three or nine-month periods ended September 30, 2015.

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 the third quarter of 2015 that were still held at September 30, 2015, 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 September 30, 2015 and December 31, 2014.

	Carrying value at September 30, 2015
(Dollars in thousands)	Total		Level 1		Level 2		Level 3		Three months ended September 30, 2015 Total gains (losses)			Nine months ended September 30, 2015 Total gains (losses)
Loans held for sale	$	5,153		0		5,153		0		83			75
Mortgage servicing rights		1,446		0		1,446		0		0			0
Loans ⁽¹⁾		9,848		0		9,848		0		39			(203	)
Real estate, net ⁽²⁾		2,504		0		2,504		0		(200	)		(200	)
Total	$	18,951		0		18,951		0		(78	)		(328	)

	Carrying value at December 31, 2014
(Dollars in thousands)	Total		Level 1		Level 2		Level 3		Year ended December 31, 2014 Total gains (losses)
Loans held for sale	$	2,076		0		2,076		0		(1	)
Mortgage servicing rights		1,507		0		1,507		0		0
Loans ⁽¹⁾		11,882		0		11,882		0		532
Real estate, net ⁽²⁾		3,103		0		3,103		0		(134	)
Total	$	18,568		0		18,568		0		397

(1)	Represents the carrying value and related specific reserves on loans for which adjustments are based on the appraised value of the collateral. The carrying value of loans fully charged-off is zero.

(2)	Represents the fair value and related losses of foreclosed real estate and other collateral owned that were measured at fair value subsequent to their initial classification as foreclosed assets.

( 5 ) Fair Value of Financial Instruments

Generally accepted accounting principles require interim reporting period disclosure about the fair value of financial instruments, including assets, liabilities and off-balance sheet items for which it is practicable to estimate fair value. The fair value hierarchy level for each asset and liability, as defined in note 4, have been included in the following table for September 30, 2015. The fair value estimates are made 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, current economic conditions, risk characteristics of various financial instruments and other factors. The estimated fair value of the Company’s financial instruments as of September 30, 2015 and December 31, 2014 are shown below.

	September 30, 2015													December 31, 2014
							Fair value hierarchy													Fair value hierarchy
(Dollars in thousands)	Carrying amount			Estimated fair value			Level 1		Level 2		Level 3	Contract amount		Carrying amount			Estimated fair value			Level 1		Level 2		Level 3	Contract amount
Financial assets:
Cash and cash equivalents	$	10,359			10,359			10,359							46,634			46,634			46,634
Securities available for sale		145,338			145,338					145,338					137,834			137,834					137,834
Loans held for sale		5,153			5,153					5,153					2,076			2,076					2,076
Loans receivable, net		432,174			430,694					430,694					365,113			364,509					364,509
Federal Home Loan Bank stock		691			691					691					777			777					777
Accrued interest receivable		2,162			2,162					2,162					1,713			1,713					1,713
Financial liabilities:
Deposits		531,586			531,310					531,310					496,750			496,494					496,494
Other borrowings		10,000			10,025					10,025					0			0
Accrued interest payable		252			252					252					93			93					93
Off-balance sheet financial instruments:
Commitments to extend credit		93			93								234,591		16			16								141,578
Commitments to sell loans		(114	)		(114	)							11,061		(30	)		(30	)							3,279

Cash and Cash Equivalents

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

Securities Available for Sale

The fair values of securities were based upon quoted market prices for identical or similar instruments in active markets.

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, net

The fair value of the loan 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.

Federal Home Loan Bank Stock

The carrying amount of FHLB stock approximates its fair value.

Accrued Interest Receivable

The carrying amount of accrued interest receivable approximates its fair value since it is short-term in nature and does not present unanticipated credit concerns.

Deposits

The fair value of demand deposits, savings accounts and certain money market account deposits is the amount payable on demand at the reporting date. The fair value of fixed maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities. If the fair value of the fixed maturity certificates of deposit is calculated at less than the carrying amount, the carrying value of these deposits is reported as the fair value.

The fair value estimate for deposits does not include the benefit that results from the low cost funding provided by the Company's existing deposits and long-term customer relationships compared to the cost of obtaining different sources of funding. This benefit is commonly referred to as the core deposit intangible.

Other Borrowings

The fair values of other borrowings with fixed maturities are estimated based on discounted cash flow analysis using as discount rates the interest rates charged by the Federal Home Loan Bank for borrowings of similar remaining maturities.

Accrued Interest Payable

The carrying amount of accrued interest payable approximates its fair value since it is short-term in nature.

Commitments to Extend Credit

The fair values of commitments to extend credit are estimated using the fees normally charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counter parties.

Commitments to Sell Loans

The fair values of commitments to sell loans are estimated using the quoted market prices for loans with similar interest rates and terms to maturity.

(6 ) Other Comprehensive Income (Loss)

Other comprehensive income (loss) is defined as the change in equity during a period from transactions and other events from nonowner sources. Comprehensive income (loss) 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. The components of other comprehensive income (loss) and the related tax effects for the quarter and nine-months ended September 30, 2015 and 2014 were as follows:



	For the three months ended September 30,
(Dollars in thousands)	2015						2014
Securities available for sale:	Before tax		Tax effect		Net of tax		Before tax			Tax effect			Net of tax
Net unrealized gains (losses) arising during the period	$	458		183		275		(234	)		(164	)		(70	)
Other comprehensive income (loss)	$	458		183		275		(234	)		(164	)		(70	)

	For the nine months ended September 30,
(Dollars in thousands)	2015						2014
Securities available for sale:	Before tax		Tax effect		Net of tax		Before tax		Tax effect		Net of tax
Net unrealized gains arising during the period	$	798		317		481		317		15		302
Other comprehensive income	$	798		317		481		317		15		302

(7 ) Securities Available For Sale

The following table shows the gross unrealized losses and fair value 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 September 30, 2015 and December 31, 2014.

	September 30, 2015
	Less than twelve months							Twelve months or more							Total
(Dollars in thousands)	# of Investments		Fair Value		Unrealized Losses			# of Investments		Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
Mortgage backed securities:
Federal National Mortgage Association (FNMA)		6	$	51		(1	)		0	$	0		0			51		(1	)
Collateralized mortgage obligations:
FNMA		2		522		(2	)		0		0		0			522		(2	)
Other marketable securities:
U.S. Government agency obligations		1		5,005		(2	)		0		0		0			5,005		(2	)
Municipal obligations		14		2,168		(6	)		0		0		0			2,168		(6	)
Corporate debt		1		337		(4	)		0		0		0			337		(4	)
Corporate preferred stock		0		0		0			1		350		(350	)		350		(350	)
Corporate equity		1		52		(6	)		0		0		0			52		(6	)
Total temporarily impaired securities		25	$	8,135		(21	)		1	$	350		(350	)	$	8,485		(371	)

	December 31, 2014
	Less than twelve months							Twelve months or more							Total
(Dollars in thousands)	# of Investments		Fair Value		Unrealized Losses			# of Investments		Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
Other marketable securities:
U.S. Government agency obligations		22	$	104,453		(551	)		1	$	4,970		(50	)	$	109,423		(601	)
Corporate preferred stock		0		0		0			1		420		(280	)		420		(280	)
Total temporarily impaired securities		22	$	104,453		(551	)		2	$	5,390		(330	)	$	109,843		(881	)

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 reported for corporate preferred stock over twelve months at September 30, 2015 related to a single trust preferred security that was issued by the holding company of a small community bank. Typical of most trust preferred issuances, the issuer has the ability to defer interest payments for up to five years with interest payable on the deferred balance. In September 2014, the issuer paid all previously deferred interest that was due and all payments were current as of September 30, 2014. In January 2015, the issuer began to defer its scheduled interest payments as allowed by the terms of the security agreement. The issuer’s subsidiary bank has incurred operating losses due to increased provisions for loan losses but still met the regulatory requirements to be considered “well capitalized” based on its most recent regulatory filing. Based on a review of the issuer, it was determined that the trust preferred security was not other-than-temporarily impaired at September 30, 2015. The Company does not intend to sell the trust preferred security 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 and the deferral of interest by the issuer. 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.

A summary of securities available for sale at September 30, 2015 and December 31, 2014 is as follows:

			Gross unrealized		Gross unrealized
(Dollars in thousands)	Amortized cost		gains		losses			Fair value
September 30, 201 5 :
Mortgage-backed securities:
Federal Home Loan Mortgage Corporation (FHLMC)	$	1,382		45		0			1,427
FNMA		2,598		41		(1	)		2,638
Government National Mortgage Association (GNMA)		40		0		0			40

Collateralized mortgage obligations:
FHLMC		1,285		9		0			1,294
FNMA		1,625		9		(2	)		1,632
GNMA		49		0		0			49
		6,979		104		(3	)		7,080
Other marketable securities:
U.S. Government agency obligations		133,151		355		(2	)		133,504
Municipal obligations		4,004		17		(6	)		4,015
Corporate debt		341		0		(4	)		337
Corporate preferred stock		700		0		(350	)		350
Corporate equity		58		0		(6	)		52
		138,254		372		(368	)		138,258
	$	145,233		476		(371	)		145,338

			Gross unrealized		Gross unrealized
(Dollars in thousands)	Amortized cost		gains		losses			Fair value
December 31, 201 4 :
Mortgage-backed securities:
FHLMC	$	1,418		90		0			1,508
FNMA		1,337		64		0			1,401
		2,755		154		0			2,909
Other marketable securities:
U.S. Government agency obligations		135,014		31		(601	)		134,444
Corporate preferred stock		700		0		(280	)		420
Corporate equity		58		3		0			61
		135,772		34		(881	)		134,925
	$	138,527		188		(881	)		137,834

The following table indicates amortized cost and estimated fair value of securities available for sale at September 30, 2015 based upon contractual maturity adjusted for scheduled repayments of principal and projected prepayments of principal based upon current economic conditions and interest rates.

(Dollars in thousands)	Amortized Cost		Fair Value
Due less than one year	$	8,180		8,228
Due after one year through five years		132,979		133,376
Due after five years through ten years		3,038		3,051
Due after ten years		978		631
No stated maturity		58		52
Total	$	145,233		145,338

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 allocation of other marketable securities that have call features is based on the anticipated cash flows to the call date if it is anticipated that the security will be called, or to the maturity date if it is not anticipated to be called.

( 8 ) Loans Receivable, Net

A summary of loans receivable at September 30, 2015 and December 31, 2014 is as follows:

(Dollars in thousands)	September 30, 2015		December 31, 2014
1-4 family	$	82,227		69,841
Commercial real estate:
Residential developments		29,074		19,960
Other		207,045		171,708
		236,119		191,668
Consumer		62,855		54,925
Commercial business:
Construction industry		7,210		7,121
Other		52,616		50,001
		59,826		57,122
Total loans		441,027		373,556
Less:
Unamortized discounts		14		14
Net deferred loan costs		53		97
Allowance for loan losses		8,786		8,332
Total loans receivable, net	$	432,174		365,113

( 9 ) Allowance for Loan Losses and Credit Quality Information

The allowance for loan losses for the three and nine months ended September 30, 2015 and 2014 is summarized as follows:

(Dollars in thousands)	1-4 Family			Commercial Real Estate			Consumer			Commercial Business			Total
For the three months ended September 30, 2015:
Balance, June 30, 2015	$	1,011			5,278			1,162			951			8,402
Provision for losses		117			(462	)		25			264			(56	)
Charge-offs		(19	)		0			(39	)		(1	)		(59	)
Recoveries		1			435			7			56			499
Balance, September 30, 2015	$	1,110			5,251			1,155			1,270			8,786

For the nine months ended September 30, 2015:
Balance, December 31, 2014	$	1,096			5,024			1,009			1,203			8,332
Provision for losses		30			(415	)		191			(45	)		(239	)
Charge-offs		(19	)		0			(66	)		(6	)		(91	)
Recoveries		3			642			21			118			784
Balance, September 30, 2015	$	1,110			5,251			1,155			1,270			8,786

Allocated to:
Specific reserves	$	270			370			307			127			1,074
General reserves		826			4,654			702			1,076			7,258
Balance, December 31, 2014	$	1,096			5,024			1,009			1,203			8,332

Allocated to:
Specific reserves	$	220			259			353			79			911
General reserves		890			4,992			802			1,191			7,875
Balance, September 30, 2015	$	1,110			5,251			1,155			1,270			8,786

Loans receivable at December 31, 2014:
Individually reviewed for impairment	$	1,867			9,728			806			555			12,956
Collectively reviewed for impairment		67,974			181,940			54,119			56,567			360,600
Ending balance	$	69,841			191,668			54,925			57,122			373,556
Loans receivable at September 30, 2015:
Individually reviewed for impairment	$	1,862			7,589			917			402			10,770
Collectively reviewed for impairment		80,365			228,530			61,938			59,424			430,257
Ending balance	$	82,227			236,119			62,855			59,826			441,027

(Dollars in thousands)	1-4 Family			Commercial Real Estate			Consumer			Commercial Business			Total
For the three months ended September 30, 2014:
Balance, June 30, 2014	$	2,085			3,823			1,164			1,624			8,696
Provision for losses		(489	)		14			(16	)		(498	)		(989	)
Charge-offs		0			0			(15	)		(55	)		(70	)
Recoveries		0			229			10			47			286
Balance, September 30, 2014	$	1,596			4,066			1,143			1,118			7,923

For the nine months ended September 30, 2014:
Balance, December 31, 2013	$	1,628			6,458			1,106			2,209			11,401
Provision for losses		60			(3,588	)		83			(1,332	)		(4,777	)
Charge-offs		(92	)		(936	)		(75	)		(56	)		(1,159	)
Recoveries		0			2,132			29			297			2,458
Balance, September 30, 2014	$	1,596			4,066			1,143			1,118			7,923

The following table summarizes the amount of classified and unclassified loans at September 30, 2015 and December 31, 2014:

	September 30, 2015
	Classified										Unclassified
(Dollars in thousands)	Special Mention		Substandard		Doubtful		Loss		Total		Total		Total Loans
1-4 family	$	191		2,556		55		0		2,802		79,425		82,227
Commercial real estate:
Residential developments		0		6,842		0		0		6,842		22,232		29,074
Other		3,158		12,744		0		0		15,902		191,143		207,045
Consumer		0		568		89		260		917		61,938		62,855
Commercial business:
Construction industry		48		185		0		0		233		6,977		7,210
Other		4,653		1,567		14		0		6,234		46,382		52,616
	$	8,050		24,462		158		260		32,930		408,097		441,027

	December 31, 2014
	Classified										Unclassified
(Dollars in thousands)	Special Mention		Substandard		Doubtful		Loss		Total		Total		Total Loans
1-4 family	$	0		2,493		207		0		2,700		67,141		69,841
Commercial real estate:
Residential developments		323		9,960		0		0		10,283		9,677		19,960
Other		7,376		8,792		0		0		16,168		155,540		171,708
Consumer		0		489		55		261		805		54,120		54,925
Commercial business:
Construction industry		0		439		0		0		439		6,682		7,121
Other		4,255		1,156		0		0		5,411		44,590		50,001
	$	11,954		23,329		262		261		35,806		337,750		373,556

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 considered uncollectible and of such little value that continuance as an asset on the balance sheet is not warranted. Loans classified as substandard or doubtful require the Bank to perform an analysis of the individual loan and charge off any loans, or portion thereof, that are deemed uncollectible.

The aging of past due loans at September 30, 2015 and December 31, 2014 is summarized as follows:

(Dollars in thousands)	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
September 30, 201 5
1-4 family	$	915		318		714		1,947		80,280		82,227		0
Commercial real estate:
Residential developments		0		0		0		0		29,074		29,074		0
Other		0		0		0		0		207,045		207,045		0
Consumer		306		290		147		743		62,112		62,855		0
Commercial business:
Construction industry		0		0		0		0		7,210		7,210		0
Other		263		20		15		298		52,318		52,616		0
	$	1,484		628		876		2,988		438,039		441,027		0

December 31, 2014
1-4 family	$	413		673		841		1,927		67,914		69,841		0
Commercial real estate:
Residential developments		0		0		0		0		19,960		19,960		0
Other		0		0		0		0		171,708		171,708		0
Consumer		550		176		131		857		54,068		54,925		0
Commercial business:
Construction industry		0		0		0		0		7,121		7,121		0
Other		136		0		0		136		49,865		50,001		0
	$	1,099		849		972		2,920		370,636		373,556		0

Impaired loans include loans that are non-performing (non-accruing) and loans that have been modified in a troubled debt restructuring (TDR). The following table summarizes impaired loans and related allowances as of September 30, 2015 and December 31, 2014:

	September 30, 2015						December 31, 2014
(Dollars in thousands)	Recorded Investment		Unpaid Principal Balance		Related Allowance		Recorded Investment		Unpaid Principal Balance		Related Allowance
Loans with no related allowance recorded:
1-4 family	$	995		995		0		755		755		0
Commercial real estate:
Residential developments		5,215		7,558		0		7,416		10,040		0
Other		500		645		0		48		216		0
Consumer		410		411		0		463		464		0
Commercial business:
Construction industry		0		102		0		80		198		0
Other		14		14		0		0		0		0
Loans with an allowance recorded:
1-4 family		867		867		220		1,112		1,112		270
Commercial real estate:
Residential developments		1,684		1,684		233		1,522		1,522		240
Other		190		190		26		742		743		130
Consumer		507		524		353		343		360		307
Commercial business:
Construction industry		0		0		0		0		0		0
Other		388		939		79		475		1,026		127
Total:
1-4 family		1,862		1,862		220		1,867		1,867		270
Commercial real estate:
Residential developments		6,899		9,242		233		8,938		11,562		240
Other		690		835		26		790		959		130
Consumer		917		935		353		806		824		307
Commercial business:
Construction industry		0		102		0		80		198		0
Other		402		953		79		475		1,026		127
	$	10,770		13,929		911		12,956		16,436		1,074

The following tables summarize average recorded investment and interest income recognized on impaired loans during the three and nine months ended September 30, 2015 and 2014.

	For the three months ended September 30, 2015				For the nine months ended September 30, 2015
(Dollars in thousands)	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
Loans with no related allowance recorded:
1-4 family	$	989		1		866		32
Commercial real estate:
Residential developments		5,884		97		6,480		287
Other		501		8		388		22
Consumer		363		1		365		5
Commercial business:
Construction industry		3		0		36		0
Other		20		0		10		1
Loans with an allowance recorded:
1-4 family		968		3		1,069		10
Commercial real estate:
Residential developments		1,705		6		1,540		24
Other		192		0		330		0
Consumer		531		2		434		16
Commercial business:
Construction industry		0		0		0		0
Other		397		4		432		13
Total:
1-4 family		1,957		4		1,935		42
Commercial real estate:
Residential developments		7,589		103		8,020		311
Other		693		8		718		22
Consumer		894		3		799		21
Commercial business:
Construction industry		3		0		36		0
Other		417		4		442		14
	$	11,553		122		11,950		410

	For the three months ended September 30, 2014				For the nine months ended September 30, 2014
(Dollars in thousands)	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
Loans with no related allowance recorded:
1-4 family	$	234		3		352		6
Commercial real estate:
Residential developments		7,691		102		7,688		112
Other		51		5		51		5
Consumer		456		8		468		10
Commercial business:
Construction industry		86		0		89		0
Other		0		0		0		0
Loans with an allowance recorded:
1-4 family		1,606		6		1,651		13
Commercial real estate:
Residential developments		1,153		0		3,521		0
Other		866		9		874		24
Consumer		489		3		479		9
Commercial business:
Construction industry		0		0		0		0
Other		981		8		990		23
Total:
1-4 family		1,840		9		2,003		19
Commercial real estate:
Residential developments		8,844		102		11,209		112
Other		917		14		925		29
Consumer		945		11		947		19
Commercial business:
Construction industry		86		0		89		0
Other		981		8		990		23
	$	13,613		144		16,163		202

At September 30, 2015 and December 31, 2014, non-accruing loans totaled $9.1 million and $10.9 million, respectively, for which the related allowance for loan losses was $0.6 million and $0.8 million, respectively. All of the interest income that was recognized for non-accruing loans was recognized using the cash basis method of income recognition. Non-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 $6.7 million and $8.0 million at September 30, 2015 and December 31, 2014, respectively. Non-accrual loans also include certain loans that have had terms modified in a TDR.

The non-accrual loans at September 30, 2015 and December 31, 2014 are summarized as follows:

(Dollars in thousands)	September 30, 2015		December 31, 2014

1-4 family	$	1,621	$	1,564
Commercial real estate:
Residential developments		6,382		8,483
Other		235		267
Consumer		797		486
Commercial business:
Construction industry		0		80
Other		17		40
	$	9,052	$	10,920

At September 30, 2015 and December 31, 2014 there were loans included in loans receivable, net, with terms that had been modified in a TDR totaling $7.8 million and $9.4 million, respectively. For the loans that were restructured in the third quarter of 2015, $74,000 were classified but performing and $26,000 were non-performing at September 30, 2015. There were no loans modified in the third quarter of 2014.

The following table summarizes TDRs at September 30, 2015 and December 31, 2014:

	September 30, 2015						December 31, 2014
(Dollars in thousands)	Accrual		Non-Accrual		Total		Accrual		Non-Accrual		Total
1-4 family	$	241		361		602		303		65		368
Commercial real estate		971		5,216		6,187		979		6,977		7,956
Consumer		121		470		591		320		251		571
Commercial business		385		2		387		434		121		555
	$	1,718		6,049		7,767		2,036		7,414		9,450

There were no material commitments to lend additional funds to customers whose loans were restructured or classified as nonaccrual at September 30, 2015 or December 31, 2014.

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 for the entire 12 month period. 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 balance sheet, as principal balances may be partially forgiven. The financial effects of TDRs are presented in the following tables and represent the difference between the outstanding recorded balance pre-modification and post-modification, for the three month and nine month periods ended September 30, 2015 and 2014.


	Three Months Ended September 30, 2015						Nine Months Ended September 30, 2015
(Dollars in thousands)	Number of Contracts		Pre-modification Outstanding Recorded Investment		Post-modification Outstanding Recorded Investment		Number of Contracts		Pre-modification Outstanding Recorded Investment		Post-modification Outstanding Recorded Investment
Troubled debt restructurings:
1-4 family		1	$	46	$	46		2	$	358	$	358
Consumer		4		53		54		11		365		367
Total		5	$	99	$	100		13	$	723	$	725


	Three Months Ended September 30, 2014						Nine Months Ended September 30, 2014
(Dollars in thousands)	Number of Contracts		Pre-modification Outstanding Recorded Investment		Post-modification Outstanding Recorded Investment		Number of Contracts		Pre-modification Outstanding Recorded Investment		Post-modification Outstanding Recorded Investment
Troubled debt restructurings:
1-4 family		0	$	0	$	0		2	$	760	$	760
Consumer		0		0		0		4		155		140
Total		0	$	0	$	0		6	$	915	$	900

There were no loans restructured in the 12 months preceding September 30, 2015 that defaulted in the three and nine months ended September 30, 2015. Loans that were restructured within the 12 months preceding September 30, 2014 that defaulted during the three and nine month periods ended September 30, 2014 are presented in the following table:

	Three Months Ended September 30, 2014				Nine Months Ended September 30, 2014
(Dollars in thousands)	Number of Contracts		Outstanding Recorded Investment		Number of Contracts		Outstanding Recorded Investment
Troubled debt restructurings that subsequently defaulted:
1-4 family		0	$	0		1	$	640
Total		0	$	0		1	$	640

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 on non-accrual status 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 accrual status. Loans that were accruing prior to modification remain on accrual status after the modification as long as the loan continues to perform under the new terms.

TDRs are reviewed for impairment following the same methodology as other impaired loans. For loans that are collateral dependent, the value of the collateral is reviewed and additional reserves may be added as needed. Loans that are not collateral dependent may have additional reserves established if deemed necessary. The reserves for TDRs was $0.4 million, or 4.5%, of the total $8.8 million in loan loss reserves at September 30, 2015 and $0.4 million, or 5.1%, of the total $8.3 million in loan loss reserves at December 31, 2014.

Loans acquired in a business combination are segregated into two types: purchased performing loans with a discount attributable at least in part to credit quality and purchased credit impaired (PCI) loans with evidence of significant credit deterioration. Purchased performing loans are accounted for in accordance with ASC 310-20 “Nonrefundable Fees and Other Costs” as these loans do not have evidence of credit deterioration since origination. PCI loans are accounted for in accordance with ASC 310-30 “Receivables – Loans and Debt Securities Acquired with Deteriorated Credit Quality” as they display significant credit deterioration since origination. In accordance with ASC 310-30, for PCI loans, the difference between contractually required payments at acquisition and the cash flows expected to be collected is referred to as the non-accretable difference. This amount is not recognized as a yield adjustment or as a loss accrual or a valuation allowance. Furthermore, any excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable yield and is recognized into interest income over the remaining life of the loans when there is a reasonable expectation about the amount and timing of such cash flows. Increases in expected cash flows subsequent to the initial investment are recognized prospectively through an adjustment of the yield on the loan over its remaining estimated life. Decreases in expected cash flows are recognized immediately as an impairment through the provision for loan losses.

The following is additional information with respect to loans acquired through the Kasson State Bank acquisition:

(Dollars in thousands)	Contractual Principal Receivable			Accretable Difference			Carrying Amount
Purchased Performing Loans:
Balance at August 15, 2015:	$	24,215			(793	)		23,422
Change due to payments/refinances		(1,730	)		122			(1,608	)
Transferred to foreclosed assets		0			0			0
Change due to loan charge-off		0			0			0
Balance at September 30, 2015	$	22,485			(671	)		21,814

(Dollars in thousands)	Contractual Principal Receivable			Non-Accretable Difference			Carrying Amount
Purchased Credit Impaired Loans:
Balance at August 15, 2015:	$	1,134			(497	)		637
Change due to payments/refinances		(16	)		0			(16	)
Transferred to foreclosed assets		0			0			0
Change due to loan charge-off		0			0			0
Balance at September 30, 2015	$	1,118			(497	)		621

As a result of the Kasson State Bank acquisition, the Company has PCI loans for which there was, at acquisition, evidence of deterioration of credit quality since origination and for which it was probable at acquisition that all contractually required payments would not be collected. The carrying amount of those loans as of September 30, 2015 was $0.6 million.

No provision for loan losses was recognized during the period ended September 30, 2015 related to acquired loans as there was no significant change to the credit quality of those loans.

(1 0 ) Investment in Mortgage Servicing Rights

A summary of mortgage servicing rights activity is as follows:

(Dollars in thousands)	Nine Months ended September 30, 2015			Twelve Months ended December 31, 2014			Nine Months ended September 30, 2014
Mortgage servicing rights:
Balance, beginning of period	$	1,507			1,708			1,708
Originations		366			316			219
Amortization		(427	)		(517	)		(385	)
Balance, end of period	$	1,446			1,507			1,542
Fair value of mortgage servicing rights	$	2,579			2,562			2,661

All of the loans being serviced are single family loans serviced for the FNMA under the individual loan sale program. The following is a summary of the risk characteristics of the loans being serviced at September 30, 2015.

(Dollars in thousands)	Loan Principal Balance		Weighted Average Interest Rate		Weighted Average Remaining Term (months)		Number of Loans
Original term 30 year fixed rate	$	210,023		4.24		299		1,813
Original term 15 year fixed rate		107,843		3.25		139		1,205
Adjustable rate		59		4.38		308		2

(11) Intangible Assets

The gross carrying amount of intangible assets and the associated accumulated amortization at September 30, 2015 and 2014 is presented in the table below. Amortization expense for intangible assets was $436,000 and $385,000 respectively, for the nine-month periods ended September 30, 2015 and 2014.

	September 30, 2015
	Gross
(Dollars in thousands)	Carrying Amount		Accumulated Amortization			Unamortized Intangible Assets
Mortgage servicing rights	$	3,736		(2,290	)		1,446
Core deposit intangible		420		(9	)		411
Total	$	4,156		(2,299	)		1,857

	September 30, 2014
	Gross
(Dollars in thousands)	Carrying Amount		Accumulated Amortization			Unamortized Intangible Assets
Mortgage servicing rights	$	3,597		(2,055	)		1,542
Total	$	3,597		(2,055	)		1,542

The following table indicates the estimated future amortization expense for intangible assets:

(Dollars in thousands)	Mortgage Servicing Rights		Core Deposit Intangible		Total
Year ended December 31,
2015	$	111		19		130
2016		414		74		488
2017		335		74		409
2018		243		74		317
2019		182		74		256
Thereafter		161		96		257
Total	$	1,446		411		1,857

Projections of amortization are based on existing asset balances and the existing interest rate environment as of September 30, 2015. The Company's actual experience may be significantly different depending upon changes in mortgage interest rates and other market conditions.

(1 2 ) Earnings per Common Share

The following table reconciles the weighted average shares outstanding and the earnings available to common shareholders used for basic and diluted earnings per share:

	Three Months Ended September 30,				Nine Months Ended September 30,
(Dollars in thousands, except per share data)	2015		2014		2015		2014
Weighted average number of common shares outstanding used in basic earnings per common share calculation		4,142		4,067		4,118		4,053
Net dilutive effect of:
Options		505		520		514		499
Restricted stock awards		26		62		40		57
Weighted average number of shares outstanding adjusted for effect of dilutive securities		4,673		4,649		4,672		4,609
Income available to common shareholders	$	820		1,178		1,758		4,283
Basic earnings per common share	$	0.20		0.29		0.43		1.06
Diluted earnings per common share	$	0.18		0.25		0.38		0.93

(1 3 ) Regulatory Capital and Regulatory Oversight

Effective January 1, 2015 the capital requirements of the Company and the Bank were changed to implement the regulatory requirements of the Basel III capital reforms. The new requirements, among other things, (i) apply a strengthened set of capital requirements to both the Company and the Bank, including new 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) revise the rules for calculating risk-weighted assets for purposes of such requirements. The new rules made corresponding revisions to the prompt corrective action framework and include the new capital ratios and buffer requirements which will be phased in incrementally, with full implementation scheduled for 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, both the Company and the Bank must meet specific capital guidelines that involve quantitative measures of their 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.

In the second quarter of 2015, the Board of Governors of the Federal Reserve System amended its Small Bank Holding Company Policy Statement (Policy Statement), which exempted small bank holding companies from the above capital requirements, by raising the asset size threshold for determining applicability from $500 million to $1 billion. The Policy Statement was also expanded to include savings and loan holding companies that meet the Policy Statement’s qualitative requirements for exemption. The Company met the qualitative exemption requirements, and therefore, is exempt from the above holding company 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) of Common Equity Tier 1 capital to risk weighted assets (as defined in the regulations), Tier 1 capital to adjusted total assets (as defined), Tier 1 capital to risk weighted assets, and total capital to risk weighted assets.

On September 30, 2015, the Bank’s tangible assets were $607.7 million, its adjusted total assets were $603.3 million, and its risk-weighted assets were $491.7 million. The following table presents the Bank’s capital amounts and ratios at September 30, 2015 for actual capital, required capital, and excess capital, including ratios in order to qualify as being well capitalized under the prompt corrective actions regulations.

	Actual						Required to be Adequately Capitalized					Excess Capital					To Be Well Capitalized Under Prompt Corrective Action Provisions ⁽¹ ⁾
(Dollars in thousands)	Amount			Percent of Assets ⁽² ⁾			Amount		Percent of Assets ⁽² ⁾			Amount		Percent of Assets ⁽² ⁾			Amount		Percent of Assets ⁽² ⁾
Bank stockholder’s equity	$	73,531
Plus:
Net unrealized gain on certain securities available for sale		(63	)
Less:
Goodwill and other intangibles		165
Disallowed servicing and tax assets		4,217
Common equity tier I capital		69,086
Common equity tier I capital ratio					14.05	%	$	22,126		4.50	%	$	46,960		9.55	%	$	31,960		6.50	%
Tier I capital		69,086
Tier I capital to adjusted total assets (leverage ratio)					11.45	%	$	24,131		4.00	%	$	44,955		7.45	%	$	30,164		5.00	%
Tier I capital to risk-weighted assets					14.05	%	$	29,501		6.00	%	$	39,585		8.05	%	$	39,335		8.00	%
Plus:
Allowable allowance for loan losses		6,211
Risk-based capital	$	75,297					$	39,335				$	35,962				$	49,169
Risk-based capital to risk- weighted assets					15.31	%				8.00	%				7.31	%				10.00	%

(1) Under the recently issued final rules, revised requirements began to be phased in on January 1, 2015, as described above.

(2) Based upon the Bank’s adjusted total assets for the purpose of leverage ratio and risk-weighted assets for the purpose of the risk-based capital ratios.

Management believes that, as of September 30, 2015, the Bank’s capital ratios were in excess of those quantitative capital ratio standards set forth under the current prompt corrective action regulations 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.

(1 4 ) Preferred Stock

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 (the Preferred Stock) to the United States 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 United States Treasury’s Capital Purchase Program under the Emergency Economic Stabilization Act of 2008.

In 2014, the Company redeemed 16,000 shares of Preferred Stock and on February 17, 2015, the Company redeemed the remaining 10,000 shares of outstanding Preferred Stock.

On May 21, 2015, the Treasury sold the Warrant at an exercise price of $4.68 to three unaffiliated third party investors for an aggregate purchase price of $5.7 million. Two of the investors received a warrant to purchase 277,777.67 shares and one investor received a warrant to purchase 277,777.66 shares. All of the warrants may be exercised at any time prior to their expiration date of December 23, 2018. The Company received no proceeds from this transaction and it had no material effect on the Company’s capital, financial condition or results of operations.

(15) Other Borrowings

The Company funded the Preferred Stock redemption on February 17, 2015 with a $10.0 million term loan to HMN from an unrelated third party that was evidenced by a promissory note. The principal balance of the note bears interest at a rate of 6.50% and is payable in consecutive annual installments of $1.0 million on each December 15, beginning December 15, 2015, with the balance due on December 15, 2021. The Company may elect to prepay the note at any time without penalty and may also elect, upon written notice to the lender, to defer one principal payment on the note prior to the maturity date provided that the note is not in default. If a payment is deferred, it would become due and payable in full on the maturity date.

(1 6 ) Commitments and Contingencies

The Bank issued standby letters of credit which guarantee the performance of customers to third parties. The standby letters of credit issued and available at September 30, 2015 were approximately $3.2 million, expire over the next eighteen months, and are collateralized primarily with commercial real estate mortgages. 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 .

( 17 ) Business Segments

The Bank has been identified as a reportable operating segment in accordance with the provisions of ASC 280. HMN, OIA and HFH did not meet the quantitative thresholds for determining reportable segments and, therefore, are included in the “Other” category.

The Company evaluates performance and allocates resources based on the segment’s net income, return on average assets and equity. Each corporation is managed separately with its own officers and board of directors, some of whom may overlap between the corporations.

The following table sets forth certain information about the reconciliation of reported profit 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 nine months ended September 30, 201 5 :
Interest income - external customers	$	15,344		0			0			15,344
Non-interest income - external customers		5,692		0			0			5,692
Intersegment interest income		0		1			(1	)		0
Intersegment non-interest income		153		2,318			(2,471	)		0
Interest expense		707		408			(1	)		1,114
Other non-interest expense		16,887		466			(153	)		17,200
Income tax expense		1,516		(421	)		0			1,095
Net income		2,318		1,866			(2,318	)		1,866
Total assets		617,870		78,354			(77,307	)		618,917

At or for the nine months ended September 30, 201 4 :
Interest income - external customers	$	15,578		0			0			15,578
Non-interest income - external customers		5,604		0			0			5,604
Intersegment interest income		0		1			(1	)		0
Intersegment non-interest income		135		5,923			(6,058	)		0
Interest expense		938		0			(1	)		937
Other non-interest expense		15,135		586			(135	)		15,586
Income tax expense		4,098		(362	)		0			3,736
Net income		5,923		5,700			(5,923	)		5,700
Total assets		593,474		80,873			(79,914	)		594,433
At or for the quarter ended September 30, 201 5 :
Interest income - external customers	$	5,390		0			0			5,390
Non-interest income - external customers		2,231		0			0			2,231
Intersegment non-interest income		51		1,007			(1,058	)		0
Interest expense		231		166			0			397
Other non-interest expense		5,832		188			(51	)		5,969
Income tax expense		657		(166	)		0			491
Net income		1,007		820			(1,007	)		820
Total assets		617,870		78,354			(77,307	)		618,917

At or for the quarter ended September 30, 201 4 :
Interest income - external customers	$	5,131		0			0			5,131
Non-interest income - external customers		2,194		0			0			2,194
Intersegment interest income		45		1,608			(1,653	)		0
Intersegment non-interest income
Interest expense		297		0			0			297
Other non-interest expense		5,283		187			(45	)		5,425
Income tax expense		1,171		(117	)		0			1,054
Net income		1,608		1,538			(1,608	)		1,538
Total assets		593,474		80,873			(79,914	)		594,433

Item 2:

HMN FINANCIAL, INC.

MANAGEMENT'S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-looking Information

This quarterly report and other reports filed by the Company with the Securities and Exchange Commission 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 increasing our core deposit relationships, improving credit quality, reducing non-performing assets, becoming more efficient and generating improved financial results; the adequacy and amount of available liquidity and capital resources to the Bank; the Company’s liquidity and capital requirements; our expectations for core capital and our strategies and potential strategies for improvement thereof; improvements in loan production; changes in the size of the Bank’s loan portfolio; the amount of the Bank’s non-performing assets and the appropriateness of the allowance therefor; our ability to integrate the Kasson State Bank operations; expectations of future taxable income and its impact on the need to establish a valuation reserve against our net deferred tax asset; anticipated future levels of the provision for loan losses; future losses on non-performing assets; the amount and mix of interest-earning assets; the amount and mix of interest-bearing liabilities; the availability of alternate funding sources; the payment of dividends by HMN, the future outlook for the Company; the amount of dividends paid by the FHLB on its stock; 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; the ability of the Bank to pay dividends to HMN; the ability of HMN to pay the principal and interest payments on its third party note payable; the ability to remain well capitalized under revised capital rules; 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 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; possible legislative and regulatory changes, including additional changes to regulatory capital rules; the ability of the Bank to comply with other applicable regulatory capital requirements; enforcement activity of the OCC and FRB in the event of our non-compliance with any applicable regulatory standard or requirement; adverse economic, business and competitive developments such as shrinking interest margins, reduced collateral values, deposit outflows, changes in credit or other risks posed by the Company’s loan and investment portfolios; changes in costs associated with alternate funding sources, including changes in collateral advance rates and policies of the Federal Home Loan Bank; technological, computer-related or operational difficulties; results of litigation; reduced demand for financial services and loan products; changes in accounting policies and guidelines, or monetary and fiscal policies of the federal government or tax laws; international economic developments; the Company’s access to and adverse changes in securities markets; the market for credit related assets; the future operating results, financial condition, cash flow requirements and capital spending priorities of the Company and the Bank; the availability of internal and, as required, external sources of funding; unanticipated acquisition integration costs and other difficulties in assimilating the recently acquired Kasson State Bank operations; or other significant uncertainties. Additional factors that may cause actual results to differ from the Company’s assumptions and expectations include those set forth in the Company’s most recent filings on Forms 10-K and 10-Q with the Securities and Exchange Commission. All forward-looking statements are qualified by, and should be considered in conjunction with, such cautionary statements. For additional discussion of the risks and uncertainties applicable to the Company, see the “Risk Factors” sections of the Company’s Annual Report on Form 10-K for the year ended December 31, 2014 and Part II, Item 1A of its subsequently filed Quarterly Reports on Form 10-Q.

All statements in this quarterly report on Form 10-Q, including forward-looking statements, speak only as of the date they are made, and we undertake no duty to update any of the forward-looking statements after the date of this quarterly report on Form 10-Q.

General

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 mix of interest-earning assets and interest-bearing liabilities, and the level of non-performing assets. The Company's net income is also affected by the generation of non-interest income, which consists primarily of gains or losses from the sale of securities, gains from the sale of loans, fees for servicing mortgage loans, and the generation of fees and service charges on deposit accounts. The Bank incurs expenses in addition to interest expense in the form of salaries and benefits, occupancy expenses, provisions for loan losses, and amortization of mortgage servicing assets. 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. In this analysis, management considers factors including, but not limited to, specific occurrences of loan impairment, changes in the size of the portfolios, national and regional economic conditions such as unemployment data, loan portfolio composition, loan delinquencies, local economic growth rates, historical experience and observations made by the Company's ongoing internal audit and regulatory exam processes. Loans are charged off to the extent they are deemed to be uncollectible. The Company has established separate processes to determine the appropriateness of the loan loss allowance for its homogeneous single-family and consumer loan portfolios and its 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 of all non-performing loans. The determination of the allowance for the non-homogeneous 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 to all loans without 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 portion thereof that are deemed uncollectable.

Purchased loans are not included in the periodic analysis to determine the allowance for loan losses. At the time of purchase, these loans are reviewed to determine their estimated fair value and appropriate credit reserves are established. These loans are recorded net of the related reserve on the balance sheet and subsequent charge offs on these loans are recorded through the provision for loan losses to the extent that the charge off exceeds the previously established reserve. Loans that are considered impaired at the time of purchase (purchase credit impaired), and purchased loans that subsequently become impaired, are periodically reviewed to determine the adequacy of the established credit reserves and any additional reserves required would be recorded through the provision for loan losses.

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 estimates are reviewed periodically and adjustments, if any, are recorded in the provision for loan losses in the periods in which the adjustments become known. Because of the size of some loans, changes in estimates can have a significant impact on the loan loss provision. The allowance is allocated to individual loan categories based upon the relative risk characteristics of the loan portfolios and the actual loss experience. The Company increases and decreases its allowance for loan losses by charging or crediting the provision for loan losses against income. 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 probable losses in the loan portfolio for which additional specific reserves are not required. 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 date, future conditions may differ substantially from those anticipated in determining the allowance for loan losses and adjustments may be required in the future.

Income Taxes

Deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. 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 liabilities.

The Company maintains significant net deferred tax assets for deductible temporary differences, the largest of which relates to the allowance for loan and real estate losses and net operating loss carryforwards. For income tax purposes, only net charge-offs are deductible, not the entire provision for loan losses. Under generally accepted accounting principles, a valuation allowance is required to be recognized if it is “more likely than not” that the deferred tax asset will not be realized. The determination of whether the deferred tax assets are realizable is highly subjective and dependent upon management’s judgment and evaluation of both positive and negative evidence, including the forecasts of future income, tax planning strategies and assessments of the current and future economic and business conditions. The Company considers both positive and negative evidence regarding the ultimate realization of deferred tax assets. Positive evidence includes the Company’s cumulative net income in the prior three year period and the probability that taxable income will be generated in future periods. Negative evidence includes the general business and economic environment. The determination that a valuation reserve was not required at September 30, 2015 was based primarily upon the existence of a three-year cumulative net income and expectations of future taxable income. It is possible that future conditions may differ substantially from those anticipated in determining the valuation allowance on deferred tax assets and adjustments may be required in future periods.

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 that are significantly different from those estimated.

Acquisition

On August 14, 2015, the Bank completed the acquisition of certain assets and assumption of certain liabilities of Kasson State Bank. The transaction increased the Bank’s total assets $52.8 million including increases in loans of $24.1 million, investments of $17.5 million, cash of $10.0 million, core deposit intangible of $0.4 million and other assets of $0.8 million. The Bank also assumed liabilities of $49.3 million including $47.3 million of deposits and $2.0 million in other liabilities. Consideration paid was $3.2 million and a gain on the transaction of $0.3 million was recorded during the quarter. The Bank continues to operate both of the Kasson State Bank locations in Kasson, Minnesota acquired in the transaction as branches of Home Federal Savings Bank.

RESULTS OF OPERATIONS FOR THREE AND NINE MONTH PERIODS ENDED SEPTEMBER 30, 201 5 COMPARED TO THE SAME PERIODS ENDED SEPTEMBER 30, 201 4

Net Income

Net income was $0.8 million for the third quarter of 2015, a decrease of $0.7 million compared to net income of $1.5 million for the third quarter of 2014. Net income available to common shareholders was $0.8 million for the third quarter of 2015, a decrease of $0.4 million from the net income available to common shareholders of $1.2 million for the third quarter of 2014. Diluted earnings per common share for the third quarter of 2015 was $0.18, a decrease of $0.07 from diluted earnings per common share of $0.25 for the third quarter of 2014. The decrease in net income for the third quarter of 2015 is due primarily to a $0.9 million increase in the provision for loan losses between the periods. The increase in the provision was primarily because there was more commercial loan growth and fewer credit rating upgrades in the third quarter of 2015 when compared to the third quarter of 2014. The loss on sale of real estate owned increased $0.2 million between the periods due to the write down of a commercial property as a result of obtaining an updated appraisal of the property. Gain on sales of loans decreased $0.2 million due to a decrease in the gains recognized on the sale of commercial government guaranteed loans between the periods. These decreases in net income were partially offset by a $0.6 million decrease in income tax expense due to the decreased income between the periods.

Net income was $1.9 million for the nine-month period ended September 30, 2015, a decrease of $3.8 million, or 67.3%, compared to net income of $5.7 million for the nine-month period ended September 30, 2014. The net income available to common shareholders was $1.8 million for the nine-month period ended September 30, 2015, a decrease of $2.5 million, or 59.0%, compared to the net income available to common shareholders of $4.3 million for the same period of 2014. Diluted earnings per common share for the first nine months of 2015 was $0.38, a decrease of $0.55 per share compared to the diluted earnings per common share of $0.93 for the same period in 2014. The decrease in net income for the first nine months of 2015 as compared to the same period of 2014 is due primarily to a $4.5 million increase in the provision for loan losses. The increase in the provision was primarily because there was more commercial loan growth and fewer credit rating upgrades in the first nine months of 2015 when compared to the first nine months of 2014. The loss on sale of real estate owned increased $1.3 million due primarily to a large gain realized on the sale of a commercial property in the first nine months of 2014. Net interest income decreased $0.4 million between the periods primarily because of a decrease in the average interest-earning assets between the periods. Compensation and benefits increased $0.3 million between the periods primarily because of increased expenses related to restricted stock awards. These decreases in net income were partially offset by a $2.6 million decrease in income tax expense due to the decreased income between the periods.

Net Interest Income

Net interest income was $5.0 million for the third quarter of 2015, an increase of $0.2 million, or 3.3%, compared to $4.8 million for the third quarter of 2014. Interest income was $5.4 million for the third quarter of 2015, an increase of $0.3 million, or 5.0%, from $5.1 million for the same period of 2014. Interest income increased between the periods primarily because of a change in the mix of average interest-earning assets held, which resulted in an increase in the average yields earned between the periods. While the average interest-earning assets decreased $3.8 million between the periods, the average interest-earning assets held in lower yielding cash and investments decreased $38.2 million and the amount of average interest-earning assets held in higher yielding loans increased $34.4 million. The increase in the average outstanding loans between the periods was primarily the result of an increase in the commercial loan portfolio, which occurred primarily because of increased commercial loan originations between the periods and also because of the acquisition of loans from Kasson State Bank in the third quarter of 2015. The average yield earned on interest-earning assets was 3.72% for the third quarter of 2015, an increase of 21 basis points from 3.51% for the third quarter of 2014.

Interest expense was $0.4 million for the third quarter of 2015, an increase of $0.1 million, or 33.7%, compared to $0.3 million for the third quarter of 2014. Interest expense increased primarily because of the change in the mix of the average interest-bearing liabilities held, which resulted in an increase in the average rate paid between the periods. While the average interest-bearing liabilities increased $8.0 million between the periods, the amount held in higher rate borrowings increased $10.0 million, the average interest-bearing liabilities held in higher rate certificates of deposits decreased $11.1 million, and the amount of interest-bearing liabilities held in other lower rate deposit accounts increased $9.1 million. The increase in the average interest-bearing liabilities as a result of the deposits assumed in the Kasson State Bank transaction was almost entirely offset by decreases in the average deposit balances held between the periods by several large deposit customers due to changes in the cash needs of the customers. The increase in the average rates paid was primarily due to the $10.0 million holding company note payable that was funded in the first quarter of 2015 in connection with the redemption of all of the remaining Preferred Stock . Interest expense increases related to borrowing costs were partially offset by the lower interest rates paid on money market accounts and certificates of deposits between the periods. The decreased rates paid on these accounts were the result of the low interest rate environment that continued to exist during the third quarter of 2015. The average interest rate paid on interest-bearing liabilities was 0.30% for the third quarter of 2015, an increase of 7 basis points from the 0.23% average interest rate paid in the third quarter of 2014.

Net interest margin (net interest income divided by average interest-earning assets) for the third quarter of 2015 was 3.44%, an increase of 13 basis points, compared to 3.31% for the third quarter of 2014.

Net interest income was $14.2 million for the first nine months of 2015, a decrease of $0.4 million, or 2.8%, from $14.6 million for the same period of 2014. Interest income was $15.3 million for the nine-month period ended September 30, 2015, a decrease of $0.2 million, or 1.5%, from $15.5 million for the same period of 2014. Interest income decreased between the periods primarily because of a decrease in the average interest-earning assets held between the periods. This decrease was partially offset by an increase in average yields earned as a result of the change in the mix of assets held. While the average interest-earning assets decreased $34.0 million between the periods, the average interest-earning assets held in lower yielding cash and investment decreased $38.6 million and the amount of average interest-earning assets held in higher yielding loans increased $4.6 million between the periods. The increase in the average outstanding loans between the periods was primarily the result of an increase in loan originations between the periods. The average yield earned on interest-earning assets was 3.75% for the first nine months of 2015, an increase of 17 basis points from 3.58% for the same period of 2014.

Interest expense was $1.1 million for the nine-month period ended September 30, 2015, an increase of $0.2 million, or 18.9%, from $0.9 million for the same period in 2014. Interest expense increased primarily because of the change in the mix of the average interest-bearing liabilities held, which resulted in an increase in the average rate paid between the periods. While the average interest-bearing liabilities decreased $22.5 million between the periods, the amount held in higher rate borrowings increased $8.7 million, the average interest-bearing liabilities held in higher rate certificates of deposits decreased $19.0 million, and the amount of interest-bearing liabilities held in other lower rate deposit accounts decreased $12.2 million between the periods. The increase in the average rates paid was primarily due to the $10.0 million holding company note payable that was funded in the first quarter of 2015 in connection with the redemption of all of the remaining outstanding Preferred Stock. Interest expense increases related to borrowing costs were partially offset by the lower interest rates paid on money market accounts and certificates of deposits between the periods. The decreased rates paid on these accounts were the result of the low interest rate environment that continued to exist during the first nine months of 2015. The average interest rate paid on interest-bearing liabilities was 0.30% for the first nine months of 2015, an increase of 6 basis points from the 0.24% average interest rate paid in the first nine months of 2014.

Net interest margin (net interest income divided by average interest earning assets) for the first nine months of 2015 was 3.47%, an increase of 11 basis points, compared to 3.36% for the first nine months of 2014.

A summary of the Company’s net interest margin for the three and nine-month periods ended September 30, 2015 and September 30, 2014 is as follows:

	For the three-month period ended
	September 30, 2015							September 30, 2014
(Dollars in thousands)	Average Outstanding Balance		Interest Earned/ Paid		Yield/ Rate ⁽²⁾			Average Outstanding Balance		Interest Earned/ Paid		Yield/ Rate ⁽²⁾
Interest-earning assets:
Securities available for sale	$	131,232		503		1.52	%	$	137,503		416		1.20	%
Loans held for sale		3,633		36		3.93			2,253		21		3.70
Mortgage loans, net ⁽¹⁾		78,820		817		4.11			70,580		835		4.69
Commercial loans, net ⁽¹⁾		259,587		3,273		5.00			237,404		3,106		5.19
Consumer loans, net ⁽¹⁾		57,040		734		5.11			54,378		707		5.16
Cash equivalents		44,358		26		0.23			76,224		45		0.23
Federal Home Loan Bank stock		691		1		0.57			777		1		0.51
Total interest-earning assets		575,361		5,390		3.72			579,119		5,131		3.51

Interest-bearing liabilities:
NOW accounts		72,995		4		0.02			70,311		3		0.02
Savings accounts		58,008		12		0.08			47,953		8		0.07
Money market accounts		154,904		84		0.22			171,329		107		0.25
Certificates		96,886		131		0.54			108,029		179		0.66
Advances and other borrowings		10,000		166		6.59			0		0		0.00
Total interest-bearing liabilities		392,793							397,622
Non-interest checking		138,571							125,751
Other non-interest bearing deposits		1,190							1,200
Total interest-bearing liabilities and non-interest bearing deposits	$	532,554		397		0.30		$	524,573		297		0.23
Net interest income				4,993						$	4,834
Net interest rate spread						3.42	%						3.28	%
Net interest margin						3.44	%						3.31	%

⁽¹⁾ Average balances of loans include non-accrual loans

⁽²⁾ Annualized

	For the nine-month period ended
	September 30, 2015							September 30, 2014
(Dollars in thousands)	Average Outstanding Balance		Interest Earned/ Paid		Yield/ Rate ⁽²⁾			Average Outstanding Balance		Interest Earned/ Paid		Yield/ Rate ⁽²⁾
Interest-earning assets:
Securities available for sale	$	139,851		1,542		1.47	%	$	120,632		1,020		1.13	%
Loans held for sale		2,485		60		3.23			1,520		45		3.96
Mortgage loans, net ⁽¹⁾		73,063		2,292		4.19			73,572		2,483		4.51
Commercial loans, net ⁽¹⁾		247,586		9,346		5.05			244,197		9,777		5.35
Consumer loans, net ⁽¹⁾		54,273		2,053		5.06			53,563		2,093		5.22
Cash equivalents		29,699		48		0.22			87,474		157		0.24
Federal Home Loan Bank stock		733		3		0.55			779		3		0.51
Total interest-earning assets		547,690		15,344		3.75			581,737		15,578		3.58

Interest-bearing liabilities:
NOW accounts		75,139		12		0.02			70,861		11		0.02
Savings accounts		51,706		27		0.07			47,259		24		0.07
Money market accounts		150,582		261		0.23			163,319		307		0.25
Certificates		95,282		405		0.57			113,200		583		0.69
Brokered deposits		0		0		0.00			1,109		12		1.45
Advances and other borrowings		8,665		409		6.31			0		0		0.00
Total interest-bearing liabilities		381,374							395,748
Non-interest checking		120,526							128,759
Other non-interest bearing deposits		1,044							983
Total interest-bearing liabilities and non-interest bearing deposits	$	502,944		1,114		0.30		$	525,490		937		0.24
Net interest income				14,230						$	14,641
Net interest rate spread						3.45	%						3.34	%
Net interest margin						3.47	%						3.36	%

⁽¹⁾ Average balances of loans include non-accrual loans

⁽²⁾ Annualized

Provision for Loan Losses

The provision for loan losses was ($0.1) million for the third quarter of 2015, an increase in the provision of $0.9 million, compared to ($1.0) million for the third quarter of 2014. The provision for loan losses was ($0.2) million for the first nine months of 2015, an increase of $4.6 million, from ($4.8) million for the same nine-month period of 2014. The increase in the provision in the third quarter and the first nine months of 2015 was primarily because there was more commercial loan growth and fewer credit rating upgrades in the third quarter and first nine months of 2015 when compared to the same periods of 2014.

A reconciliation of the Company’s allowance for loan losses for the three and nine-month periods ended September 30, 2015 and September 30, 2014 is summarized as follows:

	Three months ended September 30,
(Dollars in thousands)	2015			2014
Balance at June 30,	$	8,402		$	8,696
Provision		(56	)		(989	)
Charge offs:
Consumer		(39	)		(15	)
Commercial business		(1	)		(55	)
One-to-four family real estate		(19	)		0
Recoveries		499			286
Balance at September 30,	$	8,786		$	7,923

Allocated to:
General allowance	$	7,875		$	6,651
Specific allowance		911			1,272
	$	8,786		$	7,923

	Nine months ended September 30,
(Dollars in thousands)	2015			2014
Balance at January 1,	$	8,332		$	11,401
Provision		(239	)		(4,777	)
Charge offs:
One-to-four family		(19	)		(92	)
Consumer		(66	)		(75	)
Commercial business		(7	)		(56	)
Commercial real estate		0			(936	)
Recoveries		785			2,458
Balance at September 30,	$	8,786		$	7,923

Non-Interest Income

Non-interest income was $2.2 million for the third quarter of 2015, the same as for the third quarter of 2014. The Company recognized a gain of $0.3 million related to the Kasson State Bank acquisition that was completed in the third quarter of 2015. This increase in non-interest income was offset by a $0.2 million decrease in the gain on sales of loans between the periods and a decrease in fees and other income of $0.1 million between the periods. The decrease in the gain on sales of loans was primarily related to a decrease in the gains recognized on the sale of commercial government guaranteed loans between the periods due to a decrease in originations of these types of loans in the third quarter of 2015 when compared to the same period of 2014.

Non-interest income was $5.7 million for the first nine months of 2015, an increase of $0.1 million, or 1.6%, from $5.6 million for the same period in 2014. The Bank recognized a gain of $0.3 million in connection with the acquisition of Kasson State Bank that was completed in the third quarter of 2015. This increase in non-interest income was offset by a $0.1 million decrease on the gain on sales of loans between the periods. The decrease in the gain on sales of loans was primarily related to a decrease in the gains recognized on the sale of commercial government guaranteed loans due to a decrease in originations of these types of loans between the periods.

Non-Interest Expense

Non-interest expense was $6.0 million for the third quarter of 2015, an increase of $0.6 million, or 10.0%, from $5.4 million for the same period of 2014. The loss on sale of real estate owned increased $0.2 million between the periods due to the write down of a commercial property as a result of obtaining an updated appraisal of the property. Compensation and benefits expense increased $0.1 million primarily because of an increase in incentive accruals due to increased commercial loan production. Other non-interest expenses increased $0.1 million between the periods primarily because of an increase in expenses related to the increased loan production and costs associated with a new travel club that was established in the third quarter of 2015. Deposit insurance expense increased $0.1 million between the periods due to the increase in the Bank’s assets between the periods.

Non-interest expense was $17.2 million for the first nine months of 2015, an increase of $1.6 million, or 10.4%, from $15.6 million for the same period in 2014. The loss on sale of real estate owned increased $1.3 million between the periods primarily because of a $1.0 million gain that was recognized on the sale of single commercial property in the first nine months of 2014. Compensation and benefits increased $0.3 million between the periods primarily because of increased expenses related to restricted stock awards and increased incentive accruals due to increased loan originations.

Income Tax Expense

Income tax expense was $0.5 million for the third quarter of 2015, a decrease of $0.6 million, from $1.1 million for the third quarter of 2014. Income tax expense was $1.1 million for the first nine months of 2015, a decrease of $2.6 million, from $3.7 million for the same period in 2014. The decrease in income tax expense between the periods is primarily related to the decrease in income in the third quarter and first nine months of 2015 when compared to the same periods of 2014.

Net Income Available to Common Shareholders

Net income available to common shareholders was $0.8 million for the third quarter of 2015, a decrease of $0.4 million from the $1.2 million net income available to common shareholders in the third quarter of 2014. The net income available to common shareholders was $1.8 million for the first nine months of 2015, a decrease of $2.5 million from the $4.3 million net income available to common shareholders in the same period of 2014. The net income available to common shareholders decreased primarily because of the decrease in net income between the periods that was partially offset by a reduction, or in the case of the third quarter period, elimination, of the dividends required to be paid on the outstanding Preferred Stock. On February 17, 2015 the Company redeemed the final 10,000 shares of its outstanding Preferred Stock and, as a result, no dividends were required to be paid on the Preferred Stock after that date.

F INANCIAL CONDITION

Non-Performing Assets

The following table summarizes the amounts and categories of non-performing assets, which consist of non-performing loans and foreclosed and repossessed assets, in the Bank’s portfolio and loan delinquency information as of the end of the two most recently completed quarters and December 31, 2014.

	September 30,			June 30,			December 31,
(Dollars in thousands)	2015			2015			2014
Non-Performing Loans:
One-to-four family real estate	$	1,621		$	1,807		$	1,564
Commercial real estate		6,617			7,999			8,750
Consumer		801			743			486
Commercial business		42			11			120
Total		9,081			10,560			10,920

Foreclosed and Repossessed Assets:
One-to-four family real estate		110			0			50
Commercial real estate		2,394			2,730			3,053
Total non-performing assets	$	11,585		$	13,290		$	14,023
Total as a percentage of total assets		1.87	%		2.36	%		2.43	%
Total non-performing loans	$	9,081		$	10,560		$	10,920
Total as a percentage of total loans receivable, net		2.10	%		2.87	%		2.99	%
Allowance for loan losses to non-performing loans		96.75	%		79.57	%		76.30	%

Delinquency Data:
Delinquencies ⁽¹⁾
30+ days	$	1,778		$	1,382		$	1,682
90+ days		0			0			0
Delinquencies as a percentage of loan portfolio ⁽¹⁾
30+ days		0.40	%		0.36	%		0.45	%
90+ days		0.00	%		0.00	%		0.00	%

⁽¹⁾ Excludes non-accrual loans.

Total non-performing assets were $11.6 million at September 30, 2015, a decrease of $1.7 million, or 12.8%, from $13.3 million at June 30, 2015. Non-performing loans decreased $1.5 million and foreclosed and repossessed assets decreased $0.2 million during the third quarter of 2015. The non-performing loan and foreclosed and repossessed asset activity for the quarter was as follows:

(Dollars in thousands)
Non-performing loans				Foreclosed and repossessed assets
June 30, 2015	$	10,560		June 30, 2015	$	2,730
Classified as non-performing		940		Other foreclosures/repossessions		239
Charge offs		(51	)	Real estate sold		(401	)
Principal payments received		(2,073	)	Net gain on sale of assets		32
Classified as accruing		(185	)	Write downs		(206	)
Transfer to real estate owned		(110	)	Transfer from non-performing loans		110
September 30, 2015	$	9,081		September 30, 2015	$	2,504

The decrease in non-performing loans during the third quarter of 2015 relates primarily to principal payments received during the period. Of the $2.1 million in principal payments received, $0.6 million related to the payoff of four construction loans as a result of home sales and $1.2 million related to the payments received on a commercial development loan from lot sale proceeds.

Total non-performing assets were $11.6 million at September 30, 2015, a decrease of $2.4 million, or 17.4%, from $14.0 million at December 31, 2014. Non-performing loans decreased $1.8 million and foreclosed and repossessed assets decreased $0.6 million during the first nine months of 2015. The non-performing loan and foreclosed and repossessed asset activity for the first nine months of 2015 was as follows:

(Dollars in thousands)
Non-performing loans				Foreclosed and repossessed asset activity
January 1, 2015	$	10,920		January 1, 2015	$	3,103
Classified as non-performing		3,091		Other foreclosures/repossessions		239
Charge offs		(83	)	Real estate sold		(809	)
Principal payments received		(4,537	)	Net gain on sale of assets		200
Classified as accruing		(200	)	Write downs		(339	)
Transfer to real estate owned		(110	)	Transfer from non-performing loans		110
September 30, 2015	$	9,081		September 30, 2015	$	2,504

The decrease in non-performing loans during the first nine months of 2014 relates primarily to principal payments received. Of the $4.5 million in principal payments received during the period, $2.5 million related to construction loans to residential builders where the construction had been completed and the borrower paid off the loan from the home sale proceeds and $1.2 million related to the payments received on a commercial development loan from lot sale proceeds.

The following table summarizes the number of lending relationships and types of commercial real estate loans that were non-performing as of the end of the two most recently completed quarters and December 31, 2014.

(Dollars in thousands)

Property Type

# of

relationships

Principal Amount of Loans at

September 30,

2015

# of

relationships

Principal Amount of Loans at

June 30,

2015

# of

relationships

Principal Amount of Loans at

December 31,

2014

Developments/land

6,617

7,999

8,750

The decrease in the non-performing commercial real estate loans from June 30, 2015 is due primarily to principal payments received on construction and development loans during the quarter as a result of various building lot sales.

LIQUIDITY AND CAPITAL RESOURCES

For the nine months ended September 30, 2015, the net cash provided by operating activities was $9.6 million. The Company collected $118.6 million from the maturities of securities, $1.3 million from principal repayments on securities, and $0.8 million in proceeds from the sale of real estate. The Company purchased securities of $109.1 million and purchased premises and equipment of $0.6 million. The Company purchased $0.1 million in Federal Home Loan Bank Stock (FHLB) and sold FHLB stock of $0.2 million. Net loans receivable increased $49.3 million due primarily to increased loan originations and also because of the loans purchased in connection with the Kasson State Bank acquisition. The Company recorded a gain on the Kasson State Bank acquisition of $0.3 million and received net cash of $4.8 million in connection with the transaction. The Company had a net decrease in deposit and customer escrow balances of $11.9 million, redeemed $10.0 million of outstanding Preferred Stock, and paid $0.2 million in Preferred Stock dividends. The Company received proceeds from borrowings of $41.0 million and repaid $31.0 million in borrowings during the period.

The Company has certificates of deposits with outstanding balances of $63.5 million that come due over the next 12 months. 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. Federal Reserve Bank borrowings or proceeds from the sale of securities could also be used to fund unanticipated outflows of deposits.

The Company had three deposit customers with aggregate deposits greater than $5.0 million as of September 30, 2015. The $47.0 million in funds held by these customers may be withdrawn at any time and management anticipates that the majority of these deposits will be maintained at the Bank over the next twelve months. If these deposits are withdrawn, it is anticipated that they would be replaced with deposits from other customers or FHLB advances. Federal Reserve borrowing or proceeds from the sale of securities could also be used to replace unanticipated outflows of large checking and money market deposits.

The Company had the ability to borrow $89.7 million from the FHLB at September 30, 2015, based on the collateral value of the loans pledged. The credit policy of the FHLB relating to the collateral value of the loans collateralizing the available line of credit with the FHLB may change such that the current collateral pledged to secure future advances is no longer acceptable or the formulas for determining the excess pledged collateral may change. The FHLB could also reduce the amount of funds it will lend to the Bank. It is not anticipated that the Bank will need to find alternative funding sources in the next twelve months to replace the available borrowings from the FHLB. However, if needed, excess collateral currently pledged to the FHLB could be pledged to the FRB and the Bank could borrow additional funds from the FRB based on the increased collateral levels or obtain additional deposits.

On February 17, 2015 the Company redeemed the final 10,000 shares of its outstanding Preferred Stock after redeeming 16,000 shares in 2014. These redemptions reduced the amount of dividends paid on the Preferred Stock and increased interest expense in the first nine months of 2015 when compared to the same period of 2014 as the redemption was funded by a $10.0 million holding company note payable to an unrelated third party.

The Company’s primary source of cash is dividends from the Bank. At September 30, 2015, the Company had $3.8 million in cash and other assets that could readily be turned into cash. The primary use of cash by the Company is the payment of operating expenses and principal and interest on the third party note payable. The interest payments on the note payable are due quarterly and a principal payment of $1.0 million is due on December 15, 2015.

The Company also serves as a source of capital, liquidity and financial support to the Bank. Depending upon the operating performance of the Bank and the Company’s other liquidity and capital needs including the payment of principal and interest on the Company’s outstanding note payable. The Company may find it prudent, subject to prevailing capital market conditions and other factors, to raise additional capital through issuance of its common stock or other equity securities. 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 were to raise capital through the issuance of additional shares of common stock or other equity securities, it could dilute the ownership interests of existing stockholders, dilute the Company’s earnings per share and, if issued at a price less than the Company’s book value, would dilute the per share book value of the Company’s common stock, 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 its control, and on the Company’s financial performance and plans.

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, borrowing, and deposit taking activities. Management actively monitors and manages its interest rate risk exposure.

The Company’s profitability is affected by fluctuations in interest rates. A sudden and substantial change in interest rates may adversely impact the Company’s earnings to the extent that the interest rates borne by assets and liabilities do not change at the same speed, to the same extent, or on the same basis. The Company monitors the projected changes in net interest income that occur if interest rates were to suddenly change up or down. The Rate Shock Table located in the Asset/Liability Management section of this report, which follows, discloses the Company’s projected changes in net interest income based upon immediate interest rate changes called rate shocks. The Company utilizes a model that uses the discounted cash flows from its interest-earning assets and its interest-bearing liabilities to calculate the current market value of those assets and liabilities. The model also calculates the changes in market value of the interest-earning assets and interest-bearing liabilities due to different interest rate changes.

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 September 30, 2015.


Other than trading portfolio		Market Value

(Dollars in thousands)
Basis point change in interest rates		100		0		+100			+200
Total market risk sensitive assets	$	615,624		605,201			589,072			574,556
Total market risk sensitive liabilities		530,948		498,636			478,995			460,493
Off-balance sheet financial instruments		(610	)	0			58			182
Net market risk	$	85,286		106,565			110,019			113,881
Percentage change from current market value		(19.97	) %	0.00	%		3.24	%		6.87	%

The preceding table was prepared utilizing the following assumptions (the Model Assumptions) regarding prepayment and decay ratios, which were determined by management based upon their review of historical prepayment speeds and future prepayment projections. Fixed rate loans were assumed to prepay at annual rates of between 4% to 58%, depending on the note rate and the period to maturity. Adjustable rate mortgages (ARMs) were assumed to prepay at annual rates of between 18% and 138%, depending on the note rate and the period to maturity. Mortgage-backed securities were projected to have prepayments based upon the underlying collateral securing the instrument. Certificate accounts were assumed not to be withdrawn until maturity. Passbook accounts were assumed to decay at an annual rate of 6% and retail money market accounts were assumed to decay at an annual rate of 8%. Non-interest checking and NOW accounts were assumed to decay at an annual rate of 3%. Commercial NOW accounts and MMDA accounts were assumed to decay at an annual rate of 7% and 12%, respectively. Commercial non-interest checking accounts were assumed to decay at an annual rate of 7%. Callable investments were projected to be called at the first call date where the projected interest rate on similar remaining term advances exceeded the interest rate on the callable advance or investment.

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 which 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 which are approaching their lifetime interest rate caps could be different from the values disclosed in the table. In the event of a change in interest rates, prepayment and early withdrawal levels may deviate significantly from those assumed in calculating the foregoing table. The ability of many borrowers to service their debt may decrease in the event of a substantial sustained interest rate increase.

Asset/Liability Management

The Company’s management reviews the impact that changing interest rates will have on its net interest income projected for the next twelve months to determine if its current level of interest rate risk is acceptable. The following table projects the estimated annual impact on net interest income during the 12 month period ending September 30, 2016 of immediate interest rate changes called rate shocks.

(Dollars in thousands)
Rate Shock in Basis Points		Projected Change in Net Interest Income			Percentage Change
+200		$	2,063			9.88	%
+100			1,003			4.80
	0		0			0.00
	-100		(1,811	)		(8.67	)

The preceding table was prepared utilizing the Model Assumptions. Certain shortcomings are inherent in the method of analysis presented in the foregoing table. In the event of a change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed in calculating the foregoing table. The ability of many borrowers to service their debt may decrease in the event of a substantial increase in interest rates and could impact net interest income. The increase in interest income in a rising rate environment is primarily because more loans than deposits are scheduled to reprice in the next twelve months.

In an attempt to manage its exposure to changes in interest rates, management closely monitors interest rate risk. The Bank has an Asset/Liability Committee which 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, which are reviewed by the board of directors of the Bank. This Committee also reviews the Bank's portfolio, formulates investment strategies and oversees the timing and implementation of transactions to assure attainment of the Board's objectives in the most 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 mix, 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 restructure its balance sheet in order to better match the maturities of its assets and liabilities. In the past, more fixed rate loans were placed into the single family loan portfolio. Over the past several years, the Bank has primarily focused its fixed rate one-to-four family residential lending program on loans that are saleable to third parties and generally placed only those fixed rate loans that met certain risk characteristics into its loan portfolio. The Bank’s commercial loan production continues to emphasize adjustable rate loans with minimum interest rate floors; however, a majority of the commercial portfolio is comprised of fixed rate loans with an average maturity of less than five years.

Off-Balance Sheet Arrangements

The Company has no off-balance sheet arrangements other than commitments to originate, fund, and sell loans in the ordinary course of business.

Item 3: Quantitative and Qualitative Disclosures about Market Risk

Not applicable.

Item 4: Controls and Procedures

Evaluation of disclosure controls and procedures. As of the end of the period covered by this report, the Company conducted an evaluation, under the supervision and with the participation of the Company’s management, including the principal executive officer and principal financial officer, of the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)). Based on this evaluation, the principal executive officer and principal financial officer concluded that the Company’s disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.

Changes in internal controls. There was no change in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) during the Company’s most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

HMN FINANCIAL, INC.

PART II - OTHER INFORMATION

ITEM 1. Legal Proceedings.

From time to time, the Company is party to legal proceedings arising out of its lending and deposit operations. The Company is, and expects to become, engaged in a number of foreclosure proceedings and other collection actions as part of its collection activities. Based on our current understanding of these pending legal proceedings, management does not believe that judgments or settlements, if any and if determined adversely to the Company, arising from pending legal matters individually or in the aggregate, would have a material adverse effect on the consolidated financial position, operating results or cash flows of the Company. Litigation is often unpredictable and the actual results of litigation cannot be determined with any certainty.

ITEM 1A. Risk Factors.

There have been no material changes to the Company’s risk factors contained in its Annual Report on Form 10-K for the year ended December 31, 2014 and Forms 10-Q for the quarters ended March 31, 2015 and June 30, 2015. For a further discussion of our Risk Factors, see Part I, Item 1.A. of the Company’s Annual Report on Form 10-K for the year ended December 31, 2014 and Form 10-Q for the quarters ended March 31, 2015 and June 30, 2015.

ITEM 2 . Unregistered Sales of Equity Securities and Use of Proceeds.

None.

ITEM 3. Defaults Upon Senior Securities.

None.

ITEM 4. Mine Safety Disclosures .

Not applicable.

ITEM 5. Other Information.

None.

ITEM 6. Exhibits.

Incorporated by reference to the index to exhibits included with this report immediately following the signature page.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	HMN FINANCIAL, INC.
	Registrant


Date: November 4, 2015	By:	/s/ Bradley Krehbiel
		Bradley Krehbiel, President and Chief Executive Officer
		(Principal Executive Officer)


Date: November 4, 2015	By:	/s/ Jon Eberle
		Jon Eberle
		Senior Vice President, Chief Financial Officer, and Treasurer
		(Principal Financial Officer)

HMN FINANCIAL, INC.

INDEX TO EXHIBITS

FOR FORM 10-Q

		Sequential
		Page Numbering
Regulation		Where Attached
S-K		Exhibits Are
Exhibit		Located in This
Number	Document Attached Hereto	Form 10-Q Report

3.1	Amended and Restated Certificate of Incorporation	Filed Electronically

31.1	Rule 13a-14(a)/15d-14(a) Certification of CEO	Filed Electronically

31.2	Rule 13a-14(a)/15d-14(a) Certification of CFO	Filed Electronically

32	Section 1350 Certifications of CEO and CFO	Filed Electronically

101	Financial statements from the Quarterly Report on Form 10-Q of the Company for the period ended September 30, 2015, filed with the SEC on November 4, 2015, formatted in Extensible Business Reporting Language (XBRL); (i) the Consolidated Balance Sheets at September 30, 2015 and December 31, 2014, (ii) the Consolidated Statements of Comprehensive Income for the Three Month and Nine Month Periods Ended September 30, 2015 and 2014, (iii) the Consolidated Statement of Stockholders’ Equity for the Nine Month Period Ended September 30, 2015, (iv) the Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2015 and 2014, and (v) Notes to Consolidated Financial Statements.	Filed Electronically

Exhibit 3.1

CERTIFICATE OF INCORPORATION

HMN FINANCIAL, INC.

(Amended and Restated through July 28, 2015)

FIRST : The name of the Corporation is HMN Financial, Inc. (hereinafter sometimes referred to as the “Corporation”).

SECOND : The address of the registered office of the Corporation in the State of Delaware is Corporation Trust Center, 1209 Orange Street, in the City of Wilmington, County of New Castle. The name of the registered agent at that address is The Corporation Trust Company.

THIRD : The purpose of the Corporation is to engage in any lawful act or activity for which a corporation may be organized under the General Corporation Law of Delaware.

FOURTH :

A. The total number of shares of all classes of stock that the Corporation shall have the authority to issue is sixteen million five hundred thousand (16,500,000) consisting of:

1. Five hundred thousand (500,000) shares of Preferred Stock, $.01 par value per share (the “Preferred Stock”); and

2. Sixteen million (16,000,000) shares of Common Stock, $.01 par value per share (the “Common Stock”).

B. The Board of Directors is authorized, subject to any limitations presented by law, to provide for the issuance of the shares of Preferred Stock in series, and by filing a certificate pursuant to the applicable law of the State of Delaware (such certificate being hereinafter referred to as a “Preferred Stock Designation”), to establish from time to time the number of shares to be included in each such series, and to fix the designation, powers, preferences and rights of the shares of each such series and any qualifications, limitations or restrictions thereof. The number of authorized shares of the Preferred Stock may be increased or decreased (but not below the number of shares thereof then outstanding) by the affirmative vote of the holders of a majority of the Common Stock, without a vote of the holders of the Preferred Stock, or of any series thereof, unless a vote of any such holders is required pursuant to the terms of any Preferred Stock Designation.

C. 1. Notwithstanding any other provision of this Certificate of Incorporation, in no event shall any record owner of any outstanding Common Stock which is beneficially owned, directly or indirectly, by a person who, as of any record date for the determination of stockholders entitled to vote on any matter, beneficially owns in excess of 10% of the then-outstanding shares of Common Stock (the “Limit”), be entitled, or permitted to any vote in respect of the shares held in excess of the Limit. The number of votes which may be cast by any record owner by virtue of the provisions hereof in respect of Common Stock beneficially owned by such person owning shares in excess of the Limit shall be a number equal to the total number of votes which a single record owner of all Common Stock owned by such person would be entitled to cast, multiplied by a fraction, the numerator of which is the number of shares of such class or series beneficially owned by such person and owned of record by such record owner and the denominator of which is the total number of shares of Common Stock beneficially owned by such person owning shares in excess of the Limit.

2. The following definitions shall apply to this Section C of this Article

FOURTH:

(a) An “affiliate” of a specified person shall mean a person that directly, or indirectly through one or more intermediaries, controls, or is controlled by, or is under common control with, the person specified.

(b) “Beneficial ownership” shall be determined pursuant to Rule 13d-3 of the General Rules and Regulations under the Securities Exchange Act of 1934 (or any successor rule or statutory provision), or, if said Rule 13d-3 shall be rescinded and there shall be no successor rule or statutory provision thereto, pursuant to said Rule 13d-3 as in effect on the date this Certificate of Incorporation is filed with the Secretary of State of the State of Delaware (“Filing Date”); provided , however , that a person shall, in any event, also be deemed the “beneficial owner” of any Common Stock:

(1) which such person or any of its affiliates beneficially owns, directly or indirectly; or

(2) which such person or any of its affiliates has (i) the right to acquire (whether such right is exercisable immediately or only after the passage of time), pursuant to any agreement, arrangement or understanding (but shall not be deemed to be the beneficial owner of any voting shares solely by reason of an agreement, contract, or other arrangement with this Corporation to effect any transaction which is described in any one or more of the clauses of Section A of Article EIGHTH) or upon the exercise of conversion rights, exchange rights, warrants, or options or otherwise, or (ii) sole or shared voting or investment power with respect thereto pursuant to any agreement, arrangement understanding, relationship or otherwise (but shalt not be deemed to be the beneficial owner of any voting shares solely by reason of a revocable proxy granted for a particular meeting of stockholders, pursuant to a public solicitation of proxies for such meeting, with respect to shares of which neither such person nor any such affiliate is otherwise deemed the beneficial owner); or

(3) which is beneficially owned, directly or indirectly, by any other person with which such first mentioned person or any of its affiliates acts as a partnership, limited partnership, syndicate or other group pursuant to any agreement, arrangement or understanding for the purpose of acquiring, holding, voting or disposing of any shares of capital stock of this Corporation; and provided further, however, that (i) no director or officer of this Corporation (or any affiliate of any such director or officer) shall, solely by reason of any or all of such directors or officers acting in their capacities as such, be deemed, for any purposes hereof, to beneficially own any Common Stock beneficially owned by any other such director or officer (or any affiliate thereof) and (ii) neither any employee stock ownership or similar plan of this Corporation or any subsidiary of this Corporation nor any trustee with respect thereto (or any affiliate of such trustee) shall, solely by reason of such capacity of such trustee, be deemed, for any purposes hereof, to beneficially own any Common Stock held under any such plan. For purposes of computing the percentage of Common Stock beneficially owned by a person, the outstanding Common Stock shall include shares deemed owned by such person through application of this subsection but shall not include any other Common Stock which may be issuable by this Corporation pursuant to any agreement, or upon exercise of conversion rights, warrants or options, or otherwise. For all other purposes, the outstanding Common Stock shall include only Common Stock then outstanding and shall not include any Common Stock which may be issuable by this Corporation pursuant to any agreement, or upon the exercise of conversion rights, warrants or options, or otherwise.

(d) The Board of Directors shall have the power to construe and apply the provisions of this section and to make all determinations necessary or desirable to implement such provisions, including but not limited to matters with respect to (1) the number of shares of Common Stock beneficially owned by any person, (2) whether a person is an affiliate of another, (3) whether a person has an agreement, arrangement, or understanding with another as to the matters referred to in the definition of beneficial ownership, (4) the application of any other definition or operative provision of this Section to the given facts, or (5) any other matter relating to the applicability or effect of this Section.

3. The Board of Directors shall have the right to demand that any person who is reasonably believed to beneficially own Common Stock in excess of the Limit (or holds of record Common Stock beneficially owned by any person in excess of the Limit (a “Holder in Excess”) supply the Corporation with complete information as to (a) the record owner(s) of all shares beneficially owned by such Holder in Excess and (b) any other factual matter relating to the applicability or effect of this section as may reasonably be requested of such Holder in Excess. The Board of Directors shall further have the right to receive from any Holder in Excess reimbursement for all expenses incurred by the Board in connection with its investigation of any matters relating to the applicability or effect of this section on such Holder in Excess, to the extent such investigation is deemed appropriate by the Board of Directors as a result of the Holder in Excess refusing to supply the Corporation with the information described in the previous sentence.

4. Except as otherwise provided by law or expressly provided in this Section C, the presence, in person or by proxy, of the holders of record of shares of capital stock of the Corporation entitling the holders thereof to cast one third of the votes (after giving effect, if required, to the provisions of this Section) entitled to be cast by the holders of shares of capital stock of the Corporation entitled to vote shall constitute a quorum at all meetings of the stockholders. Every reference in this Certificate of Incorporation to a majority or other proportion of outstanding capital stock (or the holders thereof) or voting power for purposes of determining any quorum requirement or any requirement for stockholder consent or approval shall be deemed to refer to such percentage or other proportion of the votes (or the holders thereof) then entitled to be cast in respect of such capital stock after giving effect to the provisions of this Section whether or not the holders of capital stock are present in person or by proxy.

5. Any constructions, applications, or determinations made by the Board of Directors, pursuant to this Section in good faith and on the basis of such information and assistance as was then reasonably available for such purpose, shall be conclusive and binding upon the Corporation and its stockholders.

6. In the event any provision (or portion thereof) of this Section C shall be found to be invalid, prohibited or unenforceable for any reason, the remaining provisions (or portions thereof) of this Section shall remain in full force and effect, and shall be construed as if such invalid, prohibited or unenforceable provision had been stricken here from or otherwise rendered inapplicable, it being the intent of this Corporation and its stockholders that each such remaining provision (or portion thereof) of this Section C remain, to the fullest extent permitted by law, applicable and enforceable as to all stockholders, including stockholders owning an amount of stock over the Limit, notwithstanding any such finding.

FIFTH :

The following provisions are inserted for the management of the business and the

conduct of the affairs of the Corporation, and for further definition, limitation and regulation of the powers of the Corporation and of its directors and stockholders:

(A) The business and affairs of the Corporation shall be managed by or under the direction of the Board of Directors. In addition to the powers and authority expressly conferred upon them by Statute or by this Certificate of Incorporation or the By-laws of the Corporation, the directors are hereby empowered to exercise all such powers and do all such acts and things as may be exercised or done by the Corporation.

(B) The directors of the Corporation need not be elected by written ballot unless the By-laws so provide.

(C) Any action required or permitted to be taken by the stockholders of the Corporation, subject to the rights of holders of any class or series of Preferred Stock of the Corporation, must be effected at a duly called annual or special meeting of stockholders of the Corporation and may not be effected by any consent in writing by such stockholders.

(D) Special meetings of stockholders of the Corporation, subject to the rights of holders of any class or series of Preferred Stock of the Corporation, may be called only by the Board of Directors pursuant to a resolution adopted by a majority of the total number of directors which the Corporation would have if there were no vacancies on the Board of Directors (whether or not there exist any vacancies in previously authorized directorships at the time any such resolution is presented to the Board for adoption) (the “Whole Board”).

SIXTH :

A. The number of directors shall be fixed from time to time exclusively by the Board of Directors pursuant to a resolution adopted by a majority of the Whole Board. The directors, other than those who may be elected by the holders of any class or series of Preferred Stock, shall be divided into three classes, as nearly equal in number as reasonably possible, with the term of office of the first class to expire at the conclusion of the first annual meeting of stockholders, the term of office of the second class to expire at the conclusion of the annual meeting of stockholders one year thereafter and the term of office of the third class to expire at the conclusion of the annual meeting of stockholders two years thereafter. At each annual meeting of stockholders, commencing with the first annual meeting, directors elected to succeed those directors whose terms expire shall be elected for a term of office to expire at the conclusion of the third succeeding annual meeting of stockholders after their election, with each director to hold office until his or her successor shall have been duly elected and qualified.

B. Subject to the rights of the holders of any series of Preferred Stock then outstanding, newly created directorships resulting from any increase in the authorized number of directors or any vacancies in the Board of Directors resulting from death, resignation, retirement, disqualification, removal from office or other cause may be filled only by a majority vote of the directors then in office, though less than a quorum, and directors so chosen shall hold office for a term expiring at the annual meeting of stockholders at which the term of office of the class to which they have been elected expires, and until such director’s successor shall have been duly elected and qualified. No decrease in the number of authorized directors constituting the Board of Directors shall shorten the term of any incumbent director.

C. Advance notice of stockholder nominations for the election of directors and of business to be brought by stockholders before any meeting of the stockholders of the Corporation shall be given in the manner provided in the By-laws of the Corporation.

D. Subject to the rights of the holders of any series of Preferred Stock then outstanding, any directors, or the entire Board of Directors, may be removed from office at any time, but only for cause and only by the affirmative vote of the holders of at least 80% of the voting power of all of the then-outstanding shares of capital stock of the Corporation entitled to vote generally in the election of directors (after giving effect to the provisions of Article FOURTH of this Certificate of Incorporation), voting together as a single class.

SEVENTH : The Board of Directors is expressly empowered to adopt, amend or repeal the By-laws of the Corporation. Any adoption, amendment or repeal of the By-laws of the Corporation by the Board of Directors shall require the approval of a majority of the Whole Board. The stockholders shall also have power to adopt, amend or repeal the By-laws of the Corporation. In addition to any vote of the holders of any class or series of stock of this Corporation required by law or by this Certificate of Incorporation, the affirmative vote of the holders of at least 80% of the voting power of all of the then-outstanding shares of the capital stock of the Corporation entitled to vote generally in the election of directors (after giving effect to the provisions of Article FOURTH hereof), voting together as a single class, shall be required to adopt, amend or repeal any provisions of the By-laws of the Corporation.

EIGHTH :

A. In addition to any affirmative vote required by law or this Certificate of

Incorporation, and except as otherwise expressly provided in this Section:

1. any merger or consolidation of the Corporation or any Subsidiary

(as hereinafter deemed) with (i) any Interested Stockholder (as hereinafter defined) or (ii) any other corporation (whether or not itself an Interested Stockholder) which is, or after such merger or consolidation would be, an Affiliate (as hereinafter defined) of an Interested Stockholder; or

2. any sale, lease, exchange, mortgage, pledge, transfer or other disposition (in one transaction or a series of transactions) to or with any Interested Stockholder, or any Affiliate of any Interested Stockholder, of any assets of the Corporation or any Subsidiary having an aggregate Fair Market Value (as hereafter defined) equaling or exceeding 25% or more of the combined assets of the Corporation and its Subsidiaries; or

3. the issuance or transfer by the Corporation or any Subsidiary (in one transaction or a series of transactions) of any securities of the Corporation or any Subsidiary to any Interested Stockholder or any Affiliate of any Interested Stockholder in exchange for cash, securities or other property (or a combination thereof) having an aggregate Fair Market Value equaling or exceeding 25% of the combined assets of the Corporation and its Subsidiaries except pursuant to an employee benefit plan of the Corporation or any Subsidiary thereof; or

4. the adoption of any plan or proposal for the liquidation or dissolution of the Corporation proposed by or on behalf of any Interested Stockholder or any Affiliate of any Interested Stockholder; or

5. any reclassification of securities (including any reverse stock split), or recapitalization of the Corporation, or any merger or consolidation of the Corporation with any of its Subsidiaries or any other transaction (whether or not with or into or otherwise involving an Interested Stockholder) which has the effect, directly or indirectly, of increasing the proportionate share of the outstanding shares of any class of equity or convertible securities of the Corporation or any Subsidiary which is directly or indirectly owned by any Interested Stockholder or any Affiliate of any Interested Stockholder; shall require the affirmative vote of the holders of at least 80% of the voting power of the then-outstanding shares of stock of the Corporation entitled to vote in the election of directors (the “Voting Stock”), voting together as a single class. Such affirmative vote shall be required notwithstanding the fact that no vote may be required, or that a lesser percentage may be specified, by law or by any other provisions of this Certificate of Incorporation or any Preferred Stock Designation or in any agreement with any national securities exchange or quotation system or otherwise.

The term “Business Combination” as used in this Article EIGHTH shall mean any transaction which is referred to in any one or more of paragraphs 1 through 5 of Section A of this Article EIGHTH.

B. The provisions of Section A of this Article EIGHTH shall not be applicable to any particular Business Combination, and such Business Combination shall require only the affirmative vote of the majority of the outstanding shares of capital stock entitled to vote, or such vote as is required by law or by this Certificate of Incorporation, if, in the case of any Business Combination that does not involve any cash or other consideration being received by the stockholders of the Corporation solely in their capacity as stockholders of the Corporation, the condition specified in the following paragraph 1 is met or, in the case of any other Business Combination, either the condition specified in the following paragraph 1 is met or all of the conditions specified in the following; paragraph 2 are met:

1. The Business Combination shall have been approved by a majority of the Disinterested Directors (as hereinafter defined).

2. All of the following conditions shall have been met:

(a) The aggregate amount of the cash and the Fair Market Value as of the date of the consummation of the Business Combination of consideration other than cash to be received per share by the holders of Common Stock in such Business Combination shall at least be equal to the higher of the following:

(1) (if applicable) the Highest Per Share Price, including any brokerage commissions, transfer taxes and soliciting dealers’ fees, paid by the Interested Stockholder or any of its Affiliates for any shares of Common Stock acquired by it (i) within the two-year period immediately prior to the first public announcement of the proposal of the Business Combination (the “Announcement Date”), or (ii) in the transaction in which it became an Interested Stockholder, whichever is higher.

(2) the Fair Market Value per share of Common Stock on the Announcement Date or on the date on which the Interested Stockholder became an Interested Stockholder (such latter date is referred to in this Article EIGHTH as the “Determination Date”), whichever is higher.

(b) The aggregate amount of the cash and the Fair Market Value as of the date of the consummation of the Business Combination of consideration other than cash to be received per share by holders of shares of any class of outstanding Voting Stock other than Common Stock shall be at least equal to the highest of the following (it being intended that the requirements of this subparagraph (b) shall be required to be met with respect to every such class of outstanding Voting Stock, whether or not the Interested Stockholder has previously acquired any shares of a particular class of Voting Stock):

(1) (if applicable) the Highest Per Share Price (as hereinafter defined), including any brokerage commissions, transfer taxes and soliciting dealers’ fees, paid by the Interested Stockholder for any shares of such class of Voting Stock acquired by it (i) within the two-year period immediately prior to the Announcement Date, or (ii) in the transaction in which it became an Interested Stockholder, whichever is higher;

(2) (if applicable) the highest preferential amount per share to which the holders of shares of such class of Voting Stock are entitled in the event of any voluntary or involuntary liquidation, dissolution or winding up of the Corporation; and

(3) the Fair Market Value per share of such class of Voting Stock on the Announcement Date or on the Determination Date, whichever is higher.

(c) The consideration to be received by holders of a particular class of outstanding Voting Stock (including Common Stock) shall be in cash or in the same form as the Interested Stockholder has previously paid for shares of such class of Voting Stock. If the Interested Stockholder has paid for shares of any class of Voting Stock with varying forms of consideration, the form of consideration to be received per share by holders of shares of such class of Voting Stock shall be either cash or the form used to acquire the largest number of shares of such class of Voting Stock previously acquired by the Interested Stockholder. The price determined in accordance with subparagraph B.2 of this Article EIGHTH shall be subject to appropriate adjustment in the event of any stock dividend, stock split, combination of shares or similar event.

(d) After such Interested Stockholder has become an Interested Stockholder and prior to the consummation of such Business Combination; (1) except as approved by a majority of the Disinterested Directors, there shall have been no failure to declare and pay at the regular date therefor any full quarterly dividends (whether or not cumulative) on any outstanding stock having preference over the Common Stock as to dividends or liquidation; (2) there shall have been (i) no reduction in the annual rate of dividends paid on the Common Stock (except as necessary to reflect any subdivision of the Common Stock), except as approved by a majority of the Disinterested Directors, (ii) an increase in such annual rate of dividends as necessary to reflect any reclassification (including any reverse stock split), recapitalization, reorganization or any similar transaction which has the effect of reducing the number of outstanding shares of Common Stock, unless the failure to so increase such annual rate is approved by a majority of the Disinterested Directors; and (3) neither such Interested Stockholder nor any of its Affiliates shall have become the beneficial owner of any additional shares of Voting Stock except as part of the transaction which results in such Interested Stockholder becoming an Interested Stockholder.

(e) After such Interested Stockholder has become an Interested Stockholder, such Interested Stockholder shall not have received the benefit, directly or indirectly (except proportionately as a stockholder), of any loans, advances, guarantees, pledges or other financial assistance or any tax credits or other tax advantages provided by the Corporation, whether in anticipation of or in connection with such Business Combination or otherwise.

(f) A proxy or information statement describing the proposed Business Combination and complying with the requirements of the Securities Exchange Act of 1934, as amended, and the rules and regulations thereunder (or any subsequent provisions replacing such Act, rules or regulations) shall be mailed to stockholders of the Corporation at least 30 days prior to the consummation of such Business Combination (whether or not such proxy or information statement is required to be mailed pursuant to such Act or subsequent provisions).

C. For the purposes of this Article EIGHTH:

1. A “Person” shall include an individual, a group acting in concert, a corporation, a partnership, an association, a joint venture, a pool, a joint stock company, a trust, an unincorporated organization or similar company, a syndicate or any other group formed for the purpose of acquiring, holding or disposing of securities.

2. “Interested Stockholder” shall mean any Person (other than the Corporation or any holding company or Subsidiary thereof) who or which:

(a) is the beneficial owner, directly or indirectly, of more than 10% of the voting power of the outstanding Voting Stock; or

(b) is an Affiliate of the Corporation and at any time within the

two-year period immediately prior to the date in question was the beneficial owner, directly or indirectly, of 10% or more of the voting power of the then-outstanding Voting Stock; or

(c) is an assignee of or has otherwise succeeded to any shares of Voting Stock which were at any time within the two-year period immediately prior to the date in question beneficially owned by any Interested Stockholder, if such assignment or succession shall have occurred in the course of a transaction or series of transactions not involving a public offering within the meaning of the Securities Act of 1933, as amended.

3. A Person shall be a beneficial owner of any Voting Stock:

(a) which such Person or any of its Affiliates or Associates (as hereinafter defined) beneficially owns, directly or indirectly within the meaning of Rule 13d-3 under the Securities Exchange Act of 1934, as in effect on the Filing Date; or

(b) which such Person or any of its Affiliates or Associates has (1) the right to acquire (whether such right is exercisable immediately or only after the passage of time), pursuant to any agreement, arrangement or understanding or upon the exercise of conversion rights, exchange rights, warrants or options, or otherwise, or (2) the right to vote pursuant to any agreement, arrangement or understanding (but neither such Person nor any such Affiliate or Associate shall be deemed to be the beneficial owner of any shares of Voting Stock solely by reason of a revocable proxy granted for a particular meeting of stockholders, pursuant to a public solicitation of proxies for such meeting, and with respect to which shares neither such Person nor any such Affiliate or Associate is otherwise deemed the beneficial owner); or

(c) which are beneficially owned, directly or indirectly within the meaning of Rule 13d-3 under the Securities Exchange Act of 1934, as amended, as in effect on the Filing Date, by any other Person with which such Person or any of its Affiliates or Associates has any agreement, arrangement or understanding for the purposes of acquiring, holding, voting (other than solely by reason of a revocable proxy as described in Subparagraph (b) of this Paragraph 3) or in disposing of any shares of Voting Stock;

provided, however, that, in the case of any employee stock ownership or similar plan of the Corporation or of any Subsidiary in which the beneficiaries thereof possess the right to vote any shares of Voting Stock held by such plan, no such plan nor any trustee with respect thereto (nor any Affiliate of such trustee), solely by reason of such capacity of such trustee, shall be deemed, for any purposes hereof, to beneficially own any shares of Voting Stock held under any such plan.

4. For the purpose of determining whether a Person is an Interested Stockholder pursuant to Paragraph 2 of this Section C, the number of shares of Voting Stock deemed to be outstanding shall include shares deemed owned through application of Paragraph 3 of this Section C but shall not include any other shares of Voting Stock which may be issuable pursuant to any agreement, arrangement or understanding, or upon exercise of conversion rights, warrants or options, or otherwise.

5. “Affiliate” and “Associate” shall have the respective meanings ascribed to such terms in Rule 12b-2 of the General Rules and Regulations under the Securities Exchange Act of 1934, as amended, as in effect on the Filing Date.

6. “Subsidiary” means any corporation of which a majority of any class of equity security is owned, directly or indirectly, by the Corporation; provided, however, that for the purposes of the definition of Interested Stockholder set forth in Paragraph 2 of this Section C, the term “Subsidiary” shall mean only a corporation of which a majority of each class of equity security is owned, directly or indirectly, by the Corporation.

7. “Disinterested Director” means any member of the Board of Directors who is unaffiliated with the Interested Stockholder and was a member of the Board of Directors prior to the time that the Interested Stockholder became an Interested Stockholder, and any director who is thereafter chosen to fill any vacancy on the Board of Directors or who is elected and who, in either event, is unaffiliated with the Interested Stockholder, and in connection with his or her initial assumption of office is recommended for appointment or election by a majority of Disinterested Directors then on the Board of Directors.

8. “Fair Market Value” means: (a) with respect to any class of stock, appropriately adjusted for any dividend or distribution in shares of such stock or in any combination or reclassification of outstanding shares of such stock into a smaller number of shares of such stock, the highest closing sale price of the stock during the 30-day period immediately preceding the date in question of a share of such stock on the National Association of Securities Dealers Automated Quotations (“NASDAQ”) System or any system then in use, or, if such stock is admitted to trading on a principal United States securities exchange registered under the Securities Exchange Act of 1934, as amended, Fair Market Value shall be the highest sale price reported during the 30-day period preceding the date in question, or, if no such prices are available, the Fair Market Value on the date in question of a share of such stock as determined by the Board of Directors in good faith; and (b) in the case of property other than cash or stock, the Fair Market Value of such property on the date in question as determined by the Board of Directors in good faith.

9. Reference to “Highest Per Share Price” means with respect to any class of stock, the highest price per share, appropriately adjusted for any dividend or distribution in shares of such stock or any stock split or reclassification of outstanding shares of such stock into a greater number of shares of such stock or any combination or reclassification of outstanding shares of such stock into a smaller number of shares of such stock.

10. In the event of any Business Combination in which the Corporation survives, the phrase “other consideration to be received” as used in Subparagraphs (a) and (b) of Paragraph 2 of Section B of this Article EIGHTH shall include the shares of Common Stock and/or the shares of any other class of outstanding Voting Stock retained by the holders of such shares.

D. A majority of the Disinterested Directors of the Corporation shall have the power and duty to determine for the purposes of this Article EIGHTH, on the basis of information known to them after reasonable inquiry, (1) whether a person is an Interested Stockholder; (2) the number of shares of Voting Stock beneficially owned by any person; (3) whether a person is an Affiliate or Associate of another; and (4) whether the assets which are the subject of any Business Combination have, or the consideration to be received for the issuance or transfer of securities by the Corporation or any Subsidiary in any Business Combination has an aggregate Fair Market Value equaling or exceeding 25% of the combined assets of the Corporation and its Subsidiaries. A majority of the Disinterested Directors shall have the further power to interpret all of the terms and provisions of this Article EIGHTH.

E. Nothing contained in this Article EIGHTH shall be construed to relieve any Interested Stockholder from any fiduciary obligation imposed by law.

F. Notwithstanding any other provisions of this Certificate of Incorporation or any provision of law which might otherwise permit a lesser vote or no vote, but in addition to any affirmative vote of the holders of any particular class or series of the Voting Stock required by law, this Certificate of Incorporation or any Preferred Stock Designation, the affirmative vote of the holders of at least 80% of the voting power of all of the then-outstanding shares of the Voting Stock, voting together as a single class, shall be required to alter, amend or repeal this Article EIGHTH.

NINTH : The Board of Directors of the Corporation, when evaluating any offer of another Person (as defined in Article EIGHTH hereof) to (A) make a tender or exchange offer for any equity security of the Corporation, (B) merge or consolidate the Corporation with another corporation or entity or (C) purchase or otherwise acquire all or substantially all of the properties and assets of the Corporation, may, in connection with the exercise of its judgment in determining what is in the best interest of the Corporation and its stockholders, give due consideration to all relevant factors, including, without limitation, the social and economic effect of acceptance of such offer on the Corporation’s present and future customers and employees and those of its Subsidiaries (as defined in Article EIGHTH hereof); on the communities in which the Corporation and its Subsidiaries operate or are located; on the ability of the Corporation to fulfill its corporate objectives as a financial institution holding company and on the ability of its subsidiary financial institution to fulfill the objectives of a federally insured financial institution under applicable statutes and regulations.

TENTH :

A. Except as set forth in Section B of this Article TENTH, in addition to any affirmative vote of stockholders required by law or this Certificate of Incorporation, any direct or indirect purchase or other acquisition by the Corporation of any Equity Security (as hereinafter defined) of any class from any Interested Person (as hereinafter defined) shall require the affirmative vote of the holders of at least 80% of the Voting Stock of the Corporation that is not beneficially owned (for purposes of this Article TENTH beneficial ownership shall be determined in accordance with Section C.2(b) of Article FOURTH hereof) by such Interested Person, voting together as a single class. Such affirmative vote shall be required notwithstanding the fact that no vote may be required, or that a lesser percentage may be specified, by law or by any other provisions of this Certificate of Incorporation or any Preferred Stock Designation or in any agreement with any national securities exchange or quotation system, or otherwise. Certain defined terms used in this Article TENTH are as set forth in Section C below.

B. The provisions of Section A of this Article TENTH shall not be applicable with respect to:

(1) any purchase or other acquisition of securities made as part of a tender or exchange offer by the Corporation or a Subsidiary (which term, as used in this Article TENTH, is as defined in the first clause of Section C.6 of Article EIGHTH hereof) of the Corporation to purchase securities of the same class made on the same terms to all holders of such securities and complying with the applicable requirements of the Securities Exchange Act of 1934, as amended, and the rules and regulations thereunder (or any subsequent provision replacing such Act, rules or regulations);

(2) any purchase or acquisition made pursuant to an open market purchase program approved by a majority of the Board of Directors, including a majority of the Disinterested Directors (which term, as used in this Article TENTH, is as defined in Article EIGHTH hereof); or

(3) any purchase or acquisition which is approved by a majority of the Board of Directors, including a majority of the Disinterested Directors, and which is made at no more than the Market Price (as hereinafter defined), on the date that the understanding between the Corporation and the Interested Person is reached with respect to such purchase (whether or not such purchase is made or a written agreement relating to such purchase is executed on such date), of shares of the class of Equity Security to be purchased.

C. For the purposes of this Article TENTH:

(i) The term Interested Person shall mean any Person (other than the Corporation, Subsidiaries of the Corporation, pension, profit sharing, employee stock ownership or other employee benefit plans of the Corporation and its Subsidiaries, entities organized or established by the Corporation or any of its Subsidiaries pursuant to the terms of such plans and trustees and fiduciaries with respect to any such plan acting in such capacity) that is the direct or indirect beneficial owner of 5% or more of the Voting Stock of the Corporation, and any Affiliate or Associate of any such person.

(ii) The Market Price of shares of a class of Equity Security on any day shall mean the highest sale price of shares of such class of Equity Security on such day, or, if that day is not a trading day, on the trading day immediately preceding such day, on the national securities exchange or the NASDAQ System or any other system then in use on which such class of Equity Security is traded.

(iii) The term Equity Security shall mean any security described in Section 3(a)(11) of the Securities Exchange Act of 1934, as in effect on December 31, 1991, which is traded on a national securities exchange or the NASDAQ System or any other system then in use.

(iv) For purposes of this Article TENTH, all references to the term Interested Stockholder in the definition of Disinterested Director shall be deemed to refer to the term Interested Person.

ELEVENTH :

A. Each director or officer (or former director or former officer) of the Corporation who was or is made a party or is threatened to be made a party to or is otherwise involved in any action, suit or proceeding, whether civil, criminal, administrative or investigative (hereinafter a “proceeding”), by reason of the fact that he or she is or was a director or an officer of the Corporation or is or was serving at the request of the Corporation as a director, officer, employee or agent of another corporation or of a partnership, joint venture, trust or other enterprise, including service with respect to an employee benefit plan (hereinafter an “indemnitee”), whether the basis of such proceeding is alleged action in an official capacity as a director, officer, employee or agent or in any other capacity while serving as a director, officer, employee or agent, shall be indemnified and held harmless by the Corporation to the fullest extent authorized by the Delaware General Corporation Law, as the same exists or may hereafter be amended (but, in the case of any such amendment, only to the extent that such amendment permits the Corporation to provide broader indemnification rights than such law permitted the Corporation to provide prior to such amendment), against all expense, liability and loss (including attorneys’ fees, judgments, fines, ERISA excise taxes or penalties and amounts paid in settlement) reasonably incurred or suffered by such indemnitee in connection therewith; provided , however , that, except as provided in Section C hereof with respect to proceedings to enforce rights to indemnification, the Corporation shall indemnify any such indemnitee in connection with a proceeding (or part thereof) initiated by such indemnitee only if such proceeding (or part thereof) was authorized by the Board of Directors of the Corporation.

B. The right to indemnification conferred in Section A of this Article shall include the right to be paid by the Corporation the expenses incurred in defending any such proceeding in advance of its final disposition (hereinafter an “advancement of expenses”); provided , however , that, if the Delaware General Corporation Law requires, an advancement of expenses incurred by an indemnitee in his or her capacity as a director or officer (and not in any other capacity in which service was or is rendered by such indemnitee, including, without limitation, service to an employee benefit plan) shall be made only upon delivery to the Corporation of an undertaking (hereinafter an “undertaking”), by or on behalf of such indemnitee, to repay all amounts so advanced if it shall ultimately be determined by final judicial decision from which there is no further right to appeal (hereinafter a “final adjudication”), that such indemnitee is not entitled to be indemnified for such expenses under this Section or otherwise. The rights to indemnification and to the advancement of expenses conferred in Sections A and B of this Article shall be contract rights and such rights shall continue as to an indemnitee who has ceased to be a director, officer, employee or agent and shall inure to the benefit of the indemnitee’s heirs, executors and administrators.

C. If a claim under Section A or B of this Article is not paid in full by the Corporation within sixty days after a written claim has been received by the Corporation, except in the case of a claim for an advancement of expenses, in which case the applicable period shall be twenty days, the indemnitee may at any time thereafter bring suit against the Corporation to recover the unpaid amount of the claim. If successful in whole or in part in any such suit, or in a suit brought by the Corporation to recover an advancement of expenses pursuant to the terms of an undertaking, the indemnitee shall also be entitled to be paid the expense of prosecuting or defending such suit. In (i) any suit brought by the indemnitee to enforce a right to indemnification hereunder (but not in a suit brought by the indemnitee to enforce a right to an advancement of expenses) it shall be a defense that, and (ii) in any suit by the Corporation to recover an advancement of expenses pursuant to the terms of an undertaking the Corporation shall be entitled to recover such expenses upon a final adjudication that, the indemnitee has not met any applicable standard for indemnification set forth in the Delaware General Corporation Law. Neither the failure of the Corporation (including its Board of Directors, independent legal counsel, or its stockholders) to have made a determination prior to the commencement of such suit that indemnification of the indemnitee is proper in the circumstances because the indemnitee has met the applicable standard of conduct set forth in the Delaware General Corporation Law, nor an actual determination by the Corporation (including its Board of Directors, independent legal counsel, or its stockholders) that the indemnitee has not met such applicable standard of conduct, shall create a presumption that the indemnitee has not met the applicable standard of conduct or, in the case of such a suit brought by the indemnitee, be a defense to such suit. In any suit brought by the indemnitee to enforce a right to indemnification or to an advancement of expenses hereunder, or by the Corporation to recover an advancement of expenses pursuant to the terms of an undertaking, the burden of proving that the indemnitee is not entitled to be indemnified, or to such advancement of expenses, under this Article or otherwise shall be on the Corporation.

D. The rights to indemnification and to the advancement of expenses conferred in this Article shall not be exclusive of any other right which any person may have or hereafter acquire under any statute, the Corporation’s Certificate of Incorporation, By-laws, agreement, vote of stockholders or Disinterested Directors or otherwise.

E. The Corporation may maintain insurance, at its expense, to protect itself and any director, officer, employee or agent of the Corporation or another corporation, partnership, joint venture, trust or other enterprise against any expense, liability or loss, whether or not the Corporation would have the power to indemnify such person against such expense, liability or loss under the Delaware General Corporation Law.

F. The Corporation may, to the extent authorized from time to time by the Board of Directors, grant rights to indemnification and to the advancement of expenses to the fullest extent of the provisions of this Article with respect to the indemnification and advancement of expenses of directors and officers of the Corporation to any employee or agent or former employee or agent of the Corporation or any person who is or was serving at the request of the Corporation as an employee or agent of any other corporation, partnership, joint venture, trust or other enterprise, including an employee benefit plan.

TWELFTH : A director of this Corporation shall not be personally liable to the Corporation or its stockholders for monetary damages for breach of fiduciary duty as a director, except for liability (i) for any breach of the director’s duty of loyalty to the Corporation or its stockholders, (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law, (iii) under Section 174 of the Delaware General Corporation Law,

or (iv) for any transaction from which the director derived an improper personal benefit. If the Delaware General Corporation Law is hereafter amended to further eliminate or limit, or to authorize corporate action further limiting or eliminating, the personal liability of directors, then the liability of a director of the Corporation shall be eliminated or limited to the fullest extent permitted by the Delaware General Corporation Law, as so amended.

Any repeal or modification of the foregoing paragraph by the stockholders of the Corporation shall not adversely affect any right or protection of a director of the Corporation existing at the time of such repeal or modification.

THIRTEENTH :

No amendment, addition, alteration, change or repeal of any provision of this Certificate of Incorporation shall be made, unless such is first proposed by the Board of Directors of the Corporation, upon the affirmative vote of at least two-thirds of the directors then in office at a duly constituted meeting of the Board of Directors called expressly for such purpose, and thereafter approved by the stockholders by a majority of the total votes eligible to be cast at a duly constituted meeting of stockholders called expressly for such purpose; provided , however that, notwithstanding any other provision of this Certificate of Incorporation or any provision of law which might otherwise permit a lesser vote or no vote, but in addition to any vote of the holders of any class or series of the stock of this Corporation required by law or by this Certificate of Incorporation, the affirmative vote of the holders of at least 80% of the voting power of all of the then-outstanding shares of the capital stock of the Corporation entitled to vote generally in the election of directors (after giving effect to the provisions of Article FOURTH), voting together as a single class, shall be required to amend or repeal this Article THIRTEENTH, clause C.1. of Article FOURTH, clauses (C) or (D) of Article FIFTH, Article SIXTH, Article SEVENTH, Article EIGHTH, Article NINTH, Article TENTH, Article ELEVENTH or Article TWELFTH.

FOURTEENTH : The name and mailing address of the sole incorporator are as follows:

NAME	MAILING ADDRESS

Roger P. Weise	101 N. Broadway
	Spring Valley, Minnesota 55975

EXHIBIT 31.1

CERTIFICATIONS

I, Bradley Krehbiel, certify that:

1. I have reviewed this quarterly report on Form 10-Q of HMN Financial, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.



Date: November 4, 2015	By:	/s/ Bradley Krehbiel
	Bradley Krehbiel
	President and Chief Executive Officer
	(Principal Executive Officer)

EXHIBIT 31.2

CERTIFICATIONS

I, Jon J. Eberle, certify that:

1. I have reviewed this quarterly report on Form 10-Q of HMN Financial, Inc.;

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.



Date: November 4, 2015	By:	/s/ Jon J. Eberle
	Jon J. Eberle
	Senior Vice President, Chief Financial Officer and Treasurer
	(Principal Financial Officer)

Exhibit 32

HMN FINANCIAL, INC.

CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of HMN Financial, Inc. (the "Company") on Form 10-Q for the period ending September 30, 2015 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), we, Bradley Krehbiel, President and Chief Executive Officer of HMN Financial, Inc. (the “Company”) (Principal Executive Officer of the Company), and Jon Eberle, Senior Vice President, Chief Financial Officer and Treasurer of the Company (Principal Financial Officer of the Company), certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that:

(1) The Report fully complies with the requirements of section 13(a) or 15(d) of the

Securities Exchange Act of 1934; and

(2) The information contained in the Report fairly presents, in all material respects, the

financial condition and results of operations of the Company.




Date: November 4, 2015		/s/ Bradley Krehbiel
		Bradley Krehbiel
		President and Chief Executive Officer
		(Principal Executive Officer)


		/s/ Jon Eberle
		Jon Eberle
		Senior Vice President, Chief Financial Officer and Treasurer
		(Principal Financial Officer)